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UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 259
HOUSE OF COMMONS
TAKEN BEFORE THE
Appointments of Dr Donald Kohn and Andrew Haldane to the Financial Policy Committee
Wednesday 12 June 2013
Dr Donald Kohn
Evidence heard in Public Questions 1 - 61
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Taken before the Treasury Committee
on Wednesday 12 June 2013
Mr Andrew Tyrie (Chair)
Examination of Witness
Witness: Dr Donald Kohn, External member of the Financial Policy Committee, gave
Q1 Chair: Good morning. Thank you very much for coming to see us this morning. You are well known to us already and we have enjoyed your evidence in the past. Could I begin by asking you whether you think that recent events have given the appearance that the FPC’s independence might be at risk of being diluted? I am referring particularly to the appointments, to the elevation of what is supposed to be a letter of recommendations into a remit letter that might have some parallel with the MPC’s remit letters, and of course the debate and controversy about the leverage ratio, which is the issue of whether and when the FPC should acquire the authority to set it.
Dr Kohn: From my perspective, the independence of the committee has not been compromised. Taking these events one at a time, I greatly value the input of my former colleagues, Bob Jenkins and Michael Cohrs, and I will miss them on the committee. We have not had any meetings yet but I have no reason to think that the incoming members will not also add considerable value to the deliberations of the Financial Policy Committee, their independent voices. I know in my own application to re-join the committee, in my discussions with Treasury and the people who interviewed me, there was no attempt at all to compromise any independence that I would form.
It is true that I favour, like many of my colleagues on the interim Financial Policy Committee, getting a leverage ratio instrument sooner rather than later. I think that will be, or could be, a valuable tool in our toolkit if the situation looked like it was becoming more exuberant. My personal view is that 3% is probably not high enough as a steady state leverage ratio so I would want to see it move gradually higher and then have the ability to move it up and down. So I was disappointed that we did not get that tool or it was put off until a discussion in 2017, with the potential in 2018, but overall I do not feel that the decisions of the Financial Policy Committee have been constrained in other ways. As I noted in my response to your questionnaire, the Treasury representatives did express some concern about the effect of asking for higher capital on the two Government-owned banks and how that was going to come through, but we listened to that and we proceeded to do as we were going to do anyhow. The Treasury representative is there to let us know the Treasury’s thoughts. He did that and we acted against that background. I do not feel our independence was constrained in the sense that we took the actions we thought we needed.
Q2 Chair: A supplementary question on the leverage ratio. You have said there that it is not just that the acquisition of the power has been delayed; it is the acquisition of a discussion about whether you should acquire the power, and it is very important to be clear that there is no commitment by the Government ever to give you the leverage ratio until there has been a consultation. Do you think that, whether it comes sooner or later, it is essential that the FPC should have that power?
Dr Kohn: Yes. I think the leverage ratio is a valuable backstop to the risk-weighted asset, the Basel III-type capital requirements. I think capital is absolutely essential and raising capital is absolutely essential, so I would be a strong advocate for the FPC having control over a leverage ratio.
Q3 Chair: Is this something we should not be consulting about?
Dr Kohn: It is fine to have a discussion. That is what public policy is about, but I have not heard anything in the discussion that has occurred so far to back me away from the view that over time this would be a good thing to have. Would we do something with it today, tomorrow, in the next six months? I kind of doubt it, but the fact that the FPC actually mandated or recommended that the banks publish their leverage ratio on a Basel III basis as of the end of last year I think tells you the importance that we thought it should play in the overall scheme of things.
Q4 Chair: Although you have said that 3% is now too low and it should be higher, so are you saying there is something that should be done?
Dr Kohn: I think over time, maybe not now, maybe not this year, but I think we ought to have the authority to raise it, just as other capital ratios are not in their final resting places either, we do not propose a surcharge and so on.
Q5 Chair: I just want to be clear. The leverage ratio is set at the correct level now, is it?
Dr Kohn: I think III is a starting place but of course the III in Basel III does not phase in until 2018. I think I would be tempted to phase it in a little faster, just as we phased in the 7% sort of based Basel III a little faster.
Q6 Chair: Would you be thinking about doing that within months?
Dr Kohn: Within the next year or so, yes.
Chair: Within the next 12 months.
Q7 Mark Garnier: The Government recently announced the new Help to Buy mortgage guarantee scheme, which has come in for quite a lot of criticism in terms of potentially creating a new housing bubble. Do you share that criticism?
Dr Kohn: There are legitimate reasons to think that credit for particularly first time home buyers is probably more restricted now than it would be in more normal times, and I can see the rationale for Government intervention where they think there is a market failure because the banks are not making credit as available as they should be. I think it carries with it risks. Even if it is justified now and will be justified a few years from now as the banks return to better capitalisation and become more vigorous lenders, it does carry the risk of driving up prices, particularly in some segments of the market, and it carries the risk that once the Government gets involved it is very hard to extract the Government. This is an experience we are having right now in the United States where very heavy government involvement in the mortgage market has been very difficult to roll back, so I would be very cautious about this. It may be okay now but keep a very careful eye on it.
