Tougher standards for banks to avoid Northern Rock repeat
The Financial Services Authority (FSA), the City’s watchdog, is calling on banks to take a ‘belt and braces approach’ to ensure they have enough cash to cover all demands and assets that can be transferred into cash quickly.
The FSA wants to prevent a repeat of the money market turmoil that crippled Northern Rock and therefore, the regulator has launched a review of liquidity risk for all banks and building societies but said the application of existing high-level standards needs to be toughened.
The FSA said a further consultation will be carried out next summer after it comes up with firm proposals to deal with the problems identified.
Thomas Huertas of the FSA explained how the ‘belt and braces’ system would work. The ‘belt’ is a comprehensive view of all the demands for funds that a bank could face as well as a plan to meet those demands. He continued that the ‘braces’ are a quantity of cash or assets that can be turned into cash at short notice even under stressed market conditions.
The credit crunch struck financial markets in the summer and Newcastle-based Northern Rock ran into problems when it could no longer fund its business.
The majority of banks depend on savers’ deposits to fund a large portion of their lending, however, Northern Rock’s business model saw it borrow more heavily in order to lend money to clients.