UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 767-iiHouse of COMMONSMINUTES OF EVIDENCETAKEN BEFORETREASURY COMMITTEE
BANKING CRISIS: REGULATION AND SUPERVISION
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This is an uncorrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.
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Transcribed by the Official Shorthand Writers to the Houses of Parliament: W B Gurney & Sons LLP, Hope House, Telephone Number: 020 7233 1935
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Oral Evidence
Taken before the Treasury Committee
on
Members present
Mr John McFall, in the Chair
Nick Ainger
Mr Graham Brady
Jim Cousins
Mr Michael Fallon
Ms Sally Keeble
Mr Andrew Love
Mr Mark Todd
John Thurso
Mr Andrew Tyrie
Sir Peter Viggers
________________
Witnesses: Mr Mervyn King, Governor, Mr Andrew Haldane, Executive Director, Financial Stability, Mr Andrew Bailey, Executive Director, Banking, and Chief Cashier, and Mr Charlie Bean, Deputy Governor for Monetary Policy, Bank of England, gave evidence.
Q106 Chairman: Governor, welcome back to this evidence session on the Banking Crisis: Regulation and Supervision. Your Mansion House speech last week made headlines.
Mr King: Would you like me to introduce my colleagues?
Q107 Chairman: I am sorry; we thought we saw you before.
Mr King: We made some substitutions at half time! To shore up the defence I have brought along Mr Bailey, who is the Executive Director for Banking, and Mr Haldane, who is the Executive Director for Financial Stability, and on my left remains from the previous session Charlie Bean, Deputy Governor for Monetary Policy.
Q108 Chairman: Good. Governor, in your opening statement of the Inflation Report, you said, "If ever there was a time when countries need to work together to sort out the problems of the International Monetary System, this is it." What system would you like to see? Would it be all exchange rates freely floating or a managed exchange rate system?
Mr King: I do not have a simple answer to put to the committee, but I do think the system has to be one where there is recognition that there are obligations on certain major countries that their domestic policy needs to take into account what is happening in the rest of the world, and the reason why I think this is the time to do it is that, now that the surplus countries, who very often have tended just to blame the deficit countries for racking up more debt, realise that they have a great deal at stake in the deficit countries not getting into deep trouble and, indeed, you simply cannot rely on the previous set of deficit countries expanding domestic demand, they will need to reign in domestic demand for a period. So this is something where it is not a zero sum game; we are all better off if we work together. I think that this was an observation that was made at the time of the Bretton Woods discussions in 1944, and the US and the UK both had proposals for dealing with it which, essentially, did put obligations on countries not to run too large surpluses or too large deficits, and I suspect that we will need to think quite deeply about the need to go back to something like that. Otherwise, I think we will see a repetition of the problems we have had.
Q109 Chairman: Yes, but Bretton Woods, Governor, did not work, did it?
Mr King: No, but that is because there were not any symmetric obligations on the surplus and deficit countries.
Q110 Chairman: If we were to propose the rules.
Mr King: It has to be an agreement that we would subscribe to a set of rules determined within, and enforced by, the IMF. If that is unrealistic and countries are not willing to sign up to that, then, I am afraid, we are doomed to repetitions of the problems that we have seen in which there will be, from time to time, quite significant crises in the world economy, precisely because the positions of the surplus and deficit countries are not co-ordinated, and the problems that result from that in financial markets lead to substantial recessions.
Q111 Chairman: The magnitude of sorting out the International Monetary System is enormous, is it not?
Mr King: It is an enormous task, but the prize is also enormous. The ultimate cause of what we have been through in the last two years was the imbalances of the world economy and the inability to cope with the resulting capital flows, and I do not think it is a question simply of exchange rates, and it certainly is not a question of which currency we denominate trade flows in, it is much deeper-seated than that. It is about ensuring that the policy frameworks of countries fit together, and at present, if you have countries which on the one hand believe in domestic monetary frameworks and floating exchange rates and other countries that believe in development strategies in which a large current account surplus is a key part of that strategy, these things will not fit together well.
Q112 Chairman: Following the Mansion House speech, there were some colourful headlines in the Sunday newspapers like "Darling vs King: Blood on the Tablecloth", and the "Punch and Judy show" of the Mansion House dinner. Is your working relationship beyond repair, as the Sunday newspapers would indicate, or are they just making a mountain out of a molehill?
Mr King: I certainly do not see any relationship between the headlines in the newspapers and the reality. I have a good working relationship with Alistair Darling. That is almost as true now as it was before. We talk often to each other and there is no problem with that working relationship whatsoever.
