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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 546-ii
HOUSE OF COMMONS
TAKEN BEFORE THE
Wednesday 13 February 2013
RT HON Greg Clark MP and Lowri Khan
Evidence heard in Public Questions 94 - 153
USE OF THE TRANSCRIPT
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Taken before the Treasury Committee
on Wednesday 13 February 2013
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Brooks Newmark
Examination of Witnesses
Witnesses: Rt Hon Greg Clark MP, Financial Secretary to the Treasury, and Lowri Khan, Director, Financial Stability, HM Treasury, gave evidence.
Chair: Thank you both very much for coming to give evidence this afternoon, which will probably be the first of a number of sessions we will have with Ministers over the years on macroprudential tools. I will begin by asking Andrea Leadsom to ask a few questions.
Q94 Andrea Leadsom: Thank you, Chair. Good afternoon. The Institute of Chartered Accountants in England and Wales believes that the tools you have provided so far would not necessarily contribute to financial stability if conditions similar to the lead-up to the 2008 financial crisis were encountered again. Do you agree with their assessment, or how would you counter that?
Greg Clark: Well, first can I start by saying it is a pleasure to appear before the Committee for the first time? Whether on this subject or others, I suspect we are going to be together for quite a few hours.
The intention of the framework, which is very new, as you know, and was subject to consultation, was to start minimally and then have the opportunity to expand as conditions arise and as people reflect on the success of what we have so far, so I think this is not the end of the world. I think one of the reasons that you are having this inquiry, and the FPC themselves will have the power to make recommendations as to the tools that they themselves have, is the potential to evolve and to address any concerns that might be there.
Q95 Andrea Leadsom: Okay. How do you think the FPC is doing so far in its interim role? Have you been following it closely, and how do you feel it is performing?
Greg Clark: Well, of course, it is in its interim role and its early days. It will take up its full powers, we hope, from April, but I think the way that it has addressed itself to the policy issues is that it has not sat around. It has made recommendations in each of the meetings that it has had so far; some of them have been fairly newsworthy and have involved some recommendations that the FSA are now having to think through and to reflect and act on. My assessment-but I am conscious that it is rather invidious for someone quite new in my position to reflect on the performance of a body that is itself quite new-is that they have conducted themselves in a judicious way; they have made some recommendations that seem to be within their remit but not too shy from being relatively exacting in what they say. My colleague may add to that.
Lowri Khan: I think it is worth considering that the interim FPC has had, if you like, a dual role both in terms of establishing itself as a committee and also in terms of establishing the regime as well, developing the tools and thinking about what those might be and how they might work. I think it is worth thinking of those two things quite separately. The Minister spoke then of how the Committee has engaged with the conjuncture, if you like-what is going on-and responded to that. As you will have seen from its policy statement and other pieces of analysis that have come out, it has addressed itself to a lot of the deeper questions of what its toolkit should be in a fairly thorough way.
Q96 Andrea Leadsom: Minister, bearing in mind that you are very new in your role and it is very new, too, are you concerned in a strategic level that its role is far less prescribed than the role of, say, the MPC? Would your instinct be to try to pin down its role more specifically than it is at present, or do you feel it should have a broader remit, with the potential for some challenge from either politicians or the public in the event that it makes unpopular decisions? Do you think that we will be able to cope with that, or do you think that we should be aiming towards a far more specific remit?
Greg Clark: I think its remit is suited to the task that it is presented with, which is to focus on the financial stability of our financial system but also, given its secondary objective, to have regard to the Government’s economic policies. I think that covers it. Its discharge of that will become apparent over time. It is quite right that, just as its members have appeared and will appear before this Committee, the publication of its reports will invite a great degree of scrutiny and debate. We have said that we will consult on any further changes to the remit that might come about through recommendations of your Committee, recommendations of the FPC itself, or anything that the Government proposes; but in the consultation that we have had on the original tools before us, there was a degree of consensus in the responses that this was about the right place to start-it struck the right balance for a new institution.
Q97 Andrea Leadsom: Okay, but are you not concerned that it is likely, almost by definition, to make mistakes? To use Governor King’s analogy of removing a punchbowl while the party is still going, isn’t it inevitable that the determination of when that point is and how the FPC chooses to respond to it will be on occasion an error-that is, they will misjudge it, they will take the punchbowl away too soon, or they will do things that will harm growth? Are you not concerned that the lack of a definite goal, like the MPC has to target inflation, will simply leave it open to the charge of incompetence?
Greg Clark: Well, our view is that it is not susceptible to the same specificity of the goal that the MPC has. By its nature, financial stability is a broader concept; it has different facets to it. The fact that we are starting out with a number of macroprudential tools-of course, there is the possibility that others might be added in due course-and the fact that there is the secondary objective there, I think reflects the range of judgments that it needs to come to. Now, my view is that it is important that the judgments that it comes to are done in a way that is subject to scrutiny and subject to debate in this Committee and others. Insofar as it has a track record so far of how it started, I think the degree of content of the financial stability reports, for example, is quite encouraging, quite impressive.
