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Banks should seize on the row over the sale of complex financial instruments to small businesses to reform their relationship with customers and link staff pay to customer service, according to the outgoing head of the Financial Services Authority.
Speaking on his last day in the Canary Wharf head office of the FSA, Hector Sants said there was a "commercial opportunity" for financial firms to improve their treatment of customers. The regulator is examining the sale of interest rate swaps to small businesses before interest rate were cut to historic lows three years ago, leading to complaints from customers.
MPs will debate the topic on Thursday while the FSA will make a formal report on its preliminary analysis by the end of the month. Sants refused to elaborate but urged banks to avoid any re-run of the payment protection insurance mis-selling scandal, which is costing the industry an estimated £9bn after resisting for years to admit any wrongdoing.
"It's clearly an opportunity for banks to respond positively, pro-actively and with the right attitude and get on and do something about it," said Sants. "There is an opportunity to demonstrate a new approach".
In his last interview at the helm of the FSA, which will be disbanded next year, Sants also raised the possibility of changes to the way big US banks with operations in the City are regulated. The $2bn trading loss of the "London whale" - the nickname of JP Morgan trader Bruno Iksil – took place inside a branch of the US bank and is therefore overseen by US regulators whereas a subsidiary would be overseen by UK regulators. Sants said it was being considered whether branches needed to be subsidiaries.
After five years as chief executive, during which he has faced criticism for his handling of Royal Bank of Scotland and HBOS, Sants admitted that he should have moved quicker to push through cultural change at the FSA. But the 56 year old – who hopes to get another senior job next year – defended his tenure as chief executive at the FSA, which began three months before the first bank run in living memory, when queues formed outside Northern Rock branches in 2008.
The rules at the time meant that banks went into the crisis with too little capital without enough liquid instruments. "It's like leaking boats going into a storm. If your boat is full of holes you're in trouble," said Sants.
A banker for almost 30 years before he joined the FSA in 2004 to head its wholesale division, Sants said the profitability of investment banks will fall in the coming years as they are forced to amass more capital against their trading books by an international deadline of 2019 to implement what are known as the Basel III rules.
"It will bring down bonuses," he said, adding that the moves in Europe to cap bonuses so that they cannot exceed salaries could backfire. "Careful reflection suggests [the EU proposal] could be quite dangerous in driving up the fixed cost base when firms can ill afford it," said Sants.
While he took issue with the phrase "bonus culture", Sants defended the need for investment banks to pay bonuses.
"Variable compensation is a perfectly reasonable model. If you have entirely fixed costs the only way you can reduce costs is by losing people," said Sants.
But, he said that he hoped the Financial Conduct Authority, one of the bodies being spun out of the FSA, would look at linking consumer service to pay. "We need to work with industry to give more thought to how customer treatment is reflected in the compensation culture," said Sants.
He was to have headed the other regulator being split out of the FSA – the Prudential Regulation Authority – and become a deputy governor of the Bank of England if he had not suddenly announced his resignation in March. Sants recently told the BBC that he felt the run on Northern Rock could have been stopped if a guarantee had been provided to a potential buyer. He has insisted the regulator could not have stopped Royal Bank of Scotland buying ABN Amro in 2007 that eventually led to its taxpayer bailout. And Sants said he could not comment on the handling of HBOS – whose Bank of Scotland arm was accused of "very serious misconduct" by the FSA in March – because of on-going enforcement cases.
The proposals by the independent commission on banking chaired by Sir John Vickers are intended to avoid another taxpayer bailout of the kind handed to RBS and Lloyds. Sants said he was "broadly supportive" of changes but warned of the challenges in executing them – including ringfencing high street banking – given the regulatory changes being discussed in Europe to tackle the banking crisis, such as a centralised regulator.
He had not initially been a supporter of the plan to break up the FSA but stressed that what really mattered was the judgement of individuals rather than regulatory structure.
"All regulatory structure carries risk … judgement is even more important," said Sants.