Q113 Chairman: In recent testimony to Congress, the Brookings
Institute suggested there may be a need for a regulator of systemically
important financial institutions. Do you
think the
Mr King: I do not know, and I think we are long way from having a clear definition of what systemically important actually means. What we really need now is a period of reflection and debate about what are the substantive problems in the financial sector. One of the things that I said last week, and the Chancellor said, is, "Let us talk about the substance, not who does what." What is the "what" in who does what? We are a long way, I think, from deciding that. The question of "too big to fail" is a very important issue. It is much too important to sweep under the carpet and say, "Oh, no, it is too difficult, we cannot do it." There are many different approaches to it. I outlined three last week. Paul Volcker gave a speech less than two weeks ago. He is a member of the Obama administration, a former Chairman of the Fed, highly respected. Let me tell you what he said on this, because I think you cannot put it better. He said, "Deposit insurance from central bank liquidity facilities are properly confined to deposit-taking institutions. In my view, it is unwarranted that those same institutions, funded in substantial part by taxpayer protected deposits, be engaged in substantial risk-prone propriety trading and speculative activities that may also raise questions of virtually unmanageable conflicts of interest." Martin Wolf this morning in the FT also made a similar point. I think that those are two highly respected commentators, and it is not just me; others also say that this issue needs to be faced up to. As to the answer to it, as I said last week, there are three different approaches. You could have one of them or all three in different combinations. One is to have legal barriers to the range of activities that deposit insurance applies to, the other is to impose separate capital requirements, higher capital requirements on banks that take part in these risky activities, and a third, and one on which I put a great deal of weight, and I believe the Chancellor does too given that he mentioned it in his Mansion House speech, is the importance of ensuring arrangements for large and complex banks to be wound down. You cannot have a bank where we simply throw up our hands and say, actually, it is too big to fail; that is the reality; we have to accept it. You cannot accept it. Martin Wolf said, "Either at it must be possible to close an institution like that down or it has to be run in a different way. It is as simple and brutal as that," and we need to face up to that. Those are some of the big challenges we need to look at.
Q114 Chairman: We had the pleasure of meeting Paul Volcker in
Mr King: Absolutely. Hedge funds is not the central issue of regulation. Information, yes, maybe in a few exceptional cases we need to impose capital requirements, but the big issue is about the banking sector. We have time to do it. This is not something we need to sort out in the next few days. We can take time, and if you want to come back to us in the autumn I would welcome that.
Q115 Chairman: Okay, fine, but in a way it seems a bit depressing, because it looks like business as usual. When Lord Turner was before the committee yesterday he was talking about aggressive hiring by investment banks and bonuses, and we look at the remuneration package that Stephen Hester got with Royal Bank of Scotland, and when we had one of the remuneration consultants before the committee well over a year ago, Carol Arrowsmith, I think, it was, of Deloitte Touche, we said, "What is the basic remuneration package?", and she said, "Roughly about a million pounds per salary." She had options five to six times their basic salary; bonus two to three times. That is exactly Stephen Hester's, and it seems a bit depressing from this angle: the UKFI in charge of the taxpayers' interests and that type of bonus system being implemented for maybe unambitious targets at the end of the day when the share prices get up to 70 pence. So it seems to me, anyway, that the lessons have been lost pretty quickly and we are back at business as usual. Do you share that dismal view?
Mr King: I certainly share the concerns that you express about that. I am disappointed that it seems to have not yet sunk in that we made a change in the way in which these things are structured, but maybe it will come.
Q116 Chairman: Okay. Hope springs eternal.
Mr King: Hope, in the Bank of England, always springs eternal. Cautious, moderate hope, but hope nevertheless.
Chairman: Okay; thank you, Governor.
Q117 Mr Fallon: Governor, in answer to the question just now about who does what, you said the "what" was more important than the "who", but that was not quite what you said in your speech last week. You painted a rather pitiful picture of a neglected clergyman who was conducting weddings and burials but nobody was turning up for the sermon, or listening to the sermon. So the "who" does matter to you, does it not? You are saying the voice is not quite enough.
Mr King: No, what I said was (and it is a point which I made to this committee in February, so it was not a new point) what matters is that powers and responsibilities must be aligned. We were given a statutory responsibility for financial stability in the Banking Act, and the question I put to you in February at this committee, to which I have not really received any adequate answer from anywhere, was: what exactly is it that people expect the Bank of England to do? All we can do at present, before a bank is deemed by the FSA to have failed, is to write our financial stability report and give speeches. They are important. We have our next financial stability report coming out on Friday. These are important things, but, in the end, I do not believe that people change their behaviour simply because we publish reports. That is fine by me, I am very happy with that position - if you want us just to publish reports, I am very content with it - but I do want it to be absolutely crystal clear before Parliament that you in Parliament understand that the Bank of England can do no more than publish reports or make speeches. If you are content with that, that is fine by me. What you cannot do is turn round afterwards and say, "But you had the statutory responsibility. Why did you not do something?", when there is nothing that we can actually do. All I am saying is just align carefully the powers and responsibilities, but, believe me, I have got more than enough work on my plate at present; I am not looking for a whole lot more.
Q118 Mr Fallon: You said last week, "It is not entirely clear how the Bank will be able to discharge even its new statutory responsibility if we can do no more than issue sermons or organise burials." So, clearly, there is actually an extra power out there that you would like to have.
Mr King: I am not forming any judgment about what powers the Bank of England should have at all. What I said last week is that what we need now is a debate about what powers somebody should have. Let us sort that out first and then, once we have sorted that out, we can allocate it; but when we have allocated powers and responsibilities, it is absolutely crucial (and I think Lord Turner made this point you yesterday) that, however they are allocated, powers and responsibilities have to be aligned. At present I do not see a clear alignment for the Bank.
Q119 Mr Fallon: It is a mess, is it not? We have had the confusion of the tripartite when Rock started. We are two years on now. We read every day the Bank is at loggerheads with the Treasury, the FSA is feuding with the Bank, and whatever. Is not the real answer here to cut through all this and give you proper responsibility for the big systemic institutions?