Just to think of the list of indicators that it might take into account in making its judgments, there is a very full and exhaustive list there that has been put out and shared with the rest of world for people to comment on. It seems to me that so far-insofar as it is possible to discern the demeanour of the Committee-it seems to want to engage rather than be a conclave that makes decisions without being clear as to why it has made them and what information it has made them on. I suppose over a long period of 100 years there will no doubt be mistakes that will come to light, but from where we are sitting at the moment, it seems to me to be as well adjusted as one could imagine and require at this stage for it to be not too predictable that it will make mistakes.
Q98 Andrea Leadsom: A final brief question, if I may, and that is: can you confirm whether it is or is not the Government’s intention to pass comment on whatever the FPC decides to do? In other words, do you intend to give a view on whether they are on the right track or not in public as its role unfolds?
Greg Clark: I want to reserve the fact there might be specific things when there is a recommendation that is to the Government, for example, that the Government has to take a view on and that obviously requires that to be the case. I think in general, though, that if it is making a commentary on the capital position of the banks, for example, it seems to me that having set up an expert body that is required to publish not just its conclusions but its thinking, and to subject itself to questioning there-although it is not exactly the same I think, having set up the Office for Budget Responsibility, Ministers have not engaged in a debate with the OBR as to whether the conclusions that they have reached are, in the Government’s view, the right ones or not-I would expect to take the same approach to the new institutions here, in particular to the Committee.
Q99 Andrea Leadsom: Just to come back on that, I can exactly see what you are saying with regards to, for example, the capital ratios of banks, but what if it were, as we heard today, that new starter home mortgages are at the highest new level in five years, and the FPC were to try to attempt to do something because they felt suddenly that that mortgage market was overheating at a time when clearly the Government wants to see new people able to buy their homes? Is it not extraordinarily likely that the Government would not be able to resist commenting and, indeed, trying to influence the decision of the FPC in an area where it specifically affects Government policy?
Greg Clark: There are two things I would say. One is that the FPC is set up to be able to issue directions to the regulators in pursuance of its objective to achieve financial stability, and it is right that it should be able to do that if it detects and is persuaded that there is a risk to the financial stability of the country of a particular sector. For example, one of the tools that we are proposing to give, sectoral capital requirements, provides them with the means to do that. I think it would be paradoxical to issue them with the tools and then seek to apply moral suasion for them not to use them.
The second thing I would say is that of course there is the ability, indeed the requirement, for the Chancellor of the Exchequer to write annually with a statement of the Government’s economic policy and to include any aspects of public policy to which the Committee has to have regard in its activities. That seems to be the right way to do it: to set it out formally so that everyone, the Committee but also this Committee and the rest of the world, is clear what they are being asked to do.
Lowri Khan: It is worth bearing in mind in addition that the FPC does need to act proportionately in what it does. There are various constraints, including the need to conduct cost-benefit analysis and so forth, that would hopefully tease out some of these issues.
Q100 Mark Garnier: Good afternoon, Minister. Following on from Ms Leadsom’s questions, I want to focus a bit on the communications in terms of what the policies are of the FPC and particularly the overall policy of the FPC. As we have heard, it can be quite clear that when the FPC effectively takes away the punchbowl, there can be a short-term quantifiable effect on, say, a rising housing market or whatever. But actually the long-term implications, which are the more important points, may be slightly or completely missed by the wider public, who may see that somebody above them-be it the Government or the Bank of England as an independent intervener-has taken away this punchbowl. To what extent do you see it as a function of the Government to be part of the communication process, supporting the FPC in terms of making sure that everybody is absolutely clear what the FPC is trying to achieve, in particular in the long term as opposed to just a short-term bubble in the market?
Greg Clark: It is a good question, Mr Garnier. I think it is important that, having set up the institutional framework that is designed, in part at least, to involve the removal of the punchbowl, to use the analogy that is often used-it is true to say that the host of any party that removes the punchbowl is not usually a popular figure-it probably would be invidious for any future Government to simply allow the body exercising that power to be castigated and vilified for that, when this Government and Parliament has set up the institutional arrangements for this purpose. My view is that we should defend the architecture, the arrangements that we have, and to be clear that there is an obligation on the part of the FPC to make decisions that are almost certain to be unpopular with some people at the time. That seems to be part of the exercise.