Q8 Mark Garnier: You mentioned a failure of the market, but some people would argue that the market is working rather efficiently because, of course, we are at very high prices for housing anyway and that if banks are restricting credit because arguably there is a risk of downside in the housing market that is not such a terribly bad thing from the stability of the banks point of view. You mentioned how long this will last. Do you think the FPC is the right organisation to decide when this finishes?
Dr Kohn: I think the FPC can make judgments about some aspects of this, for example some of the issues you raised, Mr Garnier, about whether it is driving the price of houses above a sustainable level, whether credit seems to be growing more rapidly than can be sustained and serviced by the households that are obtaining it. I think we can have a role to play on the financial stability side of this. I question whether the FPC is the right organisation to judge whether taxpayer funds are being appropriately applied and well applied. We can judge whether the application of those funds is creating a problem in the financial market but it seems to me it is not up to us to judge whether the risk to the taxpayer is balanced by the benefits to the housing market.
Q9 Mark Garnier: I think that is very clear. You are saying it is not a good judgment of whether you are getting value for taxpayers. It is your judgment of whether you are creating instability from an action. On that point, do you think that if the Government does come up with something that arguably could be a problem for financial stability it is the right thing for the FPC to pronounce on that?
Dr Kohn: I think the FPC can pronounce on the financial stability aspects of it.
Q10 Mark Garnier: As long as it limits it to the financial stability and not a judgement on-
Dr Kohn: That would be where I would be comfortable.
Q11 Mark Garnier: That is a very fair answer. Can I turn briefly to quantitative easing? A lot of people have been talking about the fact that we have had this very loose monetary policy that has resulted in very low yields, we have a big hunt for yields, as a result of which we now have mispriced risk in the system. Are you concerned about this?
Dr Kohn: I think it is something that the Financial Policy Committee needs to take a close look at. To the extent that risk is mispriced and then it re-prices at some time in the future, that could be a threat to financial stability. I think the other aspect of this that could be a threat to financial stability is even if risk is appropriately priced now, if people are taking positions in terms of the maturity of their assets and their liabilities that exposes them to interest rate risk, when those interest rates turn around that could threaten their viability. I do not know that this is a problem for today but I do think it is a problem that should be on the FPC’s agenda, radar screen, as this situation develops.
Q12 Stewart Hosie: In simple terms, sectoral capital requirements will make it easier or harder for banks to lend to certain areas of the economy. Some people have likened that to industrial policy since the FPC could raise weights in certain sectors like commercial property. Do you think that is a correct characterisation as something akin to industrial policy?
Dr Kohn: No, I don’t, Mr Hosie, because of the rationale. It seems to me when people talk about industrial policy they talk about directing resources into certain sectors because there has been a judgment made that the benefit of directing the resources into that sector exceeds the cost of directing them out of some other sector. If the Financial Policy Committee were to raise sectoral capital requirements on commercial real estate or residential real estate it would be because of a concern about financial stability, not that there were too many houses or too few houses but that because of the way they were being financed and the price they were being sold at the market was not pricing in the risks of something untoward happening. It would have the effects of allocating capital to some extent but it is not the purpose of it.
Q13 Stewart Hosie: I understand the answer, but if the reverse was the case, that in the future these risk weights were to be reduced, surely it would precisely have the effect at least of attempting to direct capital to those areas. The signalling effect of a reduction would be precisely to be directed, would it not?
Dr Kohn: Yes. It would be a feeling that for whatever reason tightness in the credit markets had unnecessarily impeded the flow of capital into these sectors and that it was safe and consistent with resilience to reduce the capital weight. I don’t deny that raising and lowering the weights would be intended to allocate or to have effects on the cost of capital in these things. It was the motivation that I was-
Q14 Stewart Hosie: The motivation is interesting. Clearly there would be a concern about overheating or some other concern, but if we look at the real life situation now, in London and the southeast 80% of all the cranes erected in the UK are here. It is actually worse than that because 60% of them are in London but there is only 8%, 9%, 10% of the population. That would imply a horrific regional imbalance. How much weight would you give to those sort of regional imbalances when you were looking at the overall picture of a risk weight in relation to something like commercial or residential property?
Dr Kohn: The weight I would give it would depend on its importance for the resilience of the financial system. That is my job. So if I thought the overweight of construction, prices and so on in London and southeast England was going to have an adverse effect or could potentially have an adverse effect on the resilience of the UK financial system I think I would need to rethink about how to address that.
Q15 Stewart Hosie: Even if that overheating or systemic risk potential did not exist in 90% of the rest of the UK?
Dr Kohn: I need to look at the whole system. I don’t think I am qualified or the FPC is the right body to be thinking about the allocation of capital and resources from one part of the United Kingdom to the other part of the United Kingdom. We have a hard enough job looking at the United Kingdom as a whole.
Q16 Stewart Hosie: I appreciate that. Just one final question on this, Virgin Money have told this Committee that industrial sectors are hard to define precisely and the banks might use that ambiguity to game the system or game the FPC’s decision-making. Are you concerned about that?
Dr Kohn: About their gaming the system?
Stewart Hosie: Yes.