Mr King: I do not want to say what the Bank of England should be doing, I want to make up my mind about that once we have worked out what it is that needs to be done to improve the regulatory system. Let us work out what we have to do first and then work out who should do it.
Q120 Mr Fallon: Would you object if that power was given to you?
Mr King: That is a hypothetical question. I think we should wait. What I have said is that what I do not want to end up in is a position where the powers and responsibilities are not aligned. There are many configurations where powers and responsibilities could be aligned, with more or less responsibilities for the Bank; what matters most is that they have to be aligned. I do not want to argue for anything, I have never engaged in a turf battle and I have no intention of doing so. You in Parliament have to decide who does what, and I am very content to accept whatever you end up deciding.
Q121 Mr Fallon: You agree that that the powers and responsibilities are not aligned at the moment.
Mr King: Correct.
Q122 Mr Fallon: That is the point you are making.
Mr King: Yes.
Q123 Mr Fallon: It is a mess, it needs thinking about but it needs sorting out.
Mr King: Yes.
Q124 Mr Brady: Briefly, Governor, what you have said this afternoon is very much the same as the exchange we had in February, as you said, but, clearly, the powers and responsibilities were not aligned then; they are not now. You at that point were saying, "It is not for me to say where they should be." You are now repeating that. Are you not concerned that, unless you are prepared to set out how you see this being properly configured, there is a danger that in another few months you will still think they are not aligned properly?
Mr King: They are not aligned now and I would like Parliament to reflect on that fact, but you have to decide how these things should be aligned and I have no intention whatsoever of engaging in a bidding war. As I have said, I am very content to accept whatever allocation of responsibilities Parliament gives the Bank, provided that those powers and responsibilities are aligned.
Q125 Mr Brady: Governor, I am not saying you are engaging in a bidding war or a turf war, and, yes, it is for Parliament to decide, not for the Bank of England, but is it not reasonable for us to ask your views about how that alignment could best be effected before we arrive at that decision?
Mr King: It is, and my answer is that we have to work out what regulation we want to have, and I do not think we are in that position now. We have not solved the "too big to fail" problem or worked out how to handle it, we have not sorted out what the macro-prudential policy instrument or instruments, in the plural, would be and I think it is impossible to give a sensible answer to the question of who does what. I think we have got to solve that problem first. I do not think there is any immediate rush to do that. There is a lot of things that need to be thought through before we can decide what are the set of regulatory instruments that need to be available to the authorities, and only then, I think, is it sensible to ask how that should be allocated among the various players.
Q126 Mr Brady: So once we have decided what the regulatory instrument should be, you will give us your view.
Mr King: Absolutely, and we are thinking very hard ourselves about what those regulatory instruments should be, and we are very happy that we can start today and we can carry on in the future.
Q127 Ms Keeble: I wanted ask about a similar thing. Obviously, whilst it might be up to us to decide, we need some input from yourself. In terms of the possible instruments, what is your thinking about those? Would you want to comment on the range of issues that were put up yesterday in terms of the instruments; not in terms of who does what, but in terms of the instruments?
Mr King: If we take the macro-prudential instruments as one set
(and we will come on to the others in a minute), obviously making capital
requirements a function - not just a fixed number like 8%, but a function
of the size of an institution, its complexity, should it be a function of the
gross of the financial sector or a gross of the individual institution - I
think needs to be thought through. I
think one of the interesting aspects of the debate that we in the Bank put
weight on, that seems to have disappeared from the British debate but actually
has been at the centre of the American debate, is that here you would get the
impression that macro-prudential is all about having a means of ensuring that
the growth rate of credit or the banking centre is not too rapid. It is the time series aspect. In the
Q128 Ms Keeble: Looking also at the structure that Adair Turner set out yesterday, I know you do not want to talk about structures, but it does seem to provide a way in which the different areas of expertise can be brought together to consider the kind of issues that you have discussed. Would you accept that as a starting point for discussion of a model?
Mr King: I do not think it is the right starting point, no. It may be the right ending point, but it certainly is not the right starting point. The right starting point is to say, "What is it we want to do with the regulation of banks?", work out what the instruments are and then say, "Given that these are the instruments, what is the right decision-making process to think of to implement them?" I have no idea where we will end up on that. All I would say is this. If creating committees were the answer to our problems, we would not have any.
Q129 Ms Keeble: I understand that.
Mr King: It cannot be the right starting point just to say, "Let us create another committee." It may be a sensible answer, I certainly do not rule it out, but what I want to do is to discuss the substance of regulation, not who does what.
Chairman: Okay; thank you for that.
Q130 Sir Peter Viggers: Whilst we individually may think we are all a bit of a whiz in helping to design financial structures, you are the experts at the Bank of England, with respect, and we need more clues. If you are suggesting that we need to spell out the powers and responsibilities, we need to know what the tools are that need to be in the tool box, and then we can, perhaps, in our own way, try to contribute to the dialogue about how the tool box can be designed and the tools can be allocated. For instance, I have submitted for a long time that one should divide regulation, which I regard as box-ticking and the job of the FSA, from supervision, which I think is an overall structural approach, which I think the Bank of England should supply. How do you propose to proceed? Will you make further speeches pointing the way ahead?
