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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 1753
HOUSE OF COMMONS
TAKEN BEFORE THE
BANK OF ENGLAND FINANCIAL STABILITY REPORT
TUESDAY 17 JANUARY 2012
SIR MERVYN KING, ANDREW HALDANE, MICHAEL COHRS, and ROBERT JENKINS
Evidence heard in Public
Questions 1 - 187
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Taken before the Treasury Committee
on Tuesday 17 January 2012
Mr Andrew Tyrie (Chair)
Mr Andrew Love
Mr Pat McFadden
Mr George Mudie
Mr David Ruffley
Examination of Witnesses
Witnesses: Sir Mervyn King, Governor, Bank of England, Andrew Haldane, Executive Director for Financial Stability, Bank of England, Michael Cohrs, and Robert Jenkins, external members of the Interim Financial Policy Committee, gave evidence.
Q1 Chair: Good morning, Governor. We have a lot to get through. Thank you very much for coming. We have all the more to get through because you sent us an extremely interesting note, which we got on Thursday evening and have read carefully over the weekend. It is being put into the public domain as we speak. It is on that that I would like to begin. First, I would like to clarify the note’s status. Is this document written under the supervision of and with the authority of Court?
Sir Mervyn King: It was indeed.
Q2 Chair: Therefore, the person in charge of its authorship is not here today-that is, the Chairman of Court.
Sir Mervyn King: He is the Chairman of Court, but the whole of Court approved the report.
Q3 Chair: I am just trying to be clear: who is in charge of this document?
Sir Mervyn King: The Chairman of Court.
Q4 Chair: The reason why I ask that question is that I note you have signed this report as "Governor" rather than in your capacity as a member of
Sir Mervyn King: There was no reason to sign it as a member of Court. But it was important to demonstrate that my signature was on it, not least because the key part of that report is about the memorandum of understanding, which is an agreement between the Chancellor and the Governor.
Q5 Chair: Just to be clear-this was prepared by Court, under its authority and control.
Sir Mervyn King: Absolutely.
Q6 Chair: Okay. We all agree that the arrangements that have been suggested by you, Governor, and the rest of Court are ones which depend heavily on the success of the oversight committee. We have two members of Court here today, and I would like to ask Michael Cohrs whether he thinks that the oversight committee should be permitted to commission reports from within the Bank.
Michael Cohrs: Yes.
Q7 Chair: That is not in the proposal.
Michael Cohrs: Well, in the proposal there is not a lot of detail. It is a broad-reaching report. We have given examples in the letter about how you might do these.
Q8 Chair: But it is not in the report, so you argued for that and did not succeed.
Sir Mervyn King: Court already-
Chair: I am asking Michael Cohrs these questions, Governor.
Michael Cohrs: No, because we have not thought that we have gone into all the details as to how this will work. In your letter to us, you note that you want externals to do some reviews. In thinking this through, we have created the oversight committee. We do not have many details in our response back to you-a lot of those details will have to be thought about. We have given you an example of an external that might do the report.
Q9 Chair: What do you think is the likelihood of getting high-value reports from the IMF on this, against other groups?
Michael Cohrs: The IMF itself has something called the IEO, which is its internal body to look at its institution. It is an interesting body, and we might learn something from it.
Q10 Chair: But we haven’t yet, have we?
Michael Cohrs: No.
Q11 Chair: That is not included-indeed, that idea has been rejected by the proposal put before us today, hasn’t it?
Michael Cohrs: I don’t think it has been rejected. We have given you ideas and a framework, and now-
Q12 Chair: But it is a model very close to the one that we published.
Michael Cohrs: Yes. You mentioned the IEO in your report and, yes, we mentioned the IMF in our response to you. The IEO is worth looking at. The IMF is a reputable institution. It may be a sister institution to the Bank of England, therefore in some cases it may be an appropriate external body to bring in; in others it may not.
Q13 Chair: In which case you would need someone else, who might be internal. That is your view.
Michael Cohrs: I have always believed that bodies, like boards, need a certain amount of internal resource. When you have these external reports, you always worry-the Governor should worry, because he has to run the Bank-about the disruption that they cause, sometimes because of the rumours that they start. Doing as much as you can internally is a good idea, because you get good product, and it makes it a bit easier for the institution.
Q14 Chair: Given that, under the proposal put forward by Court, what it can do is restricted to process, what are the arguments against the oversight committee looking at the MPC?
Michael Cohrs: I don’t think there is a reason why it should not, but I am under the impression that we all believe that the MPC process and accountability work pretty well. The first item on the agenda was to get the FPC to where the MPC is.
Q15 Chair: But basically there is not a good argument against. I got the impression that that is what you were saying.
Michael Cohrs: I cannot think of one.
Q16 Chair: And we proposed that it should be included. Do you think that the Bank should internally investigate its own role and performance during the crisis and publish its findings?
Michael Cohrs: Probably.
Q17 Chair: Were you surprised, when you joined Court, that that had not been done?
Michael Cohrs: Not entirely, because the crisis is ongoing to some extent. If you look at the timing of the activities that I have done with the Bank, we have been so busy dealing with the ongoing crisis that it might have been premature to have done something.
Q18 Chair: But this needs to be done, and it should be done- initially, internally-as the FSA has done, for example, over at RBS.
Michael Cohrs: As I have said, it probably should be done.
Q19 John Thurso: Governor, can I come to you and try to get some detail about what the Court is proposing with regard to the oversight committee? This Committee and the Joint Committee on the legislation recommended fairly strongly that the Court should conduct ex post reviews of Bank performance in both prudential and monetary policy fields. In the memo that we have had from you, as I read it, the Court has disagreed and is suggesting that a sub-committee of the Court does this. Why does the Court disagree with us on this point?
Sir Mervyn King: I do not think that there is any disagreement on the Monetary Policy Committee. The functions that your report requested for the MPC-you went out of your way to say that you thought monetary policy was actually a model of accountability-are conducted at present by all non-executive directors, the NedCo of the Bank. That has worked well. If you want to subsume that within the oversight committee, fine. We have no problems with that. But the actual functions that you would want carried out are already being carried out, and your report did not suggest anything new in that respect.
Q20 John Thurso: Can I clarify my question, because I think you have not quite understood? My point is the reverse, which is why do you disagree that, for the new areas where we suggest there should be oversight, it should be a sub-committee and not the Court?
Sir Mervyn King: It should not be the Court, because the view taken was that in terms of the management of the Bank, the Court wanted a unitary board that would include the governors. You yourself proposed that. But it strikes me as one of the weaknesses of your proposal that you have the Court, including the governors, overseeing themselves. That does not make any sense. If there is to be oversight, it should be conducted by a body that does not include the executives at the Bank.
Q21 John Thurso: If you take the plc board structure, you may well have a sub-committee that is charged by the board and is under its authority to make an inquiry and produce a report, but ultimately it is the whole board that will always take the responsibility. Are you suggesting that the oversight committee that you wish to create would not act in that way? Ultimately, surely, it is the Court that must take the responsibility for oversight. Whether it discharges it by way of an internal arrangement of a committee, the point is that it is the Court that must have that responsibility first and foremost.
Sir Mervyn King: No, I think it would be wrong. I am surprised that you suggest that the executives should be responsible for overseeing themselves. With respect, one of the great weaknesses of the FSA report was that it was the FSA writing a report on the FSA. I do not think that that is a model for the future, and nor does Lord Turner. In future, if you are going to have reports or oversight, it is rather important that the people whose behaviour you are overseeing are not actually members of the board responsible for that.
Q22 Chair: That is why this Committee sent in specialist advisers of its own to check the FSA’s work. Do you think that that might be a model we should adopt with the Bank? Would you favour our appointing people to come into the Bank?
Sir Mervyn King: No, I wouldn’t. Either the oversight committee itself or the Treasury should appoint external people to carry out reviews. The Bingham report on BCCI was a model of that. That is a better model than either the FSA review of RBS or what you are proposing. What we see is something that we think is very close to what you want, but we think it would be a mistake to confuse the unitary board in managing the Bank with the oversight committee. The oversight committee-we don’t rule this out-could comprise all the non-executive directors, excluding myself and the deputy governors. I do not rule that out at all. It does not have to be a small committee, and it could include all the non-executive directors. That is something to be discussed. But the key principle on which the Court was very clear was that when it was discussing the budget of the Bank-remuneration, the management of the Bank and its normal day-to-day affairs-there should be a unitary board. The Court was absolutely unanimous on that, and when it comes to the oversight, the executives should leave the room. That seems the proper procedure.
Q23 John Thurso: If that oversight is conducted and a report is prepared by an oversight committee of all the non-executives, ultimately the Court has to take the responsibility for and give an authority to that. We cannot have a situation-surely you would agree-where the matter has been hived off into a sub-committee and the Court can say, "Well, that is a sub-committee; we do not really have to worry about it." That is the principle of all boards. Whatever work is done by the audit committee, the risk committee, the nomination committee or whatever committee you have, ultimately both the authority and the responsibility rests with the entire board. Would you not agree that however it is done in administrative terms, it is for the Court to accept that responsibility?
Sir Mervyn King: Well, if you want the governors to take part in a process that may end up forming a judgment about what the governors actually do, that is up to you, but I think people outside would find it very peculiar that the people whose behaviour and conduct was being investigated were on the committee that approved the report that passed judgment on them. I cannot see the merit in that.
When it comes to the policy decisions of the MPC and the FPC, the Court was also adamant that it did not want to be in the position of second-guessing whether those individual decisions were correct or not, either at the time or ex post. Other people will do that and, of course, in monetary policy it happens all the time. It is already beginning in financial policy as well. There is plenty of room for ex post review, but I do not think the oversight committee should set itself up as a body and say, "We are more expert than the FPC or MPC." Who is going to oversee them?
Q24 John Thurso: So, what you are suggesting is a committee that would work out if all the wrong decisions had been taken correctly.
Sir Mervyn King: No, I’m suggesting-
John Thurso: If the result of the process is a poor decision, who says that it was a poor decision? If all the governance steps in the process were correctly taken, but the result was wrong, which I think is what a lot of the criticism-
Sir Mervyn King: There are two or three groups you could point to. First, this Committee clearly has the role of challenging the policy-making committees. Secondly, there are outside commentators all the time. Thirdly, what we see as a key role of the oversight committee is, if necessary, to commission reviews from people outside, and then challenge the policy-making committees by saying, "Look, here is a respectable group that we commissioned to write a report. They found the following problems with the way you carried out policy. What is your response? What is your reaction?" They challenge them and make sure that those policy-making committees respond by giving a reasoned defence of what they did, or say, "Actually, yes, we have learned something from this experience. These people have a point in this or that area, and we have changed the way that we operate."
However, I do not think it makes any sense to have another group of unelected officials saying, "Actually, we want to second-guess the decisions taken by the first group." If you really believe they are better, you should put them in the first group to start with, and if you don’t think they are better, why do you want to listen to their views? Their job is not to second-guess the policy decisions, but to ensure a proper process of inquiry and governance; to make sure that the policy-making committees listen to other people’s views, respond in a reasoned way and conduct adequate debate within the committee; to ensure that there is proper exchange of views and information; and to ensure that policing-making committees are behaving in the way that you would want them to behave.
To do that, unlike the MPC, the FPC may in certain circumstances be using information that you, as a Committee, do not have access to. That is the real difference between the financial stability work and the monetary policy work and why, in our report, we focused on the financial stability oversight committee. We have no objection to the oversight committee taking on to itself the responsibilities that are currently carried out by all the non-executive directors in terms of oversight of MPC.
Q25 John Thurso: Can I ask about how you propose that the oversight committee would respond to Parliament and effectively to this Committee? Would the oversight committee respond directly to requests for information and make direct appearances as a committee in front of us?
Sir Mervyn King: Yes.
Q26 John Thurso: How do you see the potential conflict that may or may not be there if that oversight committee is coming to us directly, as opposed to as part of the Court?
Sir Mervyn King: None at all. It may be all the non-executive directors, but you have had hearings with the non-executive directors. When you have had the Court for a hearing here, actually, you have not invited the Court; you have invited the non-executive directors. I think that tells us quite a lot about what, in practice, you actually want. When you have had a hearing, you did not have a hearing with the Court, where I, the Chairman of Court and others came; you invited only the non-executive directors. That strikes me as appropriate.
John Thurso: We have been guests of Court, as I recall.
Q27 Chair: We invited the chairman and one of the deputy chairmen of Court, to be fair, and you make regular appearances. You seem to be reading a great deal into this.
Sir Mervyn King: No, no, I am just saying that when you want to discuss the oversight of the Bank and its governance, you quite rightly talk to the non-executive directors.
Q28 John Thurso: One last question, if I may, in regard to what is in your paragraph 13, which is the question between internal and external reviews. Listening to Michael Cohrs’s responses to the Chairman, it seems to me that that was not quite what was in paragraph 13. Paragraph 13 seems to me to state clearly that the oversight committee does not seek to get involved in any way in judgments that have been made. Having a good assessment of how judgments are made and where they arrived at is a critical part of learning for the future, however, whereas paragraph 13 would suggest that that can be done only by outsiders.