Dr Kohn: Yes. I think the FPC needs to be careful that when it makes a recommendation or gives a direction that it is carried out in the way it was intended to be carried out. I think part of the gaming is the potential for regulatory arbitrage outside of the regulated sector and the perimeter of regulation is something that the FPC is going to have to pay close attention to, what is going on in the areas that are not directly under the PRA or FCA for example. We will need to be on constant lookout for information we need that might be out of the ordinary and not from the usual sources. I think we need to keep talking to people in the financial sector about where they see problems developing. They are right in the middle of it and they will be very quick to say, particularly from the regulated sector, what the unregulated sector might be doing. There are a number of ways of coping with the gaming, which after all is primarily just reacting to the incentives that the market plus the regulators are setting up, and we need to be very careful about that.
Q17 John Thurso: Good morning. In question 13 of the questionnaire we asked about your assessment of the public communications of the FPC and the challenges that remained. You said that, "The FPC needs to continue to build public awareness and understanding of its role. We need to explain how our actions interact with promoting stable growth and how we balanced costs and benefits in arriving at our decisions. These will be challenging but necessary." A little later on you pointed out that the role of externals is very much to guard against group think and then concluded that, "The main communications objective should be to explain our decisions as well as possible". How do you best see that being done?
Dr Kohn: I think it is done through a combination of things. The decisions we make should be explained as clearly as possible and the press conferences that the Governor and others have should help to explain that and help the press to understand what we have done, and if they don’t then we are not doing a very good job of explaining it. Individuals such as myself and other members of the committee can visit with people in the non-financial sector and the financial sector, give press interviews, give occasional speeches. I think that is helpful as well. Finally, I would be very remiss if I did not include these hearings and the hearings you hold on the financial stability report as critical elements and your questions forcing us to explain what we are doing and why.
Q18 John Thurso: How many speeches have you made?
Dr Kohn: I have made two or three and I have given a couple of interviews in the papers.
Q19 John Thurso: The Bank of England website thinks you have not made any speeches, because I had a quick look. Obviously they are not up to speed with where you are.
Dr Kohn: That is a surprise.
Q20 John Thurso: When Martin Taylor was in front of us I asked him this same question, and it is a question I asked Michael Cohrs when he came before us originally, about the importance of communicating the views. Martin pointed out that he still meets people who think that the FPC set interest rates and people don’t actually understand what the committee is about. I am trying to get a handle on the importance of the externals explaining their views and how important you think it is to go out and make sure your views are in there with the others.
Dr Kohn: That is one of the things I think I could do more of and do better over the next two years than I have over the past two years. I agree.
Q21 John Thurso: Thank you. My other question, which is slightly related, is when you came before us for the original hearing the Chairman pursued you at great length over your time commitments and the fact that you are based in America and have a very prestigious and important series of positions there. You gave us an assurance that you would give the time that you have given going forward. I want to ask for a reaffirmation of that commitment. Will the FPC continue to be your top priority?
Dr Kohn: Yes.
Q22 John Thurso: Roughly what has the time commitment been in the UK and what will it be going forward?
Dr Kohn: The nominal time commitment that they have specified is a 30% time commitment. I can assure you I have given that. Before it was 20%, and I was doing more than 20% so I think 30% is a reasonable number. I try not to come over just for the meetings but to spend extra time here in London and meet with people in the private sector and in the universities when I come here, and I will continue to do that. Among the speeches they say I haven’t given was one at LSE and I have scheduled a speech-
Q23 John Thurso: I will be berating the Governor when I next see him on the poor quality of the website.
Dr Kohn: I will be giving a talk at Oxford in November, so I already have one lined up there. So, some academics, and I have done a few interviews. I went to Liverpool to talk to businesses up there and gave a talk there. It wasn’t put on the website. It was an informal regional discussion. I think I could do more particularly of these informal regional discussions. There is more that can be done and I agree I can’t just jet over for meetings and go back. Even if I read a lot of UK newspapers and the staff of the Financial Policy Committee sends me a lot of information, which I read, there is something about being here and talking to people here that is absolutely necessary to do my job. I agree.
Q24 Jesse Norman: Dr Kohn, the fact that there is no possibility of the FPC having a leverage ratio control does not mean that you can’t consider leverage as part of your assessment of stability or make recommendations before then.
Dr Kohn: That is correct.
Q25 Jesse Norman: That is built into your current processes and instructions.
Dr Kohn: Absolutely, and in fact in the recommendations we made in March having to do with the capital of the institutions we said to the FSA/PRA, becoming PRA at that point, "When you talk to these institutions, these numbers we are giving you are a starting point and among the things you need to pay attention to is whether an institution looks more highly leveraged than other institutions". We have already said that.
Q26 Jesse Norman: Is there a danger that you might be thinking of leverage just in terms of large institutions, because they are the ones that would upset stability, rather than it having a more blunt effect on smaller institutions that are less of a threat to the system?