Mr King: I think, through our report and speeches and, I hope, evidence to this committee, we will put ideas about what the tool kit should look like into the public debate, but I think it is for others to take the lead in the debate on who does what. Again, I do not want to get into that territory, but we do want to play our part and, I am afraid, I do not have a well-designed tool kit today in my pocket to bring out and say, "This is what the tool kit should look like." We have thoughts, we have ideas, but there is a lot of work to be done and we are doing this, obviously, in conjunction with many of our central bank colleagues abroad, through the Financial Stability Board, and so on.
Q131 Sir Peter Viggers: You gave us a helpful and rather complicated note towards a macro-prudential instrument and it points out that a well-designed macro-prudential instrument exercises control over the liabilities and the assets of financial institutions. It is a complicated point. Would you like to expand on that?
Mr King: Let me ask Andy Haldane, who edits and manages our financial stability review, to come in here.
Mr Haldane: I think in the note we sent to you, which I hope you found helpful, we aim to set out the spectrum of instruments that could potentially be used to influence institutions' credit decisions. Looking through history, some of those instruments operated on the liability side of the balance sheet, so a capital ratio would be one example of that, a time-bearing cyclical capital ratio would be one means that the Governor mentioned of exercising some degree of control over banks' lending decisions. Equally, you think of instruments that acted more directly on the asset side of the balance sheet. For example, loan-to-value ratio caps, loan-to-income ratio caps would act more directly on the loan decisions on the asset side. So, I think, in the note we sent you, what we were aiming to do is not at this stage to plum for one or other, but to set out, as the Governor said, the menu of options that could be available to bear upon accurate loan decisions.
Q132 Mr Love: Can I ask you, Governor, about some of the specifics
that Lord Turner in his review, and indeed in speeches, has been suggesting to
see what your response is? For example,
in a speech he made in
Mr King: I think very positive, but, as I say, there is an awful lot of work to do to translate the concept into a practical instrument where you could actually explain clearly to the banks, who would be on the receiving end of this, exactly what it would mean and, then, when you could decide who would actually implement it. This is an idea that has been around for some while, and we certainly have pushed very strongly for this in the international debate too.
Q133 Mr Love: Let me be clear on the principle. You think judgment has a role but there needs to be some specific econometric data?
Mr King: No, I think there has to be a role for, as you put it, judgment, not least because, as I said, one of the things that ought to matter here is not just looking at the rate of growth of the financial sector but also at the risks that are created to the system as a whole from the interconnectedness, and that is a question of judgment. There are other policy instruments in the tool kit that could be brought into play. One of the reasons why, in the Bank, we have been pressing strongly, as have the Americans, for pulling greater weight on central clearing of many derivative type transactions is that this would help to reduce the interconnectedness, in effect, among the banking sector and, therefore, reduce some of the risk. So there are elements of the infrastructure that can play an important role in reducing the degree of risk in the financial sector, hence reducing the reliance on variable capital requirements as part of the policy tool kit. I think this is why, deep down, it may not be easy to identify a single policy instrument which you can say is the macro-prudential instrument. I suspect it will be a range of instruments in the tool kit and their use will depend on many of the other reforms that we would like to see.
Q134 Mr Love: Taking that point, Lord Turner seems to be attracted by the Canadian example of a gross leverage ratio as a backstop, not as a safeguard, a safety net. Do you have any thoughts on that?
Mr King: Yes, I am all in favour of a leverage ratio. I think the Swiss, in particular, found, with a large banking sector, that this was a sensible way to go, and I think one of the big lessons from this is how ineffective, in many ways, the risk adjustments to the Basel ratios were. A vast amount of effort, untold expenses and manpower went into designing these regulations, and in normal times the calculations, I am sure, were much more sophisticated than before, but in normal times it did not matter a great deal. When it really mattered, then the models that were used to estimate the risk were pretty worthless. So this was a very good example, I think, where you need to be careful not to be so complicated and sophisticated and actually miss the big picture, and I think leverage ratios clearly have a role to play there.
Q135 Mr Love: Finally, you mentioned about Basel II not recognising the crisis that was going to hit us, but almost everyone says the next crisis will not be the same as this crisis. To what extent can we try to look forward to what may be the next crisis and what we are doing in terms of regulation?
Mr King: It is very difficult, but I think that is why identifying certain clear principles, rather than pretending that some kind of minor massaging will work, is important, and I think that focusing on the "too big to fail" issue, the size and complexity which our banking system has reached, is a very important part of it, and if you want to reduce the likely frequency and severity of future crises, it is almost impossible to avoid dealing with that issue.
Q136 John Thurso: Can I follow on from that question of size and complexity and return to a discussion we have had before about narrow banks and Glass-Steagall, and so on. Would it be right to say, having listened to the answers that you gave the Chairman, that an overriding objective for all of us should be to find ways to suppress the interconnectivity and reduce the risk of that by one of the three means that you put forward?
Mr King: Yes, I think that is certainly one of the things that I would put enormous weight on. It is not the end of the list; there are many other things. In our Financial Stability Report on Friday we will try to draw attention to some of the areas where attention needs to be focused, but I myself do believe that tackling this issue head on and finding a way of dealing with it is absolutely crucial, because the enormous expansion of risk-taking through proprietary trading activities in institutions which were in receipt of taxpayer financed insurance, using retail deposits to fund a good chunk of that activity, is asking for trouble. I am not saying there is an easy way of handling it - there is not - but I do not know anyone who does not actually think this is an issue that needs to be tackled. There may be some differences of view and emphasis on the right approach to it, but I think everyone recognises that this needs to be tackled one way or another.
