The Financial Services Authority is considering imposing stricter liquidity rules on banks and building societies in order to prevent another Northern Rock-style fiasco.

Hector Sants, chief executive of the FSA, yesterday said that the regulator is considering re-writing the rulebook on the proportion of liquid assets held as well as what counts as a liquid asset, declaring that existing guidelines were not adequate.

Speaking at the Building Societies Association (BSA) annual conference in Manchester, Mr Sants confirmed that while the City watchdog has not already introduced new limits, it is now debating whether or not to introduce higher minimum liquidity levels for lenders.

Current rules state that building societies must keep at least 3.5 per cent of their total funding liability in assets which can be turned into money to lend borrowers in 8 days, although the average amount held by societies in liquid assets is 20 per cent. However Mr Sants gave warning that "a simple figure of 20 per cent does not in itself ensure that liquidity is adequate.

The head of the regulator also criticised some building societies for poor management of capital adequacy and credit risk, accusing some individual mutuals of: "excessive concentration in the buy to let market; continued acquisition of mortgage books, even when routine funding was becoming problematic; and poor understanding of the extra risk of major exposures to commercial borrowers."

He said that while the FSA's work on a new long-term liquidity policy had begun before the credit crunch, recent changes in mortgage market conditions had "caused us to accelarate our work in this area".

Before applying to the Bank of England for emergency funding last September, Northern Rock funded a large proportion of its mortgage book through the wholesale markets and consequently suffered when banks stopped lending to each other following the collapse of the US sub-prime mortgage market. Since then, mortgage lenders have been introducing tighter borrowing rules, boosting retail savings deposits and reducing exposure to the wholesale markets in order to minimise risk.

Mr Sants said: "The current regime was designed when societies held even lower levels of wholesale funding and the main objective was for them to hold a stock of assets which could quickly be turned into cash in the event of sudden retail outflows. The problem now is that ... the stock of liquidity held, in many cases, has proved less liquid than the regime envisaged."

The FSA is due to publish a consultation paper in the Autumn.

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