A History of Banking Regulation in the UK

    by Alistair McConnachie

    This was the first UK Act to put banking regulation on a statutory footing. Prior to 1979 there was no regulation of the sector. This was around the same time as EC Directive No 77/780 of 12 Dec 1977(1) intended to promote harmonisation in financial services.

    This Act introduced the requirement for institutions to be licensed in order to accept deposits from the public. It made no attempt to define a bank or “banking business” and its provisions were applicable only to deposit taking institutions.


    The best description in UK law is found in Case Law. In United Dominions Trust v Kirkwood(2) Lord Denning in the Court of Appeal describes what makes up a bank. In this case, Kirkwood, a garage, argued that UDT could not recover on a debt because they were neither a bank, and as unregistered money lenders, they were unable to recover due to the provisions of the Moneylenders Act 1990. Consequently, UDT sought to show that it was a bank.

    The Court of Appeal defined 3 elements for determining whether or not a person is a banker:
    1- The nature of the banking services provided.
    2- The importance of these services in relation to the business as a whole.
    3- The reputation of the institution.

    Lord Denning also found that the following were characteristics usually found in the business of banking:
    a- Accepting money from and collecting cheques for customers and placing these at the credit of the customers’ accounts.
    b- Honouring cheques or orders drawn on bankers by the customers when presented for payment, and debiting their customers’ accounts.
    c- Keeping running accounts for customers in which debits and credits were entered.

    UDT did not do these things, and it was found not to be a bank, but also found exempt from the Moneylenders Act 1990.

    The Banking Act of 1987 tightened the Bank of England’s regulatory control. The 1987 Act largely repealed and replaced the 1979 Act.

    The impetus for the 1987 Act was the crisis in the Johnson Matthey Bank in 1984 which exposed the deficiencies in the 1979 Act. While the Bank of England took over the running of Johnson Matthey under the authorisation of the Chancellor Nigel Lawson, the BoE did so with the intention of running it down carefully. It did not take it over in an attempt to keep it going as a viable business, as has been done recently with Northern Rock and others.

    As Lord Lawson has stated, maintaining Northern Rock is simply exposing the taxpayer to risk, raising issues of unfair competition and continuing a bad reputation for the UK in this field.(3)

    The 1987 Act increased the BoE’s supervisory rule significantly, including the power to vet shareholders of UK banks. There was an absolute prohibition on the accepting of deposits by a person in the course of carrying on a deposit-taking business, unless that person was an “authorised institution” in the words of the Act as per sec 67(2). Authorisation could be revoked or restricted and the Bank had powers of investigation.

    It established a Deposit Protection Scheme, for the protection of customer accounts, into which the banks paid, which was replaced in 2001 by the Financial Services Compensation Scheme. It contained provisions for the controlled use of banking names and descriptions.

    An authorised institution was required to report to the Bank if it entered into a transaction relating to any one person as a result of which it was exposed to the risk of losses in excess of 10 percent of its capital. Regulation of overseas institutions based in the UK was also included in the Act.

    The 1987 Act is now repealed as a consequence of the FSMA 2000, below. Between this Act and the next major Banking Act in 1998, there were two banking scandals.

    The Bank of Credit and Commerce International (BCCI) collapsed in 1991 as a result of fraud perpetrated by senior staff. It was a criminal laundering exercise. Following the collapse, an Inquiry was commissioned by the Bank of England under its supervisory powers, and was carried out by Lord Justice Bingham.

    The Bingham Report was published in October 1992.(4) It made a number of recommendations. These can be separated into three broad areas:
    1- The Prohibition of Opaque Financial Structures.
    2- The Detection and Prevention of Fraud.
    3- The Improvement of Information Flows to Supervisors.

    The Report states that “the most important single lesson of this debacle is that banking group structures which deny supervisors a clear view of how business is conducted should be outlawed”.

    The recommendation, therefore, was that the Bank of England should be given express power to refuse or revoke authorisation of banks where proper supervision is impossible. This is now the responsibility of the Financial Services Authority (FSA). The Report recommended that this be a statutory power. It should be noted that the main problem identified by the Bingham Report above, was the complex and opaque company structure.

    The Bank of England allowed Barings Securities to be conducted as a regulated subsidiary of Barings Bank UK. The effect of this was to allow an unrestricted flow of monies from Barings Bank to Barings Securities, which funded the derivative trading of, amongst others, Mr Nick Leeson, a trader for Barings Singapore.

    Mr Leeson’s trading on the futures market amounted to debts of around £827m. Despite these losses, action by Regulators and other banks meant that Barings derivative positions on the Exchanges in Singapore and Japan, were closed with no apparent losses to other parties.

    Through the sale of most of the assets and liabilities of the Baring Group, the interest of depositors was protected. Barings survived and depositors got their money back.

    Lord Wolff investigated(5) and his Report had 3 conclusions: Losses were a result of unauthorised and concealed trading activities within Barings Singapore; due to serious failure of control and managerial confusion within Barings; and these activities had not been detected by the external auditors, supervisors or regulators.

    This granted determination of monetary policy to the Bank of England. The Act had two objectives:
    1- to give the Bank operational responsibility for setting interest rates to meet the Government’s inflation targets, and
    2- to transfer responsibility for the supervision of deposit taking institutions from the Bank to the FSA.

    As Crerar has written, “The proposals of the Chancellor allowed the Government to retain responsibility for the goals of monetary policy to Parliament, while the Bank would be responsible for the operation of monetary policy, and be required to report to Parliament.”(6)

    According to Crerar, reasons for the transfer of supervisory functions from the Bank to the FSA included firstly, the fact that the reputation of the City continued to be undermined by scandals such as Robert Maxwell’s fraud and the collapse of BCCI and Barings Banks. The Bank’s supervisory function had been found to be severely wanting by Lord Bingham’s Report in the aftermath of BCCI, and Lord Wolff’s Report after Barings.