Q137 John Thurso: Talking to us yesterday, Lord Turner did not reject out of hand but reiterated his view that the kind of straightforward old-fashioned Glass-Steagall was not the way and that he preferred to go down route of what he would describe in shorthand, I think, as a capital tax. It seems to me that there are lots of things that happen in a big bank, but there are two. At each end there is a function. At one end there is the money utility, which basically ought to be low-risk and receives, in return, a high protection, and at the other end there is an equally valuable role, which is in the kind of capital entrepreneur, the slightly old-fashioned merchant banking. Do you think that those two activities can sit culturally in the same organisation without importing the worst of each culture into the other?
Mr King: I do not know. I do not claim to be an expert on the cultures of banking, but what I do know is that if you put into the same institution, on the same balance sheet, very risky activities which are financed by, basically, retained deposits which have an implicit state guarantee, then you are going to encourage a lot more risk taking, and that is not a question of culture, it is a question of incentives, and I think that is the most important thing that we need to look at. I do not think the differences in approach here are perhaps as big as have been portrayed. After all, the approach which Lord Turner suggested is one that we had talked about and the Americans have talked about. It is not in the Turner Report, but he has come round to advocating it, I think. It is based on the idea of using capital requirements to make it more expensive to combine these activities. That is only a matter of degree different from saying, if you make it expensive enough, you might as well prohibit it. So it depends on the size of the tax. That, in the limit, is the same as prohibiting it, and if there are difficulties in defining the activities on which to base a prohibition, there are also going to be difficulties in defining activities on which to calculate the tax base. So I do not think these things are quite as different, and I do not have strong views about which way we should go at all, but what I do think is that we should not rule any of these things out at this stage; we should discuss it, debate it, learn from people with experience, talk to them and say, "What is the right way forward?", and let us have a debate and see if we can design a financial system which is somewhat less prone to crises in terms of their severity and frequency. We will never get rid of the national crises - a bank is inherently a dangerous institution that will generate crises from time to time - but what we ought to be really concerned about is that the impact of these crises and their frequency is not diminishing over time. We get used to the idea that aeroplane crashes are less frequent and that we make passenger transport more safe over time. In the financial sector it seems to be the other way round, and that is why we cannot, I think, just put the issue to one side and say practical people who understand the world know there is nothing you can do about it. That is a council of despair, and we cannot afford a council of despair given the damage that has been wreaked on the rest of the economy by the problems in the financial sector.
Q138 John Thurso: One last question on this. Do you think there might be a role for looking at the licensing system such that each brand has to have its own licence rather than having one licence for a group of brands, noting that some elements of RBS which were separately licensed actually were perfectly strong and could have been hived off at any time, but extending that across from not only retail to the other side, so that a large bank was an agglomeration of separate licenses for separate activities, so that bits of it could die and be plucked off and pruned without bringing the whole thing down?
Mr King: I am not sure about the licenses. That may be right, but I certainly think that the complexity of banks has reached a point where institutions that seem to people, in life, to be one business entity when problems occur, in death, turn out to be a very large number of separate entities.
Q139 John Thurso: It is about legally defining that in advance and making it transparent?
Mr King: I think allowing banks to have become so complex with so many different entities of the same umbrella organisation, many of which are off-shore, is a recipe for creating an institution that nobody can wind down remotely easily and, given how important they are, it is very important that we can wind them down. That is the answer to it, I think, in large part. So I do put some weight here on the resolution issues, and I know the Chancellor is very keen to push this forward at the G20 and to see whether we cannot work with our international colleagues to do more here, but I do not think we can say that if they do not do anything we should abandon it. It is too important to simply say without international agreement we can do nothing. We cannot afford to do that. We have got to take action ourselves irrespective of whether others do or not, and that is clearly the approach of the Americans.
Q140 John Thurso: And possibly take the consequence that some
institutions may choose no longer to be domiciled in
Mr King: Indeed.
Q141 John Thurso: Because, as you rightly put it, what lives internationally dies nationally.
Mr King: Yes
Q142 Mr Tyrie: Do you think that reform of corporate governance has anything to offer to try and sort out financial crises of the types we have seen?
Mr King: I do not know. It may do, and I am sure that there can always be improvement in any form of governance, including corporate governance, so I do not think it is a wasted effort to do it, but I think the idea that somehow non-executive directors are going to suddenly turn themselves from people who have had no impact, and who if only they had done their job this would never have happened, into people who would suddenly prevent executives from running institutions. After all, the job of a non-executive is not to substitute themselves for the executive; it is to pose questions, to pose challenge. In the end I think any well run company is bound to have to accept that it is the executive that runs it and what matters are the incentives facing the executive, and if we create a financial system in which the incentives for the executive and the shareholders are to take lots of risks because that is the profitable thing to do for shareholders, it is very hard to see how you should expect non-executives to prevent that. That is not to say it is not worth making efforts in all these areas to improve things.
Q143 Mr Tyrie: What you said a moment ago was a caricature, where you were implying that these non-executives had no influence.