Q101 Mark Garnier: There is a wider implication here, though. On the one hand there is the unpopular thing that you are going to read about in the Daily Mail or whatever it happens to be, where people are going to be complaining about the fact that their house has not gone up in value to the extent they were expecting; but the other side of this is that by having a wider understanding by the general population, they will realise that actually what looks like the start of a bubble is not going to last. The very fact that people realise that means that, within itself, it probably will not happen either, because you then will not get that flood of credit following it and people balancing it. It is really that element of it-the understanding of really what is behind an action. I will ask the question again. Do you feel it is part of the Government’s responsibility to help educate people as to why this whole thing is there in the first place, not just why they have made an unpopular decision but actually this is just part of a much greater strategy for financial stability for the long term?
Greg Clark: Yes, I think that is absolutely right and I think the new Governor has said as much. There is a great degree of appreciation that terrible things happen to our financial system, but I think that needs to be accompanied over time with an understanding of what arrangements we have put in place to address it in future. It is a challenge. Just in my few weeks and months in this job I have been looking at ways in which one can-through articles, speeches or whatever-communicate not just the fact that we are doing something about the problems that we are trying to sort out, but broadly what they are. In most other areas of policy, whether it is the schools policy or the health service, we do manage to communicate a reasonable understanding of what the Government’s policies are, and I think we should aim for the same in financial services, although I am conscious that it is a subject that does not necessarily lend itself to that. That means that we and the FPC need to try harder to do that.
Q102 Mark Garnier: Do you think a more frequently produced financial stability report might help?
Greg Clark: Well, whether it is more frequent or whether it is how they are communicated, I am not sure. I do not have a view on that. I know it is common to other jurisdictions as well. I was in Frankfurt a few weeks ago, and I know that in the Bundesbank they are having exactly the same questions as to how they can communicate the direction of policy and the shape of policy to the public, who are much more interested at one level than they have been in these matters, but sometimes do not have the background to be able to engage in the debate. In answer to Ms Leadsom’s question about the need for decisions to be taken in the context of scrutiny and debate, the more people are able to engage in that, including the newspapers, including the Daily Mail that you mentioned, the better.
Q103 Mark Garnier: Can I turn to the lobbying that is likely to happen? Clearly, the actions of the FPC are going to be having an effect on the financial services industry, which of course includes banks, and banks, as we know, are pretty good at lobbying. Do you think the FPC and, indeed, the Government are ready for the colossal amount of lobbying that is likely to come their way and, if so, how do you think they should deal with it?
Greg Clark: The decisions that the FPC will take clearly are of great economic moment, and no doubt when economic interests are engaged, people will argue for those positions. I think the role of transparency in terms of why decisions are taken, the publication in advance, as has been done, of the indicators that would lead to intervention, the interests of this Committee and others in that, I think, is very important. In terms of the requirements of members of the Committee, it is very important that they should bear in mind the scale of their responsibilities and how they should have in their minds the knowledge that they may be attempted to be influenced and to put that aside. It is worth reminding them of that at every stage.
Q104 Mark Garnier: How far do you think they should engage with the financial services community or, indeed, the City specifically? Should they take a step-back approach and look at it from 100,000 feet and see what is going on, or should they get in there and start meeting with bank managers and senior executives?
Greg Clark: I think they do need to do both. It obviously gives rise to some of the tensions that you suggest, but I do not think that the deliberations of the FPC should be entirely closeted so that they are not aware of the talk and the experience of people in the industry. I would say that they need to be open to the world, just as I would expect this House to communicate to them the concerns of our constituents about things. I think they ought to know that.
Q105 Mark Garnier: Would you advocate any direct contact with the financial services industry being as transparent as possible, in order to avoid any accusations?
Greg Clark: Yes, I think banks should obviously listen.
Mark Garnier: Fantastic. Thank you.
Q106 Chair: A moment ago you were talking about the remit letters and how you could vary the remit, and by doing so emphasise various aspects of Government policy while letting the regulator get on with the job. Have I summarised accurately what you were saying, or do you want to adjust that in any way?
Greg Clark: The remit letter requires and allows the Chancellor to set out from time to time what the economic policy of the Government is. Just in strictly procedural terms, I think it right to do it in a letter, because if there is a requirement that part of the objective is to support the policy of Her Majesty’s Government, including its objectives for growth, to have a debate about what those policies and objectives are would be unhelpful. I think it is better for the Chancellor to set them out.
Q107 Chair: I am just trying to clarify if there is anything I have said there that you are challenging.
Greg Clark: No.
Q108 Chair: It was a correct summary?
Lowri Khan: Sorry, just a slight correction. You referred to the Government’s policy, but the statutory requirement relates to the Government’s economic policy, just for the sake of complete clarity.
Q109 Chair: This is the Treasury Select Committee. On the whole, we do not deal with Home Affairs. Just to get back to the point, if you change these remit letters at all frequently, aren’t you going to devalue the quality of the independence?
Greg Clark: I certainly do not think you should be chopping and changing them every month.
Q110 Chair: Every year?
Greg Clark: Well, there is no requirement to change the policy every year. Indeed, I would hope and expect that they would be-
Q111 Chair: Every couple of years? When you talk about you can vary this, how much are you planning to vary this? How much do you envisage the Chancellor-I say the Chancellor; he is not here, but all in good time-doing that?
