Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

FSA Review of Northern Rock Supervision

The Financial Services Authority of the UK has published
an executive summary
of a review carried out by its internal audit division into its
supervision of Northern Rock. It has also published the recommendations
of this review as well as a high level summary of
the Supervisory Enhancement Programme that it has undertaken in
response to the Internal Audit Report.

It is possible that the executive summary is a somewhat sanitized
version of the report, but I did not find anything interesting in
it. It is always possible to criticize the original supervisory
process with the benefit of hindsight; the published summary does not
to my mind rise above this to any clear evidence of supervisory
lapses. Moreover if it is true that “the supervision of Northern
Rock was at the extreme end of the spectrum within the firms reviewed
in respect of these failings and that its supervision did not reflect
the general practice of supervision of high-impact firms at the
FSA,” then it does not make sense to embark on a major
supervisory enhancement.

The decision that in future, “High-impact firms will be a key
area of supervisory focus, regardless of probability of failure”
is also a little puzzling to me. Impact and probability of failure
should jointly guide the supervisory effort and the decision does not
make sense unless it is believed that it is not possible to make a
reliable assessment of the probability of failure.

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