Mr King: It was a complete caricature, because I think the idea that somehow there is a massive improvement to be had by changing the role of non-executives is, to my view, a bit of an illusion. I think there is a limit to what non-executives can be expected to do. They are, by definition, non-executives.
Q144 Mr Tyrie: I know that you are not keen on hypothetical questions, but were the Bank of England to resume a role in banking supervision, you would also, presumably, restore or want to restore, indeed you are to some degree already restoring, what were very close links with the financial institutions that are based very close to you in the City?
Mr King: I think, irrespective of what powers we do or do not exert in the future, the fact that we are involved in the resolution framework for banks and the fact that we need to produce our Financial Stability Report means that we do need to monitor very carefully what goes on, and that involves having close contact with people in the financial sector. We have done that for a very long time. The market area of the Bank, one of the first things I did the first day I became Governor, I asked the Markets Director to set up a market intelligence function, and that has blossomed in the last six years, but we are expanding those contacts. Maybe we made a mistake in saying to FSA before 2007 that we would not tread on their toes. We left them to deal with many of the smaller individual institutions. We may need to expand our range of contacts, because at some point we will, or may, have to act as lender of last resort or may have to act to resolve a bank that is in difficulty. So I think we need to know more, and we will do that irrespective of whether we do or do not obtain any extra powers.
Q145 John Thurso: Can I clarify one point from your remarks, Governor, which was regarding non-executives. I wholly agree with everything you have said, but, if I have understood it correctly, one could say that the greatest failure of corporate governance is the failure of remuneration committees, because it is the one area that the non-executives have the ability to affect the overall behaviour of the executives in the forthcoming time. Is that a correct assumption?
Mr King: I stand corrected. You are absolutely right.
Q146 Mr Todd: Can I unpack the word "big". There seem to be three components. One is sheer size, the second is the complexity of the business model and the range of products and investments that may be traded and the third is the internationality of the business. How do you weigh those factors, because it has been simplified as "too big to fail"? One can imagine a very big utility bank which presents a very different problem from a bank with a very complex model of activity and one that trades across a wide range of very different territories with very different governance.
Mr King: You are absolutely right. I think for us what brings the different dimensions together is the answer to the question: how easy would it be to resolve this bank; that is to intervene in the bank before the conventional definition of bankruptcy which would create chaos? In the case of an international bank, we saw in Lehman Brothers the complexity that was caused by banks that were, as I said, international in life and national in death, and, therefore, one obvious way to proceed is to ask oneself the question, "What can we do to such institutions to make them easier to resolve?" If we cannot get agreement with other countries about resolution mechanisms, then we may need to say they will have to rely more on separately subsidiarised operations and less on branches, and, as I said, I think last week, there is great merit in forcing these institutions to submit plans for how they could be wound down so that we know the degree of complexity involved and, if necessary, impose a higher capital requirement relating to the degree of complexity. So that is on the international side. If it is just too big, then I think the question is, if we were to resolve it, how easy would it be to sell the deposit book, for example, to another bank and how easy it would be to sell the asset side? If it is big but simple, then it may actually be relatively easy to resolve.
Q147 Mr Todd: The answers must differ really.
Mr King: The answers will differ according to the impact which the failure will have on the rest of the financial sector.
Q148 Mr Todd: The instruments that you would apply would differ as well, because it would be unreasonable to apply, for example, a very high capital tariff, effectively, to a relatively low-risk utility bank, whatever its size, arguably?
Mr King: Indeed.
Q149 Mr Todd: You said that if we cannot reach international agreement, that is not an excuse for doing nothing. That is clearly true. We have regulatory powers over financial institutions that operate in our country which we can impose for ourselves and, effectively, force changes, at least in the model from which they operate within our shores. Is that not so?
Mr King: Yes.
Q150 Mr Todd: Obviously, international regulation is appropriate, because otherwise many of these institutions would choose to rebalance a business against us if we have acted wholly alone without any comfort from the action of others, but how seriously do you contemplate that kind of arbitrage between different nations if we act alone, as you are perhaps suggesting?
Mr King: We certainly should not be blackmailed into accepting institutions that create the too big to fail problem because of the threat of going elsewhere, but, equally, I feel this may be less of a problem than one might have thought in the past, because all of our major partner countries feel that the same problem is there also.
Q151 Mr Todd: It is no competition to have high-risk banks operating within your shores.
Mr King: Take the Americans.
Having announced that they are going to have higher capital
requirements, they did not worry that no-one else was announcing that; they
just did it; so I suspect that is not a major worry. To go back to what I was saying about the G7
meeting in 2008 in
Q152 Mr Todd: One instrument which sounds potentially quite unattractive is attempts to directly regulate the instruments which banks may choose to sell, on the basis, presumably, that innovation will always keep ahead of the individual regulatory decisions a nation might take. Is that reasonable?
Mr King: Yes, and I think the immediate concern is that you just cannot imagine that this is a moment when banks are going to want to rush out and take lots of risk with instruments they do not fully understand.
Q153 Mr Todd: No, but we must try and define this for a generation's pasture which is greener than this.
Mr King: We have to have time to think this through. People have raised questions about product regulation. I do not take any view on that. I am not the expert on that, others are, and I have no objection to that being discussed and considered, but it is not to my mind the main issue in terms of prudential regulation.