Dr Kohn: I think a fair point is that we have concentrated a lot of our analysis on the large institutions. They are such an important part of a very concentrated UK financial system. We have not paid as much attention to the small institutions, but your point is well taken. When you make a pronouncement about leverage it applies to everybody and we need to be aware. Not only are large institutions potentially systemic but groups of small institutions can be systemic, as the United States found out with the S&L crisis.
Q27 Jesse Norman: That is very helpful. There are economic scenarios in which the UK is growing and potentially growing quite robustly by 2017 and sometimes in some contexts with inflation starting to move up quite quickly. That is never a good time to be thinking about something as potentially controversial as a leverage ratio. Wouldn’t it be better to be thinking about instituting such a ratio now when those concerns are not so clearly felt?
Dr Kohn: The leverage ratio may not be a tool of ours but it will be instituted under Basel III by 2018, so it will be in play in 2018. I think raising the leverage ratio at a time such as you describe is exactly what the Financial Policy Committee ought to be thinking about, the regulators ought to be thinking about, because it is in those exuberant times that the risks look low but are building up in the system. There will be a leverage ratio in 2018. Whether it will be a tool of the FPC, as the Chairman has pointed out, is supposedly subject to a study. That does not mean that the FPC can’t make recommendations on the leverage ratio.
Q28 Jesse Norman: The argument for putting it in place now would be this is the time for calm and sober reflection, not at the moment where it might be needed to be deployed.
Dr Kohn: As I said, I favour getting a tool now and beginning the discussions now, perhaps not raising it. This might not be the right opportunity to raise it.
Q29 Jesse Norman: That is very helpful. You are in the very unusual position of having had enormous experience of the Fed as well as sitting in the FPC. Are there lessons that we are not adequately absorbing from your experience of the Fed?
Dr Kohn: There is very good communication between the Bank of England and the Federal Reserve, both bilateral and as part of things like the Financial Stability Board where all central banks and regulators bring their lessons to bear on international regulation. So I think by and large everyone is trying to learn lessons from each other. We have all had our crises and we have all made our mistakes through these various fora. One of the things that the Financial Policy Committee said in its last announcement that it is thinking of pursuing-and we will need to discuss this over the next couple of weeks-is stress tests. That was very successful in the United States, for some particular reasons but it was very successful. I think the Financial Policy Committee needs to give very careful thought as to how those might be implemented in the United Kingdom as a marcoprudential as well as microprudential tool. That is one thing we are in the process of trying to import from the US over here.
Jesse Norman: That is an extremely helpful thing. Thank you very much indeed.
Chair: Dr Kohn, thank you very much for giving evidence this morning. I think we will move straight on to the next session.
Examination of Witness
Witness: Andrew Haldane, Executive Director, Financial Stability, Bank of England, gave evidence.
Q30 Chair: Good morning, Mr Haldane. Thank you very much for coming to give evidence. You heard the question at the beginning that I put to Dr Kohn on the leverage ratio. Do you agree with the reply and is there anything you would want to add?
Andrew Haldane: I did agree with the reply that Don gave. I am a strong supporter of the leverage ratio of long standing. I think it is the single most reliable and robust measure of the capital adequacy of a bank or of a banking system. Past crisis experience bears that out. I would have much preferred if the FPC could have had directive powers over the leverage ratio with immediate effect, not because I think it needs immediately to be altered but because in the period between now and 2018 it is possible we might want to do something with it, so having it now is the right thing, I think.
Q31 Chair: You said in your evidence to us that, "The discussion around capital needs for the two part state-owned banks was very difficult to detach from the issues around the public purse", which is a polite way of saying the Government was interfering, wasn’t it?
Andrew Haldane: The situation is somewhat peculiar. The FPC is there to make recommendations about, among other things, the capital adequacy of the banking system. Almost half of the UK banking system is in state hands, so we have had discussions at a time where the majority shareholder in half the banking system is also around the table and that is difficult. That makes it somewhat awkward for everyone. Has that had a material impact upon the recommendations we have made? I agree with Don on that. I don’t think it has.
Q32 Chair: Did it make it more difficult to get to your recommendations than it otherwise would?
Andrew Haldane: Perhaps a little but I don’t think it has fundamentally shaped, for example, the quantum of capital we believe those two banks might need. It did impose something of a constraint on the avenues that might be used to raise that capital. It was made very clear to us that that was not to come from Government, or indeed from private sector sources, and therefore those shortfalls needed instead to be made good by asset disposals. That was absolutely fine but did somewhat constrain the range of options available to us for the two state-owned banks.
Q33 Chair: But you are satisfied with the plans overall to make up the capital shortfall for RBS and Lloyds, are you?
Andrew Haldane: Yes. I think we made very clear in our November recommendations that there are a variety of routes available for meeting those shortfalls, one of which was a raising of capital but another of which was a disposal of assets of various types, subject to not retarding lending to the real economy. My hope and expectation is that the plans for the two state-owned banks will be consistent with those recommendations.
Q34 Chair: I think I am right in saying in the past you have supported the proposal of the Banking Commission for electrification of the ring fence. Are you satisfied with the progress that is being made by the Government to implement that?
