Regulator also shared investors’ hubris

MARKETS are very good at telling us there’s a problem – like ratings agencies – when it’s bleeding obvious,” FSA chair Lord Turner opined yesterday.

Unfortunately, if there is one thing the FSA’s 450-page report made obvious yesterday, that adage could just as well apply to regulators.

Determined readers of the tome were treated to a mind-numbing account of the back-and-forth between RBS and its supervisors.

The picture that emerges is one of a body constantly playing catch-up, whether it was on liquidity rules, asset values, financial engineering or the basics, like data collection.

Only with the benefit of hindsight is it clear quite how muddled regulators’ and markets’ assumptions were: using the modern rulebook RBS would have recorded a common equity tier one ratio of just 1.97 per cent in 2007 (compared to the new minimum of 9.5 per cent for large banks).

In order to illustrate the degree to which supervisors had participated in “the delusions of this time”, Turner pointed to a pre-crisis report by international regulators praising the stabilising influence of now-hated complex financial instruments that many banks had invested in.

None of this excuses the shoddy judgements made by RBS’s management. But it highlights the hubris of Britain’s regulatory overhaul, which assumes that regulators can spot bubbles and deflate them gently.

This new role for regulators is meant to come with a strengthening of market discipline, with creditors forced to take losses if a bank fails.

The danger is that amid the current debt crisis, the latter reform gets watered down, leaving us wholly in the hands of a muddled regulator. Based on yesterday’s report, that is hardly a reassuring prospect.