Sir Mervyn King: With respect, no. The oversight committee is to get involved in and find out how the decisions are made; it is not to second-guess what those decisions were. It is not to say, "You should have said to the banks" this or that, or, "Interest rates should have been half a point higher or lower." That is not what the oversight committee is. The oversight committee is there-including attending the policy meetings themselves and seeing whatever paper is circulated around the Bank-to form a judgment about whether the Committee is working in a proper way, whether it is listening to all views and whether it is properly ensuring that all points of view are represented. That is what the oversight committee is.
Q29 Jesse Norman: Governor, when did you first learn our recommendations about the changes to Court?
Sir Mervyn King: When your Committee report was published.
Q30 Jesse Norman: And when was that?
Sir Mervyn King: It was before Christmas.
Q31 Jesse Norman: It was 9 November. So why have we had to wait until this point, with one sitting day of Parliament, before we see a very substantive response from you and from Court on this rather delicate and important issue?
Sir Mervyn King: I did consult your Committee, through the Clerk, and it was suggested to me that January would be an appropriate time. There was no opportunity for you to call us here before today.
Q32 Jesse Norman: Well, I must say that this is a delicate matter. It would have been enormously helpful if you could have given us more than one sitting day of parliamentary time to consider it. I think it is rather disrespectful to the Committee, even if the Clerk did so advise or give any input. These are important and delicate matters.
Sir Mervyn King: Of course they are, but the legislation has not been introduced into Parliament yet.
Q33 Jesse Norman: If you are coming before us, we should have an adequate period of time to consider serious recommendations-on which you have consulted internally for months-before we have a chance to discuss them.
Sir Mervyn King: No, not for months. We are very happy to come back again if you wish to raise it at a time of mutual convenience.
Chair: Given the interest in this subject, I do not exclude that, Governor. Furthermore, we may need to reconvene to look at the FPC material as well.
Q34 Jesse Norman: Thank you for that, Mr Chairman. How much internal review has been done so far of the Bank’s performance before and during the financial crisis?
Sir Mervyn King: I shall be writing to the Chairman after this hearing about that. We have carried out reviews and we have published them. All the Bank’s responsibilities were subject to internal reviews, and we published those reviews. Indeed, the reason why the Chairman asked the question, I suspect, is because we actually move faster than most members of this Committee were aware. We published a review of our provision of liquidity insurance. Another document went out for consultation with the market, and we changed our arrangements. We have acted on the lessons we learned, and we published a completely new red book that governs the arrangements for liquidity insurance. There is no doubt that we could have done better in ensuring that we drew your attention to all this-I certainly accept that-but we did carry out reviews and we published the material.
Q35 Jesse Norman: Was the review of the internal decision processes within the Bank and the decisions made about the level of regulation and scrutiny to be adopted before the crash?
Sir Mervyn King: Sorry, can you expand on that last point?
Q36 Jesse Norman: Was there a substantive assessment, as part of that review, of the decisions made by you as Governor and other senior executives in the Bank before the financial crisis?
Sir Mervyn King: The decisions we made were exclusively to do with our legal responsibilities, and they were the provision of liquidity insurance. We have also sent a document to your Committee-
Q37 Jesse Norman: So it sounds like the answer is no. It sounds as though there was no substantive assessment of whether the right decisions were made in preparing the Bank for the collapse of the biggest asset bubble seen in recent memory.
Sir Mervyn King: That is not true at all. The responsibilities we had were non-existent in the area of bank regulation, and in terms of handling bank failure we had no direct responsibility at all. That was a matter for the FSA and the Treasury.
Q38 Jesse Norman: It still sounds as though there has been no substantive analysis or review of management or other organisational decisions by the Bank in the run-up or afterwards.
Sir Mervyn King: Our responsibility in the event of a collapse of a bank was to act as a lender of last resort and to think about liquidity provision to the banking sector more generally, and that we have carried out reviews into. We have published all our arrangements on that and the review that we carried out, and we consulted with the market. We have actually implemented them: we have not just published a review; we have done it. We have a completely new arrangement for the provision of liquidity to the banking system. It clearly would have been better if that had been in place before, but we carried out the review and we acknowledged that-as, indeed, "The run on the Rock" report from your Committee pointed out. We responded to that, we reviewed our arrangements, we reformed them and we changed them.
Q39 Jesse Norman: Your case for the oversight committee suggests that it is rather hard for anyone outside the Bank to challenge policy making on financial stability.
Sir Mervyn King: No. I think that was a point that you made in your report. The argument for having some kind of internal oversight committee was precisely because it would be harder in the area of financial policy for people to challenge the Bank, because not all the information was in the public domain.
Q40 Jesse Norman: Sorry, I do apologise, I am just quoting. It says, "Together, these differences will make it more difficult for an authority outside the Bank, like the Treasury Committee, to challenge and question individual financial stability policy makers."
Sir Mervyn King: Yes, and we are agreeing with the point that you yourself made in your own report.
Q41 Jesse Norman: This is the conclusion of an argument-I can see that you have made an argument-where you say, "Financial stability policy is different" from monetary policy. That is why this is an argument.
Sir Mervyn King: Yes, and we agree with your report in that respect.
Q42 Jesse Norman: No, this is not an argument: you are not deferring to our Committee on this point; you are making a separate argument.
Sir Mervyn King: No, I am not deferring; I am saying we reached the same conclusion.
Q43 Jesse Norman: You have made a separate argument to the same conclusion.
Sir Mervyn King: It is not separate: it happens to be the same argument that you made, but no matter. We set it out, we have gone through this and we have concluded ourselves that financial stability-
Q44 Jesse Norman: Good. So you hold that view-the key point is that you hold that view yourselves. Why is it the case, then, that you think the oversight committee should commission the views on financial stability policy from outside expert authorities, when you have already accepted-indeed, made the argument-that outside authorities cannot effectively hold the Bank to account?
Sir Mervyn King: Because with the benefit of hindsight, after at least a year-as in your own report-an ex post review could be carried out by a knowledgeable expert as to whether the right judgments were made.
Q45 Jesse Norman: Where does it say in our report that an oversight committee should do that? It doesn’t say anything of the sort. It talks about a supervisory board of the Bank of England.
Sir Mervyn King: Mr Norman, please read carefully the report. We have said that the oversight committee can commission from external experts-which could range from the IMF at one extreme to a UK individual expert on another-their views on the actual decisions that were taken and whether those decisions were appropriate. The oversight committee can then confront the FPC with that report and say, "In the light of this report, do you think you should change the way you carry out your work? Do you think you should have done something rather differently? What changes do you wish to make in the light of this?"
Q46 Jesse Norman: I apologise if I have not read adequately a report that I had one sitting day to review. You say that it is not possible for internal reviews to take place because of the risk that any internal review may be seen to take sides. Am I right about that?
Sir Mervyn King: That is a review on the substance, yes, and it is a very important point-it is a point I made before, to Mr Thurso. Let me give an example. Suppose you applied this to the MPC-you are more familiar with the MPC, so here is an example. If you are going to have the oversight committee say on the MPC, "We agree with the majority, and disagree with two minority members on the MPC about their stance on interest rates," and then those two minority members have a concern about the processes and whether they are being given adequate resources or information in reaching their judgments, the only court of appeal they have is Court and the oversight committee-so, non-executive directors. If they feel the non-executive directors have already taken up a position on their own policy stance-to disagree with them and say that they agree with the rest of the Bank-I think you will find that those external members of the FPC or the minority members, whoever they are, will feel that the situation has been prejudged.
Q47 Jesse Norman: It is a very curious thing to suggest that what the oversight committee is really doing is substantive, because what you have said is that the oversight committee does not seek to second-guess the decisions of policy makers. So those judgments are not actually going to engage in any of the substance, as one would probably consider it, at all.
Sir Mervyn King: It will engage in the substance.
Q48 Jesse Norman: In other words, Governor, what you are preparing and have presented to us, which we have had very little time to scrutinise or reflect on, is a situation as follows-if this is wrong, correct me. The Court has no substantive responsibilities and the substantive body will not tackle any issues of substance-that is to say, second-guessing decisions of policy makers-and will not be accountable. How on earth can we be expected to have a situation where we want substantive accountability and you’re giving us an approach that offers the Court with no substance and the oversight committee with no accountability?
Sir Mervyn King: I find your view quite extraordinary, to be honest. We want to be accountable to you in Parliament on substance-that’s what it’s for. I thought what your report suggested was that in certain areas, particularly financial stability, it was difficult for you to hold the FPC to account in the way you hold the MPC to account, because of the existence of information that at times is not available to you or the public. Therefore you need an oversight committee to do it. But as for the idea that you are going to create a Court of the Bank that is somehow going to say, "Actually, we think interest rates were set at the wrong level", or, "FPC decisions were wrong", or, "What not the PRA? They should have done something else to our bank," why on earth do you have an MPC, an FPC or a PRA to make those decisions? Their role is a key one. It’s not to second-guess the substance of individual decisions; it is to hold those bodies accountable.
Chair: That point is made very clear in our report. We agree with that point.
Sir Mervyn King: Absolutely.
Chair: So to be fair, you seemed to be, at that point, rehearsing arguments we’ve set out very clearly.
Q49 Michael Fallon: Just one small point, Governor. I think you said a few minutes ago that when the oversight committee met, you and the Deputy Governors would leave the room. The paper says that you may be invited to contribute to its meetings. Does that mean that you’re in attendance but not a member of it?
Sir Mervyn King: No. It’s entirely up to the oversight committee to decide its own procedures, but I would imagine that on certain occasions they would want us, if you like, to give evidence to them, but not to sit there normally.
Q50 Michael Fallon: Who’s going to chair this thing?
Sir Mervyn King: It will be one of the non-executive directors, and I think who does that has to be decided down the road. It is not for me to decide.
Q51 Michael Fallon: I wondered if you had a view.
Sir Mervyn King: The obvious person is the Chairman of Court, but I think we have to see who’s on Court and what their respective qualifications are.
Q52 Michael Fallon: Let’s bring in a non-executive, Mr Jenkins. Can you have one more go at this issue that the committee really should be looking only at process, rather than policy? Is that the best way to characterise it?
Robert Jenkins: Are you talking about financial stability policy?
Michael Fallon: Yes.
Robert Jenkins: I’m a little bit confused, actually, by the entire discussion. I think Mr Thurso quite rightly said that what we’re doing is replicating a lot of the best practice in board experience. There is a Court that’s akin to the board. The board can appoint a sub-committee; the sub-committee makes a recommendation; the board will approve or reject the recommendation. This Committee will examine the results of that recommendation. It can question it; it can challenge it. It will, with the blessing of the Governor and the executives, be free to call to account the oversight committee. So I think the issue of transparency and accountability is there. The Court could not disown a report by the majority of its independent non-executive directors, who by definition are in the majority of the board. If they were to have a conflict, you would be among the first to know about it when you conducted a review.
Going back to your question, I think that process is the issue. Inevitably, in reviewing what was done and why it was done, two things will be evident. First, with the passage of time it will be evident whether the decision was right or wrong; secondly, the process will reveal why it was right or wrong.
Q53 Michael Fallon: Michael Cohrs, do you agree with that, that it is possible to weigh the quality of the decision by focusing on the process rather than the policy?
Michael Cohrs: I think it’s possible. This is not an easy question. The Governor’s correct that there’s no point in having people second-guess the MPC and interest rate policy-that’s dysfunctional. But it’s also got to be the case that if you’re on this oversight committee and you’re looking at process, you have to look at the decision in retrospect. If the decision in retrospect was correct, that takes you down one path. If the decision in retrospect was not correct, that’s another path. That’s not entirely process, right? You could have had a great process and still have come, in retrospect, to a decision that wasn’t fantastic. So it’s a little more subtle than that, I would suggest.
Q54 Michael Fallon: So how would you characterise it, then? You’ve signed this thing.
Michael Cohrs: In a spirit of looking at your concerns, we’ve tried to address your concerns, but there’s a lot of detail that hasn’t been worked out yet.
Q55 Michael Fallon: But this isn’t detail, is it? It is going beyond process and saying there will be circumstances in which you want to examine the policy itself-where there has been a major disaster and something has clearly gone wrong, for example.
Michael Cohrs: No, look, Mr Fallon, I think that that must be the case but it is my experience thus far that the culture of the Bank is such that it itself will want to co-operate and make sure that it learns. What we are talking about is learning, right? We are trying to learn from what we go through, and I think that the Bank will want to learn. I think the Bank will co-operate in helping this oversight committee, if it is assembled and depending on how it is assembled, do its work. It is very hard to sit here today, because you are both right. The Governor is right that you don’t want any second-guessing, because that is dysfunctional. You are absolutely correct that just looking at process becomes a bit too sterile and may not get you to the heart of the issue.
Q56 Mr McFadden: Governor, the memorandum that you sent to us makes no reference to the Committee’s recommendation that the Court or the supervisory board should be responsible for responding to requests for information either from us or from the Treasury. Why not?
Sir Mervyn King: I think it depends on the form. The Court is not just going to send across hundreds of papers, but it would always respond, and the Bank has always responded, to requests for information from this Committee. At various hearings, this Committee has asked for a paper on this or a note on that. We have always provided it, and I am sure the oversight committee would too. We take that as given.
Q57 Mr McFadden: So if we regard what you said to us as not the final word, you would be quite happy to add something?