    Secondly, EU legislation required to be implemented and thirdly, there had already been a shift of responsibility for regulation from the Dept of Trade and Industry to the Treasury in 1992. Fourthly the pressures of globalisation necessitated a new regime.

    Section 13 of the Act established a Monetary Policy Committee within the Bank. Sec 21 transferred the Bank’s supervisory functions to the FSA – this was not a new regime, just a change of supervisors.

    That is, “regulating the acceptance of deposits in the course of a deposit taking business, the Deposit Protection Scheme, banking names and descriptions, overseas institutions with representative offices, and the gathering and disclosure of information”(7) – continued to be governed by the Banking Act 1987.

    This legislation repealed much of the 1987 Act, parts of the 1979 Act as well as the Insurance Companies Act 1982 and the previous FSA 1986.(8)

    The primary function of the Act was “to create a unified system of statutory regulation to preside over the financial services market”(9) which also now includes the regulation of both mortgages and general insurance business.

    The FSMA 2000 continues the need for persons to be authorised in order to conduct banking in the UK, in the sense of “accepting deposits”.

    A person is prohibited from carrying on a “regulated activity” as defined in sec 22 of the 2000 Act, or purporting to do so, unless ,b>authorised or exempt (the “general prohibition”) under sec 19. Breach of the “general prohibition” is a criminal offence of strict liability.

    “Authorised person” is defined in sec 31. The FSA terminates authorisation under sec 33.

    Art 5(1) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (No. 544) defines “accepting deposits” in terms of two alternative categories of activity:

    1- The first is where “money received by way of deposit is lent to others”.
    2- The second is where “any other activity of the person accepting the deposit is financed wholly, or to a material extent, out of the capital of or interest on money received by way of deposit.”

    Essentially this means that “accepting deposits” is receiving money in order to lend to others or to finance activity.

    “Deposit” is defined in Sch 2, Para 22 of the 2000 Act and the same definition is also found in Article 5(2) and 5(3) of the Regulated Activities Order above.

    In essence, a deposit is defined as a sum of money paid on the basis that it will be repaid with or without interest or premium either on demand or as agreed.

    Some commentators are saying that regulation must be returned to the Bank of England. This is to miss the point that the question is not so much “who” regulates, but “how” regulation is conducted.

    Furthermore, it is not so much a problem of complex and opaque company structures as in the pre-BCCI days, which we face today, but rather complex and opaque financial instruments which make it very difficult to work out what is going on. Consequently, calculating banks’ vulnerabilities is much harder.

    It could be argued that the discipline of the free market may be the best form of regulation. In that regard, financial institutions should be no different than any other type of company which must face the dangers involved in mismanagement.

    It could be argued that it is not the job of the FSA to get involved in monitoring or deciding which financial instruments the banking sector should purchase.

    After all, it could be said, it is a free market and private banks should be free to make the wrong decisions and suffer the consequences. For shareholders, any risk of purchasing stock in companies is simply the nature of the marketplace. It need not be the role of the FSA or the Bank of England to police these options, nor the role of the taxpayer to cover any losses.

    However, there is a problem with this “free market” analysis! It only works if the institutions are indeed allowed to fail and are not propped up by the taxpayer. Right now, we don’t have a free market. We have an unjust situation where profits are “privatised” and losses are “socialised”.

    Why should the financial industry be different in this way? Why aren’t these corporations simply allowed to go to the wall if they have mismanaged their assets – just like any other company?

    The reason, as we never tire of pointing out in Prosperity, it is because we have a privatised money supply. If we want money to keep coming into society, then these huge private corporations must be propped up by the taxpayer because – in the absence of a source of publicly-created money – they are responsible for our money supply. Without them we have no money coming into society.

    Our money supply, and the functioning of our economy, has become unhealthily dependent upon the credit created by private companies for their own profit-seeking purposes.

    We could let the free market reign if we did not depend upon a corporate-created money supply. So long as we are dependent upon these private corporations for our money supply, then the taxpayer will always be called upon, unfairly, to bail out those which are now “too big to fail”.

    Perhaps the credit crunch will lead to a return to banking basics. Financial businesspeople now talk of a return to “old fashioned banking” where banks grant loans only to clients they know and from resources already available. Others call for improved “internal regulation” instead of statutory regulation.

    Whatever happens, we won’t get to the root of the problem until we acknowledge that we have a corporate-created money supply and that a publicly-created alternative is necessary.

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    Alistair McConnachie received a First Class mark for his Law of Commercial Banking (Hons) exam at Strathclyde University in 2008.
    (1) Official Journal(OJ) L322/30.
    (2) United Dominions Trust v Kirkwood (1966) 2KB 431.
    (3)  David Hencke and Nicholas Watt, “Audit office launches inquiry into rescue”, The Guardian, 21-2-08 at p.26.
    (4)  Report of Inquiry into the Supervision of the Bank of Credit and Commerce International, (the Bingham Report) (Cm. 198)(1992).
    (5) Report of the Board of Banking Supervision Inquiry into the circumstances of the collapse of Barings, (published 18 July 1995).
    (6)  Professor Lorne D Crerar, The Law of Banking in Scotland, (Edinburgh: Tottel Publishing Ltd, 2007) at 46. This book is the main source for the material in this article.
    (7)  Ibid at 48.
    (8)  All UK statutes can be researched at www.statutelaw.gov.uk
    (9)  Crerar, op cit at 50.