Greg Clark: You are promoting me.
Chair: Let us try the Minister. How often are you planning to change this?
Greg Clark: I am not aware of any expectation that there would be variation that is planned in advance; by 1 May, I think is the requirement. The Chancellor will write-
Q112 Chair: Okay, you are giving me a bit of waffle there. What I am trying to get at is: are these remit letters going to be cast in stone like the remit for the MPC, or are these things that will be varied more frequently?
Greg Clark: Clearly, they are able to be varied but-
Chair: We know that, but I am asking you if-
Greg Clark: I am not aware of any intention to vary them. I think it is-
Q113 Chair: You gave the impression a minute ago that this was something you could vary if you needed to and that you might want to do so, as you put it, to emphasise various aspects of Government policy.
Greg Clark: No, I am trying simply to make a statement of fact, Chairman, that that this is what the remit letter is about. It seems to me right that the Government should specify these matters. It could be that the FPC may make a recommendation when they want to have guidance on a particular matter. It is set up to allow that to happen, but in all honesty I am not aware of any intention to vary it.
Q114 Chair: Let us try to ask this question in a slightly different way, since we have had a nil return so far, which no doubt is your skilled intention. Let us have another attempt. If you look at the MPC, the MPC is given a remit. Everybody knows the Government can alter the remit but altering it is a big step. It is big potatoes, so Governments tend not to do that very often, indeed hardly at all. Would you envisage this remit in this letter being thought of as similarly only reluctantly altered or more subject to variation?
Greg Clark: I cannot calibrate it, but it is desirable that it should be reasonably stable.
Q115 Chair: That is, as stable or less stable?
Greg Clark: Mr Chairman, I said I would not calibrate it.
Q116 Chair: I am not asking for a calibration-a number-just an indication. This is quite a big and important question, and it is very important that at the start we know what the terms of trade are here, both for Parliament and for the country.
Greg Clark: There is no prior expectation that this would be changed frequently.
Chair: Well, you have said that already. Okay, we will move on now.
Q117 Mr Newmark: I want to again focus on FPC versus MPC. Are you concerned that there could be a conflict between the FPC and MPC, or do you think they both really have a secondary remit to promote economic policies of the Government that will mitigate the tension?
Greg Clark: Well, they do have the similar secondary remit. I think this Committee recommended that they should. There are other ways in which their work can and will refer to each other. There is cross-membership of both Committees, as you know. The bank-my colleague will say more about this-has set up arrangements to coordinate areas where there is clearly joint interest in this. Although they do have different remits, I think there is an expectation and understanding that there can be some joint working on areas of mutual interest. In terms of the arrangements, perhaps Lowri might fill us in.
Lowri Khan: Stepping back a bit, the frameworks they both operate in are separate in terms of primary objectives. They share a common secondary one and clearly a lot of things that they are dealing with at certain times will act together and other times may diverge a bit. I think some of the benefits that you get from having both Committees within one institution are that rather than there being ill-considered tension, you have a constructive resolution of any tensions that do emerge. I guess one of the benefits-
Q118 Mr Newmark: In one institution, or as one entity?
Lowri Khan: Within the institution of the Bank of England; I think they will share the resources, if you like, of the Bank of England and be able to work from a common evidence base, for example. In that, combined with cross-membership, the intention is to help to ensure that where they do feel that their objectives are not entirely aligned, they can internalise that.
Q119 Mr Newmark: On the direction of travel, let’s take a couple of quotes. One is from Martin Weale, who says, "We have to recognise that the distinction between monetary policy, fiscal policy, regulatory policy and macroprudential policy is no longer clear-cut". Then we go on to Sir Mervyn himself, who says the boundaries between monetary policy, macroprudential policy and fiscal policy were "blurred". As they are both developing, there seems to be a lot of crossover in what they are doing. I am wondering what your thinking is on those comments and the direction of travel that may be within the Governor’s mind.
Lowri Khan: I would not wish to read the Governor’s mind.
Mr Newmark: Not that one would wish to comment on what was in the Governor’s mind, but-
Greg Clark: Well, just to reflect on the institutional arrangements, the fact that the FPC was set up as part of the Bank of England rather than being something entirely separate, as was possible, I think reflects the fact that there clearly is a common interest in some of the aspects of policy, not least the evidence base. The whole institutional architecture is to reflect precisely that degree of both tension and convergence: that it is separate but part of the Bank of England, with some common membership but some differences.
Q120 Mr Newmark: Right, but I think the conversation seemed to be heading towards-this is where I am heading, too-that perhaps the institutions themselves should really be merged into one. I guess when Sir Mervyn was asked about this, his response reminded me of Henry Kissinger’s response when asked what he thought of the French revolution. He said, "It’s a little bit too early to tell". The Governor himself I think said that he preferred to wait five years before considering merging the FPC and MPC. I am just curious. Is merging the FPC and MPC something you have discussed with the Governor or anybody else at the Bank of England?