Q154 Nick Ainger: Governor, you said earlier, when we were discussing
how you should have the powers as well as the responsibilities, that it was
important to actually put together what was needed, the instruments and so on,
before you decided what the structure was, but last week the European Systemic
Risk Council was set up. Is that not
developing the structure before the actual instruments have been
developed? Could you comment on that? Were you actually consulted before this
agreement was reached in
Mr King: This is one of the proposals from the De Larosière
report. I think it has already changed
its name from the Council to the Board.
It will start off, I think, meeting four times a year, and no doubt we
shall have very fruitful discussions on it.
Any recommendations it makes are not binding on the
Q155 Nick Ainger: So you do not actually think that this council will
have any serious impact on the
Mr King: I do not think it need have any adverse effect, in
that none of the recommendations are binding on the
Q156 Nick Ainger: Senŏr Bini Smaghi has been critical, saying that
because the risk board or council, whatever its title is, will have
insufficient power, as you have indicated, over national authorities, it is a
wasted opportunity. Do you agree with
that? It is a classic argument about
Mr King: No, I do not think it should have greater powers at this stage, because, again, this is an area where no-one has worked out what powers somebody should have. I think it would be a great mistake to hold back progress domestically in order to wait for some European agreement. I think in terms of going further than that, in terms of the regulation itself, the Chancellor made the fundamental point last week that there cannot be a pan-European body making decisions that imply the use of taxpayers' funds nationally.
Q157 Nick Ainger: I think it is the Prime Minister rather than the Chancellor.
Mr King: They both made it then. The Chancellor certainly made it - I have heard him make it - and he is right to make it, and I think it is peculiar. Again, there is no alignment of powers and responsibilities. You cannot have a decision made at European level if somebody else is then forced to raise taxes or cut spending in order to finance it. There needs to be an alignment. It is not for me to say where that should be, but there has got to be, somewhere, an alignment. So, I think, no. Whether this body turns out to be a mere talking shop or a useful talking shop, in terms of an exchange of views and ideas being generated, remains to be seen - that is up to the people who sit on it. We will see. I go to vast numbers of international meetings and I cannot claim that most of them live up to the billing that one would hope. Nevertheless, as I said, hope springs eternal - cautious, moderate hope for this committee - and we will do our best to try and raise the level of debate.
Q158 Nick Ainger: Will that debate follow the lines that the
Mr King: No, I think it will start from first principles, and it will start from the question of what we think in Europe were the problems that we faced, what went wrong and what do we need to put it right? I welcome that. I think it is right to go back to those first principles, and I am sure that the European Central Bank in the Chair, if that is where they turn out to be, will encourage that debate.
Q159 Jim Cousins: Governor, do you not think that the "too big to wind down" strategy and compelling winding down strategies to be in place for large complex international banks, it is very difficult to see how that would have a lot of credibility without an international agreement?
Mr King: I do not think so, because the problems that we saw following the failure of Lehman Brothers were real problems for the UK with a global bank failing, and I think, one way or another, we do not want to leave ourselves exposed to that again, and if there is no international agreement on it, it does not make sense to leave ourselves exposed to those problems again but to do something domestically. It may not be the first best, I agree. The first best is to try to get an international agreement, and I think the time is propitious to try to do that, and we should certainly put that as our first preference, but I do not think we should adopt the attitude that, if we cannot get that, then there is nothing we can do. That is all I am saying.
Q160 Jim Cousins: Do you think that the way that this particular debate has developed in this country right now, with the appearance of some tensions and disagreements between significant players in all of this, impedes the possibility of recovery and increases the stress on the banking system that we were discussing in the previous session?
Mr King: I do not think it is a good thing. I must say, I think that is why I think all three of us, Alistair Darling, Adair Turner and myself, have all said in the last week that the big question is the what not the "who", and that is what we are focusing on, but I do not think it has any impact on the stresses facing the banking sector or the chances of recovery, no.
Q161 Jim Cousins: Do you think there is a role for new competition authorities here?
Mr King: Of what kind?
Q162 Jim Cousins: To break up banks: an anti-trust approach.
Mr King: We have those authorities already, and they have already expressed views about competition in banking, and there is no doubt that is one of the issues that it would be sensible to discuss, but I do not think it is obvious we need new authorities; we have already got them.
Q163 Chairman: Governor, you did say earlier that you have no complete tool kit for macro-prudential supervision and you have not finished thinking about it, but could you give us an idea how you will progress that and when maybe you think there could be a settled view and who will be involved in coming to that settled view? Would it involve the Chancellor, the Chairman of the FSA, parliamentary bodies like ourselves?
Mr King: I certainly hope that all of us will be involved in discussing it in one way or another. I think all of us would want to think that, come the autumn, we could take the debate a stage on. I do not think there is any need or any sense in imposing an artificial deadline here because, as I said, we are not facing a situation in which the banking sector is gung-ho and taking lots of new risks. I think it is crucial that we maintain the momentum to consider reform - that is fundamental - and I think that on this committee you have a crucial role to play in that because you can maintain that momentum, but I do not think momentum to debate and discuss reform is the same thing as rushing to judgment on the decisions. We have time to get that, and I would hope that in the autumn we would be able to move to the next stage of this, and certainly we would be happy to come back to you with further thoughts then.
