Britain's financial watchdog will boost its oversight of the country's largest banks after admitting that its supervision of Northern Rock was unacceptable and failed to highlight the mortgage lender's vulnerability.
In an internal report published today, the Financial Services Authority (FSA) said its supervision of the lender, brought into public ownership last month, was insufficient and failed to follow up key issues, including the bank's business model and increased risks as market conditions deteriorated.
It also highlighted insufficient internal FSA checks over its work - blamed on a lack of continuity in heads of department and on staff turnover - and said it had inadequate resources focused on the bank.
The crisis at Northern Rock, which has borrowed £25 billion ($50 billion) from the Bank of England since last September, left the FSA facing the biggest crisis since it was set up - accused along with other regulators of failing to do enough to prevent the first run on a UK bank in over a century.
"It is clear from the thorough review carried out by the internal audit team that our supervision of Northern Rock in the period leading up to the market instability of late last summer was not carried out to a standard that is acceptable," FSA Chief Executive Hector Sants said today.
"Although whether that would have affected the outcome in this case is impossible to judge."
The watchdog said it now planned to employ a new group of supervisory specialists to review oversight of "high-impact" UK retail and investment banks, boost staff numbers and implement a minimum team size for key firms, as well as improve training.
The FSA has focused on having fewer, but better employees, but Wednesday's internal review found that poor staffing levels and the need to prioritise resources meant some fundamental elements were "squeezed out" of its oversight process.
The FSA expects to boost staff numbers by 100, taking its number of supervisors to 625 by March next year.
It said today that supervisors should review banks' business and strategic plans annually, something they failed to do for Northern Rock, but also increase the rigour of everyday supervision of the firms.
The watchdog said it would also increase its focus on liquidity, particularly for high street banks, and raise the emphasis on the competence of banks' senior management.
The FSA is already reviewing liquidity rules, having last year highlighted areas of concern including the stress-testing, or the tests carried out by banks to ensure they can survive both extreme and lengthy liquidity crises.
In the case of Northern Rock, the bank remained solvent after August's crisis but was unable to fund lending after the summer's liquidity crunch became chronic and long-lasting.