Greg Clark: I have not discussed it, and I am not aware that any of my colleagues have. It is rather early to say. I am sure in a few years’ time, whether it is five years’ time or some other time, the Committee might take an interest in this. The heritage behind the system that we have established was that there was not a clear enough focus on financial stability, on macroprudential policy in the system. Having set up an architecture to address that deficiency, I think it is reasonable to allow it to establish itself and to-
Q121 Mr Newmark: Effectively, you are saying give them a little bit more time?
Greg Clark: Yes.
Q122 Mr Newmark: Just to be clear, then, this is not something the current Government would consider doing in the future-merging them?
Greg Clark: All I can report, Mr Newmark, is it is not something that has been considered.
Mr Newmark: Okay; thank you.
Q123 Mr Love: Can I come on to the countercyclical capital buffer? When the FPC raises the buffer, you will need to explain to the public, "Yes, lending will be reduced and your business may not get the credit it needs to grow, but this is all for the long-term good and stability of the economy." How will you explain that to the public?
Greg Clark: It is the same point, in essence, that Mr Garnier made. At that point it is going to be a difficult thing to communicate. As I said, the host of the party that takes away the alcohol is not seriously a popular figure at that time. I think one of the reasons to draw attention to the arrangements now, when the deficiencies of the previous cycle are still relatively fresh in people’s minds, and if we can manage to communicate why this system is in place-I recognise it is difficult to do so-when it comes to the system making those decisions, then that might be recalled. But it will be an exercise of communication, and it will not be popular with everyone, I can see that.
Q124 Mr Love: Would it help if there were a bout of honesty on the part of Government and politicians-I include the Treasury Select Committee and Parliament in this-in suggesting that both lending more money and replenishing the capital base of our companies may well be mutually exclusive objectives? Maybe a little more honesty?
Greg Clark: There can be, but I know the Governor-designate was asked about this. Of course, there are ways to replenish the capital base while still lending. One of the things that the FSB, going back to Ms Leadsom’s questions, have recommended to the FSA is that remuneration should be reflective of the need to rebuild balance sheets, for example.
Q125 Chair: Just to be clear, you are saying that maybe we should cut their bonuses and have pay cuts in banking in order to replenish balance sheets?
Greg Clark: I am saying that bonuses should be less than they would be if balance sheets were sufficient for their purpose. At a time-Mr Love has it absolutely right-when we want to get banks lending, they need to make sure that the decisions that they are taking are in the interests of consumers as well as their shareholders. I think we should be clear about that.
Q126 Mr Love: Would you say the same thing about dividend payments?
Greg Clark: Absolutely.
Q127 Mr Love: There is an exercise going on to see what additional capital the banks may have to issue in the foreseeable future. They have been very reluctant for all sorts of reasons to do this, but would you recommend to them that perhaps they look to go into the market to raise capital as an alternative way?
Greg Clark: I think, Mr Love, that is properly for the FSA. It is a good example of the policy system already doing what it was designed to do. The FSB in its interim form has made recommendations to the FSA that balance sheets be rebuilt and, in particular, that the regulator should take an interest, to put it that way, in remuneration, in dividends and in disposals, for example. That seems to be the right thing. They have made a recommendation to the regulator, who then has an obligation to put that into effect. I think that is the way that it should work rather, than the Minister making directions or statements that seem to circumvent that process.
Q128 Mr Love: Is there any circumstance in which you would go further than exhortation and intervene?
Greg Clark: Again, that is for the regulator. The regulator has powers, in particular when it comes to remuneration and all of these matters, to make sure that the individual or the microprudential stability of the bank is assured, and is not jeopardised by these things. It is absolutely right that they should have the powers to do so. Ministers do not have those powers directly; they are vested in the regulator. I wrote a few days ago about this. I think that it is incumbent on and increasingly recognised by banks certainly that they have obligations to their customers and shareholders.
Q129 Mr Love: Let me come on to the mirror image in terms of reducing the countercyclical capital buffer, because some people think that is a sensitive task as well. How do we make sure that the FPC get it right as to when they give that signal that they can raid the capital buffer?
Greg Clark: It is a difficult judgment again, Mr Love. I think what the FPC in its interim form has done is to say very clearly that it wants this to be based on evidence, and not evidence that is produced at the time. In their January draft policy statement, table C, they listed, I think, 17 different indicators, which are the core indicator set that determines when the countercyclical capital buffer is applied one way or the other. That goes from looking at leverage ratios to the credit-to-GDP gap and various other ones. I think it is the right thing to lay it out. When they get to that point, it is not possible to say with certainty that at any point they are going to make the right call, but I hope they will be able to evidence that the call that they have made is evidence-based and is a reasonable response to what the evidence is showing. You have read the way that they have applied that to historical crises. They are satisfying themselves that calibrating their use of it would have had a beneficial effect in the past.