Sir Mervyn King: Well, I am not saying that we would change our view. I think that is a different issue. If you write to us and publish your response to our response we can come back with our counter-response, but I don’t think you should expect us necessarily to change our view just because you disagree with us.
Q58 Mr McFadden: I am not asking you to. What I am asking you to do is to respond to a specific recommendation in our Report.
Sir Mervyn King: Well, I am doing it now. If this Committee wishes to have a paper on something I am sure we will do our very best to supply that.
Q59 Chair: That is not good enough, Governor, is it? If we ask you for some information, are you going to supply it?
Sir Mervyn King: It depends on the quantity of information, the amount and the resources-
Q60 Chair: If it is an unreasonable request, you should explain that it is unreasonable. But that is unlikely to be the case, isn’t it?
Sir Mervyn King: I am perfectly content-
Q61 Chair: Have we asked you for anything unreasonable so far in the time that you have been Governor?
Sir Mervyn King: No, and have we ever refused you so far?
Q62 Chair: We need a counter-party who can assist us in working out what to ask.
Sir Mervyn King: If you make reasonable requests, I can give you that promise, as long as your requests are reasonable, so you’ve got your undertaking straight away.
Q63 Mr McFadden: Why are you so unwilling to write this down?
Sir Mervyn King: I don’t know that we are unwilling to write it down.
Q64 Mr McFadden: Will you add it to the note that you send us?
Sir Mervyn King: We will send you an extra letter saying that if the requests are reasonable, we will certainly meet them.
Q65 Mr McFadden: This is quite an important point, because there is a lot of talk about accountability in the paper that you sent us. The Committee regards it as very important to have access to information in order to make reasonable judgments. Without that, how does any accountability mechanism work? It seems to me quite reasonable to ask you in a 16-page or 17-page note on this to say that you agree with the Committee’s prior emphasis on this. Is that not a reasonable thing to ask?
Sir Mervyn King: I am very glad you have had the time to read the paper so carefully and notice this. I am very happy to confirm that. Clearly the accountability responsibilities of the Bank are not just between you and us. It is also to do with the Treasury, which will have views on all this. But I thought that the purpose of your report was to say that we should not think of accountability solely in terms of being directly to you, because, given the nature of the issue and the fact that many of the data or pieces of information could not be made available to you at the time, the kind of accountability that was appropriate was different from that of the MPC. I took that to be the main point of your report, and we have tried very hard to respond to it by creating new machinery. Just as with the MPC, where we feel ourselves directly accountable to you, we do not actually see a significant purpose in having another form of accountability, although the non-executive directors play a key role in monitoring the processes and being a court of appeal to any member of the Committee. We, as a Bank and as a MPC, have always responded to your requests for information, and we basically took it for granted that you would carry on.
Q66 Mr McFadden: We are asking for something more formal than that. I am not saying that your accountability is exclusively to this Committee, but in order for us to be able to do our work, it is important that, in this new structure that is being set up, the Committee has an assurance that requests for information will be met. You seem to be sort of hedging around this.
Sir Mervyn King: Well, I suppose it is partly because we have seen what has happened sometimes with FOI and certainly with parliamentary questions, where the burden is sometimes unreasonable. As long as we can argue that the amount of information that you are requesting is unreasonable and that the time scale is unreasonable, we will have an ability to say, at times, that we cannot meet all that. The general presumption, however, will be that, provided it is reasonable, we will certainly provide it.
Stewart Hosie: I just want to pick up a little bit more on this. Obviously, the recommendation was that the supervisory board-the Court-should respond to requests for factual information. You make the point in your memorandum that financial stability policy decisions not taken by the FPC, including covering the Bank’s balance sheet, would be made irregularly, sometimes in a crisis, and that they would on occasion remain undisclosed for some time for reasons we all understand. Is there a concern that if the Court or the new board were responsible for responding to those requests, such information might be made available earlier than would otherwise be the case? Is that a concern?
Sir Mervyn King: I think that it is question of whether there is a point at which information that previously could not be disclosed can be disclosed. Right from the very beginning, going back many years to when I first became Governor, if you look at the annual report, we said then, in the absence of any crisis, that when there was a lender-of-last-resort operation, we might need not to disclose that in the annual report or in our accounts, if such an operation could be identified. However, we also said that as soon as it was possible to disclose it in a way that was consistent with the purpose of the operation, we would immediately disclose it at that point.
Q67 Stewart Hosie: Let’s get into that substance, because we understand that you might not want a lender-of-last-resort operation to be published when it is ongoing, and we respect that. Indeed, general liquidity provision might come into that category, as you said earlier. However, we did not find out that the £60 billion loan to RBS had been made until about a year after it had been repaid. Was it reasonable that we were unable to scrutinise why that might have been done until that loan had been repaid? What is reasonable there in terms of information?
Sir Mervyn King: The first thing is that I understood that the Chair of the Treasury Committee had been informed. It turned out that that was not the case, but I had been led to believe that he had been. There is now an agreement, which the previous Chancellor made clear to the House, that from now on any such operation, even if not disclosed publicly, will be explained to the Chair of the Treasury Committee and the PAC, and there would be a joint briefing by the Chancellor and myself to those two Chairs. That is a very sensible arrangement.
How long afterwards is a matter of judgment. There were specific reasons in the case of RBS that were partly to do with state aid and partly to do with its market position. The legislation to which it was subject-the whole business of the asset protection scheme, which in the end turned out to be in operation for only RBS-was not finalised for a long time. As soon as it was and as soon as that was clear, I then recommended to the Chancellor that this operation could now be disclosed, and it was disclosed.
Q68 Stewart Hosie: How much did it prey on you that this information was sitting there and that it had not been disclosed? Was that something that you considered often?
Sir Mervyn King: We regularly considered when it was sensible to disclose it, and I remember having meetings with Andrew Bailey in the Bank, who was responsible for doing our work-vis-à-vis the Bank’s-in terms of providing liquidity, and saying, "Look. When are we going to disclose this?" The very clear view was taken, and I take responsibility for this, that until the asset protection scheme negotiations had been completed and until the market knew about that, the stability of that bank was at risk. Once people knew there was clear framework of what the Government were going to do and what they were not going to do, it would have put the underlying operation at risk if we had disclosed it before it was sensible to do so. We certainly reflected on it regularly.
Q69 Stewart Hosie: Let me just come back to the original recommendation and be clear, given what you have just said. In terms of our recommendation that the board would be responsible for responding to requests from us for information, I take it that you would have no concerns at all that it would approach these matters in any way that was different from the way that you did.
Sir Mervyn King: No, and indeed the transactions committee of Court was informed about all those things. It was aware of this, and it had to approve the use of the Bank’s balance sheet. It knew that all the way through.
Q70 Andrea Leadsom: Governor, I am pleased to see that the Court agrees with our recommendation that accountability as the economy moves into a crisis should be very, very clear. Can you explain why the Court proposes that that should be done via a memorandum of understanding between the Bank of England and the Treasury? How will that ensure that those lines of accountability are clear?
Sir Mervyn King: As I understood it, the concern expressed not only by your Committee but by others was that the question was, "Who was responsible for what?" The only way to do that is to write down a memorandum of understanding, which sets out with total clarity who is responsible for what at which particular stage of the crisis and what is the role of the Chancellor. That is a memorandum of understanding that, once the legislation is passed and the FSA, as such, ceases to exist, the regulation of banks becomes a PRA in the Bank. That is a matter between the Treasury and the Bank, and the Chancellor and I have been discussing and are very close to finalising the memorandum of understanding which, I believe, will go a very long way-if not all the way-to meeting the concerns that you expressed in your report.
Q71 Andrea Leadsom: If you look back to the scenario with Northern Rock, where effectively you had the Treasury looking at the Bank of England looking at the FSA, nobody did anything and we had a run on the bank. How would a memorandum of understanding have prevented that period of time where the public were so uncertain that they all decided to take their money out?
Sir Mervyn King: Well, up to that, none of the issues that we had discussed had any relevance at all. The reason why Northern Rock produced a run was twofold. This was a point I made to this very Committee only days after it had happened, when I came before this Committee-Mr Mudie will remember. First, deposit insurance arrangements were inadequate, so whatever was said, it was rational for people to take their money out because they wouldn’t get 100% protection. Now we have 100% protection up to a certain point.
Secondly and most importantly of all, there was absolutely no resolution mechanism which gave any of the authorities the legal power to resolve the bank. The problems that led to Northern Rock had nothing at all to do with lack of communication among the tripartite. Everyone knew exactly what their own responsibilities were.
Q72 Andrea Leadsom: But just to push back on that slightly, it was very clear at the time that nobody felt utterly accountable. What this seeks to deal with is the specific accountability for dealing with that crisis, and what was very clear then was that nobody had that accountability-no one body-which is why everybody was looking to everybody else, wasn’t it?
Sir Mervyn King: No, I don’t think that that is quite right. That came after the problems at Northern Rock. The reason you may feel that is, of course, because nobody had any responsibility for a resolution mechanism. There was no such mechanism in place. Governments of both parties had not put in place such a mechanism over many years. We were the only G7 country without a resolution mechanism, and there was absolutely nothing that could be done. Nationalisation of the bank was the only alternative to a resolution mechanism, which is, of course, where we ended up.
Q73 Andrea Leadsom: But in the case that we are talking about here, if we move to crisis, and crisis could be defined as a bank collapse, what happens, and certainly happened in the case of Barings-which I know you remember and I certainly remember-there was a call from the Bank of England to the Treasury, which said, "You are on your own, chaps," so the Governor at the time very much took charge, and there wasn’t a run on the bank. That was an issue of personal accountability. There was no taxpayer money going to be forthcoming.
How does what you are proposing ensure that that couldn’t happen in the future? In the case of Barings, it was an isolated incident. What we are staring down the barrel of now is again another banking crisis. Is a memorandum of understanding really enough to ensure that somebody is in charge? You are talking about resolution mechanisms. We wouldn’t be in the position of a resolution mechanism alone, would we? It is about public confidence. It is about who is actually in the driving seat. What this Committee has proposed is that, in the event-you might feel this is the case now-that we come close to the point where taxpayers’ money would need to be used to prop up a banking crisis, the Chancellor of the Exchequer should be notified and given the opportunity to take charge of that crisis. That is very clearly the recommendation of this Committee. Instead, you have come back with a proposal that there should just be a memorandum of understanding. How does your suggestion improve on what we have suggested?
Sir Mervyn King: If you look at our paper, it goes into somewhat greater detail on the powers that a Chancellor would have. I do not want to go into too much of this now because the memorandum is being finalised, but I am absolutely confident that, when you see it, the objective as you have just described it is completely met by the memorandum of understanding.
Q74 Andrea Leadsom: Just one more press on this. The taxpayers care about their money being used to bail out banks. We have seen that, haven’t we? There is absolutely no doubt about that. People really care about that, and the person who is accountable for the use of taxpayers’ money is undoubtedly the Chancellor, not the Governor. It is a political decision, and the Chancellor should be accountable for the decision to use taxpayers’ money. How is he going to get into the driving seat before it becomes a fait accompli where, effectively, if he doesn’t do so there is a banking collapse, all bets are off and the economy collapses?
Sir Mervyn King: This goes back to Johnson Matthey. I think you will see that there is a statutory duty on the Bank and the Governor personally to ensure that the Chancellor at all points is informed.
Q75 Andrea Leadsom: That was not the case in the very recent financial crisis, was it?
Sir Mervyn King: Yes, it was.
Q76 Andrea Leadsom: It was really a fait accompli.
Sir Mervyn King: What was?
Andrea Leadsom: By the time the Treasury stepped in to bail out the banks, there wasn’t really an alternative. We were not ahead of the game, were we? We were actually in a position in which the taxpayer had to bail out the banks. There were not lots of options on the table.
Sir Mervyn King: With no resolution mechanism, there was nothing that could be done about Northern Rock other than nationalisation. With the other banks, they were grossly undercapitalised and needed a great deal more capital, and I had been putting, right through 2008, a great deal of pressure to ensure that the banks raised more capital. Eventually, they did raise more capital, and the Government stepped in to do it. That was an issue where, very clearly, we were trying very hard to make sure that people knew that there was the likelihood that public money would be needed to ensure that banks were recapitalised. But the decision on whether to use taxpayers’ money, no matter whether it is £60 billion or £6, always has to be for the Chancellor. There is no question about that. This memorandum will make that absolutely clear if it is not. I would say that the irony of the situation in many ways is that ever since the early 1990s, if not long before, the only pressure the Bank has come under in the use of public money has been to play somewhat faster and looser with it than we ourselves would wish. Far from the Bank wanting to use public money, it has always been the other way around.
Q77 Andrea Leadsom: Just to turn it on its head slightly. Why isn’t it the best solution to have the Chancellor able to step in, if he or she chooses, to take control of a crisis as it emerges? Why is it better to have an MOU than simply a statutory right for the Chancellor to say, "Right, now I’m taking over because we could clearly end up in a situation where taxpayers’ money has to be spent"?
Sir Mervyn King: The MOU may well incorporate exactly that. As I said, I do not want to anticipate what the MOU will say. All I will say is that it will be published when the Bill is published, and you will see that.
Andrea Leadsom: An MOU is not a statutory right, is it?
Q78 Chair: Yes, just to be clear, Andrea’s question is, "Why can we not put this in statute?"
Sir Mervyn King: No reason at all, and I think you have to see it. The MOU will make it clear-
Chair: That is what we proposed.
Sir Mervyn King: Yes. I am not going to say any more about it now. This will be published by the Treasury, but I understand where you are coming from. I do not think you should assume today that we will end up in a different position.
Chair: I understand your reticence. Your replies are very helpful on this point.
Q79 Michael Fallon: There was a memorandum of understanding with the old, ill-fated tripartite, was there not?
Sir Mervyn King: There was, but there was no resolution.
Q80 Michael Fallon: But the issue, Governor, if you recall, is that it was not just the absence of a resolution procedure or depositor protection. The real issue-I asked you about this at the time in September 2007-was who was in charge. When I asked you that question, you replied, "Define what you mean by ‘in charge.’" I think that told us exactly what a mess we were in.
Sir Mervyn King: With great respect, it did not. At the time, the Government, like the present Government, said that under no circumstances-I repeat, no circumstances-did they wish to take charge of the responsibilities that had been given to the prudential supervisor. That is, the responsibilities to supervise the Bank will always stay with the regulator. That is the view of the current Government and it was the view of the Government then. I do not think you can say "in charge" vaguely. There has to be a clear definition of the powers and of who will be able to wield them.
I totally understand the point Mrs Leadsom is making is that we need to be clear that, in certain circumstances to be defined-a crisis-the Chancellor can exercise a well-defined set of powers that go beyond those which he would exercise in what we might call peacetime. That is precisely the purpose of, first, the MOU and, secondly, possible amendments to legislation.
Q81 Michael Fallon: We have proposed quite a wide discretionary power for the Chancellor to direct the Bank once there is an early warning that public funds are at material risk. The power you are proposing seems much more circumscribed and caveated.
Sir Mervyn King: May I suggest we wait for the MOU and have the conversation then? I think you may be pleasantly surprised.
Q82 Chair: If we are not, we may have to resume this conversation.
Sir Mervyn King: If not, we can have another conversation, but there is no point in having a conversation about a document that I am in no position, today, to release.
Q83 Chair: It is clear that this part of your paper has been extensively discussed with the Treasury. Indeed, you are telling us that you are in discussion with the Treasury and probably with the Chancellor right now on this.
Sir Mervyn King: It is more than that. I would say we are close to finalising it.
Q84 Chair: Could you just clarify whether the whole of this document has been seen and discussed with the Treasury?
Sir Mervyn King: I did send it to them.
Q85 Chair: When?
Sir Mervyn King: A week ago-something like that.
Q86 Chair: What response did you get?
Sir Mervyn King: That they had no comment they wished to make on it.
Q87 Chair: At all, except in this area?
Sir Mervyn King: Except on the MOU, where it is clear that this is something we are doing with them, yes.
Chair: Okay-it was just to be clear on that point.
Q88 Mr Love: I am in somewhat of a difficulty, Governor, because I think this discussion we are having at the moment goes to the core of the difficulties we experienced in the past. Calls to wait for the memorandum of understanding would, you may understand, frustrate us.
Sir Mervyn King: No, indeed. I suggest that we can discuss it again when it is published. I have no control over the timing of the publication of this. This is a document which the Treasury will put out when they publish the Bill. As the Chairman mentioned earlier, there is an interaction between the MOU and legislation here. It is not for me to do that; the Chancellor has to publish the proposed legislation and we can discuss the MOU when it is in the public domain.
Q89 Mr Love: But if we take your document-I call it your document; the Court’s document-and compare it with ours, in which we are asking for a statutory power for the Chancellor in certain circumstances, you seem to be suggesting conditions under which that should apply, as has already been said. It worries the Committee that we will not get the clarity of responsibility that is necessary in a crisis.
Sir Mervyn King: Well, all I can say is that having spent some time discussing the MOU, the one thing I would claim that it has is total clarity, and you will see that when it is published.
Q90 Mr Love: Let me just raise one issue with you. We asked for a formal notification of a risk to public funds, and that should be made. You have added that there should be a "serious threat" to financial stability as well. Why have you added that as a caveat?
Sir Mervyn King: No, I think there are different triggers here for quite different things. I think it is my responsibility to go to the Chancellor and say, for example, "Look, I am worried about a development in this sector of the economy. This poses threats to one or two banks, or to some other part of the financial sector. You ought to be aware of this. It is a long way down the road, but I can’t rule out that this could turn into something more serious that would require the use of public funds. I want you to be aware now." I promised him that he will not be deluged every Friday afternoon with a 75-page document spelling out the risks to financial stability or the use of public funds, because that is a document he will never have a chance to peruse. We will tell him when I am genuinely worried about something, but I will do it early. To take up Mrs Leadsom’s point, we will not wait until the last minute; we will tell him early. That is a very different threshold from saying, "Gosh, we are in a crisis. Now do we need to change the responsibilities in certain areas to give the Chancellor more control?" I think it is reasonable to have different thresholds for those different sets of powers-one is a warning and the other is a trigger for a potential change of powers.
Q91 Mr Love: We talked a lot about early warnings. The definition we put down was "a material risk to public funds". Should we be defining that? Will that be defined in the memorandum of understanding? Will we all be clear about the basis on which you will go to the Chancellor to tell him that his financial stability is at risk?
Sir Mervyn King: It is not for me to decide when he takes the powers. The Chancellor would consult me but I would not expect the Bank to be able to say, "No, no, no, we have not reached that threshold. You can’t take control over certain things." No, that would be for the Chancellor. But I can’t believe that any Chancellor will want to be put in a position where he has the ability to take control too early. Otherwise he will be held entirely accountable for everything that will happen. That does not seem a very sensible position to end up in. My job is to make sure that I don’t just use the detailed words in the legislation not to give him the information that he should have before. I think it is rather important that I give him information and express my judgment-these are in the end judgments-about whether I think there are potential risks down the road as soon as possible, so that he is aware of my thinking and how it evolved. We meet regularly every month and part of my duty is to make sure that each month I tell him whether my concerns have got bigger or smaller, there are new concerns, or all concerns have disappeared, so that he is aware of my views and judgment on this as time goes by. That seems to me completely separate from the question of under what circumstances would certain powers be vested in the Chancellor. But as I said, the MOU will make all that crystal clear.
Q92 Mr Love: What that seems to suggest is that the power will lie in your hands as to whether you should inform the Chancellor about a material risk to public funds. What we are anxious to know, and the public will be anxious to know, is the basis on which you will have to inform the Chancellor of what is going on.
Sir Mervyn King: Well, as I have said, I would feel under an obligation to inform the Chancellor of everything that I know that creates a potential risk to public funds, not in the sense of burdening him with vast amounts of paper as a way of getting it off my back and clearing my position, but as a way of having a conversation between a Governor and a Chancellor who trust each other where I say to him, "My judgment is that there are some severe risks" or "My judgment is that these risks are not terribly significant." That is a permanent duty and, as far as I can see, it is enshrined in the draft legislation. I have a statutory duty. If I did not do it, after the event this Committee could bring me here and say, "When did you tell the Chancellor about bank X or bank Y?" I would have to tell you when I told him about bank X or bank Y. There are minutes of the meetings that I have with the Chancellor. But, as I say, that is a different issue altogether from the criteria under which powers should be vested in the Chancellor.
Q93 Mr Love: This goes to the absolute core. The previous Chancellor said that he was frustrated in his ability to intervene to take charge at the time of the credit crunch. How can we ensure that that situation does not occur again?
Sir Mervyn King: I am not going to go into the details of the past. There is lot more to be said about that than has been said. All I would say is that the MOU makes that very clear and I would just ask you to wait patiently until the end of the month when the Treasury publishes the legislation and the MOU and then you can decide whether you feel that that is adequate or not.
Q94 Chair: Linking this to our earlier discussion, suppose after the event you failed in your duty to inform the Chancellor in a timely fashion, is that something you would expect the chairman of Court to make sure we were aware of?
Sir Mervyn King: I think it would become apparent that you would be asking me directly but I certainly think the oversight committee would-
Q95 Chair: We need to know to ask, don’t we?
Sir Mervyn King: If it is a statutory duty that I should inform the Chancellor and keep him in touch and then there is an event where a bank failed, I think it would be pretty odd if you did not know about it. You would read it in the newspapers if you had not seen it yourselves.
Q96 Chair: That depends what information came to you which may have led to a putative trigger. That is exactly the type of question that has led us to feel that the Court should have a duty to supply us with information in a timely way.
Sir Mervyn King: I would be disappointed if you did not ask me to demonstrate that I had informed the Chancellor, but I am sure the oversight committee would also want to know.
Q97 Chair: Okay. That is a helpful additional remark. You made another helpful remark when you said there might be a number of different triggers for informing the Chancellor. The relevant sentence in paragraph 31 of your note states: "That power should be triggered when there is a material risk to public funds and the Chancellor, having consulted the Governor, is satisfied that there is a serious threat to financial stability." If we were to change the "and" to "or", that would cover your point, wouldn’t it, Governor?
Sir Mervyn King: You are saying that the Chancellor should take the powers even when there is no risk to public funds.
Q98 Chair: But you are saying that there may be different triggers. That is what you said in an earlier reply.
Sir Mervyn King: That is something that we can discuss when the MOU comes out. My understanding was that this is about the risk to the use of public funds.
Q99 Chair: Just to be clear, when you were asked about a double trigger and whether two triggers need to be satisfied-first, the public funds, and second, the threat to financial stability, I had the impression that your answer was no when Andy Love asked you that question. Have I misunderstood what you said?
Sir Mervyn King: I think you may have.
Q100 Chair: So there is a double trigger, and the current drafting is exactly what you meant?
Sir Mervyn King: Yes. There is a double trigger for the change of powers, but there is a different issue altogether concerning the responsibility to inform the Chancellor of evolving concerns about public funds. I am sure you would not want to remove that. It would be very odd.
Chair: I think we need to give further thought to this.
Q101 Mr Mudie: I really am suspicious, Governor, of this paper and this particular part. Two Committees of the House-this Committee and the Joint Committee-have said that at a time of financial crisis the Chancellor takes over, or has the option to take over. He may devolve operational matters to you, but he takes over. He has that ability without using the 1946 Act.
Sir Mervyn King: What exactly do you mean by "take over"?
Q102 Mr Mudie: Takes control, takes charge.
Sir Mervyn King: Of what?
Q103 Mr Mudie: The Bank of England.
Sir Mervyn King: In terms of monetary policy?
Q104 Mr Mudie: We are at this moment in time discussing your paper on crisis management. Shall we just leave it at that, without being funny?
Sir Mervyn King: No, I am not.
Q105 Mr Mudie: Let’s just take crisis management. You mention three key principles in your paper. The first principle states: "At the most general level, the Bank has operational responsibility for financial crisis management; the Chancellor…should have…responsibility for decisions on…public money". You qualify that in principle two, but we will come to that. The third principle is "that the Chancellor should have a power to direct the crisis management operations of the Bank." Faced with those two things, who is in charge of crisis management-the Chancellor or yourself?
Sir Mervyn King: The Chancellor-when he chooses to exercise the power to transfer the powers that otherwise are vested in the Bank to him. But he will have to wait for the MOU to see the detail.
Q106 Mr Mudie: You are confirming that-it is the will of the Joint Committee and this Committee-when a crisis is notified and there is a danger of public money being used, the Chancellor has the option to take over control of crisis management in the Bank.
Sir Mervyn King: That is the principle that we have spelt out here.
Q107 Mr Mudie: That is where I think you are attempting to cross Parliament and muddy the waters, which did not serve very well in the last crisis. What does this mean in terms of the second responsibility? It is something you have never challenged before-the Chancellor’s right to take all decisions on the use of public money. In your paper, paragraph 30 states: "The Treasury must take decisions involving public funds in a way that does not hinder operational management of the crisis." What does that mean?
Sir Mervyn King: It means, if you take the special resolution regime-it has the example to which this essentially refers-that if the Treasury does not take decisions on the use of public funds in a resolution in a sufficiently clear and timely way, the operational management of that resolution will come under serious threat. We have seen examples of that.
Q108 Mr Mudie: Clearly, that is a matter for the Chancellor. He is in charge, remember. He would take the decision, and he would report and be responsible to Parliament for it.
Sir Mervyn King: Then the special resolution regime, the unit and the people doing it should be wholly transferred to the Treasury so that you can see who is actually doing what.
Q109 Mr Mudie: But this is your argument-throwing the toys out the pram-whenever anybody seeks to interfere in your empire.
Sir Mervyn King: No, it is not.
Q110 Mr Mudie: We have agreed that the Chancellor is in charge.
Sir Mervyn King: Absolutely.
Mr Mudie: We have agreed that there has never been any question-
Sir Mervyn King: I think you will find that the Treasury itself agrees with this point. It feels that it has to give the Bank sufficiently timely notice of its view on the use of public funds in order for the special resolution regime to function effectively.
Q111 Mr Mudie: But don’t you think that the Chancellor, being in charge, is pretty close to the Treasury and would do that without having it stipulated?
Sir Mervyn King: That is why I think you will find that the memorandum of understanding will go along exactly with what I have just said.
Mr Mudie: I watch with suspicion this memorandum of understanding.
Q112 Mark Garnier: On the make-up of the FPC and the MPC, in your response to us when we said that the ratio between internal and external members should go from 54% to 45%, you said that that was neither necessary nor desirable. Why did you say that?
Sir Mervyn King: It is a red herring, the link between numbers of internal and external members. The evidence we have got from the MPC makes it very clear that there is no suggestion that the external members operate together as a bloc, nor that the internal members operate as a bloc, nor that the decisions can be seen as internal versus external. Each person operates as an individual, and I think that will be true of the Financial Policy Committee too. I do not see the significance of the issue about numbers of internal versus external.
When it comes to the Financial Policy Committee, there are 11 voting members-12 with the Treasury non-voting member. Of those 11, five are Bank executives from the main policy part of the Bank. One is going to be the chief executive of the PRA. One is the chief executive of the FCA-clearly external to the Bank-and there are four conventional external members. I think that is a perfectly reasonable balance, and I cannot see any point in elevating to a principle that the number of external members has to be greater than the number of internal.
Q113 Mark Garnier: We have taken evidence from a great number of people who said that there was a very real danger that if you have a group, it will be a Bank of England group. The external members are a group of individuals, whereas you have one very identifiable group of Bank of England members. The advisers came to us saying that even if there is not at the moment evidence of group think, which you have obviously demonstrated in your document, there is a danger of it. I think the other point that is very relevant is that there could be a perception of group think. How would you respond to that?
Sir Mervyn King: We have got a long track record with the MPC. The one thing you cannot say about the MPC, whatever else you say about it, is that it has exhibited group think. There is no monetary policy committee in the world that has exhibited greater variation of votes and views than ours. We have got a demonstrable track record of not having group think.
On the Financial Policy Committee, it is true that our recommendations so far, in six months, have been unanimous. That was true for the first 11 months of the MPC. There are still a variety of views being expressed, however; you can ask the external members here today. I do not think we all agree with each other on everything, by any means.
Q114 Mark Garnier: Any committee can develop internally, as part of its culture, a culture of non-group think-of independence of thought-just as easily as any committee, or certain parts of it, can develop an internal culture of group think. We are talking about a new committee that is about to be set up in the FPC, rather than the interim one. How can the Court of the Bank of England ensure that no group think develops into this, when one of the easiest ways of demonstrating there is not group think is just to change the ratio to 54% of external members?
Sir Mervyn King: I don’t think that that in any way removes the danger of group think. What you need is to have a committee of individuals who are prepared, clearly, in a non-aggressive way, to put across their different points of view and to argue the issue through. The example you gave from one of your witnesses was that externals are fine because they are individuals, but the internals operate as a group. There is no evidence at all that the Bank individuals on the Committee-the Bank insiders-operate as a group. We have exhibited more dissent among the inside members of the MPC than any other central bank in the world. We have a track record.
Q115 Mark Garnier: How would you respond if there became a perception? It is easy for the press to take a view that there is group think. You would then have to go to the press and argue-
Sir Mervyn King: The best way of doing it would be for you to invite members of the FPC to this Committee and ask them what they think about different issues. I think you will find varying answers.
Q116 Mark Garnier: How will the Court monitor in future whether there is group think? If it monitors it, and concludes that there is a beginning of a tendency towards group think, how will it react?
Sir Mervyn King: There are two ways. First, as it does now. The Chairman of Court has an in-depth interview with each individual member of the MPC. The Chairman has made it clear that that will be extended to the FPC. They will be asked, in private, "Do you have any concerns about how the committee is being operated? Do you think that there are signs of group think? Are you worried about that?" Secondly, the Court, or the oversight committee if you adopted our recommendations, will be able seek views from outside people about whether they think the committee is exhibiting group think.
One of the challenges to any policy-making committee is that it has to combine two things that are very different and that often conflict. First, we have to exhibit, in internal discussions, the absence of group think, so that we think through issues sufficiently carefully to get to the right answer. Secondly, to the outside world, we have to convey that there is a message from the committee and a clear signal about what its decisions are. That requires an element of team work in relation to communications. Both committees are conscious of that. We have an extraordinarily good record in the Bank over the past 15 to 20 years of not having group think.
Q117 Mark Garnier: In future, will the minutes of the FPC continue to be as detailed as the ones that we have had from the MPC, in terms of the views of each individual member?
Sir Mervyn King: When we get to the point of having votes, and if there is a dissenting vote, all the views will be expressed in the minutes, as they are with the MPC.
Q118 Mark Garnier: But when various members voice their concerns or opinions about certain things, do you not think that minuting all that would be a very good demonstration-
Sir Mervyn King: Yes, and we will certainly do that. The MPC is somewhat different from the FPC, because in the MPC there is a single instrument-it used to be interest rates; now it is asset purchases-over which members form different views. You have arguments for and against, and that can be spelled out. On the FPC, we have to go through two stages. The first is to try to work out the questions on which we think it is worth spending more time and which instruments we should explore at each meeting as something on which we might or might not want to make a recommendation. If we decide that we do not want to go any further down a certain route, we stop. The first part of our minutes, we hope, will explore some of the arguments that led us not to go down those roads but to focus on the two or three questions on which we eventually voted. We always have a formal vote on the recommendations, and the arguments for and against them are in the second part of the minutes. In the first part, we hope to explore some of the arguments that led us to focus on the areas on which we ended up making three or four-whatever the number-recommendations.
Q119 Teresa Pearce: Governor, in your response you said that the change in ratio of external members of the Committee was neither necessary nor desirable. You have said that there is no group think in your track record, which demonstrates that change is not necessary, but why would it not be desirable? You have said that group think does not happen, but that does not mean that it could not.
Sir Mervyn King: It would be very peculiar to make a principle of having more external than internal members. I am also concerned about the total size of the committee. The MPC is nine-people strong. I think the Federal Reserve board is nine for the internal debates. But there is a formal meeting when they get together in a larger group. We want to have genuine and open meetings. Nine is more than enough for monetary policy. Eleven-12 with the Treasury representative-is the FPC. It is actually very difficult to have a good discussion, where you can get to the bottom of things and everyone has a chance to give their view and argue through a point, with more than that. Otherwise you end up just going round the room with each person having a short say, and then on to someone else. That is not a good vehicle. You have sat on more committees than I have, I am sure. Where it is that a chairman has real control of a meeting is where no individual has a chance to say much, apart from one or two short interventions. Our meetings are not at all like that. They are genuine across-the-table debates about the issues. It is very important we have that. There is a real cost to just increasing the numbers.
Q120 Teresa Pearce: So your objection would be to an increase to the numbers, not changing the ratio between internal and external.
Sir Mervyn King: Yes, but I think that the internal members who are on it are on it for very good reasons. It wasn’t we who said that the chief executive of the FCA should be on the FPC. People have added those to it for good reason. You need to have the people. Andrew Haldane is the man whose team is responsible for drafting the financial stability report. He needs to be there, just as the chief economist is present on the MPC. It would be most peculiar to have an MPC without the chief economist of the Bank sitting on it, and it would be most peculiar to have his opposite number in financial stability not on the financial stability committee.
Q121 Teresa Pearce: In your response, you said that diluting the internal membership would undermine the Government’s purpose of asking the Bank to undertake activities in the first place. But now you’re saying that that is not-
Sir Mervyn King: I think it is another powerful reason.
Teresa Pearce: But it is more about the size of the committee.
Sir Mervyn King: I am sorry that Mr Mudie is gone. No doubt he would say I was-
Chair: He will be back in a moment.
Sir Mervyn King: Good, but I will make the point now. If you have got a majority of non-Bank of England people on the committee, it’s hardly a Bank of England committee; it’s an ad hoc committee with a few Bank of England representatives. I think that one of the roles that the internals play is, on certain issues, to represent the long-term interests of the institution. The concern about stability and the reputation of the Bank of England are things that we should take great account of.
Q122 Chair: That is a pretty scathing and sweeping remark about a proposal that has been made by a good number of ex-MPC members.
Sir Mervyn King: Most of the people who have sat on the committee would not want an expansion of its size. I am not at all clear that the majority of former MPC members would go down that route. Those who chose to speak to you-
Chair: I did not say that.
Sir Mervyn King: No, you did not, but those you chose to speak to.
Chair: Are you suggesting that we picked people with the intention of getting particular evidence, Governor?
Sir Mervyn King: Only you can answer that, Chair.
Q123 Chair: You are withdrawing that suggestion, are you? Could I just bring in Mr Jenkins?
Robert Jenkins: Could I offer a trite observation? I think a lot of the discussion is driven by the desire to replicate what we know to be best practice in corporate governance, to the extent possible within the Bank; Mr Thurso began with that theme. Certainly, when it comes to the Court, or supervisory board, a majority of independents is an appropriate and good analogy with best practice. When it comes to the operating committees-the key policy and decision-making committees-I think the analogy tends to break down. These are executive functions of the organisation, which is being overseen by the Court.
I think at the policy level, whether it is the MPC or the FPC, the issue is not whether there should be a majority of externals, but rather whether the configuration is sufficient to deliver on the objective. Whereas the majority of externals are there at the Court level to ensure independence of views and to avoid conflicts of interests from the internals, at the policy committee, the role of the externals is to challenge the thinking, to bring to bear additional expertise that might or might not be available within the Bank, and to stimulate discussion and ideas that might otherwise not take place. That needs to be done, and it still needs to get the job done. Getting the job done requires, first and foremost, expertise on the issues of the day. The people who are around the table from the Bank are needed.
I think what you should focus on going forward is whether the external and independent members are truly independent. Do they actually perform the job that you hired them to do? Are we yes-men? Do we hesitate to express our views, publicly or privately?
Q124 Chair: That is why I began with whether this was a Court-agreed document.
Robert Jenkins: But my point is that the parallel breaks down when you get to the MPC and FPC level.
Q125 Chair: That is very helpful clarification. I now turn to what was going to be the subject of this hearing, had that interesting memo not come to us. We are very grateful for that memo and, notwithstanding a number of questions that have been raised about it, it does take us some of the way, and has a number of very interesting thoughts in it. Mr Cohrs said that a huge amount depends on the detail, which is not set out in the paper. On the basis of what we have heard, I think we would all agree that that is true. We on our side also think that there are a number of substantive points that probably need to be taken much further.
I want to make one more point to you, Governor. We do not see this as a zero-sum game. This is a process whereby, if we can get the accountability right, the authority of the Bank will be greatly strengthened. There are benefits on both sides.
Sir Mervyn King: That was entirely the spirit in which we constructed our document. All I would do at the end of this section of the hearing is urge you to think carefully about how far ahead of other central banks we are, in terms of accountability. The Federal Reserve and the ECB do not even have a court of any description whatsoever.
Q126 Chair: Even if we are doing well, I am sure you would agree that we should always try to do better.
Sir Mervyn King: That is what we are trying to do, Chairman, in the right way.
Q127 Chair: With that in mind, let us turn to the work of the FPC. I would like to ask you one general question at the start, before bringing in George. It has to be about the activity taking place with respect to EU treaty changes. The UK exercised what is described as a veto in order to signal that it had not obtained the safeguards that it wanted with respect to regulation, among other things, of financial policy. Do you think that veto secured the safeguards?
Sir Mervyn King: That is not for me to say; that depends on how legislation will pan out. I know that members of this Committee have taken different views about the decision that was taken. This is a political matter. I am very mindful of the fact that at earlier hearings you have always advised me not to stray into political territory, and I think I should be mindful of that advice. I am not going to comment on that.
Q128 Chair: I cannot remember saying that, though no doubt I might have done. You have said that views differ across the panel; it would be helpful-
Sir Mervyn King: No, I said that across your Committee they differ.
Chair: Oh, across our Committee. In which case, I will bring in George.
Q129 Mr Mudie: Governor, since June the FPC has been advising banks to limit their distribution in dividends, salaries and bonuses. This is almost déjà vu; this is the Bank and the FSA in pre-crisis days making speeches and the financial world taking no notice and carrying on, with disastrous consequences. The FPC has made its position clear. Is there anything the Bank and the regulator can do to stop what looks like the intended ignoring of public opinion, and bad practice within the banks? They are sacking thousands of people and they are not lending to small businesses, but the same CEO is taking millions home, to the disgust of the British public.
Sir Mervyn King: I sympathise with the sentiments behind that, so let me be clear about the powers.
Q130 Mr Mudie: What about the powers?
Sir Mervyn King: As far as the FPC is concerned, of course, it has no powers at all at present. I very much hope that in Parliament you will vote to give the FPC powers, so that ultimately, once the legislation is passed, it will be able to issue a direction to the FSA. We cannot do that now; we can merely advise. Clearly, the FSA itself at present has limited powers; it can merely enforce the codes on compensation that have been agreed at international level. Of course, once you have the power of a supervisor, that gives you a greater ability to influence, and I have no doubt at all that the FSA is being absolutely clear to the major banks about what it expects. It has asked them to submit their compensation proposals.
As far as the FPC, which is the only body on which I can speak today, is concerned, we can merely reiterate that our view is that banks will be very well advised to ensure that, whenever possible, they improve the resilience of their balance sheets, so that, when there are surprises down the road, they will be in a stronger position and they will not have to cut back lending to the real economy. At present, the best way to do that is to ensure that, rather than distributing a great deal in dividends or compensation, they plough it back into the balance sheet of the bank. However, we are of course not responsible for an incomes policy for banks, and I do not think that would be a sensible direction to go in.
I would say one final word on this, Mr Mudie, which is that there are four big banks that dominate the market for lending in the UK, and we have been through-you know this-a crisis where the squeeze on real living standards has been unprecedented. That squeeze on real living standards has been on people who were clearly in no way responsible for this crisis. I think the reputation of those institutions will be affected if their senior executives reward themselves-particularly in a period when the performance of the banks, in terms of their share price, has hardly been stellar-with very substantial compensation. That is a matter for them to decide.
Q131 Mr Mudie: You say that we do not have an incomes policy, but a nurse gets 1% and the bankers can get what they award themselves. We are going through austerity, and there is real anger about it out there. It is quite disgraceful.
When we last had you in during the crisis, one of the things that you hit us with was that your justification was "I didn’t have any powers." We asked whether you had sought them, and your answer was yes. Have you, the Bank, the FPC or the FSA sought help from the Government? Ten days ago, the Prime Minister and his Chancellor were in the papers, saying "We’re going to have to do something about this." Has anybody asked them to do anything about this up to now? Have you made representations?
Sir Mervyn King: I am not going to disclose the private conversations that I have had, but I think you can take it for granted that your concerns about the impact of this scale of compensation and the attitudes of other people in the economy are very much in my mind. I do think that if we expect a market economy to work efficiently, not merely must it be efficient, based on incentives, but it has to be seen to be fair. The rewards have to be understood. If some people are accepting very low rewards at present, they must understand that it is fair that other people receive very high rewards, and it is rather hard to see that happening at present.
Q132 Mr Mudie: The story with the senior banker in RBS who is tipped to be earning £4 million this year is that the remuneration committee cannot explain, and no one can find out or see any specific details, in terms of performance, that permit him to get this £4 million. Is that acceptable in the banking industry?
Michael Cohrs: No, it is not acceptable. Even with contracts, there can always be discussions when circumstances change.
Q133 Mr Mudie: While we have you-a recent banker-here, why are major banks so willing to spend money abroad and with fellow banks, but genuinely reluctant to fund small and medium-sized businesses? If we are going to rebalance the economy, it cannot take place without funds.
Michael Cohrs: Because, Mr Mudie, lending to SMEs is a very expensive business. The loans are of small amounts. You might end up with hundreds of thousands of loans that have to be administered. You end up with thousands of credit officers, because you cannot rely in any way, shape or form on a public rating for these companies.
Q134 Mr Mudie: The Germans do it.
Michael Cohrs: We did do it when I used to do that.
Q135 Mr Mudie: Yes. They are continuing to do it successfully, and have kept a manufacturing base intact.
Michael Cohrs: Basically, we ran the units, and they were not very profitable, but we saw it as our duty to the country to run the Mittelstand books. It is an expensive business.
Mr Mudie: Well, pay the bankers less money, and we might be able to afford it. Is that not the circle?
Q136 Mr McFadden: Following on from this, Government policy makers have been faced with the argument from the banks over the last few years that they are being asked to do two contradictory things. One is to strengthen their capital position, and the other is to do more lending to the small and medium-sized businesses that George Mudie talked about. Mr Jenkins, I want to ask you about your speech, "Lessons in lobbying", from November. In that, you took on this argument and said: "the truth is that banks can strengthen their balance sheets without harming the economy. They can do so by cutting bonuses, by curtailing intra-financial risk-taking and by raising term debt and equity." I want to ask you to expand on that a little, because it is really important that the public understand. Are you saying that the argument that the banks have been peddling, about contradictory pressures being put on them, is completely bogus?
Robert Jenkins: Yes.
Q137 Mr McFadden: There is therefore no need for them to curtail their lending to small and medium-sized businesses in the way that we have seen over the last two or three years, in your view.
Robert Jenkins: Making the banks safer through greater resilience in their balance sheets and more capital does not, in and of itself, prevent additional lending. Every £1 billion of less bonus would support £20 billion of additional small business lending.
Q138 Mr McFadden: That is quite a striking figure. The bank shareholders are also beginning to turn to this argument. The Chairman quoted the letter from the Association of British Insurers, which was sent round. That letter said: "It is our members’ view that it can no longer be business as usual for this remuneration round. They"-that is, its members-"expect to see significantly lower bonus pools and individual awards given the current market circumstances. It is essential that all banks take, and are seen to take, a responsible approach." When we asked Bob Diamond whether he agreed with that, he could not tell us. What is your view of the mood among bank shareholders? Do you see it becoming more activist on the question of reward?
Robert Jenkins: It is a very good question. It almost invites an hour’s lecture on the fragmentation-
Chair: Another time.
Robert Jenkins: Yes, I know. I think the main issue-this will come up in the Government’s recommendation to make remuneration votes binding-is not that; it is whether or not shareholders, through their agents, hold failed management and boards to account. I do not recommend that investors manage who gets what bonus, or even necessarily the details of the structures, but I lament the failure of the investment management industry to hold directors-executive and non-executive-to account for allocating far too much of shareholder funds to the employees.
Q139 Mr McFadden: Finally, may I ask you this, Governor? The political parties have been almost competing with one another in recent weeks to come up with different policy ideas on the question of reward. I know you cannot go through them one by one and make a judgment, but taking them in the round, I want to ask you two things: first, do you think there is a danger that political rhetoric will not be matched in reality by sufficient control mechanisms on reward at the highest level? Secondly, is the political focus on reward at the top-for perfectly understandable reasons, going back to what George Mudie said about the nurse who is on a pay freeze or a 1% limit for the next few years-in danger of crowding out a more important discussion about the function of banks, and the lending to the real economy that will create the jobs and growth that we need to see?
Sir Mervyn King: I would answer yes to both questions. On the first, you can see the risk in the international debate about compensation, where there was an attempt through the financial stability board to construct a code that would limit compensation. Frankly, everyone involved in that knew that this was something that could be got round relatively easily. There is a gap, I think, but I understand why the political rhetoric is there, for all the reasons that we have heard.
Secondly, to go to the question of what we do about it, the point you make is of profound importance. I have always felt that the easiest way to deal with this is not to put pressure on, or to try to create edicts saying, "Thou shall not pay a bonus", but to go to the heart of the question of why it is that these bonuses are being paid. Deep down, far and away the most important objective that we should have is to end the "too important to fail" characteristic of banks. If we could do that, we would reduce to a very large extent the profits that are being earned by transacting in financial instruments on the back of money borrowed at very low interest rates, because people feel the institution will be bailed out if things go badly wrong.
Therefore, the Vickers report is of fundamental importance in taking us a step down that road, as are all the other aspects of dealing with resolution and ending "too important to fail". That is the thing that, in the end, will change the economics of banking in a way that will make their wish to pay these bonuses much less.
Q140 Mr McFadden: Vickers is really directed at the universal banks, and the danger of the implicit taxpayer guarantee underwriting risky activity. You are making a wider point, and it is obviously true: the culture of high reward goes well beyond the universal banks that Vickers has focused on. It goes right across the board.
Sir Mervyn King: It does, but I have not heard many people, when I have gone round the country, complaining about the returns to people in hedge funds. They can make a lot of money running a hedge fund, but they can also lose their job and go bust tomorrow. We have many examples of people who have done both, but the one thing that everyone round the country knows is that their taxes are not being paid to bail them out. That is, deep down, one of the reasons why people have become so concerned. They have seen this extraordinary squeeze in their living standards, but as for the institutions were right at the centre of the crisis that created these problems, those people now seem not only not to be suffering a gigantic squeeze on their living standards, but actually get continued very high remuneration, in part because the taxpayer has been forced to step in and bail them out.
Q141 Mr McFadden: The anger is reinforced by the function point.
Sir Mervyn King: Indeed.
Q142 Mr McFadden: As well as all that going on, we still have small and medium-sized businesses saying that they cannot get the funds.
Sir Mervyn King: Absolutely.
Q143 John Mann: We had a long discussion about accountability, which I did not contribute to, but I want to ask the Governor about the accountability of the ratings agencies. We have had plenty of examples of rogue traders. Is it possible that the concept of a rogue rater could exist?
Sir Mervyn King: The rogue traders we have seen have been people who have been accused-and in some cases found guilty-of criminal behaviour. I don’t think there is any suggestion of that in rating agencies. As I understand it, the concern has been, in the wider debate at least, primarily in terms of their competence and in terms of their pro-cyclicality-that is, that they got carried away themselves by the hubris surrounding the financial sector before the crisis; and, once the crisis has hit, they rush in to be the first to downgrade and then create a pro-cyclical process.
The question is what we do about it. To my mind, far and away the best way of dealing with this is for public authorities around the world to be seen to rely far less on ratings than they do. Central banks are right at the heart of this; so in our own operations, we do not use ratings as a mechanical basis for which we would extend funds. I think that central banks, including the Bank of England, need to go a lot further down the road of dispensing with the use of rating agencies and the ratings.
There ought to be a market for ratings in the end, and we want as much competition as possible, so that they have a reputation that can be used. The problem that we are seeing at present is very much focused on ratings of sovereigns-and this was never an issue until pretty recently. Here it is very difficult, because the last thing you would want to do is to create a publicly owned rating agency, because you would know that it would never come to an objective view about its own sovereign debt, and it might not well come to an objective view about other sovereign debt. Equally, what we need to do is to move to a point-I think markets have gone some way towards that-where they pay less attention to the verdicts of the rating agencies. From that point of view, I think we can be reasonably encouraged that the response of financial markets to the downgrading of France, for example, has been pretty muted. Most people make up their own mind what they think about France. They don’t just rely on the rating agencies. What we need to do is to make sure that, as far as possible, we don’t have a large pool of investors-whether it be pension funds or others-who have built into their portfolio decisions mechanical responses to changes in ratings, which you can see from time to time. That is what we need to find a way to get away from. Central banks have a big responsibility for taking a lead on that question.
Q144 John Mann: I am not asking you to comment on its judgments, but we have one ratings agency-Standard & Poor’s-that has been quite unique compared with its competitors in what it has been stating and announcing. That has had huge amounts of publicity, over a period of quite some months now, when it comes to its rating of sovereigns. Don’t you think that there is a danger that, not the informed markets, but politicians, media and others are increasingly over-responding and potentially over-relying on a highly unaccountable set of organisations, one of which, in this instance, has taken a very different view from all the others?
Sir Mervyn King: But a way round that is to put less focus directly on what the rating agencies say and more on what the market as a whole is saying-in the sovereign debt case, for example-in terms of the spread or yield on the sovereign debt of a particular country. It is one thing to say these rating agencies are just reacting and trying to make up for the mistakes of the past; it is another to ignore the message from the market that the yield on Government debt has moved to very high levels. That is not the rating agencies driving that; that is the judgment of very many investors all round the world. That is something that we should focus on much more than the actual official rating.
Q145 John Mann: That is what I wanted to ask you about next. There are, in terms of everyone’s agenda round this table, increasing problems with sovereign debt. Within that, what would you see in the next 12 months as being the key priority for the UK, not just in terms of your own role, but in terms of the UK and the UK economy?
Sir Mervyn King: It is two levels really. What we are seeing is a problem in the world economy, and it is vital that we try and work with our partner central banks and Governments abroad-we try and do this through the G7, the IMF, the G20, and so on-to try to move to a position where we get back to steady growth. 2012 will pose a challenge in that respect, because some of the big emerging market economies are slowing down. Within Europe there is a particular challenge, clearly. The European Central Bank, with the operations it announced just before Christmas, has gone a long way to try to ease some of the immediate financial pressures on banks in the euro area. But of course, the European Central Bank cannot, on its own, change the underlying problems which are a challenge to the euro area, which are: loss of competitiveness and current account deficits, which, by the laws of arithmetic, need financing-they must be financed somehow. The question is: who is going to finance them and how? Those are the underlying challenges. Creating yet another liquidity facility buys more time, but we have bought a lot of time over the last two years. It is hard to argue that the time that was bought has been used productively. The European Central Bank can do so much, but no more. In the end, this has to be a question for the Governments of the euro area.
Q146 John Mann: In terms of your role and the Bank’s role, interest rates have been set at record low levels. That is not a new approach on policy; that has been consistently the case. You have used quantitative easing in a significant way twice. In terms of the position of UK banks in relation to the ongoing debt crisis, do you have options or, in essence, are you and the Bank a rather small but stable player that is parked on the side, in terms of what you are doing?
Sir Mervyn King: I do not think anyone can put themselves outside the turmoil that is going on in the world economy. We are going to be affected by it as much as anyone else, but in terms of the UK banking system, we announced, again just before Christmas, a new facility-the extended collateral term repo facility-which we have not activated yet, because UK banks do not need it. They have a lot of liquidity at present; they are not under immense immediate liquidity pressure.
One of the reasons why the FPC has put so much focus on trying to encourage banks, when there is a suitable opportunity, to increase their capital reserves, to have more capital in the bank and to increase liquidity, if they can, is so they can put themselves in a position where they will appear to be as secure as possible when unexpected events come along. The proof of the value of that is twofold. First, I do not think that any UK bank, despite what it said at the time, regrets raising more liquidity or capital over the past 18 months-I think they are pretty glad they did, and they have got it. Secondly, when the European Banking Authority carried out its assessment of the capital needs of big European banks in the autumn, it concluded that over €100 billion of additional capital was needed around Europe, but that the amount of additional capital that it thought British banks needed was zero. In other words, it judged that British banks were as secure as any other and in a reasonably strong position.