Andrew Haldane: The electrification proposal is one that I supported when I appeared before you on several occasions on the Parliamentary Commission on Banking Standards. That is now being put through the legislation. The devil very much will be in the detail. If this electrification option is to have teeth, if it is to have value, then it needs to be executable in an expeditious way and in a way that does not raise the bar too high in the first place. I think when the detailed legislation comes back to Parliament we need to be vigilant to ensure that this option is one that is exercisable in a sufficiently expeditious way and without the bar being raised too high, the burden of proof being set too high before it is exercised.
Q35 Chair: Well, you had better let us know. Can we have a commitment that you will let us know if you are concerned about that?
Andrew Haldane: I would happily do that.
Q36 Chair: And that you will discuss this on the FPC as well?
Andrew Haldane: I can’t make that commitment as only one member of 10 but I would hope-
Q37 Chair: Would you raise the issue?
Andrew Haldane: I would happily raise it.
Chair: Thank you very much.
Q38 Mark Garnier: Good morning, Mr Haldane. You would have heard my questions a bit earlier to Dr Kohn. They are broadly speaking the same ones but I will remind you what they were. Do you share the concerns that a number of people have raised about the fact that the Government’s Help to Buy mortgage guarantee scheme could create financial instability and another housing bubble?
Andrew Haldane: I think that does bear some watching. I very much agree with what Don said about this, which is that our role as FPC is to be vigilant to any signs of this or anything else causing credit growth to the household sector or house prices beginning to move away too rapidly in a way that might imperil financial system stability. We are not there at the moment but there is no question in my mind we need to be super-vigilant to that in the period ahead. The other role that the FPC has been handed, as you know, is to reach a judgment on whether the scheme should be withdrawn after three years. I have a rather mixed view on whether that is a good idea or not.
Q39 Mark Garnier: Do you mean whether it should be withdrawn after three years or that you should have the decision?
Andrew Haldane: Whether we as FPC should have that decision. On the one hand, it puts us in a rather invidious position of punchbowl removal when the party is in swing. On the other hand, that is one of the FPC’s roles and certainly I would strongly support the points made by the Governor, and by Don this morning, that this is not a scheme that we want there forever. I think US experience is salutary in this respect. Fannie Mae and Freddie Mac were also temporary schemes and 75 years later they were still in place and blowing the world up. So I think we need to have a safeguard against that and I am happy to see the FPC be that safeguard.
Q40 Mark Garnier: That is very interesting. I will ask you the same question I asked Dr Kohn. If you see the Government making a policy announcement such as this one-and I absolutely take your point that if you see it developing into a bubble that it is a problem-do you think it is the right job for the FPC to say at the point at which it is announced that this is something that could create a bubble in the future or this could create instability in the future?
Andrew Haldane: As soon as we know what the details of this scheme will be-and of course at the moment we don’t-it would be only right and proper for the FPC to discuss that, to reach a judgment on that, and then to monitor its impact as it moves through. I hope that is what we would do. I don’t think it would be right for us to exercise any veto at the point of entry of the scheme. I do think it may have a role in veto and advising on the point of exit from the scheme.
Q41 Mark Garnier: That is very interesting. Can I turn briefly to quantitative easing and just have a quick look at that? I asked about this whole idea of you suddenly have a search for yield and as a result a potential mispricing of risk, but what I wanted to talk to you more about was that although the MPC decides the size of quantitative easing, it has to now have regard to the policy actions of the FPC. If you thought that QE was creating financial instability, would you try to warn the MPC and, if so, how would you do it?
Andrew Haldane: I absolutely see it as my one of jobs as an FPC member to alert not just the MPC but this Committee and the wider world if I thought that QE, or monetary policy actions more broadly, was posing significant risks to UK financial system stability. How would we do that? Our public communications would be one means of doing that but in addition I would hope we could have occasional joint meetings between FPC and MPC. We have had one already actually and we might seek to build on that co-ordinated approach in the period ahead. That is the process answer to your question.
To the substance, this is a risk that I feel very acutely right now. If I were to single out what for me would be the biggest risk to global financial stability right now it would be a disorderly reversion in the yields of government bonds globally, for any one of a variety of reasons. We have seen shades of that over the last two or three weeks. Let’s be clear, we have intentionally blown the biggest government bond bubble in history. That is where we are, so we need to be vigilant to the consequences of that bubble deflating more quickly than we might otherwise have wanted. That is a risk. It is one we as FPC need to be very vigilant to.
Q42 Mark Garnier: What might precipitate that? If there is a single risk that might emerge, what do you think could deflate that bond bubble?
Andrew Haldane: I think there is any one of a number of things that could potentially trigger. The one that people fixate on-over-fixate on, in my view-is signs of exit from QE or forward guidance. That is one possibility, and of course the Fed signals on that over the last few weeks have had some impact on US treasury markets, but it is by no means the only one. There has been a collective flight to safety over the last several years. Were that flight to safety to reverse sign that too could have an impact on the long end of the yield curve. So I think there is a variety of potential triggers. As FPC, we don’t need to reach a view on which of those is most likely. What we do need to reach a view on is the consequences if yields were to shift upwards very steeply. Who is bearing this long duration interest rate risk. Is it the banks? Is it the non-banks. Would it cause significant damage or not? Is this risk hedged or is it not? Those are the questions the FPC needs good answers to if and when yields were to correct from the uncharted territory that they have been in for several years now.
Q43 Stewart Hosie: Mr Haldane, you heard many of the questions earlier this morning. On the main question I asked Dr Kohn about sectoral capital requirements making it easier or harder for banks to lend to certain areas of the economy being interpreted or defined as industrial policy because it effectively directs resources, is that a characterisation you would agree with?
Andrew Haldane: You will be unsurprised to hear I agree with Don’s answer to that question but let me add a bit of a gloss of my own, if I may. Personally I would much prefer the FPC to use tools that have the fewest possible redistributional consequences. I think in general we should ask ourselves the question why wouldn’t we act on headline capital ratios rather than immediately moving to more sector-specific capital ratios, for some of the reasons that you gave: the scope for arbitrage between different sectors; we may just displace risk from one sector into another sector, what we call parochially the waterbed effect. Personally my preference would be to start the conversation about instruments at the highest level of aggregation, which might be headline capital requirements. That is not to rule out more surgical sector-specific interventions if we see a particular market or sector getting ahead of itself in ways that could imperil systems specifically.
Q44 Stewart Hosie: That is really interesting. I gave Dr Kohn the example of the erection of construction cranes, that 60% of all of the cranes erected in the whole of the UK were in London. I said that implies a massive regional imbalance elsewhere in poorer areas. You said that you would like to use those tools that had the least redistributive effect. The politicians might want you to use these tools to have the most redistributive effect because of the imbalance that the current system has. How would you deal with that conflict of pressures?
Andrew Haldane: We have a statutory remit that makes very clear what the FPC is there to do. It is not within the FPC’s current statutory remit to engage in a redistribution of lending or of capital between different sectors. It is there with headline aggregate system resilience as its objective and, subject to that, supporting growth more broadly, not growth in the construction sector or any other sector. We must act in line with our statutory remit otherwise we are falling short. Sometimes we will act in ways that will have redistributional consequences. It is an unavailable consequence of any public policy but that is not because we are overtly seeking to do something of a redistributional nature. It is a consequence of pursuing our headline statutory objectives.
Q45 Stewart Hosie: I understand that and I can understand because of the relationship with politicians and the Treasury you will be able to say, "No, we can’t do this", but when you pick up the papers and one part of the country is booming and there is inflation in one sector or many sectors but other parts of the country have not come out of the last recession or recovery is really fragile, that surely must play some part in the thinking because you know what the consequences of an action you take might be.
Andrew Haldane: I think it is very difficult to argue that we would be blind to some of the facts that you mentioned. Of course we would not be. But I think we have to, to a degree, blindfold ourselves to some of those regional or sectoral differences at the point we get around the FPC table and act, as I say, in line with our statutory objectives, which very clearly put us on the hook for seeking system-wide stability and aggregate growth rather than any sectoral or regional distribution within that.
Q46 Stewart Hosie: You mentioned yourself Dr Kohn’s answer about gaming the system, about arbitrage. What has been done so far or what is intended to be done to ensure the banks will not game or will not be able to game the rules in terms of sectoral capital requirements?
Andrew Haldane: We will never rid the regulatory system of gaming. It is in the nature of regulation. One of my reasons for favouring a leverage ratio is precisely because of its simplicity and therefore that it may engender somewhat less gaming than alternatives. When we are executing sectoral capital requirements, or indeed any tool, we will have to be extremely vigilant to attempts to obviate or move around that tool. It could be displacement activity to the shadow banking sector. It could be people reclassifying loans. The fact that we have the PRA as part of the new bank family I think will help us in monitoring attempts to arbitrage FPC actions but I don’t doubt that we won’t rid the system of it because I think it has always been with us and always will be.
Q47 John Thurso: Can I ask you a quick question on the remit, which had a much stronger comment on growth than perhaps many people were expecting? Do you think that in any way impairs the committee from achieving its primary objective with regard to financial stability?
Andrew Haldane: The first thing to say, Mr Thurso, is we are yet to discuss the remit as a committee, so these will be personal reflections. I don’t think so. I was personally a strong supporter of having a secondary growth objective. The legislation makes very clear that the Government is required to set out what it means by the secondary growth objective on at least an annual basis, and that it has done in the letter to the Governor. It also makes clear in the legislation that the Government is able to make recommendations to the FPC about how its objectives are to be interpreted, including its financial stability objective, and that the Government has also done. So the letter we have received is fully in line with the legislation. We will have to, as a committee, discuss that and we will respond in time to the Government on the letter that has been received, including the recommendation. It is that; it is not a requirement, it is a recommendation that we weigh particularly somewhat more heavily the secondary objective in the current environment.
Q48 John Thurso: I shall forgo further questions on that until you have discussed it but I think it is something that we will come back to over time.
In our questionnaire we asked you about what your greatest concerns are regarding financial stability in the UK and we have had interesting and different answers from all of the different people that have been before us. You came up with as your A-I don’t know whether they are all equal but it was the first one you mentioned-operational/cyber risk, which was interesting. Can you flesh out why that is one of your top five concerns and what you think the risk is?
Andrew Haldane: One of the prompts for me putting this in my list of the top five was a meeting I had with the chief risk officers of the major banks in the UK about six months ago. I have these meetings regularly to discuss what they see as the biggest risks and feed that into the FPC. In the prior meetings the focus had been on the usual suspects, the euro crisis, slump in the economy, asset prices going up. Then we sat down six months ago and went round the table and four of the five identified cyber risk as having risen to the top of their list, which I thought was very interesting. As interesting was the fact that the fifth firm didn’t have it on its list.
John Thurso: I bet they do now.
Andrew Haldane: They now do, which is a source of some reassurance. It made me think that understanding and management of this risk was still at a somewhat early stage. I think what is true of financial firms is at least as true of financial infrastructures, payment systems, security settlement systems. You could see why the financial sector would be a particularly good target for someone wanting to wreak havoc through a cyber route so I very much hope FPC and wider government, because I think this has to be wider government, would take a close look and a deep dive into the state of preparedness of the financial sector for such threats, which of course are ever evolving. The cyber risk is one that is difficult to keep up with because it has moved at such pace over the last six to 12 months. I hope we can do more on this as FPC as part of the wider government.
Q49 John Thurso: Have you drilled down into cyber risk at all? It seems to me there are two sides of it. You have the criminal element, fraud and all the rest of it and the immense potential that the use of electronic means gives to their criminal endeavours, but there is also the national security side of it. There were reports recently, for example, that the US have been very bullish, stating that they think China has been deliberately "attacking" the US, the possibility that states can have a go at each other without actually going to war with anything. If you have identified this as one of your top five risks, who is going to do something about it? You have identified it; the committee discusses it; maybe the committee decides it is a big risk. Is that something you tell the Government to get the security services to look at or is that something the firms have to deal with on their own? How do you see that being dealt with?
Andrew Haldane: I think the overarching responsibility probably does lie with the Government looking across sectors and that currently is where responsibility resides, but I think we as FPC, we as the Bank of England, do have some responsibility in respect of the financial sector to ensure that its state of preparedness is adequate, that we understand where firms are and, as importantly, we understand the inter-linkages between firms. Both Bank and FPC will have a role in addition to wider Government, which will hold the ring on this.
Q50 John Thurso: You listed five things in this section. The other four were too big to fail, search for yield, low global real interest rates and non-bank intermediation. Can I quickly ask you on non-bank intermediation as a key risk to financial stability, where do you see that risk lying and what should we be looking to guard against?
Andrew Haldane: The risk there is two-sided. One of the risks is that we squeeze the banking system and risk pops out somewhere else in an undesirable form, as a shadow bank that if it were to go pop would ripple back to the real economy. The FPC, as Don said, has a distinct responsibility to monitor the shadow banking system and to suggest changes in the regulatory perimeter if we think those risks are considerable. But the risk is two-sided. I would very much want the UK, Europe indeed, to move to a financial system that has a wider, broader and deeper set of non-bank financing channels. I think it needs that. We are currently too much of a banking monoculture and that is not good for financial sector resilience. There is some risk of over-zealous regulators like me getting in the way, retarding the growth of this second cylinder for the financial engine, which I think we very much need in the UK and more broadly.
Q51 John Thurso: For clarity, what we are really saying is that some activities, particularly say in the capital markets, actually sit better in a hedge fund and a partnership model than they might do in a universal bank and that therefore the fact that it moves out of the banking and into that shadow banking not inevitably but may be quite a good thing?
Andrew Haldane: Quite so, and I think you can make the point even more compellingly in respect of institutional investors, such as pension funds and insurance companies. In terms of long-term financing of the wider economy, the natural holders of those longer maturity assets are those with longer maturity liabilities, which are insurance companies and pension funds. You back up 30 years and that was the case to a much greater extent than it is today.
Q52 Jesse Norman: To be clear on leverage, Mr Haldane, are you absolutely happy with the current 3% level?
Andrew Haldane: I think it was a jolly good thing that internationally we agreed for the first time ever to have a leverage ratio set at 3%. My personal view is that is insufficiently ambitious as an objective. A 33 times leveraged banking system sends shivers down my spine if that were to be a long-run goal from a stability perspective.
Q53 Jesse Norman: That is clear and helpful. Thank you. Have you been following the situation with the Co-op Bank closely?
Andrew Haldane: Yes.
Q54 Jesse Norman: Could you comment on that? You don’t often see banks downgraded by six notches to junk status on the Treasury grid so it is quite interesting when that happens.
Andrew Haldane: To be clear, as an FPC member, as you know, it is not our responsibility to get into the fortunes of individual firms and we have not done that as FPC. The Co-op situation is plainly difficult. The six-notch downgrade did come as a surprise to I think almost everyone. Thus far that has not caused the haemorrhaging of liquidity that some might have feared, so that is a good news story, but nonetheless it is clear that further needs to be done to put the Co-op into a situation of resilience and sustainability, and I know my colleagues at the PRA are working closely with the Co-op new management on just that.