Q130 Mr Love: In a sense, they will not have to satisfy the Treasury Select Committee or the Government or the Treasury. They have to satisfy the markets. The markets may well be somewhat worried about running down capital levels, especially in the circumstances where we are only too well aware what the consequences of that have been in previous years. How do we reassure the markets that this has been taken for the right reasons at the right time?
Greg Clark: Again, I think setting out in advance the indicators and the evidence that they would use has the effect of introducing some valuable constraints. If you say that these are the indicators that are going to determine your response and then those indicators turn in a particular way that would justify that response, then it becomes very obvious and transparent if suddenly, perhaps as a result of lobbying pressure or whatever, you decide not to bother with them after all. I think the more that you can pre-commit and pre-announce the way in which you make those decisions, the more likely you are to be held to them when it comes to it.
Q131 Mr Love: The reality is that if anything goes wrong, the public will not turn to the FPC or to the Treasury Select Committee; they will turn to Ministers to answer for what has gone wrong. How do you assure yourself that the decisions that will be taken by the FPC will be ones that you can justify in the court of public opinion?
Greg Clark: Well, I think the architecture that we have set up is to provide, I suppose, cooler heads than sometimes apply in day-to-day politics, to be able to take these decisions. The cooler head actually consists of a number of cooler heads who are selected and recruited for their track record and ability to be able to exercise their important responsibilities dispassionately and expertly. Again, it is a theme of our discussion so far-the more that one can talk about the system that has been set up and is being built for the future, so that there is a greater awareness that actually this is not some knee-jerk decision of the then Government or Chancellor of the Exchequer but actually is a consequence of arrangements that I think have enjoyed a degree of cross-party support in being set up. That is no guarantee of political popularity at all, I am quite conscious of that, but at least one can truthfully reflect at that time that the arrangements were set up in a well-intentioned way, having respected opinion across the board.
Q132 Chair: Do you think that regulators are likely to be any better than anybody else at spotting asset price bubbles?
Greg Clark: Time will tell whether this particular set of arrangements will work, but the answer has to be yes because there would be no point at all in making any institutional arrangements if we thought this was a complete random walk and there was no point in exercising any judgment at all. We have a responsibility to look forward. Again, the analysis that the interim FPC has done is not definitive, but it is persuasive that if some of the indicators that they are proposing should inform their judgment in the future exercise of these powers had been used in the past, it would have been possible to take action earlier. It is not just blind faith in some-
Q133 Chair: It is about using the powers rather than about spotting whether to use them?
Greg Clark: No, the indicators make an argument-
Chair: Since the next crisis will be about something else.
Greg Clark: No crisis is the same as previous ones, but there is a degree of variation over time. I have not brought the full report, but they do review past crises and how different indicators would have performed there, so at least they are informed by that. Mr Chairman, I am not going to pretend that they are Olympian figures that can be relied upon to spot at the precise moment everything that is going to happen in the future, but I do think it is the right thing to set up a body and give them powers and responsibilities that from where we sit, at the state of the world that we are, it is our best attempt to equip them.
Q134 Stewart Hosie: The consultation paper issued by the Treasury on macroprudential tools stated that, "The effectiveness of the countercyclical buffers may be limited by the robustness of risk-weighted asset measures". How concerned are the Treasury about the efficacy, the robustness of the RWAs?
Greg Clark: Well, there is a debate as to how robust RWAs are. I confess I am not technically qualified to give an opinion that would be valuable to the Committee as to whether they are useful or not, but clearly having a leverage ratio is one of the ways in which there can be a degree of reassurance that does not rely entirely on RWA weights. Plus, of course, one of the things that the FPC can do through its expertise and through its deliberations and enquiries, whether it is at a sectoral level, is to adjust any weights that it becomes persuaded need to more accurately reflect the risk that it might perceive there.
Q135 Stewart Hosie: That is certainly the theory, and I agree with it and think that is helpful, but, of course, at the same time as the Treasury have concerns about the efficacy of the risk-weighting; the Building Societies Association, for example, were deeply concerned about the use of unweighted solutions. They said that could affect businesses like them who had relatively low-risk assets on the balance sheet and they could actually decrease or stop them lending. That is a heck of a conflict and quite a circle to square: the use of RWAs, which makes sense, versus a deep concern about using unweighted assets. What thought was given to that and the dichotomy between these two issues?
Greg Clark: I think a lot of thought has been given, and, in fact, it has been much debated, as you know. One of the recommendations of the Vickers commission was that we should have a higher leverage ratio, and one of the reasons the Government did not accept that was precisely the concern that you describe. Sometimes two policy measures that for the most part broadly have results and intentions that are valuable and to be welcomed do have some interference between the two.
