The growing importance of risk in financial regulation



11

- The FSA then prioritises its regulatory position by “multiplying” the impact of the
problem (if it occurs) by the probability of the problem occurring.91

- Having completed these assessments, the FSA, taking into account the resources at its
disposal, will decide on its regulatory response.

Reasons for the FSA's risk based framework relate to uncertainty not only from the challenges
of regulation but an increasingly complex and global financial environment, public
expectation that the regulator would clean up the industry and by political demands for a safe
but innovative and globally competitive industry.92 It is quite implicit in any risk-based
regime with limited resources that priority will be given to the greatest risks - hence not all
risks will be addressed.93 Relating risks to its objectives also enables the FSA to establish a
boundary around its regulatory role.94 This boundary allows it to justify the exclusion or
limitation of other roles such as that of regulating for distributive goals.95

Firms remain the main focus of regulatory activity and as a result, immense attention is given
to identifying the risks-to-objectives that they might pose.96 This process involves an
assessment of the impact that a firm's failure or lapse of perspective will have on the FSA's
objectives.97 The scoring process is mainly based on balance sheet information supplied by
the firm and on this basis firms are scored into one of four categories: low, medium-low,
medium-high, high.98 Generally, low impact firms will not be subject to a full risk assessment
and will receive less intensive monitoring.99

Just as risk is used as a technology of governance in relation to firms, it is also used in relation
to consumers - in particular, to private citizen consumers of financial services.100 At first
instance, the specific statutory objective to achieve “an appropriate degree of protection for
the consumer” suggests that the regulator should take a proactive, protectionist role -
however, this statutory objective is governed by statutory principles which require the FSA to
recognise the different types of risks involved in different transactions as well as the general
principle that consumers should take responsibility for their own decisions (“caveat
emptor”).101

The FSA has identified four principal risks that consumers may face namely: prudential risk,
bad faith risk; complexity/unsuitability risk and performance risk.102 It has also made it clear
that in pursuing a risk-to-objectives approach it will not guarantee a zero-failure regime.103

91


92

93

94

95

96

97

98

99

100


101

102

103


ibid; Banking : A Regulatory Accounting and Auditing Guide (Institute of Chartered Accountants 2001) 124;
in doing this it takes into account (i) Its confidence in the information on which the risk assessment is based;
(ii) The quality of home country supervision - for overseas banks in the UK and (iii) The anticipated
direction of change in the impact and probability gradings.

J Gray and J Hamilton, Implementing Financial Regulation (2006) 29

Ibid p 30

ibid

ibid

Ibid p 31

ibid

ibid

ibid

Ibid p 47 ; Through the implementation of “consumer protection” and “public awareness” objectives, the
FSA attempts to portray citizens as proactive and risk-aware consumers who seek the opportunity to secure
their financial future through participation in financial markets and who accept responsibility for the results
of the choices they make.

ibid

Ibid p 48

Ibid : Firms will be allowed to fail with resulting consumer loss.



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