13.2.3The 1998 reforms

Following the election of the Labour government in 1997, two major regulatory

changes were announced. The rst was the abandonment of the self-regulatory

system for the City of London and the re-establishment of full statutory regulation.

This was to be administered by a single regulatory authority, the Financial Services

Authority (FSA). This duly came into operation, following the passing of the neces-

sary legislation, on 1 June 1998. The FSA’s powers were conrmed by the Financial

Services and Markets Act (FSMA), which received royal assent in June 2000. However,

the process of taking over regulation from the existing regulatory authorities was

not completed until the second half of 2001. Between mid-1998 and 2001, the old

authorities had continued to act on behalf of the FSA while it built up its organisation

and its handbook of rules and guidance and developed its regulatory philosophy.

The second major change was the transfer from the Bank of England to the FSA

of responsibility for the supervision of the banking system and the wholesale money

markets. This also occurred on 1 June 1998 under the terms of the Bank of England

Act 1998. Although the Bank of England had had severe embarrassments in the 1990s

in its role as supervisor of the banking system (notably in the collapse of the BCCI

and Barings Bank), it did not lose its supervisory responsibility because of these.

It did so partially because the increasingly blurred boundaries between the different

types of nancial businesses mentioned above suggested the need to consolidate the

supervision of banking together with other nancial institutions in a single agency.

A more specic reason for the change, however, derived from the other major element

in the new Bank of England Act – the granting to the Bank of independent control of

British monetary policy. The aim was to avoid a possible conict between the monetary

policy role and the supervisory role. This possibility follows from the argument that,

where central banks are involved in bank supervision, nancial sector representatives

are strongly inclined to lobby central banks for easier monetary policy to reduce the

regulatory burden on banks. That is, the supervisory role might compromise the

monetary policy of the central bank. There is no strong evidence for this proposition,

but many aspects of the movement to independence of central banks were based

upon institutional arrangements in Germany. There, and in several other countries,

monetary policy and bank supervision were carried out by separate organisations.

Although it lost the responsibility for banking supervision, the Bank of England

retained responsibility for the stability of the nancial system as a whole. This requires

the Bank to work with the FSA. The Memorandum of Understanding, published in

October 1997, set out a framework for cooperation between the Bank and the FSA,

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