The actions that our banks have taken over the past year have put them in a stronger position than they would otherwise be in-a strong position vis-à-vis their European counterparts. What the FPC is saying is: "Don’t relax. If you get an opportunity to plough money back into the bank, to raise capital or liquidity, take it. If you get an opportunity to raise term funding, it may not look cheap, but it doesn’t matter-take it. You won’t regret it-you’ll have a stronger balance sheet, and in the long run, that will underpin the success of your bank."
Q147 John Mann: We have a higher budget deficit than some within the eurozone. Do we not have a dilemma, policy-wise, in the sense that we are seen as a safe haven at the moment for investors, not least in relation to bonds, but we want the eurozone to get its act together? If it does, we will no longer be such a safe haven, and therefore the competitive pressures will potentially lead us to being even more exposed, year on year, because of the level of our deficit. How should we deal with that dilemma?
Chair: Try to answer more quickly than the question, if you can.
Sir Mervyn King: If the euro area is successful over the next two or three years, that will benefit us enormously, because our exports will go up, our rebalancing will improve, our growth will rise and our deficit will come down. I do not think we have any interest in the economic failure of any other part of the world economy.
Chair: You probably already know that we are doing an inquiry into risk rating agencies, and we will be starting to take evidence on that towards the end of February.
Q148 Andrea Leadsom: Andrew Haldane, I thought I might bring you in. The Governor has just been saying that UK banks are actually in pretty good shape-their capital ratios are good, they do not regret any of that and, in a European sphere, they are okay. Do you agree with that? Do you think that the UK banks have vulnerabilities, and if so, where?
Andrew Haldane: What is certainly true is that UK banks, relative to banks on the continent, did a better job of building up their buffers-both capital and liquidity-immediately following Lehmans, and that, as the Governor mentioned, has served them well. How much capital and liquidity is enough? I think that is almost an impossible question to answer right now, given the very significant catastrophe risk that is the euro area. That goes back to the FPC’s recommendations, which were about banks doing all that they could, given this hostile environment, to boost their capital levels; because while it is impossible to know quite how much capital is needed, in this environment more must be better than less. What is more, more would be rewarded in funding markets, which would enable banks to on-lend to customers at lower rates or be less willing to constrain credit.
I do not think that the Governor was saying that UK banks-or any other bank in the world-are invulnerable. In a sense, it is in the nature of banking that there is that intrinsic vulnerability. No amount of capital can ever be quite enough to completely remove risk, but the banks are certainly in a much healthier state than was the case in 2008, and they are certainly in a relatively better state than some banks around the world.
Q149 Andrea Leadsom: What would you say are the vulnerabilities of UK banks at the moment? What are the biggest vulnerabilities?
Andrew Haldane: Funding markets remain disturbed-globally, funding markets remain disturbed. What we saw in the second half of last year was an effective lock-out of all European banks from unsecured borrowing markets. There are tentative signs in the early weeks of this year of some of that unfreezing, and hopefully that will continue, but as long as funding markets are in this disturbed state, it is impossible to say that any bank in Europe-or, indeed, globally-is out of the woods yet.
On the capital side, as I say, buffers have been built, but were there to be a big event globally-or, indeed, a big event within Europe-that would plainly eat into those capital resources. A key message that we have given, and which the global community is now beginning to talk to as well, is the importance of these buffers and resources being usable. What we have seen over the last six months is that the buffers that UK banks built up pre-emptively have been run down to cushion the effects of the stresses that I mentioned. I think that is tremendously important. We have gone 30 years within the regulatory community without properly emphasising that these rainy-day resources are there to be used on a rainy day, and at the moment it is pouring. I think that that message is getting through, and it is the FPC’s job to keep on reinforcing it.
Q150 Andrea Leadsom: Would you then say that the FSA’s decision to loosen liquidity requirements as a result of market difficulties is something about which we should be pleased, rather than concerned?
Andrew Haldane: Yes. I am on record as saying repeatedly that buffers are there to buffer. We have seen that happen in respect of liquidity, and I would want to see it happening in respect of capital. That is why, in our FPC recommendations in December, we specified those in terms of the level of capital, not the ratio. Personally, I would be perfectly happy to see banks’ capital ratios falling in the current inclement weather, but that is not the same as them building up the level of capital to guard against even worse storms ahead. So yes, that is good news, and I think the rest of the world is slowly waking up to the self-same point. The EBA exercise that the Governor mentioned, by specifying its target in terms of ratios, was to some extent shooting itself in the foot. That is why we specified our target in terms of levels.
Q151 Andrea Leadsom: Michael Cohrs, do you have any other perspective on UK bank vulnerability to world activity?
Michael Cohrs: As Andrew and the Governor have said, our banks are in good shape, but they are very vulnerable if there are events of default in some of the European countries.
Q152 Andrea Leadsom: When you say very vulnerable, is that to the point where their current capital and liquidity positions would not see them through in the event of the eurozone crisis worsening and perhaps a country or two leaving the euro? Would the UK banks still be safe in that scenario?
Michael Cohrs: If we look at most of the countries we all talk about that we know will default, the British banks are in pretty good shape. If we look at some of the countries that we are not allowed to talk about, if those countries get in deeper trouble, the banks are not in as good a shape.
Q153 Michael Fallon: Mr Haldane, you draw attention on page 18 to the exposure of UK banks to falls in asset prices, which reduce the value of the collateral they are holding. Is that because you expect those asset prices to continue to fall in some of the weaker European economies?
Andrew Haldane: I am not sure I would want to take a very firm view on what the direction is for asset prices in Europe. I think there is some risk that what we might be seeing is a rather longer-lived retreat from risk even than we saw in 2008-09. If you look at the pattern of capital flows during the second half of last year, we saw a retreat from Europe by not only some of the shorter-term speculative money but by some of the longer-term real money investors. That being the case, it is unlikely that money would return at speed, or at the speed it did in 2009. That might speak, other things being equal, to asset prices remaining lower for longer. That is not the same as thinking that they are necessarily going to head further south from where they are right now, but that must be a risk, given the risk that we have spoken about across the whole of Europe.
Q154 Michael Fallon: Is this concern about asset prices relating to the French and German banks that we have primary exposure to, or to the secondary exposure that those banks have to the Mediterranean economies?
Andrew Haldane: The chain might well be the indirect consequences of, say, a southern European country coming unstuck, knocking on to, say, French and German banks and thence on to the UK. As we found at the time of Lehmans, it is often those chains of exposure that imperil the system most, because they are not visible and therefore they are hardest to manage. That is a concern that is still there.
Q155 Michael Fallon: You also suggest on page 23 that one way out for banks would be to increase their reliance on collateralised term funding such as covered bonds, but those, too, depend on the value of the underlying asset. I am not sure whether this sentence is a prediction or a recommendation-or a worry; is it?
Andrew Haldane: It is probably a bit of all of the above. What we did see, usefully, during the course of last year was UK banks, and not just UK banks, diversifying their sources of funding. That included, importantly, covered bonds. The fact is that because unsecured markets were closed, there was a lengthy time during last year when only secured funding such as covered bonds was open to UK bank. Other things being equal, that is a good thing. Of course, that is reliant on the underlying credit quality of the assets backing those covered bonds. If you look at the evidence on that, at least in the UK, UK mortgages have performed rather well. Defaults on those have been very low indeed, so the underlying credit quality has not been under question. That would lessen the downside risk to the underlying collateral pool from issuing those instruments.
Q156 Mr Love: Governor, the financial stability report quotes concerns about developments in European legislation that might impact on the work of the new Financial Policy Committee, yet the Government threatened a veto in December, suggesting that they were not being given support and protections for the City of London. Has that been a help in those negotiations, or do you think there will be an adverse reaction at a European level to some of the vital regulatory issues that are being discussed there?
Sir Mervyn King: People at European level are discussing the issue on its merits. As I have said to this Committee before, we are most concerned about the two following proposals. First, the proposal for maximum harmonisation as part of the capital requirements directive, CRD 4, and secondly, the proposal that the ability of individual countries within Europe to carry out macro-prudential measures be restricted and their ability to do it be something that has to be approved centrally. These are two very important questions, which would affect the operation of both the FPC and the PRA. We are baffled as to why anybody would want to restrict an individual country from imposing higher capital requirements than would be imposed by the implementation in Europe of the Basel III regime. We are equally baffled as to why anyone would want to prevent a country from carrying out its own macro-prudential regulation-again, if it was above the minimum-because circumstances vary from country to country. You may get a boom in one country and the opposite in another, so you need a national response, not a common European-wide response.
The European systemic risk board has discussed this on a number of occasions, and virtually everybody around the table has come to the view that they cannot see the rationale for maximum harmonisation. They think that, while informing other countries of our actions on the macro-prudential front, individual countries should nevertheless be free to carry out those macro-prudential actions, which, after all, is the entire rationale of the Financial Policy Committee. That is the general view among central banks in Europe. Clearly, the Commission does not share that view, but I was very glad to see that Mario Draghi of the ECB expressed sentiments yesterday in the European Parliament very similar to the ones that I have just expressed. Intellectually, we have gone a long way to make our case, and I hope we will win the argument. But this is now a matter of negotiation between Governments and in the European Parliament that will produce legislation in the months to come. It is a very important issue for this year, but I think people are debating it on its merits.
Q157 Mr Love: Let me just press you a little on that. There was a time when, not only because of the influence of the City and financial services and also the expertise that we had built up in this country, at a European level they deferred to those twin priorities for the UK. Since 2008, there has been a period of what I call regulatory activism. Europe seems to have a slightly different view of the need for regulation than we do in this country. Do you think that that will work to the long-term advantage of the UK, or are we in more difficulties than we were previously?
Sir Mervyn King: No, we need to put in place reforms to the regulation of banks, both in terms of capital and liquidity requirements and in terms of the structural measures, which goes back to the Vickers proposals. There is a slight irony in that some of our partners in Europe seem to think that our attitude is that we want to impose a lighter regulatory burden than they do and that somehow 26 countries believe in regulation and one does not. The truth is that we are the one country in Europe that has led the charge for higher capital requirements in the long run, and higher liquidity requirements, and it is some of the key core countries in Europe have done their best to downgrade the implementation of the Basel agreement.
One of the key things we need to do now in Europe is to implement Basel III in its totality. This was an international agreement. The Basel committee is going to monitor the implementation of Basel III into the legislation in different countries, and this year it will monitor the implementation of the translation of Basel III into legislation in Europe, the United States and Japan. This is the first time that the Basel committee has moved into the territory of monitoring the implementation of the Basel agreement. It is a very important step forward. I think that within Europe and among most of those who look at this objectively we are winning the argument on maximum harmonisation and on the ability of individual countries to pursue macro-prudential measures, subject, of course, to the constrictions of the single market and of the need to make sure that whatever we do does not mean that our capital requirements or other aspects of regulation go below the agreed minimum. But to allow countries to impose higher capital requirements to protect their own taxpayers seems to me a natural and sensible thing to do. I cannot think of colleagues around Europe who dissent from that view.
Q158 Mr Love: You mentioned the perception that there were 26 countries on one side and the UK on the other, which is often characterised as the Anglo-Saxon model. There are views out there that do not consider the facts, evidence or arguments that we are putting for each of the regulatory changes. How do we impact positively on those perceptions and change them?
Sir Mervyn King: We are certainly improving our ability to engage in the debate in Europe. We are trying to shift some of our resources into working and operating with it in the committee structure and putting the arguments clearly. There are plenty of allies around Europe, and, as I said, Mario Draghi of the ECB made very clear in his statements yesterday to the European Parliament that my arguments about maximum harmonisation and macro-prudential regulation were ones with which he wholeheartedly agrees.
Q159 Mr Love: Can I turn to the completely different subject of counterparties?
Chair: Briefly, if you would, Andy.
Mr Love: I had two questions, but I will make them into one. There has been a move to use central counterparties much more often. Are you, as the FPC, concerned that that is increasing risk? How do we deal with increasing risk created by moving things on to central counterparties?
Sir Mervyn King: This is a key question. It is a very important development. We approve of the increasing use of central counterparties, but it does concentrate the risk. It means that there is a risk of creating another category of too important to fail institutions. We are tackling one-the banks; we do not want to create another-the central counterparties. That means that we must consider the circumstances in which such institutions might have access to central bank liquidity-if it had to pay out within a few hours because of the failure of one of its counterparties. In addition, first, we should insist on appropriate legal powers to resolve such central counterparties, if necessary; secondly, they must have adequate capital; and thirdly, there must be proper, legally enforceable loss-sharing arrangements, so that different members of the central counterparty arrangement have to share losses and there is no ambiguity. These institutions must operate only under the strong presumption that they will not be bailed out by the taxpayer.
Q160 Mr Love: That sounds like a resolution regime.
Sir Mervyn King: We certainly need that.
Chair: I will move the discussion on, Andy, unless this question is extremely brief and there is an extremely brief reply. Can that be done?
Q161 Mr Love: There is some concern that by moving more on to central counterparties, some will choose not to hedge, which may well increase risk in their businesses. Are you concerned about that?
