Does the FSA really have the answers?

It is, of course, no more than one would expect of the FSA's bosses to own up to the mistakes of the past. After all, the wreckage of the financial system lies all around us, grim witness to the total failure of a light touch regulatory system bullishly promoted here and in the USA. Also, on the very day that the European Commission made its pitch to take over regulation you would expect the FSA to come out fighting.

A more detailed consideration of what Lord Turner said yesterday does suggest that there is much more going on behind the scenes than they are being given credit for. Whether it is enough to preserve the FSA's key position in the regulatory firmament is by no means clear but it does point the way to a fundamental shift in its approach to financial regulation and, crucially, aligns it more closely with European thinking and the consumer lobby in the UK.

The commitment to embrace product regulation is a rejection of the last 25 years of financial regulation in this country. Ever since the unfettered free market regime of Margaret Thatcher in the 1980s and the battle with the European Union in the run-up to the creation of the single market in 1992, product regulation has been dismissed in this country as the great inhibitor of dynamism and growth in financial services. We won that battle in Europe and Solvency II is one of the products of that regime where all the emphasis is on capital adequacy and balance sheets, ignoring the products. The European Commission wants Solvency II fully implemented by May. Why? So that it can clear the decks for an assault on the products of financial institutions. The FSA is foreshadowing this.

Don't run away with the idea that the FSA is just looking at the high risk financial instruments of the investment banks when it talks about product regulation. The example it offered yesterday was mortgages where Lord Turner suggested that capping loan-to-value at 80% or 85% might be something the FSA should do.

The other clue as to the FSA's thinking was the promise to increase "by several times" the amount of capital that banks must hold to cover the riskier end of their trading books. This seems to be a way of separating retail and investment banking by stealth. The FSA seems to saying that if it can't move quickly - because the Prime Minister doesn't accept the case - to separate retail and investment banking, then it will do it by imposing tough capital rules that will make it attractive for some institutions to back away from investment banking. This is probably the route that Royal Bank of Scotland will go down later today.