New capital standards 'to reduce risk of failure'

Clive Briault, FSA Director of Prudential Standards, said:

"The purpose of the proposed framework is to reduce the likelihood that consumers will suffer loss or that markets will be disrupted as a result of the financial failure of a firm, although the possibility of failure can never be removed altogether."

"The main benefits of this proposed framework are that it meets our overall aim of reducing the probability of prudential failure, in a cost efficient way that creates greater transparency in the arrangements for setting regulatory capital levels, while at the same time promoting a strong culture of risk management."

"We have included within this paper proposals for the setting of an enhanced risk-based capital regime for insurance and for major securities firms. It also includes proposals on how we intend to meet our supervisory responsibilities under the new Basel Capital Accord."

Current minimum capital standards were developed to set adequate capital for some of the firms to which they apply, but do not capture all the risks facing all firms. In the past this has been dealt with by the setting of bespoke capital requirements, but in different ways in the various financial industry sectors. This paper proposes a more harmonised approach within which the appropriate capital levels can be determined on an individual firm basis.

The proposed framework includes two key elements: a self-assessment undertaken by firms within a framework of rules and guidance set out within the FSA Handbook; and a supervisory assessment by which a firm may be required by the FSA to hold additional capital in response to specific systems and controls related concerns.

The framework reflects the FSAs new risk-based approach to regulation, which is designed to:

• ensure that prudential standards are cost-effective and proportionate to the risks run by firms;
  

• take into account the impact on customers and markets of the failure of different types of firm; and
  

• facilitate a system within which firms can contribute to the process of determining the appropriate amount of capital for them to hold.

The single framework aims to retain sufficient flexibility to avoid the pitfalls arising from a one size fits all approach. The self-assessment process should encourage ownership by the firms senior management and provide incentives to them to identify and manage their business risks and systems and control risks. There will also be benefits to the FSA as it aligns capital standards more closely with the integrated risk assessment framework.

The framework for individual capital adequacy standards will be a key part of the FSAs regulatory regime. The FSA proposes to implement the new requirements in 2004 for insurance firms, and for other firms at a later date which will depend on progress in agreeing new international standards within the revised Basel Capital Accord and related European Union capital adequacy legislation.

Notes for editors

1. The individual capital adequacy standards (ICAS) framework is set out in Consultation Paper 136 which is available on the FSA Website www.fsa.gov.uk. Comments on the paper should reach the FSA by 31 August 2002.

2. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection of consumers; and fighting financial crime.

3. The FSA aims to maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal.