Northern Rock was the Financial Services Authority's perfect storm. The regulator held only eight meetings with the bank (including none at all in 2005) over 2 years. That compares with 143 meetings held with the big five banks. Northern Rock had a revolving door of FSA department heads responsible for overseeing its supervisors and was the only bank without a risk- mitigation programme. It was one of only four permitted by the FSA to go 36 months without an assessment. If there was a blunder to be committed, the FSA committed it on its dealings with Newcastle's favourite bank.

But if the regulator had got everything right, would it have prevented Northern Rock's near-demise last year when its heavy reliance on wholesale funding, combined with a shutdown in global credit markets, forced it to ask for an emergency central bank loan? Probably not.

If sharper FSA supervisors had picked up the inherent risks in the bank's dependence on wholesale loans, the regulator would have had two choices: indicate to Northern Rock's management that perhaps they should tone down their racy business model, or make rare use of its powers and force the bank to slow its rapid growth.

A raised eyebrow to management might have worked in the days when the Bank of England supervised Britain's bankers and City gentlemen dined at the same clubs. The same type of disapproval is unlikely to have worked on Northern Rock's super-confident, non-Establishment young chief executive.

Sources at the regulator admit that the second option — flex its muscles and force change at the bank — was even less likely. The sun was shining on the sector in 2005 and 2006 and there was no reason to believe that last year's credit crunch would ever occur. Even the sector's most ardent critics acknowledge that such a global liquidity freeze had never been seen before. So to tell the bank to temper its growth would have been a very unusual move. And if the FSA had done so in 2005, it may not have been soon enough to prevent Northern Rock's downfall. It would have taken more than two years for the bank to build up the kind of retail deposits needed to significantly reduce its reliance on wholesale borrowing.

The FSA is now using these powers — telling firms to change their methods rather than asking them nicely to do so. Issuing these kinds of instructions requires the regulator to make difficult decisions. Right now the FSA is being flagellated for not doing something, for failing to act on the danger signals. Acting on signals, making hard decisions and issuing tough instructions opens the regulator up to another kind of criticism, that it used its powers wrongly.

Note Hector Sants's emphasis on the fact that changes implemented in the aftermath of Northern Rock would not result in a “no-failure” regime. The FSA's chief executive appears to be issuing a warning: we will behave more aggressively than before, but do not beat us with your 20-20 hindsight. We are a financial regulator, we are not God.

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