The UK’s Financial Services Authority has published a review of global banking regulation, calling for sweeping changes to supervision.

The review, which was released Wednesday, identifies three underlying causes of the crisis — macroeconomic imbalances, financial innovation that had little social value, and important deficiencies in bank capital and liquidity regulations. These were underpinned by an exaggerated faith in rational and self-correcting markets, the review finds.

Among other things, the review recommends:

> fundamental changes to bank capital and liquidity regulations;

> more and higher quality bank capital;

> counter-cyclical capital buffers;

> much tighter regulation of liquidity;

> regulation of so-called “shadow banking” activities, such as hedge funds, on the basis of economic substance not legal form;

> regulation of the credit rating agencies to limit conflicts of interest and inappropriate rating techniques;

> national and international action to ensure that remuneration policies are designed to discourage excessive risk-taking;

> major changes in the FSA’s supervisory approach to focus on business strategies and system wide risks, rather than internal processes and structures; and

> major reforms in the regulation of the European banking market, combining a new European regulatory authority and increased national powers to constrain risky cross-border activity.

Additionally, the review highlights areas where it is premature to recommend specific action, but where wide-ranging options need to be debated. These include product regulation in retail and wholesale markets.

“The financial crisis has challenged the intellectual assumptions on which previous regulatory approaches were largely built, and in particular the theory of rational and self-correcting markets. Much financial innovation has proved of little value, and market discipline of individual bank strategies has often proved ineffective,” said Lord Turner, chairman of the FSA, who carried out the review at the request of the Chancellor of the Exchequer.

“A global market economy remains the best means of delivering global prosperity: it requires a global banking system focused on serving the needs of businesses and households, not in taking risks for quick return. Major changes in regulation and in supervisory approach are required to deliver that,” Turner added.

“The approach has to build on a system-wide perspective: failure to look at the big picture was far more important to the origins of the crisis than any specific failures in supervising individual firms. And it must reflect the reality of a global financial system without a global government; we need both far more intense international cooperation and greater use of national powers” he said.

Lord Turner also warned that the transition to higher bank capital will need to be managed carefully, as the short-term priority is to keep banks lending to the real economy.

Along with the review the FSA published a discussion paper, which sets out more detail on specific policy proposals.

In response to the review, Adam Phillips, acting chairman of the UK’s Financial Services Consumer Panel, said, “Adair Turner should be congratulated for his candid assessment of what went wrong leading up to the current financial crisis. However, we are concerned that the Turner Review, for all its revealing content and excellent analysis, has not commented on the appalling way which banks have treated their customers both before and during the banking crisis.”

“The review suggests that the FSA has been biased towards conduct of business rather than prudential regulation of banks. However recent history in terms of bank charges, the selling of PPI and mortgages shows that the FSA cannot be allowed to think it has the regulation of the consumer facing side of financial services under control,” he added.

IE