Q55 Jesse Norman: Are you comfortable it does not pose a wider systemic threat?
Andrew Haldane: I think as FPC we would need to reach a judgment on that once we know a bit more about the remediation plan for the Co-op.
Q56 Jesse Norman: Would you back Dr Kohn’s comment about improving stress tests?
Andrew Haldane: Absolutely I would. I think we are at present some little way behind where other countries are, including the US, and I very much hope we can move to a rather more comprehensive and systematic, regularised assessment of the system’s capital adequacy and be in a position to announce remediation plans when necessary at the same time as the stress test results are released, which is the US model.
Q57 Jesse Norman: You are giving very clear and brief answers. I am very grateful for that. Very quickly, are you happy with how the Funding for Lending Scheme is working? Does it not give banks who do enter a weak incentive to improve net lending while still benefiting from scheme membership?
Andrew Haldane: I think the Funding for Lending Scheme has achieved some of its intended objectives, in particular in squeezing funding costs for banks, which have fallen pretty dramatically. Particularly for some of the weaker banks, the fall in funding costs has been pretty dramatic. FLS has not been the only explanation for that but it has been a contributor. It has had some impact on lending rates, in particular in the mortgage market. It appears to have had some impact in making available in particular higher loan to value mortgages. Its impact on wider credit availability, particularly to the SME sector, has been a touch disappointing so far, to be brutally honest with you. It is still early days. The impact it has had on lending spreads and borrowing costs has itself been a positive. Do I hope ultimately it will trickle out of the pipeline as higher lending quantities, mortgages, SME loans and the like? Yes, I do. I think there is still time for that to happen.
Jesse Norman: That is an eloquent understatement. Thank you very much.
Q58 Andrea Leadsom: Good morning. You said as your second key risk that "too big to fail" has not been solved. You said it remains essentially unsolved. Clearly competition is a big part of breaking up the big "too big to fail" banks and bringing in new players. Then you have also said that you are concerned that internal models for calculating risk-weighted assets penalise smaller banks because it effectively makes it cheaper for bigger banks who are internally assessing to do business. Is that something that you intend, on the FPC, to try to put right?
Andrew Haldane: I hope that is an issue that we can engage with because I think the lack of completion in the UK banking market does have a direct bearing upon the FPC’s objectives, which is to support a more resilient, diverse financial system. There are many such obstacles. There is the one that you and Mr Garnier have written about in the context of current account portability and easing the barriers to entry that come from current account switch. There is the one that you mentioned in your question, which is currently the capital regime does somewhat discriminate against new entrant banks and smaller banks.
Q59 Andrea Leadsom: Smaller banks will argue that it massively discriminates, that it is a real barrier to them lending to SMEs. It makes it so much more expensive, prohibitively so, for them to get into the market. Sorry to interrupt you.
Andrew Haldane: I can see why they say that. The scale on capital that you would apply if you are a small bank on a simple standardised approach by comparison with a large bank on an advanced models approach could be four, five, six, seven times more capital. They are vast. I hope that is an issue that FPC might turn its mind to. If not, I would hope that I, as executive, could do that anyway in my role on various international committees. The playing field needs to be levelled. It is a deep perversity in the current regulatory system that it in some ways encourages the "too big to fail" problem by discriminating against new entrants and smaller banks and I hope we can right that wrong. Those are two barriers, current accounts and capital requirements.
Q60 Andrea Leadsom: On current accounts, can I tempt you to go on the record and say that you think bank account number portability could resolve one of the big barriers to entry?
Andrew Haldane: You can tempt me. Yes, I do think that is something, an initiative whose time has come. I am also reassured by some of the work I have seen most recently about the costs of moving to that regime, that this will not be punitive, that relatively modest changes to the existing architecture could be engineered to deliver the benefits of current account portability. So I think this is one of the ingredients of us creating a more contestable banking system. Capital is the second. A third, perhaps just for completeness, is that I think the way in which information, the credit histories of loans to in particular small and medium-sized enterprises, is stored acts as something of a barrier to entry to that market too. This is on the loans side of the balance sheet rather than on the deposits side of the balance sheet. I think it is worth thinking through whether we couldn’t open access to information on the credit histories of smaller firms to make it easier for new entrants to come in and pick up that business as you want them to do.
Q61 Andrea Leadsom: I have heard you talk about that idea before and just as a rejoinder, what if rather than open access, which runs the risk of people getting false entries and so on and is actually being harmful to them, it was like medical records and you, as the SME, could require access to your own credit records for your own purposes as opposed to them being out there in the ether and tamperable with and so on?
Andrew Haldane: There would definitely need to be some safeguards if you were to put in place this informational infrastructure. Let’s be clear, this is not shooting for the moon. Many countries already have credit registries doing something broadly of this nature. Many more countries have those than don’t around the planet, so this is not pie in the sky. If we think there is a structural failure, a missing market for SME financing, this could be one of the ingredients that could help fill that missing market.
Chair: Thank you very much indeed for giving evidence this morning. It has been extremely valuable, as usual, relatively brief but it is the answers being so crisp that has enabled us to be brief. We are very grateful.