Q136 Stewart Hosie: The answer to the interference was to permit higher leveraging, at least for the time being, but isn’t the use of the time-varying leverage ratio the most effective backstop against the risk of unreliable risk-weighted asset measures? Certainly, the evidence from non-financial firms is that using these time-dependent models allowed businesses better to predict the default rates over a long period of time. Surely it is the introduction of the time-varying leverage ratios that would be the solution to both of those problems.
Greg Clark: Yes, I think that can be an important solution, and it is one of the reasons why the intention-I think we have been persuaded by the work of you and your colleagues-is that there should be such a time-variable weighting.
Q137 Stewart Hosie: Why have the Government delayed giving that tool to the FPC?
Greg Clark: For a couple of reasons: one is that we are making the case internationally, particularly at Europe, that this should be available under CRD IV and CRR and that this should be one of the tools that is available at an international level. You understand the reasons and the desirability of having some international coordination of action there. But we are arguing that case-we are arguing it very strongly in Europe live this quarter, and it is part of the discussions with the Irish Presidency. We want to have that, we want it to be available to the FPC, and we want it to be available with other countries and other jurisdictions.
Q138 Stewart Hosie: Let me just ask, then, about the international perspective on this. The Government has said it wants consistency with international European standards. Does that mean agreement on setting the leverage rate 16 times, 22 times, 33 times, or does it simply mean how the leverage ratio should be calculated, agreed, set or arrived at domestically but coordinated with other jurisdictions? Does it mean a number, or does it mean a process?
Greg Clark: The first stage is beyond that, as to whether there should be an ability to have an addition of a time-variable leverage ratio. That is the first thing that we need to persuade people of. Then if we do it seems to me that what we would like to see is for national regulators, the FPC in this case, to be able to reflect the particular conditions of the jurisdiction, which may be different in the UK than it might be in France or Germany at any particular time. We would like to see that opportunity for variability.
Q139 Stewart Hosie: So, we are getting agreement on that first, but it would be variable across Europe but the process would be agreed fundamentally this was desirable within a domestic context?
Greg Clark: Yes.
Q140 Stewart Hosie: Okay. There are various timelines for implementation of Vickers, and of the European regulated framework, agreed or not-2017, 2018, 2019. How long will it take to get agreement or not, to get an answer from Europe on time variability, and will that affect what the UK finally decides to do?
Greg Clark: The answer is we do not know, but it is possible that we might know very soon because, as colleagues will know, CRD IV and CRR are being discussed very actively at the moment. It is possible that a resolution may be agreed that provides us with that knowledge, and if we can get to that point, then that is clearly very desirable. It may be that that does not happen, that an agreement cannot be reached, in which case we have some further distance to go. It is not possible really to say at that point, but perhaps the next time I come before the Committee we will at least know whether during the current negotiations we have managed to get the result we want on that.
Q141 Chair: You said a moment ago that there were two reasons that pointed to delay of the transfer of responsibility for leverage, for the decision on whether to transfer responsibility for leverage to the FPC. The first was that there are international negotiations going on about all this. What was the second?
Greg Clark: The second we have addressed, which is the differential impact on different types of institutions.
Q142 Chair: Why should international negotiations require a delay in the transfer of responsibility?
Greg Clark: If you want to and think it is desirable to coordinate these things internationally, then it seems to me when it is literally live-this week and next week it is being discussed in the Irish Presidency of the EU-it is sensible to wait for that to be resolved, given that it is some time away.
Q143 Chair: I have not understood. Have another go. Why can’t you nonetheless hand the power to the FPC?
Greg Clark: Hand what power to the FPC?
Chair: To set the leverage ratio.
Greg Clark: One of the outcomes of the negotiations is likely to be some methodological agreement on how that is done or limits as to a variation that might be possible to member states.
Q144 Chair: But you can hand it to the FPC with those constraints now.
Greg Clark: Not if they are not known. It seems to me that if you can make them known, then to vest those powers in the FPC as we are wanting to do without needing to tinker with them, something that the implication of your previous question is that we should avoid, that seems to be the desirable way to approach it.
Q145 Chair: It was a helpful reply, that first one. When you say you want to do it, you mean that unless something that you cannot foresee now crops up, you are going to do it?
Greg Clark: Yes. My personal view and-
Chair: No, I am asking for the Government’s view.
Greg Clark: I was going to say my personal view and the Government’s view is that we want to give the FPC a time-varying leverage power, and that is our intention. It is exactly as you described it.
Q146 Mr Newmark: I just want to pick up on a point that the Chairman was making about regulators not being able to spot asset bubbles. Regulators are never going to be as fast as the market and the whizz-kids in the City who are always coming up with constructs to get around regulation. One such example is to do with risk-weighted assets, which are vulnerable to regulatory arbitrage. An example is collateralised debt obligations, which were pooled together and had this synthetic wrap around them to make them look like a triple-A credit rating when actually inside of that pool were some pretty toxic assets. Is that a concern of yours? Do you think that going forward regulators are going to be a bit smarter in spotting these things? What are your thoughts on that?