Q164 Chairman: That would be good. How many Bank of England staff are working on macro-prudential supervision at the moment and how many are working on financial stability, Andy?
Mr Haldane: About 140 people.
Q165 Chairman: One hundred and forty.
Mr Haldane: Yes, depending on how you define it. If you define macro-prudential in the broad way that the Governor has defined it (i.e. embracing a range of instruments, some of which pertain to financial institutions, some of which pertain to the structure of financial markets), then in a sense all of those people, plus some of the other directorates, are involved in thinking about those questions.
Q166 Chairman: Lastly, Governor, to go back to the beginning, we say, business as usual, and you said you have had time, and we have had this aggressive hiring in the trading divisions of the City banks mentioned by Adair Turner yesterday. Will we lose the prize? Will we lose the momentum in that if we do not do certain things? Will we let it slip us by?
Mr King: I think the most important thing is not to worry so much what one or two banks are doing now, but we have got to maintain this momentum to have a debate about the form and to put in place a new structure for banking and its regulation. That is the most important thing. If we keep our eyes on that, if we can achieve that, then what happens in the short run elsewhere will not matter, but having that approach in the long run is absolutely fundamental.
Q167 Nick Ainger: What is the process? You have told us that there will be discussions, but what is the actual process? Is there an agenda between the tripartite authorities to address this issue? Will it produce something for consultation at the end?
Mr King: I do not think the tripartite will, as such. The tripartite is not a decision-making body. The Chancellor will no doubt put forward some proposals shortly in July where he said he wants to publish a White Paper on some of these questions. I do not suppose that this is the last word on it.
Q168 Nick Ainger: But you will be consulted in that process before the White Paper?
Mr King: I imagine we will be. We will see. Some of these questions are not for the Bank to decide on, some questions are for government, and it is up to the Chancellor what he says and thinks about that. The most important thing is that we have a proper public debate about it, that this committee plays a role in it, and actually none of us, I think, are in a position where now, hand on heart, we can say we know what the right answer is, and in that situation it is actually very important that we go away and work out what the right answer is.
Q169 Nick Ainger: That is why I am asking about the process.
Mr King: We will go away and think hard about it - that is what needs to be done - and we will be talking to the FSA and Treasury, no doubt, but also talking to our colleagues abroad to share our ideas and thoughts, and many of these things are international issues, and come up with some thoughts and ideas on it, and I hope that the committee will be a forum in which this can be discussed.
Q170 Chairman: If we believe the jungle drums, the White Paper could be out next week, but you have been consulted on that, Governor, have you?
Mr King: It all depends on your definition of consultation. I have not seen a draft of it, no, but no doubt we will have a chance to see it before it appears. It may appear next week, it may not. It may be the week after that; I cannot say that.
Q171 Chairman: Somebody has come somewhere or other through the Bank, "Do you think this is a good idea, a bad idea, or should we put it in the bin?"
Mr King: We will see. I have no idea what questions will be asked by the Treasury.
Q172 Mr Fallon: But you have been consulted.
Mr King: I have not been consulted on what will be in the White Paper and I have not seen a draft of it, but no doubt at some time I will. There is still time to be consulted on it before it appears, and I am sure the Chancellor will show it to me before it appears.
Q173 Mr Fallon: That does not sound like consultation, showing it to you before it appears!
Mr King: It depends on what is meant by consultation. White Papers tend to get written somewhat faster these days than they used to!
Chairman: That is quite a fascinating answer.
Q174 Jim Cousins: In the earlier session you referred to your good working relationship with the Chancellor and the fact that you regularly discuss matters with him. Clearly the things we have been talking about just now will presumably be part of the good working relationship and the things that you would discuss with him?
Mr King: He has told me that there will be a White Paper, he has not told me the date when it will come out, because, as far as I know, he has not decided the date when it will come out, but I will see it when it is ready and before it appears.
Q175 Jim Cousins: Yes, but just as you have discussed the three alternative approaches you have set out quite helpful for us, presumably your discussions with the Chancellor have also involved those three different approaches.
Mr King: I have no idea what range of issues the White Paper will cover. It may cover some of the things that we have discussed; it may cover some of the things that we have not discussed. I have no means of knowing.
Q176 Chairman: If I were to say to you tomorrow will be Thursday and we do not know what the weather is going to be like, Governor, is your exchange with the Chancellor more meaningful than me saying there is going to be a tomorrow? In other words, have you got a fair idea, a working knowledge of what you think is going to be in this White Paper or is it a blank sheet and you are saying, "Oh, this is a White Paper"?
Mr King: I do not know what will be in the White Paper. Whether anybody else does, I do not know, but no doubt we will discover what is in the White paper.
Q177 Sir Peter Viggers: The tripartite is not a decision-making body; it is the three bodies with responsibility for financial regulation. How can it possibly be that a White Paper is anticipated in the early future without one of the more important parts of the tripartite not being consulted on it.
Mr King: There has not been a principals meeting of the tripartite to discuss a draft White Paper. That is all I can say.
Q178 Chairman: Okay. I do not think we are getting much further. I think the important point is in working on this issue, the macro-prudential supervision aspect, Governor, there is a lot of work to be done there. We, hopefully, will play a part and continue that discussion with you, but thank you for your attendance today; it has been very helpful to us.
Mr King: Thank you, Chairman.