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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 874-v
HOUSE OF COMMONS
TAKEN BEFORE THE
Accountability of the Bank of England
Tuesday 28 June 2011
SIR MERVYN KING, PAUL TUCKER, CHARLIE BEAN, ANDY HALDANE and ANDREW BAILEY
Evidence heard in Public Questions 373 - 419
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Taken before the Treasury Committee
on Tuesday 28 June 2011
Mr Andrew Tyrie (Chair)
Mr George Mudie
Examination of Witnesses
Witnesses: Sir Mervyn King, Governor, Bank of England, Paul Tucker, Deputy Governor, Financial Stability, Bank of England, Charlie Bean, Deputy Governor, Monetary Policy, Bank of England, Andy Haldane, Executive Director, Financial Stability, Bank of England, and Andrew Bailey, Executive Director, Bank of England, gave evidence.
Q373 Chair: We may as well get under way now that you have your new team, your extra players, and we will make sure that Paul Tucker gets more airing in the second session. Governor, the Treasury have now published a pretty thorough document setting out the blueprint for reform of this area of regulation. Is there anything in there that you think probably needs further attention or amendment?
Sir Mervyn King: There is a great deal to be looked at. I think, as I explained to you last time, our first preference had been to have a clean, new Bill, spelling out the new system rather than just amend FSMA.
Chair: By which you mean fresh draft legislation?
Sir Mervyn King: Yes.
Q374 Chair: Before we move off that, I am sorry to interrupt, what are we losing by not going down that road?
Sir Mervyn King: We are losing the simplicity and the ability to have a cleaner debate about the new framework. Certainly the Government rejected our request to have a new Bill and the argument that they gave, understandably, was that at the cost of some complexity we could ensure that all the provisions that were appropriate could be put into an amended FSMA and it would be a faster way of doing it. I think we have seen the complexity. I am not quite sure whether we have avoided delay. I think what has made me a little concerned is that the nature of the discussion that has taken place has been coloured by the nature of FSMA, which was a Bill put in place specifically to govern an all singing and dancing regulator covering everything. So there are a number of aspects that have coloured all that. There are some specific areas that I would still be a bit concerned about.
I think the FPC, or the Bank itself for that matter, doesn’t have an information power. We have to go through the PRA to get data. I don’t think that is entirely desirable. The FPC can’t give a direction to the PRA as to the timing of a macro-prudential measure. It can recommend and it can direct that the PRA get on with doing something, but the PRA itself decides how long it should take to do it. In the context of trying to deal with a countercyclical problem, that seems a little odd to us.
Obviously I think our first preference would have been not to have had responsibility for insurance companies. I do think insurance companies are different. We accept that the Government has wanted the PRA to take responsibility for insurance companies, but I do think that has left open some quite tricky aspects about the allocation of responsibilities between the PRA and the new FCA, the Financial Conduct Authority, particularly to deal with with-profit life insurance policies, and this concept that has come in through recent legal cases of policyholders’ reasonable expectations. I think this is a mess and it would be very helpful if you, in Parliament, could try to get to grips with this concept of policyholders’ reasonable expectations, which seems to me almost impossible to define for the regulator and leaving the regulator open to ex post judgements by others in court as to what it should and should not have done. I think that could have an impact on the way regulation is done.
There are aspects connected with Europe that we are a little worried about. We wanted to be able to impose some more requirements on central counterparties. We think this is very important because there is a tendency now to think that central counterparties are the answer to everything in financial markets; as long as every transaction is with a central counterparty that gets rid of counterparty risk. That is not true. The risk is concentrated in the central counterparty and it is absolutely vital that we don’t create new "too important to fail" institutions. There is a debate going on around the world about whether such institutions should have access to Central Bank liquidity. We are not opposed to the possibility that, in a crisis situation, for a very short period, a central counterparty might require liquidity from a Central Bank. But as soon as you start to hardwire that in, you are creating the concern that those central counterparties will behave in a way knowing that they will get bailed out by the Central Bank, and we are going to be creating, all over again, another set of institutions that are too important to fail, which end up as a burden on the taxpayer. The way round that is to make sure that they are very highly capitalised- very highly capitalised-because, if all the risk is concentrated in them, you need to make sure that it would be a very, very, very rare event that means that they would need genuine capitalisation from outside. I think the PRA needs to have the ability with the FPC to impose requirements on some of those central counterparties.
There is a more general concern I have, which I have expressed before, and it is not particularly to do with the Bill but it is to do with the whole regime of regulation, which is, increasingly, the European not just directives but regulations are constraining the ability of domestic regulators to do what they think is appropriate. This is not all entirely a problem coming from the rest of Europe; this is very much to do with the way in which directives are translated into UK law. Where other countries are prepared to interpret the spirit of the directive when they apply it to their domestic law and in particular cases, here it gets translated literally into words, which then have to be applied in a very literal sense, and that can cause serious difficulties. I am very worried about the way in which we translate directives into UK law, and I am also worried about the scope and the extent to which in Europe there is pressure to have control over national supervisors.
You can see it through the example of the Capital Requirements Directive, where the Commission clearly believes that, in order to impose a single rulebook on the whole of Europe, it must impose not just minimum capital requirements but maximum capital requirements. I think most Central Banks in Europe-we had the discussion recently-feel this is a step too far, that there is a very good case, particularly to support a single market, to have minimum capital requirements. That after all, at the global level, was exactly the rationale of Basel I and the subsequent Basel agreements, but the Basel agreements are very clear that they are there to impose minimum requirements not to harmonise maximum requirements, because that will prevent a country from protecting its own taxpayers.
So there are a number of issues that I think are worth examining and exploring when the Bill comes to the House.
Chair: That is a very impressive list and a very thorough answer. I should say, for the sake of the record, that I gave you 90 seconds’ notice of that question. I dread to think what would have happened if I had given you half an hour.
Sir Mervyn King: We would be delighted to come back at any point of your choosing to expand.
Q375 Chair: There were a number of really important points in there, and I hope we will be able to pick up on at least some of them. On this question of the literal translation of directives, it would be extremely helpful if the Bank could provide us with specific examples in writing that we can take up. I have already written on gold plating, as you probably know, to try and get some clarity on that.
In the interests of giving Mr Tucker further work, could you tell me, Mr Tucker, why is the FPC a committee of the Court under the proposals while the MPC is not?
Paul Tucker: I think the main difference is that on the monetary policy side everything that matters is done in the MPC-the interest rate decisions, decisions about QE. Whereas on the financial stability side the macro-prudential tools vary in capital requirements over the cycle, perhaps varying margin requirements, giving directions to the FCA and the PRA about what they should look into and so on. That will be located in the FPC.
Decisions about emergency liquidity assistance, lender of last resort, are decisions for the Court of the Bank and the Bank executive. The bog standard liquidity insurance operations, which we do routinely, are matters for the Bank executive and Court, in both cases because they affect the Bank’s balance sheet. The oversight of payment systems is in the Bank because it is associated with our operation of payment systems and the oversight of central counterparties is going to go with that.
What I am doing is painting a picture of the financial stability policy instruments being distributed across the Bank, and the job of the Court is to ensure that we keep this coherent. That is easier for Court to do, frankly, if FPC is a committee of Court than something that was to one side of Court and did not recognise its authority beyond processes. The thing I should emphasise is that this does not take Court into policy, the substance of policy per se. It takes Court into ensuring that we, as an executive, are joined up and ensuring coherence across our responsibilities.
Q376 Mark Garnier: Can I carry on with that one? Do you ever envisage that there will be a disagreement of policy between the FPC and the MPC and possibly even the PRA?
Paul Tucker: Theoretically this is possible and we may live to see it. It is occupying quite a lot of discussion, not only in this country but elsewhere as well. Frankly, I think the concern is exaggerated. So a story is told whereby the FPC raises capital requirements or asks the PRA to raise capital requirements; that slows the economy. The MPC eases interest rates; that fuels the credit boom. The FPC tightens capital requirements again, and so on. But it is much more likely that the MPC are just going to be extremely relieved that there is somebody there that is ensuring that the banking system is safe and sound, so that when bad things happen the banking system does not flake away and the economy with it. So I think first order this is pretty unlikely. Could it happen? I have given you theoretical circumstances where it could.
Because it could happen it is helpful, not only for us but for the country, that the support for the two committees will be provided by the Bank staff. There is a common Chairman in the Governor. There is overlapping membership. The information base going to the two committees is broadly the same. Something that is no secret, but perhaps we have not said so openly before, is that FPC members are able to sit in on the briefing that the MPC receives on the economy and MPC external members are able to sit in on the briefing for FPC. So we are going to ensure joined-upness. If ever there is tension it is not going to come about by things falling through the cracks.
Q377 Mark Garnier: In terms of the Governor-who is looking as if he wants to come in with an answer to this-one thing you did mention, Governor, a bit earlier was that you are unhappy about the way that the PRA can only respond to the FPC on the basis of if it feels like it. Broadly speaking, the FPC-
Sir Mervyn King: No, that is a slight exaggeration. We will make directives under the draft Bill to the FPC. It is just that the PRA will have the timetable of the response under its own control, which is slightly odd because it is quite hard to make a recommendation.
Mark Garnier: But here is a prime example of how there could be a need for an arbitrator to resolve problems and conflicts between the three organisations. We already have a situation where the MPC is answerable directly to Parliament. The FPC is answerable directly to the Court of the Bank of England.
Sir Mervyn King: And to you.
Mark Garnier: The PRA are, yes.
Sir Mervyn King: Can I answer this one. I don’t think this issue arises between MPC and FPC because the instruments that the two committees will be using are quite distinct. We don’t yet know the full set of instruments for the FPC. You and Parliament will determine that, but they clearly will not be the same instruments as are given to the MPC. The link between FPC and PRA is slightly different. The FPC have to take a macro-prudential judgement and then issue directives to the PRA as to how that should be implemented with respect to individual institutions. So there is a closer link in that sense between FPC and PRA. All we are pointing out is that, in that macro-prudential sense, there seems to be some ambiguity about the ability of the FPC to ensure that its recommendation is implemented in a speedy timetable.
Q378 Mark Garnier: This is quite a complex area with the different tensions being pulled on it, different terms of accountability and all the rest of it. Do you think the Court, and the individual members of the Court, are equipped to fulfil the role of making sure the FPC is working properly?
Sir Mervyn King: I think it depends what you think the role of Court is.
Mark Garnier: To be running the Bank of England.
Sir Mervyn King: Paul made the point very clearly that Court is not responsible and should not be responsible for policy. There are three separate decision-making bodies.
Q379 Mark Garnier: Sorry, if I might just cut across you again, and my apologies for interrupting you. Why is the FPC a committee of the Court and not accountable to Parliament?
Sir Mervyn King: The FPC is accountable to Parliament. There is no question about that at all. Indeed, in response to Mr Mudie, I made very clear that the FPC should be appearing before you regularly. Frankly, the question of whether the FPC is or is not a committee of Court I don’t think is a major question at all. What does matter is that the three bodies, MPC, FPC and the board of the PRA, for policy decisions should always be accountable directly to you or a Committee of Parliament that you recommend it be accountable to, but it should be accountable to Parliament, full stop. It is accountable to the public as well. The three bodies are all accountable to the public. That is why it is important to have transparency mandated in the three bodies, and it is, and we fully support that. I think you would recognise-as you did in your report earlier this year-that we have a very good track record of transparency on the MPC and we fully intend to carry that over to the FPC and the PRA, so on policy that is not Court’s role. Court has two major roles, I think. One is to ensure that there is proper stewardship of the resources of the Bank, the remuneration, the budgets and so on.
The reason why I think you need an independent body to do that is because the Bank is an independent Central Bank and it would be only too easy-forgive me for putting it this way-for politicians to find a way round the independence of the Bank by interfering with the resources and budgets of the Bank. That is why in most countries round the world those policy areas are ring-fenced from the kind of audit functions that you see in other parts of government. I think the Court, therefore, needs to be appointed by politicians, by the Government, but to be an independent body with the responsibility for oversight of how the Bank uses its resources and for how the processes of those three boards work, so that if any member of the MPC, FPC or PRA board feels unhappy with the way the process is operating they can go to Court and say, "This is not working and we want you to step in and find out why".
I think for that set of functions, first of all Court should be accountable to you, so I think Court ought to come to you on a regular basis and report to you, not on policy, not on whether the Bank took the right decisions on interest rates or made the right kinds of speeches or took the right decisions on the FPC or took various regulatory actions. You should hold the three boards directly accountable for that to you. You should hold Court accountable for its functions in terms of the Budget and stewardship, the remuneration of the senior members of the Bank and also for the way in which the processes of those three boards work.
Q380 Mark Garnier: One of the things I am slightly concerned about-and your answer could not have been clearer; I think it is very, very clear indeed-reflecting back what you said in your earlier answer, is that that leads me to think that the Bill is very, very unclear. What slightly concerns me is that as this Bill passes through Parliament people are going to be looking at this and saying, "Well, the FPC is a committee of Court, therefore is the Court going to be expected to be a dispute resolver between these organisations?" While you are being very clear here today, and I think we all understand exactly what you are saying, do you think that the complexity of the way this has been written, and all the various issues that go with it, may mean that by the time we end up getting Royal Assent on this Bill the wrong outcome has happened because of some of the lack of clarity in the way this has been-
Sir Mervyn King: If the question of whether the FPC is a committee of the Court or the Bank is a problem, then let’s change it. What I want to make sure is that there is a very clear view agreed by you in Parliament. It is very important to me that this happens otherwise we will get confusion down the road. The policy responsibility ought to be directly from the three decision-making bodies to you or the relevant Committees in Parliament. That should be crystal clear and nothing should be allowed to confuse that.
Paul Tucker: It can’t be any other way because the objectives of the three bodies will come from legislation. The instruments and powers of the three bodies will all come from legislation and therefore FPC, MPC and PRA board automatically are directly accountable to you.
Mark Garnier: Thank you very much. You have been very helpful.
Q381 Mr Ruffley: Mr Tucker, on the question of the FPC-the different parts of the Bank all working together with the FPC-you indicated that the Court would be responsible for making sure there was that co-ordinated work. I think that is the justification you gave for the FPC being a committee of Court. Yes? Who is going to be doing that specifically at Court? Is it going to be a small group? Do you know who the individuals are and do you think they will have the expertise to pull all that together?
Paul Tucker: I think the way this will manifest itself is that in the current Bill the Court has a responsibility for ensuring that the Bank as an organisation has a strategy for its financial stability work. This goes exactly with what the Governor was saying about stewardship of resources. Its key responsibility is to ensure that we touch all of the bases. Of course, we, the executive, take a draft to Court and the existing legislation says "consult FPC on that", "consult the Treasury on that", but ultimately it is signed off by the Governor and company, which is Court. Whether or not that is done via a subcommittee; at the moment it is. It is done via something called the Financial Stability Committee that was created during the crisis under legislation. That committee will cease to exist as a statutory committee. It will be up to Court whether they want to create a subcommittee of their own to do that.
In terms of the people on Court, I don’t think it is for me to comment on that, quite frankly. Like me, these people are appointed by the Chancellor of the Exchequer. I think it is important that there is a blend of skills. I think it is important that some of them are reasonably expert in the financial services industry. I think it is important they don’t have conflicts and have a degree of distance from the day-to-day. I think all of that could be set out publicly, but in terms of the individuals that has to be from the Chancellor and the Prime Minister.
Q382 Mr Ruffley: There could be a subcommittee constituted from existing Court members but that would be up to the Chancellor? I just want to understand the composition of the oversight body at Court. You are suggesting it is Court or it could be a subcommittee?
Paul Tucker: Technically the Court can choose to do it itself entirely or it can itself choose to establish a subcommittee for that purpose.
Sir Mervyn King: Can I give an example, which I think illustrates this very clearly? One of the most important functions of Court, and where I think you do need a body to look at this, is to ensure that the Bank manages the risk on its balance sheet effectively. We have seen an enormous expansion of our balance sheet during this financial crisis, and I hope at some point we will see a contraction. Court was determined to ensure that all the procedures we had put in place for managing the collateral and for managing the risk were done to the highest possible standards. The Audit and Risk Committee of Court is comprised of people with a great deal of experience of both audit and risk management in business and they have gone to great lengths-they meet regularly, they go into enormous detail, and they monitor. The internal auditor of the Bank reports directly to them, to the non-executives, and it is very important that this be done. Although it is not publicised very much, this is an important role of Court. What I would quite like to do if I could, Chairman, is to offer you a short paper spelling out some examples and functions that Court carries out in this process of managing the way the Bank operates.
Q383 Mr Ruffley: Yes. Just finally on this point, when would you expect that body to be constituted after Royal Assent?
Sir Mervyn King: Well, the Audit and Risk Committee works now.
Mr Ruffley: No, the committee that Mr Tucker was referring to that will be overseeing-
Sir Mervyn King: The Court only has eight non-executive directors from outside the Bank, if you exclude Lord Turner. But you have eight non-executive directors appointed with their expertise at running businesses. These are serious senior figures. They are not experts in policy, and I think the mistake would be to believe that they should be second guessing or able to comment on the policy decisions.
Mr Ruffley: I quite understand we don’t want any second guessing.
Sir Mervyn King: These eight people can do it in full session of Court, if they want to set up a subcommittee to monitor particular aspects. But one of the things that the Chairman of Court has always done with the Monetary Policy Committee, and I am sure he would do it with respect to the Financial Policy Committee and the PRA board, is to have at least annually, if not more often, private interviews one-on-one between the Chairman of Court and individual external members, and one of the questions he asks them all the time-he has done with all the external MPC members you saw earlier on-"Are you unhappy about any aspect of the processes of the committee? Do you have the resources to do your job properly? Are you worried about how it is working?" If there is any suggestion that they are, he will initially bring it to me and say, "I want you to correct that. I don’t want to hear this again" or he will take it to Court for a full discussion if necessary. He always reports back on these interviews to Court. So I think that is another very concrete way in which the Chairman of Court can ensure that these committees can function effectively.
Q384 Mr Ruffley: It is a very helpful answer. I think we are all agreed, we don’t want anyone at Court second guessing on policy. I think we are all agreed on that. I just wanted to understand better than I did how this oversight function is going to be constituted and I think, Chairman, it might be useful if we had that committee in at some stage, whenever it might be constituted.
Could I just move on, Governor, to the first point you made in your very helpful opening remarks, that you didn’t have an information power and that you would have to go to the PRA? Could you just flesh out what you meant by that?
Sir Mervyn King: I think that one of the things we were concerned about in setting up the FPC was obviously one area the FPC has to look at, which is the boundary of regulation. Indeed, it has the right to recommend to the Treasury whether that boundary should be moved. It will be the case from time-to-time that we will need information on institutions other than regulated institutions. But even where it comes down to regulated institutions, it does seem to me that it would be proper for the FPC to be able to say, "Well, look, we need these data" and be able to go to institutions. We can use the current data collection methods in the Bank in our unit that collects data from banks, but to have to go through the PRA always raises the difficulty that the PRA will say to itself, "This request has come in from the FPC. Is it really within the vires of the PRA to ask for these data?"
It seems to me, the only way to clarify this unambiguously is to give the FPC an information collection power. It may seem a small thing, and in many ways I don’t anticipate great practical problems, but it has the potential at some critical point in the future where the PRA hesitates to collect data. We did see this with FSA in 2007-08, where we wanted data and they were reluctant at some point to collect it, under the very reasonable view that they had not seen the need for it and it wasn’t clear to them that for their statutory purposes they should be collecting these data. It was just that the Bank wanted the data. I think it helps to have a greater clarification of the specific powers of MPC, FPC and PRA in respect of data gathering.
Q385 Mr Ruffley: Yes. The IMF have set up the Independent Evaluation Office to conduct independent and objective evaluations of Fund policies and action and the US Treasury has set up the Office of Financial Research for independent investigation and fact-based policy analysis. Do you see any merit in a similar arrangement being set up to evaluate policy work at the Bank?
Sir Mervyn King: To be honest, I think the evaluation of the policies that we carry out should be done by you. The question is whether you need a unit of that kind to help you. The reason the IMF needs such an Independent Evaluation Office is precisely because it isn’t accountable to anyone else. It has an executive board but that is not-
Q386 Mr Ruffley: What about the US Treasury?
Sir Mervyn King: The US Treasury is not an accountability body. The US Treasury is a body to do with collecting information. I think it is very easy to set up committees and say, "Let’s collect lots more data". I honestly don’t think that is the solution to better policy. If we felt we needed more data then we would collect it ourselves, but the important thing is that you should feel content that you are able to evaluate the policies of MPC, FPC and PRA, not in a sort of technical second-guessing sense, because there is no point in that. I have always felt that far and away the most effective kind of accountability is when people ask very simple questions, not complicated technical questions but very simple direct questions. The question that came earlier this morning saying, "If your aim is to hit the inflation target, why is inflation so high?" That is not an easy question for us to answer. We have explanations and I think what you should be trying to do is to get us to explain what we are doing and why, in words and terms that everybody can understand. That is what I feel is policy accountability to Parliament.
Paul Tucker: Can I just add one thing on this, which is that the US Treasury body created in Dodd-Frank is, I believe, in part a product of just how many agencies there are in the US involved in financial stability. There is a commodities regulator, a securities regulator, three bank regulators, state-wide insurance regulators, and the Financial Stability Oversight Committee embedded in the Treasury is attempting to pull all those together. It is a bit like a tripartite committee for the US with, I think, more than a dozen members. In the UK we are taking a different approach. Other than the use of public money, all of the financial stability tools will exist in the Bank of England group. Therefore, we will produce the data publicly enabling us to be held to account, and if we don’t we can be held to account for that.
Q387 Chair: Going back to the point you made a moment ago, Governor, about the distinction between processes and policy. I agree that we won’t find ways of getting to better policy just by creating extra committees, but you then said, "Of course, if we want to collect more data we will collect more data". It was the case, wasn’t it, that the executives of the Bank ran down the resources devoted to financial stability in the years prior to this crisis and that the cash allocated to that function was overseen, because it was a process function, by the Court? Isn’t that the sort of issue where process and policy meets where we do need a body that can comment?
Sir Mervyn King: I take responsibility for that switch of resources. We put it to Court and Court accepted that recommendation. I think it is very important that all organisations ask themselves, "Do you need the resources to carry out this function?" The reason I did it was when I inherited my position there were 150, 160 people working at financial stability and their only responsibility was to produce a report. That was it. I believe you can produce a report once every three months with fewer than 150, 160 people, and my job is to ensure that taxpayers’ money is used wisely. So we cut it from 150, 160 to 120. That was a change. I cannot believe that the reason we had a financial crisis in the UK was because we tried to write a quarterly report with 120 people rather than 150. We may have made mistakes, we may have missed things, but I do not believe it was because we didn’t have those 30 or 40 people. Indeed, I think the great difficulty with what went on in the run-up to the financial crisis was precisely that too many people were focused on details and not on the big picture.
Chair: You are answering a question I didn’t ask. I didn’t say: why on earth did you go and cut all those people, what a terrible mistake it was and what possible justification do you have for it? I said: don’t you think that this function of examining decisions like that is something where processes and policy meet and isn’t that a function for a body like the Court?
Sir Mervyn King: They are clearly interrelated, but I don’t believe that the oversight you need to make decisions on that kind of issue is related to the technical expertise of the people you need on the policymaking committees. So what you need on Court to handle that are people who are able to make judgements about representations put to them about budgets: we need more resources for this area rather than that area.
Q388 Chair: Let’s examine this in relation to the private sector. I have been chairman of audit in a public company. When the head of compliance comes to you, you ask him, "Do you have the resources you need to do your job?" If he says, "No, I haven’t and I want more", you don’t just say, "Well, here’s a cheque", you sit down and have a discussion with him about how he is conducting that job. That means getting involved in finding out how the policy function is being performed in some detail.
Sir Mervyn King: That is what Court does.
Q389 Chair: Okay. So that is where policy and processes meet and to that extent there is a policy function, there is a policy oversight function?
Sir Mervyn King: If you want to define it as such, yes, but what it is is clearly very different.
Chair: I am not defining it any particular way. I am taking up exactly the way it is defined in corporate law and corporate practice now.
Sir Mervyn King: What Court does in this respect is clearly something that is distinct from the decisions of the FPC, MPC and PRA. Those three bodies do not sit around, nor should they, debating their own budgetary allocations or the resources that are needed. They can make representations but Court has to decide on that. But the decisions that the PRA, FPC and MPC make on policy are not decisions that the Court need to second guess, and therefore they don’t need the expertise to do that. What they do need the expertise for is the expertise of someone who is prepared to say, "My job is to probe and challenge the executives of an organisation when they claim they would like more resources". To be honest, the experience of the last 10 years has been mainly that we have been trying to reduce the resources. We have kept, in real terms, the expenditure of the Bank flat over 10 years. I take pride in that achievement. It has not been achieved elsewhere in government but it has been a contribution to the taxpayer and I do believe-and I think Court has been able to probe on all of this all the way through-that our ability to carry out our policy functions has not been jeopardised by running a careful ship financially, but Court does look into it.
Q390 Andrea Leadsom: I am also a big fan of straightforward, simple questions and I think, Governor, you understand we have some very real concerns about the ability of Court to do its job. In particular, from a lot of the evidence that we have taken, it seems that there is some confusion over where we scrutinise the activities of the Bank of England and where the Court scrutinises. I would be interested to know whether any of you gentlemen have any concerns, either about the division of responsibilities where you report to Parliament through this Committee or to the Court on matters of efficient running of the Bank, and whether there are any areas where you think that there needs to be greater clarity. Do you all feel it works perfectly?
Charlie Bean: It seems to me there ought to be clarity in principle, which is that on anything to do with policy-related decisions it is you to whom we are accountable, and there should be complete clarity on that. As far as Court is concerned, it is management of the Bank’s resources, the processes that support the policy-making decisions, that they have purview over. So that is where I consider-
Q391 Andrea Leadsom: Mr Bean, if I can give you a precise example, which is the fact that the Court did not look at a complete review of the Bank’s handling of the financial crisis. They have not had an investigation, and there was some surprise from other witnesses on this particular inquiry about that fact. Is that, therefore, something that this Committee should have done, and only this Committee? It would not have been appropriate for the Court to consider the way in which the Bank of England functioned during the financial crisis? Where does that become a matter for the Treasury Committee versus the Court?
Charlie Bean: I would certainly have said that, insofar as it relates to policy decisions that were taken, it is clearly this Committee. Indeed, this Committee has undertaken a number of investigations into various aspects of the financial crisis, including our role in it. You had a report on Northern Rock. You had a report on the collapse of the banking system post Lehman’s, and so forth.
Q392 Andrea Leadsom: But specifically what the Bank did, who did what, when, how many meetings there were, whether they were minuted properly, how decisions were taken? That is a huge grey area, is it not? That is where-
Sir Mervyn King: To be perfectly honest, I see this as an important question and you should be concerned about it, but in my view this Committee has played a very important role. It has been a permanent standing public inquiry into the financial crisis. I don’t think there is any decision that the Bank made during this crisis that has not been discussed openly at this Committee and that we have not been asked questions and given answers on, and that you have not written about and commented on in your reports. You have written a large number of reports. If you go back and look at the reports of this Committee, I think you will see that all the decisions that were taken were discussed and commented on by this Committee in your reports, and this seems to me what accountability is all about.
Q393 Andrea Leadsom: But for example, Governor, that would be true about the decisions that were taken, but it would not be true about the individual performance of decision-takers at the Bank of England, nor would it be true of the level of focus of the Bank of England during that period. In other words, the number of meetings and how many people were present and what they were looking at, and that sort of thing. That would not have been considered by this Committee. I wasn’t here at the time but I don’t-
Sir Mervyn King: It is not true. We were asked about the number of meetings and the way we went about it. You have talked about the performance of individual decision-takers; no one does that in respect of the MPC. You can ask all the members of the MPC what their views are and form your own opinions, but what I am baffled about is what it is about the performance of the Bank that was not covered by your own deliberations. The great thing about your Committee and its reports was that it was done, not by the Bank, but by you. It was an external, independent, highly public inquiry. Within three or four days of the run on Northern Rock, we were in front of this Committee giving evidence to you and this is my twenty-first appearance in a Parliamentary Committee since September 2007.
Andrea Leadsom: So you have come of age.
Sir Mervyn King: Indeed, and if that is not permanent accountability, I don’t know what is.
Q394 Andrea Leadsom: Yes. I do agree, but I think you understand that there is still this grave concern that the Bank of England is accountable to the Court and we have concerns-I don’t want to speak for my colleagues, but I have concerns-that the Court is not structured in such a way as to provide the level of procedural oversight. It is not a reflection on any of the individuals concerned; I am sure they are absolutely eminent people. But it seems to me that there is a grey area. If you like, it is our own tripartite arrangement: you are doing it, they are overseeing it and we are discussing how you did. There is this issue of who is directing; who is saying, "Well, I am sorry but Mr Tucker was completely useless in this particular area and really he needs to be taken out and dusted down"? Who would be doing that and where does that-
Sir Mervyn King: I have regular conversations with Court about the performance and appraisal of individual executives in the Bank, and they have regular meetings with the executive directors where the Governors are not present so they can then ask about the performance of the Governors. What I would like to suggest is two things. One is that we provide you with a short paper spelling out what Court does day-by-day, because I think a lot of the confusion here, and a lot of the evidence you had from people outside, has taken the form, one, the Court should not be doing policy, and I think we all totally agree on that, there is no difference of view, but two, most of them have no idea what Court does and I don’t think they should make sweeping generalisations on the basis of no facts. So I think it is up to us now to provide you with a paper that spells out exactly what Court does, and with real examples. We can give you some examples today of challenge of Court to the executive, if you like, but we can give you that paper.
Andrea Leadsom: Thank you.
Sir Mervyn King: The second thing, I think, which is worth considering-
Chair: I should say we have a rough idea of what Court does. It is fairly well spelt out in a number of public documents already. We went through those with some care before we cross-examined Court, and I think to suggest that this whole debate has arisen as a consequence of a confusion-
Sir Mervyn King: Most of the evidence you have had, which dismisses the role of Court, is frankly based on no knowledge at all.
Chair: That is a reference to external elements that might have come in.
Sir Mervyn King: Indeed.
Q395 Andrea Leadsom: If I may say, Governor, when the Court directors came in themselves, it was a lot of their evidence that gave rise to the initial concern. It was what they were telling us, not what third parties were telling us. So that is where it started.
Sir Mervyn King: I understand that. I read the transcript of that session. There were very few questions directly about this kind of oversight responsibility. They were mainly about policy.
Andrea Leadsom: I think we were really shocked.
Sir Mervyn King: What I would like to do is to give you some concrete examples of what Court has done. But I think the second thing that we need to do is to make sure that it is clearly understood that, ultimately, even this function of oversight is accountable to you, but the way that should occur is that you should hold sessions with members of the Court on a regular basis, so that you can hold them accountable for the way they carry out this oversight process.
Chair: We note what you say and indeed we just had Court in, so it is not as if we are not active on this front.
Sir Mervyn King: Indeed.
Chair: I also note your suggestion that you provide some further evidence, which we would certainly like to see. While you are at it, since you have mentioned it, you might also give thought, if I could suggest, to the issue of what kind of support a Committee like this might need in order to perform this enhanced scrutiny function.
Q396 Mr Mudie: Governor, I want to move away from the Court and put in place the democratically elected Members of Parliament, as well as the Government. I am not certain we are not exchanging some powers, giving away powers, and all we get is you are going to be accountable to us. Today you have described the kind of accountability you like as, we do not have to second-guess you on policy; secondly, you would prefer us to ask simple questions, and you will give us an explanation and we will be all the wiser. That is a very interesting view of someone, an unelected individual, being given vast powers-as you would say-by Parliament, so it is then them to blame. But when something goes wrong, because of your actions, we get the blame, but there is not much we could have done about it because all we can do is ask simple questions and listen to your very erudite explanations. I am not trying to be rude or anything, but that is a simple question, from a simple man. What good is that sort of accountability to elected politicians?
Sir Mervyn King: I think it is worth a great deal for the following reason. There are certain functions-but only certain functions-that you in Parliament decide to delegate to a group of people with expertise who are independent of day-to-day politics. You don’t have to do that and if you feel that these decisions are better taken by the elected Government, then you should take the powers back from us and give the power to set interest rates to the Chancellor. You could certainly do that and we would not resist it. I think we would point out some of the potential drawbacks, but I think on all sides, and in most countries around the world, people can see the case for certain decisions, but only certain decisions, being delegated to a group like that.
The question then is how you hold them accountable. You should be prepared to second-guess our decisions and you are entitled to do so. What I suggested was not that you are not prepared to do that, but that there is little point engaging in a purely technical debate. The way to second-guess us is to say, "The policy you are following is very damaging and wrong. Can you justify it?" It is that kind of accountability.
Q397 Mr Mudie: No, but say we do. Let’s just take an example from this morning. On your leadership of the Monetary Policy Committee on interest rates, I watched to see if you would buckle to the pressure that you were under and I was glad that you didn’t because I thought that was eminently sensible. As you said in an interview, it would have caused great harm to ordinary people, for what? It would not have affected inflation because there were external factors. But then I put to you that there is another instrument that you have that would not affect that inflation rate but could be used, and it would ease the pain on small businesses and individual householders, mortgages and so on, or just people trying to buy a house, if you took that small step. Now I received a reply. I am not satisfied with the reply, not that it was a bad reply, but the frame of mind. Say this Committee said we think quantitative easing on a sensible scale would help small businesses, as we had some members of the Committee say. What is the point of saying it to you, because we are not here to second guess you? We are here to sit at your feet, listen to your words of wisdom and put simple questions to you, as you have said.
Sir Mervyn King: But your reports are pretty hard-hitting, and I don’t regard your reports as equivalent to sitting at our feet and listening to learned answers. You can be pretty direct in your reports if you are not convinced by the answers. I think that is the only form of accountability you can have once you have decided that you think it is in the long-run interests of this country to delegate these decisions to an independent Central Bank. The most effective constraint on that independent Central Bank is coming before you. It is not an easy experience to come here and to answer questions in public for which we are accountable in the future. We are reminded of the answers we gave on future occasions and have to justify our actions. I think that is a very powerful weapon in holding us to do what we have been tasked to do by Parliament.
Q398 Mr Mudie: I hear that, but let us see how Bob Diamond does it. Bob Diamond gets a big firm to get a group of actors who will study us and each of our weaknesses, how to play us and our background, and so when he comes he only has to face up to a particular individual who might ask the wrong question for 10 minutes. In 10 minutes the Chairman gets restive, and then we will move on to another person who will invariably, because of the agenda, move on to another part of the business. You have done it today. We have moved from one subject to another. So if you are dealing with one part: "Can you not flannel it for 10 minutes, Governor?" "Of course I can". Now you praise us: "Oh you do such a tough task". Do we, hell? We might give you an uncomfortable task, but in terms of influencing you-and remember we are talking about things that affect the people out there on the street. We are giving you great power-
Sir Mervyn King: Yes, you are.
Mr Mudie: -and we have little power to force you to rethink.
Sir Mervyn King: You have the power to take back.
Q399 Mr Mudie: Tell us one occasion when we have used it. Right off the top of your head, tell us when you have altered an action because of what this Committee said?
Sir Mervyn King: We think very carefully about all the points you raise and it feeds into our discussion and debate later. But if you think our job is just to go away and say, "Gosh, they didn’t like what we did. We had better change our mind", you would not respect us for that.
Mr Mudie: Come on, you have had time to think though. Give me one time, one action that you have changed because this Committee came across strongly on a given issue.
Sir Mervyn King: I would sincerely hope there was no action that we took that was as a direct result of what you have said because that would be to compromise independence. But all our discussions-either you want the Committee to take decisions-
Q400 Mr Mudie: That is game, set and match. In other words, if we put such a strong case you dare not change it because that would indicate that we had interfered with your independence. Well, how on earth do we influence you?
Paul Tucker: We have changed what we publish about the way we go about our job over the years because of these hearings. If I may say so, Mr Mudie, the way you describe it would be as if we were meeting in closed session with nobody here, but our appearances change the public debate about monetary policy hugely, and the quality of public debate about what we do compared with before 1997 is absolutely unrecognisable, and these sessions are the centrepiece of that in any one year. Yes, our minutes matter too and yes the inflation report press conference matters too, but the things that come out of this press conference- some years ago we were asked about the accuracy of the forecasting process, and we have published much more about that as the years have gone by, not always to our credit, but it needs to be out there. You do have an effect on the way we communicate and try to hold ourselves accountable to the public. In the legislation, the Chancellor does have the power to override us if he goes to Parliament.
Q401 Mr Mudie: You have just proved my point. You have kept talking and the Chairman said, "George, time". Do you see? So it works. Let me ask you one last question on accountability. Do you think it is sensible to keep the Chancellor or the Treasury out of this exercise? The Treasury’s input is to have one of their staff at the end of the table without voting rights. The Chancellor only comes in when there is a crisis. The Americans have put the Chancellor or a member of the Government chairing their Committee. Do you think it is sensible to take all this power and keep politicians out? It will be, I would suggest to you, until it blows up and you will take the blame.
Sir Mervyn King: If you would prefer the FPC to be a committee of the Treasury or an independent public committee, by all means recommend that. That is not for me to say. What I would say is that if you were to go back to a committee chaired by the Chancellor you would simply recreate the tripartite. Now you may want to do that. I am not arguing against it, but that is what in effect it will mean. With great confidence I predict the following will happen: when it is a generally peaceful time the Chancellor would find that he had more pressing responsibilities than to attend meetings of this committee and deputies would get involved, and there would only be a meeting involving the Chancellor when there was a crisis. The previous tripartite, we managed twice I think to have meetings with principals. We did hold two war games to find out what might go wrong.
Chair: Before the crisis?
Sir Mervyn King: Before the crisis. Only after the crisis, did we start meeting as a tripartite. Many people feel that that wasn’t terribly satisfactory as an arrangement, in large part because the tripartite had no direct responsibilities. Each of the players had their own responsibilities. I don’t think co-ordination was ever an issue in the crisis, to be honest. What there was was a lack of powers for anyone to deal with particular situations as they arose. But if you want the Chancellor to be in charge of this committee in a crisis, what I would say is you had better make sure he is in charge of it in peacetime too, because one of the problems that we found was that not being involved in these areas in peacetime made it much more difficult for us to get involved when it became wartime.
There are many arrangements for doing this. I have no particular brief for one rather than another. All I would say is: if you want a committee of the Bank, we will run it. If you don’t, fine. Make it a committee of Government or an independent separate public committee, but just have clarity about where it is and who is on it. But I think you will find that it will be very difficult to get the Chancellor to turn up for meetings in peacetime because other things are always more pressing.
Chair: We have listened carefully to that, and there are a range of views around this table, but we will be producing one report.
Q402 Jesse Norman: I have a slightly diverse set of questions that I would be grateful, given the time, for short answers if you could. Governor, do you share my view about the affordably of the Private Finance Initiative and the super returns that seem to be made on it to the institutions involved?
Sir Mervyn King: I don’t think it is for me to comment on the Private Finance Initiative. I know that many people think I stray too much into political territory. This is one I am happy to leave to you to deal with. It is not my responsibility.
Q403 Jesse Norman: Put it this way: does the Bank have a concern about the debt implications of continuing that kind of system when real interest rates are at minus 5%?
Sir Mervyn King: I am always in favour of having as much transparency as possible about the implications for the public finances, but I am not going to comment on the PFI.
Q404 Jesse Norman: I am grateful for that, thank you. Mr Bailey, could you describe, please, the experience you have had since you have been in the FSA and how it is responding to treatment?
Andrew Bailey: I have been there for 12 weeks now. I am still a director of the Bank, which is why I am here today, but I spend most of my time there and I am responsible for bank supervision there. I have learnt a great deal since I have been there. You learn a great deal by being in the FSA. There are changes taking place, and I think that one of the clear changes taking place you saw last week, which is the publication of the Financial Stability Report, which has in it direct recommendations to the FSA. I am very pleased to see those recommendations. I think there was a very good process that led up to the FPC agreeing those recommendations and giving them to us. By the way, the point was made about the comparison with the US. Let me say, I don’t think any report of this nature is coming out of the US system, which is a clear assessment of the state of financial stability and very clear transparent recommendations to the supervisory authority on what it should be doing.
You may have seen that we have published two documents in the last three weeks or so: one an outline of our future approach to supervising banks, and the second one last week, an outline of our approach to supervising insurance companies. We would be very happy to come and take your questions on those if you want. That gives you a sense of where we are heading to. Obviously the next big thing is for the legislation to enter Parliament, but we are committed to starting to make those changes to the way supervision is done ahead of the passage of the legislation, and it is not to, in a sense, abuse our role. We think there are very real practical things we can do to make the system more judgemental, to make it more focused, and we are starting to do that.
Q405 Jesse Norman: So this rather supports the view that has been widely held that it was rather dysfunctional before these changes?
Andrew Bailey: I think the FSA has changed a great deal in the last four years. So there is a view of the FSA prior to 2007. The FSA has changed since 2007, as a response to the crisis. My own view is that it needs to further change and I think you wouldn’t see any difference between Hector Sants and me on this point. I think it needs to become more focused. It has become more intense in terms of what it is doing. It has become more intrusive. I think it needs to have an appropriate focus and an appropriate framework of risks-of which, by the way, the Financial Stability Report is a very big part-for doing that work. Otherwise you are just going into banks and sort of hammering them with questions in the hope that you spot the thing that is wrong but you don’t actually know quite where you are going. So it needs to have a very clear focus for the issues that it is taking up with institutions, and that requires judgement. Frankly, that requires a change of style and in some cases a change of skills as well.
Q406 Jesse Norman: Thank you for that. Mr Tucker, when I asked the Governor earlier on about contingency arrangements for dealing with contagion in Europe, vis -à- vis Greece and then Ireland, his response, quite properly, was: these are not for public discussion. As a Committee, how are we a expected to exercise parliamentary scrutiny and accountability as matters presently stand, given that so many of the most vital decisions are going to be taken, essentially, behind closed doors within the Bank?
Paul Tucker: You can see part of what we have done. The Governor has already talked about the liquidity facilities. The terms of those are-
Jesse Norman: I am asking you a question about accountability rather than about business arrangements.
Paul Tucker: I am going to go onto that because I want to make a point that the Governor did not make earlier. There are a limited number of things that this country can do within its own power to protect itself from a tsunami that may be bred elsewhere. One of the things we can do is say to our banks, "To the extent that you can, build up your capital during the good times when you are making good profits", and the FPC concluded that. It has asked the FSA to pursue that. That is not a sermon, which we were previously restricted to, it is a plan. We could have done that completely privately. We have put it in the public arena. The broader issue about how we can be accountable for invisible things is incredibly hard. In the arena of lender of last resort, I think there are arrangements for very private discussions and maybe they should be extended in some circumstances.
As the White Paper makes clear, we will have no responsibility whatsoever for decisions on public money. The Chancellor will retain those responsibilities, obviously. A Memorandum of Understanding will be required by the draft legislation on how we will give the Treasury the information it needs for its crisis management role. I suggest that when that process has advanced and there is an MOU, that is the time to come back to your question, because the key question then is: how can we and the Treasury officials and the Chancellor, be held accountable for our part in that MOU? This is going to be a very, very important MOU, easily the most important in the whole of the package.
Q407 Jesse Norman: Great play has been made today about the accountability of the Bank to this Committee. Indeed, the Governor’s previous answer mildly uses a form of exculpation as to why there had been no internal report on the Bank’s potential failings in regulation before the crisis. I think if the Bank genuinely believes in accountability to public authorities, you should consider preparing a memo to us about how that accountability could be extended in areas such as these where there are invisible operations taking place, which nevertheless require some genuine public understanding, even if they cannot be made available to markets or to the public in that sense.
Sir Mervyn King: We will certainly send you a note where we spell out how we think accountability for those things should be carried out. As Paul mentioned, about lender of last resort, which I think was quite a good example here, we have said in our annual report for many years-we have made this quite clear-that there will be possibly some lender of last resort operations that could not be disclosed at the time, if that disclosure would undermine the purpose of the operation itself, but that we would always disclose ex post once we felt we had reached the point where disclosure would not jeopardise the operation. That commitment was always there. Many people have not noticed it but it was always there. There is now a very clear arrangement under which any lender of last resort operation, which by the way has to have the approval of the Chancellor, cannot be done just by the Bank. Any risk of public money always has to be approved by the Chancellor. If that operation were to take place, the Chancellor and I would jointly brief the Chairman of your Committee and the Chairman of the PAC. I had understood that was going to be the case before. It did not happen but it will from now on.
Q408 Jesse Norman: I have one final question, Mr Chairman. I don’t know if you want to bring Mr Bailey in on this question first.
Andrew Bailey: I want to make one point, which is that there has been a degree of accountability. I have certainly appeared the PAC on the question of operations undertaken by the Bank. It was another Committee, but that accountability has existed and there are reports on that.
Q409 Jesse Norman: Ex post, yes. Thank you very much indeed for that. The final question is probably one for the Governor. The FPC code of conduct is quite clear about the discussion of MPC business and the need to avoid speaking about any aspect of UK monetary policy during the MPC purdah period. Will the MPC members’ code of conduct be updated to reflect this MPC-
Sir Mervyn King: Yes, indeed.
Jesse Norman: There will be a standard across the board?
Sir Mervyn King: Absolutely.
Q410 Jesse Norman: Would it be fair to say that you take a very tough line on public disclosure of information that might unsettle the markets?
Sir Mervyn King: Sorry, I missed that last point.
Jesse Norman: Would it be fair to say that you take a very tough line on all public disclosures of information that might jeopardise the markets?
Sir Mervyn King: Indeed. I think it is one of the most important things to have a set of rules surrounding information that is disclosed, whether it is by us, by institutions themselves. There has to be a very clear framework within which people know what information is or is not available, and any breach of those regulations I would take very seriously.
Jesse Norman: I am very grateful for that. Thank you.
Q411 Chair: Looking at the code of conduct, of course, I understand the risks that are attached to the non-executives on the FPC commenting on monetary policy, but there is quite an imbalance, isn’t there, in the arrangements you are putting in place? You are suggesting that only academic comments can be permitted on the conduct of monetary policy. Paul Tucker, you cited a moment ago an example, which may be more than theoretical, of a potential clash between the exercise of policy by the FPC and the MPC. Why is it not legitimate for a member of the FPC, an external member, to comment on it?
Paul Tucker: I think in those circumstances it would be because they would be commenting about the things within their own sphere of responsibility.
Chair: Right, but that is certainly not an academic comment, is it? That would be a very policy orientated comment. So this needs some redrafting, doesn’t it?
Paul Tucker: I think that what you are pointing to is-I can’t remember the exact words, but I am confident that it is okay in terms of the words that are there because an MPC member would be talking about influences on MPC decisions. I think the spirit of this is that MPC members, who are not on the FPC or the PRA board, going out and making apparently Bank of England comments on central counterparties, or FPC members ranging off-piste as well could be absolutely confusing to people. I don’t think there is a difference between us at all in terms of the spirit.
Chair: It is something we might come back to.
Q412 John Thurso: I am still trying to get my head round the idea of finding an actor capable of playing George Mudie, but we will let that run.
Governor-I stress this is absolutely nothing personal and I have the utmost confidence in your abilities-the Governor will now chair the Court of the Bank, chair the MPC, chair the FPC, the PRA and will be Vice-Chair of the European Systemic Risk Board. Is that too much for one person?
Sir Mervyn King: It depends on how it is done. I correct you: I do not chair Court. One of the things I did when I became Governor was de facto to hand the chair to the senior non-executive director, because I believed that was the right way for Court to operate, and I managed to persuade the Government to put that into legislation when there was an opportunity to do so. So I do not do that, and right through my term of office I have been keener to get rid of responsibilities than to build an empire, and I have a pretty good track record on that.
So the question is: why should the Governor chair all these bodies? I think the answer is: do you want these functions in the Bank? If they are in the Bank, and they are major policy-making functions, the Governor really has to chair that body. I am not the only member of the Bank who is sitting on all of these bodies; several other people are as well. So you may ask whether these functions are too much in total for the institution. Should the PRA be an independent, free-standing body? There are arguments for and against that. We can have that discussion. Once I think you have put them in the Bank, I think the Governor has to take responsibility, but then he has to change the way he does his job.
One of the things that is striking to us is that we have been doing this in practice ever since the crisis began. Andrew Bailey has been in many ways a de facto prudential supervisor for many of our biggest institutions, and I have had to be involved in that, and he has reported to me on that. Financial policy we have been drawn right into the middle of. So these three areas of responsibility have taken up a lot of our time anyway in the last four years, and I think whatever the arrangements for prudential supervision or monetary policy, the Central Bank, in a crisis, is bound to be heavily involved. So to make it feasible, what one has to do is to delegate many of the functions to others, and I have delegated a number of my functions and responsibilities, which I did personally before 2007 in the monetary policy area, to Charlie. In the prudential policy area, Paul and Andy are taking the brunt of the burden of developing the work in that policy area, and in the prudential supervision area, we have a steering committee to design the new functions for the Bank, which meets every six weeks. On that committee are: Hector Sants, Andrew Bailey, Paul Tucker and myself, and we meet every six weeks to oversee that process. Between that, that is delegated to Andrew Bailey to be responsible for. So I think you do have to delegate in order to carry it out, but we have doing this in effect for the last four years.
Q413 John Thurso: Can I just check, because I am dying to ask Andy Haldane a question, but I am not sure if he figures in the right place? You are currently Executive Director for financial stability. Will you be on the FPC, working for the FPC? How will you relate to the FPC?
Andy Haldane: Yes, I am on the interim FPC, and we met for the first time a couple of weeks ago.
John Thurso: In that case, I can ask you the questions I want to. Several of the witnesses we have had-and I have had discussions with them-have raised the difficulty confronting the FPC of knowing what it is it is trying to do, whereas the MPC has a very clear remit. The FPC will have a role in crises, obviously, but its real success will be to help avoid a crisis. That means you need to define financial stability. Can you define it for me?
Andy Haldane: Well, I can have a good go, I think, at defining what you would want from the financial system. I think that is pretty well hardwired into the plan, the new legislation, which is a system that is resilient to events, to shocks of various types, by which I mean, when it is shocked by this or that, it is still able to offer confidence to depositors, credit to customers and to other functions in insuring risk of various types. I think that is words rather than a number. I think we are somewhere short of having a quantitative target for this objective, but obviously I think it is pretty clear what failure looks like.
Q414 John Thurso: Let me take you back. Let us say the new system was in operation in 2006. Given what we now know happened from 2007 onwards, particularly in 2008, you would expect all the indicators to be at least at the top end of amber, if not creeping into red. What would we have seen, what would we have been looking at, what would be the dials that allowed us to make that judgement?
Andy Haldane: I think it is many of the same things that Charles Goodhart mentioned, I think, in his one-page submission to you. So I think that the two key indicators are, I would say, a measure of leverage in the system and measures of mismatch. So looking back historically, it is very difficult to unearth any system-wide crisis event that has not had at its core excessive leverage and/or excessive maturity mismatch within the system. That could be banking, it could be shadow banking. So those two things for me would be at the core of any diagnosis. In truth, if you reran history using only those two or three things, you would have had 90% of what was going wrong. There is no question but that augmenting that, whether it is with measures of asset prices, whether it is measures of mispricing of risk, helps to embroider the story, give you a fuller picture of what is going on. Taken together, I think that would be adequate to know when the lights were flashing amber or red. It isn’t quite the single summary statistic that monetary policy offers, but I think we know enough already to have a rough idea of what is on the dashboard.
Q415 John Thurso: Let me put to you my two concerns. On the monetary side it is a doddle, because the Chancellor writes you a letter saying, "Do this", you produce a great report, and we have a lovely session beating you up because you have not got there, or you have got there or whatever. But it is all out there in the open, and we can have a very adult debate about it and get the issues we got out in the session this morning. As yet, I see no target that you can be given, which would enable you to behave towards us in that way, and the counterpoint is it makes it extraordinarily difficult for us to scrutinise when we don’t know what we are scrutinising. That then leads on to the problem-using the phrase the Governor often used a couple of years ago-about how difficult it is to take the punchbowl away when the party is in full swing. What the FPC does will be judged by our ability to justify the removal of the punchbowl in time. So how do you think you can go about designing those for us?
Andy Haldane: I think our report takes us somewhere in that direction. It provides a narrative, backed up by numbers, on where we see the state of the system. Is it warming up? Has it warmed up too far? So I think that is a reasonable starting point, in the same way that the Inflation Report, is the best starting point for a conversation about whether our monetary policy is on an even keel. What our report doesn’t have, but which the Inflation Report does have, is that fan chart, that single measure, that judgement of where things might be one or two years hence.
John Thurso: Is there a possibility that a fan chart could be developed that would show an increasing risk of financial instability, or would that just be a rather meaningless toy?
Andy Haldane: We should seek to do that, because in some ways the case for a fan chart, a distribution, is even stronger on the financial stability side than it is on the monetary policy side, because all you really care about are those big, fat tails out on the left-hand side of the distribution.
Paul Tucker: This is not a completely hopeless endeavour if one has a horizon of, say, five years or so. What matters is the resilience of the financial system and that it can withstand nasty shocks, so the question is how you measure the resilience of the financial system-leverage, capital ratios, and various other things. Then one can say, "Well, what would those capital ratios or liquidity ratios look like if the following nasty things happened?" That is exactly what stress testing is about. Probably the single biggest change in supervision that has come about through the crisis is the idea of doing forward-looking stress tests, and this is not in a completely different universe from doing forecasts of what we think are going to happen to inflation and growth. We are years away from being able to do this scientifically, but this is being employed in real time now. It was employed in the States in 2009 to good effect. It was employed in Europe last year, not to very good effect, and Europe is about to have another go. One of the things that Andy’s team is going to do over the next few years, as with the ECB, is to work out to what extent one can do what are called top-down stress tests. Without sending armies of people into the banks, can you take relatively simple scenarios and take publicly available or even privately available data for us from the banks and say how the bank would fare under these stress tests? Over time we could make those things transparent.
Q416 John Thurso: It seems to me the challenge you have is more than that, because you and the Governor were making speeches warning us all. Those of us who read those speeches could heed the warning. There were lots of people in the market who said, "This can’t last". I can’t remember who said, "As long as the music is playing, you have to dance and we’re still dancing". How do we get to the point where you can say, "Right, stop the orchestra"?
Sir Mervyn King: I don’t think it is quite that simple, but I do think there are two things that we could do that will make a big difference. One is that the link between the FPC, with the self-confidence to make judgements about the overall position, can then reinforce the willingness of regulators to take action institution-by-institution. Because one of the things that is so difficult for supervisors is they go in and they say to an institution, "Look, you really ought to have more capital, times are a bit risky now", and they say, "Well, look at all these other institutions". So I think that link is crucial. The second thing we could do is that for each session that the FPC will have with this Committee, we can provide maximum one page-only on one page-some numbers or just one number, on leverage and mismatch, which don’t capture the entire picture but are the basis for an initial conversation, which would make it possible for you to say, "Well, look, you have done nothing about this. Why not?" and we could explain why, given everything else that was going on, we felt we should not, or that we had done something and why. That won’t capture everything the FPC does, but you will be able to go back to the recommendations and ask us questions on that.
Paul Tucker: And don’t drive us to over-simplification, because otherwise what will happen is there will be a nice chart of leverage being okay over here, and there will be loads of nasty leverage just outside in the corridor, and so you just have to be patient, as we do, for a number of years. We know a lot more about how to do this than anyone knew 10 years ago, but we are a decade away from meeting your desire for a numerical target that you can hold us to account for, which isn’t saying that we can’t do a lot now.
Q417 John Thurso: Just to be clear, it is not the actual number that interests me.; it is to have something that is sufficiently credible that when the then Governor or whoever it is says, "This is it, we are in the danger zone", the markets and the Government don’t ignore them and carry on regardless, because they can’t afford to stop, but they say, "That has been said. We now have to behave differently". That is the objective.
Sir Mervyn King: But I think one of the values-not only of our report but of your reports too-is that they will help to bolster the willingness of non-executive directors, of others working in institutions, to challenge what is going on, and I don’t think you should underestimate the impact that these kind of things can have.
Paul Tucker: Every board of every bank of any size in this country should go through last Friday’s statement and say, "What does this mean for our bank?" Rather than waiting for the FSA supervisors to turn up and ask about it, they themselves should ask about it. We are not going to be in the business in years ahead of saying, "We think there is this risk. We wish you would all calm down, please". If you give us the instruments that the Government is suggesting-you, Parliament-at various points we will be saying, "We think it ought to slow down and here is what is going to happen to the requirements on you so that it does slow down", and then we will be able to see whether it does or not. We will misfire occasionally, but you will be able to hold us to account for that.
Chair: Charlie Bean, you have been very quiet. Have you anything you want to add before we bring this session to a close? In particular, do you agree with Charles Goodhart’s three indicators?
Charlie Bean: I think the important thing to realise about them is they are indicators, in the same way as, say, on the monetary policy side, things like the rate of monetary growth or the rate of nominal demand growth might also be indicators of inflationary pressure down the road. So think of them in that way, but not as targets. They are reference points to have a discussion around, and certainly for explaining policy. They may be very useful to frame an explanation about why we have raised capital requirements, with reference to how those are evolving. For instance, that is exactly what is envisaged in Basel III with the capital buffer, where the Basel Committee particularly referenced it alongside credit growth. But think of them very much just as indicators to help aid the discussion of where the issues are, not as an inflation target, as a hard thing that we are trying to achieve.
Q418 Chair: Governor, you have told us that a good number of the people who have given evidence to us have been labouring under various misapprehensions, and you have been kind enough to suggest that you will supply us with more written evidence in order to address those, and set those people straight. I think we could do with that sooner rather than later, because we want to get on with this work, not least because the legislation has just been published. I want to end with one question to you, Governor. I have a fair deal of contact with the City and have done over a number of years. They tell me that when this crisis started, the informal links between the Bank and the financial sector were weak and had been run down, and that this was a severe defect. There was a lack of high-quality intelligence gathering. The MPC, and the Bank on behalf of the MPC, have in place high-quality intelligence gathering about the real economy. Are you now going to-and are you in the process of-reconstructing that intelligence gathering on the financial side, which once was in place in the days when we all relied on your eyebrows?
Sir Mervyn King: I don’t think that the statement that we did not have an intelligence gathering operation is correct, and I don’t think one should confuse lunch or dinner parties with intelligence gathering. When I was appointed Governor, and before I took up the job, I talked to Paul Tucker and I said I wanted him, as Markets Director, to create a new market intelligence function, and that started when I became Governor. It was to build on what we had seen operate successfully at the New York Fed, which used many of the people trading, not to do lots more trading but to use that, to leverage off that and to find a great deal of intelligence based on that. That market intelligence function operated from 2003 onwards and was immensely helpful to us. It was the basis of much of the reporting in the Financial Stability Report, which you referred to earlier when commenting on the fact that we had made warnings. So I do not think we have a lack of a market intelligence function. It was extremely effective and very good, and I don’t think one should confuse the views of people who felt if only they had been able to call in personal favours to get something that they would like to have had in that situation. That is a very different relationship from the one that you need for a market intelligence function. We are beefing up that market intelligence function in order that it will support not just the Monetary Policy Committee in our previous financial stability responsibilities, but the FPC as a whole. Its function is doing that work under Paul Fisher now, with Paul having moved to Deputy Governor, and we are also having a large number of contacts with people in the financial sector, some of which will be done through PRA, some through the financial stability side.
But I will refer you to one example of something that was extremely effective here, which I think belies the assumption behind some of the comments you referred to. In 2008, when we began talking about the Special Liquidity Scheme, this was a proposal of the Bank, and I put it to a private meeting of the chief executives of the big banks. I think they were surprised by the scale and ambition of that plan, but they could see that its virtue was that it was a three-year plan, it was generous, it was big, but it was restricted to the assets that they held when the crisis began, so it wouldn’t involve any temptation to create assets and have them financed by the Central Bank. These were the key principles, which are absolutely right, and I think we handled this in the right way. The key thing about that is that we had to have detailed discussions with people in clearing banks in order to make that scheme an operational one. We did that for two weeks. Paul took a major role with Alistair Clark in going round the banks to sort out the details. Nothing leaked at all from that group. We were able to make that a very effective process and it was finally announced. I think that is evidence that the Bank can and does work with the financial sector, not to do them favours, not to give them something that they would like to have because it makes life easier for them, but in the interests of the financial stability of this country, and we have done it.
Q419 Chair: That is a helpful answer, and related criticism of the FSA is that whenever they have any contact with the people they regulate, it is to act as a policeman, and what is required is a much more two-way response. Have you heard that criticism and do you think that is something that needs to be addressed?
Sir Mervyn King: I have very much heard the criticism and I know Andrew is dealing with it and changing it, but when senior members of banks met with the FSA, they had too low a level of representation from the FSA. They weren’t probed and challenged on the big risks that they might or might not be taking. They were being quizzed about whether they speeded or engaged in a parking offence, rather than something much more serious. That is something that we are adamant we want to change, but I think the way to do it-and I don’t blame FSA entirely for this-that approach to banks came out of the attempt to merge prudential supervision into the same operation as conduct of business, enforcement and consumer protection. They are very different kinds of regulation and should be done by different people in different ways. That is why I think the split of FSA into prudential and the Financial Conduct Authority is exactly right. It is a simple question as to whether you want the PRA in the Central Bank. I don’t feel strongly about that, and we certainly did not ask for it to be in the Central Bank, but I do think that having a separate prudential regulatory body is the right way to go.
Chair: Thank you very much for giving evidence this morning. For two of you, at least, it has been a pretty long couple of sessions, and it has been very illuminating. We are very grateful and looking forward to your written evidence.