Lowri Khan: I think one of the important bits of the architecture that is not often looked at is the powers of the FPC to make recommendations on the scope of the regulatory perimeter, and by extension from that clearly it will have a need to look beyond the narrow scope of what is currently directly supervised to activities outside the banking sector that are off balance sheet, et cetera, and look for the build-up of risks there. I think it has moved forward, if you like, from supervisors looking for that because they naturally have their eyes drawn outside of the core banking system and to the wider-
Q147 Mr Newmark: I think out of that whole experience, which proved to be a disaster, were three things. First of all, rating agencies were disingenuous at best in terms of giving these instruments triple-A credit ratings, and I certainly have a concern over that. I think hopefully there will be more looking into the way credit rating agencies work and their behaviour, how they are compensated and so on, but I think there is a big, important issue of transparency, that even if something is wrapped with a bond-is something that you believe we must be looking into much more is more granularity at looking at these sorts of pooled assets so the buyers of these assets understand much better these assets there? Because you could have risk-weighted assets that look on the surface to be triple-A-rated but in reality are really junk bonds in some ways.
Lowri Khan: It has been part of the early focus of the interim FPC to look at some of these opaque funding structures, and I would hope it will be continuing.
Q148 Mr Newmark: The importance of having industry practitioners on the FPC, then, I think would be an important thing. Just following on from what Mr Hosie was saying, there are many important places where the UK regulation differs from global financial centres. As we have heard, the UK plans to implement higher capital requirements than the Basel III baseline. Based upon a recommendation from this Committee that the UK needs to go beyond the existing international standards, what makes the leverage ratio itself so special?
Greg Clark: It is a fair question. There is always a balance between having international consistency and avoiding regulatory arbitrage and reflecting the particular exposure of the UK economy. I think the fact that we have in this country institutions such as building societies, for whom this would be a material constraint on their business practice, leads us to pay particular heed to the distortions that it might introduce here. But it is a live debate, and I am not going to pretend to you that there is an answer that satisfies-
Q149 Mr Newmark: You must have a view on whether 3% or 4% is the right place to be. Because we had a race to the bottom when ratios began at around 6% or 7% at one stage and ran all the way down to pretty close to 1% when Lehman Brothers had 80 times’ debt and Northern Rock had 55 times’ leverage, I think. I am just curious. You are fairly new in the job. Do you have a view on that?
Greg Clark: There is an international debate about this. When Mark Carney was here, he reflected on the different experiences of Canada and of the US, and part of the discussions in Europe is around this. There is both the question of what is there, what is part of the denominator, how it is calculated and what the rate should be. I do not want to give a personal view at this stage as to what I would prefer to see. This debate is there and I think is-
Q150 Mr Newmark: Okay. Well, a decision was made, and again, following on I think from a point Mr Hosie made, leverage ratios are a clear restriction on the banking sector. I am just curious. Did you delay the implementation of a tool because you or your predecessor were actually lobbied by the banks on this issue?
Greg Clark: It was always our intention I think from the beginning this was going to be something that would be coordinated. Lowri will correct me-this was before my time-but in our response to the Vickers-
Q151 Mr Newmark: There were no conversations with the banks? There was a complete chinese wall?
Greg Clark: Well, I cannot recall any such conversations. I certainly did not feel under any pressure to do-
Q152 Mr Newmark: No, but was there a dialogue? Did you have a conversation with them, you or even your predecessor, on this?
Greg Clark: I cannot speak for my predecessors. I can write to the Committee. Lowri might recall.
Lowri Khan: I have a relatively short tenure.
Greg Clark: I think we both inherited-
Lowri Khan: I am afraid I have no recollection.
Q153 Mr Newmark: I think it would be interesting to know as a matter of record if there was a conversation that did take place between the banks. It is important for the banks. Banks are keen to obviously keep those ratios low and want to keep them low. We here felt, based on the recommendation that we had, that ratio should be higher. As there is the tension between what I think we felt was right, what an independent body felt was right, and what the outcome was-which was a different ratio, which was a lower ratio that as someone who came from a background in the City is probably more attuned to what they wanted-I was wondering, and I am really sorry to push you a bit on this, was there actual lobbying by the banks to you, your department or individuals on this issue?
Greg Clark: It is a fair point. I think, as I say, it goes back beyond the history of my colleague and me in it, but we will write.
Mr Newmark: Okay, that would be helpful. Thank you very much, Mr Chairman.
Chair: Thank you very much for coming before us this afternoon in your first hearing before the Treasury Select Committee and almost certainly not your last.
Greg Clark: Thank you, Chairman. Thank you, colleagues.