Sir Mervyn King: No, I do not think that this will change the sort of transactions that people undertake. It will enable them to undertake them through a central counterparty, in whom they can have more confidence than in a third party counterparty.
Q162 Mark Garnier: Governor, on 12 January, you kindly sent the Chairman a table of financial stability indicators, which is useful. I appreciate that this is not the full extent of the indicators that you will be using at the FPC. I think you say that, over time, you will develop your own thinking on appropriate indicators to monitor financial stability. I am interested in the set of indicators that you have selected and the averages. Let us take this as an example, if you like, of a dashboard that you might use at the FPC. How would you and the FPC use it in your deliberations?
Sir Mervyn King: To begin a conversation among FPC members about what we think are the risks and challenges to financial stability. Just as, I think, one of your reports mentioned that it would be useful to have a table like this to get a conversation going, so we find it helpful. Each of our FPC meetings is not just a meeting; it is a series of meetings that builds up to our policy decisions. The very first meeting is a briefing by staff on what has been going on in the world and on what has been happening to financial stability. They will show us many indicators-not just these, but these are among the most important. We give them here as a summary so that if you wished to create a conversation about the conjuncture for financial stability, this is not a bad place to start.
Q163 Mark Garnier: I am very interested in what you have chosen. For example, you have picked an average between 1997 and 2000 for those five indicators. That is quite an interesting one because you start at quite a conservative time economically and end with a real aggressive bubble. So an average to me over that sort of period would have been dragged up quite aggressively towards the end of that cycle. In using that as an average, why did you pick that period? Why not a cleaner period that does not have a bubble at the end of it?
Sir Mervyn King: We give the latest value, but obviously the latest values are not very helpful without knowing what the normal past values were. We give the immediate pre-bubble or the pre-crisis average.
Q164 Mark Garnier: Which is 2007?
Sir Mervyn King: Which is the average for 2007. Then we give it for the previous 10 years. There is no more science in it than that. If you yourselves have a view as to which period you would like to see averages for, we would be delighted to supply you with them.
Q165 Mark Garnier: My question really is that given the fact that you have the latest value for, say, household debt to income, which is 152% having peaked at 169%-clearly, given what was going on in 2007, 169% was not desirable-what would you say is a desirable level? How would you as a committee decide on what the right and the safe level is?
Sir Mervyn King: That indicator was discussed quite extensively by the Monetary Policy Committee at the time. It looked at the very bottom row here, which is the UK long-term real interest rate, and it said, "Well, if real interest rates fall significantly, what would you expect to happen?" The answer is asset prices would go up. So, the normal, sustainable ratio of house prices to income, and hence the likely long-run ratio of household debt to income, will almost certainly move up. Let me summarise the position. I do not think that it is enough to say that the level that house prices or household debt reached was unsustainable. You also have to ask the question of whether you think that the long-term real interest rate was sustainable and whether you think that long-term real interest rates are here to stay for many decades-that does appear to be the market indication. Quite astonishingly, the UK Government managed to issue a 35-year index-linked bond at a negative real interest rate recently. This is a world that none of us ever thought that would be in. That is why we included this bottom indicator. It is telling us something really profound about what is going on. If those are the likely long-term real interest rates, you would expect to see very high ratios of asset prices and debt to income.
Q166 Mark Garnier: But does anybody seriously think that we are going to have a long-term negative real interest rate?
Sir Mervyn King: I leave it to you and the market to fight it out.
Q167 Mark Garnier: But there is a very serious point with this. If you look at this household debt to income ratio and if you do start seeing interest rates rising-I do not think that we ever expected a few years ago to have long-term very low or negative real interest rates-we could just as easily turn to a new paradigm in the future where this goes back to a pre-2007 norm. Suddenly the new paradigm will be hitting households appallingly badly. There is very high household debt to income ratio. I completely accept everything that you say, but that surely must present an enormous risk to households in terms of their ability to service that debt and indeed to repay it in the future.
Sir Mervyn King: There is absolutely no doubt that one of the real vulnerabilities of the world economy is if these extraordinary low real interest rates were to move up sharply. There is no question about that. That is one reason why we look at leverage ratios of all kinds-not just of the banks although they are the most vivid example of this. It is also important to look at companies and households because they illustrate more than anything else the vulnerability if there are big shocks in asset prices. That is the big difference between having an equity stake and owing a debt. There is a real vulnerability where you owe a debt. You will lose income and wealth if your equity share goes down, but you may have to go into default if the debt burden rises too much.
Q168 Mark Garnier: Absolutely. Is there any particular indicator either here or elsewhere that you feel is the most significant threat to our economy?
Sir Mervyn King: No, I do not think that we want to pick out one. The more important thing is to tell a narrative that links together these various indicators to explain where we think the big vulnerabilities are. At present, the major vulnerabilities are twofold. They are all linked to the imbalances that have grown up in the world economy. One is to the very low level of long-term real interest rates in the global economy and the second is to the prospects for resolving the crisis in the euro area. Both of those have the capacity to cause serious damage to the balance sheets of banks, companies and households in the UK.
Q169 Chair: Mr Haldane, before I ask you a few questions, I presume you had a big hand in the preparation of these indicators.
Andrew Haldane: Certainly my staff were involved in bringing up the data for these, and they are largely drawn from our work.
Q170 Chair: I would be happy to ask the Governor the questions if you were not closely involved, because I have a few thoughts on it.
Andrew Haldane: I was certainly involved.
Q171 Chair: You are on point for this.
Andrew Haldane: Yes, I am happy to be.
Q172 Chair: The key part of this table-a very interesting one that we are grateful to the Bank for providing, and which does start an interesting conversation-is footnote 4 in the fine print. That says that this is your preferred measure of leverage. That is the second of the two items on this table. That takes into account only high-quality capital. It adjusts total assets to reflect only assets that put capital at risk. Is that correct?
Andrew Haldane: That is right.
Q173 Chair: Does that not take us back to Basel II, bringing back risk rating?
Andrew Haldane: It does not go anything like as far as Basel II.
Q174 Chair: No, but I asked whether it takes us back towards Basel II.
Andrew Haldane: It is in the direction of assigning different weights, different classes of capital asset, yes.
Q175 Chair: So the answer is yes.
Andrew Haldane: It is in that direction. It is quite different though.
Q176 Chair: Weren’t you one of those who argued that Basel II’s risk rating was a problem and something that we had to move away from?
Andrew Haldane: I certainly was and feel the same about Basel III, of course. There is a generic risk-weighting problem, which is that it is essentially, "Think of a number." It is also, "Think of a rather complex number." No one quite understands what the risk weights are. The real merit of a leverage-type ratio is that it assigns weights to different categories of assets that are either zero or one and not the gobbledegook in between. That is what this measure is doing; it is stripping out one or two of the measures of assets.
Q177 Chair: I do not want to prolong the discussion now but I think it would be helpful-back to our discussion about obtaining detailed information-if we could have more detail on this definition and an explanation for the use of that preferred leverage ratio.
Andrew Haldane: I’d be happy to.
Q178 Chair: Also some detail on which bank assets are deemed not to put banks’ capital at risk. So that we can see which those are and, therefore, which will be zero-weighted, presumably, under this approach.
Andrew Haldane: Yes, absolutely.
Q179 Chair: I will ask the Governor this: do you think that this list is subject to Goodhart’s law, that as soon as we start measuring these things we will influence their behaviour?
Sir Mervyn King: Goodhart’s law is about using it to make a policy decision, to link an instrument to this directly. We are not proposing that. This is a way of starting a conversation.
Q180 Chair: So, at the moment, not.
Sir Mervyn King: No, and I do not think that we would. This is a way of starting a conversation. We saw this not as of primary significance for the FPC, because we would do this anyway but with a much larger range of indicators. We saw this as something else. Indeed, it was Professor Goodhart himself who suggested we supply this to your Committee as a means of starting the conversation.
Q181 Chair: That does not necessarily guarantee consistency but it might give us a chance.
Sir Mervyn King: No, but it might help. The purpose of this table is to help you, if you would like it changed or altered. We can certainly provide a background note to explain the detail. I think if it is going to be useful to generate a conversation at these hearings, it ought to be as simple as possible, not misleading but simple. You can see what the numbers are; they hit you and you can say, "What is going on here? Is there anything we should be asking you about?"
Q182 Chair: Let us see some more information on what footnote 4 really means and then we take it forward from there.
Sir Mervyn King: Yes. We are very happy to change it according to your preferences.
Q183 Mr Ruffley: Governor, I have been very grateful for your frank replies. Before we wind up today, I just want to return quickly to an earlier skirmish we had about the oversight committee. You have made it very clear in your answers today that you do not think that the oversight committee should be empowered to make ex post judgments on the merits of policy. You have been very clear about that. I am just wondering how you came to that conclusion. Are there any central banks in the developed world that have an oversight body that makes ex post assessments of the merits of policy?
Sir Mervyn King: Not that I know of. There are well over 100 central banks around the world, but I cannot think of any. There are many-as I said, the Federal Reserve and the ECB-that do not have any oversight body full stop, let alone one that second guesses their earlier decisions.
The key point I would make about this is that, for it to work and for the oversight committee to be effective, it has to earn the trust of the policy making committees. It has to say to the policy making committees, "Look, not everyone agrees with what you did. Can you explain to us whether you now, with the benefit of hindsight, would take a different view and whether you think you would in future, in terms of process or the information you would look at or the kind of things you would discuss, approach the issue differently from the way you did?" It other words, it is probing and challenging, but not in a way that starts off by saying, "You were wrong and we are right". There is no conversation to be had on that.
Q184 Mr Ruffley: You have made that clear. Finally, to quote from its website, "The IMF’s work is reviewed on a regular basis by an internal watchdog, the Independent Evaluation Office… The IEO is fully independent from IMF management and operates at arm’s length from the Executive Board, although the Board appoints its director." This is the important bit: "The IEO establishes its own work program, selecting topics for review based on suggestions from stakeholders inside and outside the IMF. Its recommendations strongly influence the Fund’s work." I just wondered whether that was a model you had looked at and, if not, why not?
Sir Mervyn King: The reason why we think the IMF is different is that the IMF has no oversight board at all. Its board is actually an executive board that takes the policy decisions. The equivalent in the Bank of England would be for the FPC and the MPC to have an independent evaluation office reporting to themselves directly, to say, "Is there anything you would like to say about the way we operated?" I do not want to say too much about the internal workings of the IMF, but we have seen very closely how this works and the effectiveness it has. I do not think this is a model that has a great deal to offer the Bank, because its set-up is really very different.
Q185 Mr Ruffley: You do not think there is any merit in an "internal watchdog", to use the IMF’s own description of the IEO, to take "suggestions from stakeholders inside and outside the IMF"? You do not think that might lead to ex post judgments of the merits of policies?
Sir Mervyn King: It would. That is what it will be designed to do.
Q186 Mr Ruffley: I am just trying to understand. If it is good enough for the IMF, why is it not good enough for the Bank of England?
Sir Mervyn King: Because we have lots of other forms of accountability which the IMF does not have. The IMF is not accountable to a Parliament or a parliamentary committee like this. There is no accountability of that kind, and there is no oversight body governing the IMF. The board of the IMF is not like a board of a conventional kind or the Court of the Bank. The board of the IMF takes the judgments about loans-the individual decisions.
We will have an oversight body and my point is that, if you want to bring in outside views about the merits or otherwise of the decisions that were taken, it is better to get experts to do that. They will be very different experts depending on the decision that was taken. It could be the FPC; it could be the MPC. If it is the FPC, it could be very different kinds of decisions that we have taken, with different experts as appropriate to challenge it. The role of the oversight committee is to make the committees face up to the fact that there is challenge and to be forced to come up with a proper response. They will say, "This is why we took the decision we took", and either "We still are of the view that we would take the same decision in the same circumstances," or "This is what we have learned from that experience and we have changed the way we operate and, in the light of this experience, this is how we would do it in future."
That is a constructive role for the oversight committee, whereas to have a body that simply says, "The MPC or the FPC took the wrong decision"-that is the oversight committee asserting that-will not create a useful dialogue in which you can be confident that the MPC or the FPC will actually learn the lessons. The role of the oversight committee, in my view, is not to say, "There is something that you ought to think further about"; the oversight committee is to bring in views from outside and then say to the MPC and the FPC, "Look, we are not saying whether you got it right or wrong. What we are saying is that you need to explain more carefully why you took the decisions you did, whether you have investigated the way you took the decisions and whether there are lessons to be learned." The oversight committee’s job is to make sure that the response of those policy committees is fully adequate in that respect. I do not think it can play that role-it will not have the confidence of the policy committees in engaging with the oversight committee-if the oversight committee just takes the view that it is like another commentator out there in the press who says that the MPC got it right or got it wrong. We have got more than enough of those.
Mr Ruffley: That is very clear. Thank you.
Q187 Chair: You have touched again on one of the key issues or points of difference between your response and our report. We will be coming back to this very shortly and, of course, the Chancellor will shortly be writing the legislation. It has been a very helpful exchange today. Thank you very much for coming in. We really appreciate the thought and care that you have taken both on our report and, clearly, on the FPC side, on the replies that you have given us this morning. Thank you very much indeed.
Sir Mervyn King: Thank you very much, Chairman.