Hector Sants is preparing to go eyeball to eyeball with top City bankers to see if they are taking on too much risk – and threatening the entire financial system.

As designated head of the soon-to-be-created (but not snappily named) Prudential Regulatory Authority, Sants plans to fix bank bosses with his stare as he takes charge of “promoting the safety and soundness of regulated firms”.

He said: “The style of the regulation will benefit from that focus. This a key message. The senior executives of the PRA will be intimately involved in the supervisory decisions.”

Calibre

But he insists: “Individuals can be found who recognise the rewarding nature of the role in the wider sense and are attracted to the concept of public service.”

He set out his plans for the PRA to a packed conference room in Westminster on Thursday. A five-stage assessment is to be introduced in what will be known as a PIF (Proactive Intervention Framework). Firms ranked one will be regarded as facing a “low risk” to their viability. Five will mean “winding-up under way”. Banks will know how they are ranked and the PRA has not ruled out making a firm’s ranking public.

Out goes the “principles-based” style of regulation – of trusting firms to manage their affairs, an ethos that Sants himself had endorsed until the crisis. In its place comes “judgment-based supervision”, under which regulators will be expected to think for themselves.

Bonus payments and dividends will be assessed to ensure they do not pose a “risk to the safety of the financial system”, while banks will be required to publish regulatory returns, and Sants also wants more uniformity about the way banks value their riskiest assets.

Sants is adamant that the FSA has no powers to publish reports but understands the clamour for an explanation. “Whenever you have events of a cataclysmic nature [like RBS] … it’s right that there is a public account of it.”

While the FSA conducted a painful audit of its regulation of Northern Rock after the bank was nationalised, Sants believes comparisons with RBS are misplaced. “The important question is why did RBS fail and what was management’s role in that event – the FSA is not set up to answer [this] in a public fashion,” he said.

Debacle

Sants stresses that before the banking crisis, there was a widespread belief that “market discipline” would in itself be enough to ensure financial stability.

“It is that central premise which has been shown to be at fault,” he said.

As PRA chief, he will have just one objective – financial stability – unlike as chief executive of the FSA, which had myriad goals. For Sants it was much more about managing an organisation of 4,200 people than being a hands-on supervisor. “The PRA objective is one of focus … that contrasts starkly with the FSA,” he said.

Sants, who commutes from his family home in Oxford to Canary Wharf, is not keen to elaborate on why he had a sudden change of heart a year ago when he resigned as FSA boss, only to agree to take on the PRA job a few weeks later.

The U-turn, announced triumphantly by George Osborne last year, has allowed Sants to learn the lessons of previous crises – some, such as BCCI and Barings, that were handled by the Bank of England, and more recent ones that took place on the FSA’s watch: “We’ve tried to absorb all the lessons.”

Starkly, Sants believes the FSA did not have adequate standards for capital and liquidity. “If we had had effective capital, liquidity and leverage standards in place in 2005 then history would have been different,” he said. Sants also cites the FSA’s assumption that the judgment of banks’ senior management should not be questioned.

He feels the FSA was not understood. “One of the major problems of the FSA is that it didn’t have consensus support for its purpose and its approach. It tried to explain it, but people were not persuaded,” he said. “It is really important that the PRA clearly delivers the message that failure is an acceptable part of an innovative system as long as those occur without significant impact on the system as the whole.”

He wants the PRA to be judged on how it handles the failure of banks – and how it explains this to taxpayers. “Where failure has occurred, it would not have come as a material cost to the system as a whole. Regulators are not superhuman. Nobody gets everything right all the time – a message that some people don’t want to hear.”

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