Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 80-98)

25 MARCH 2004

MR MERVYN KING, SIR ANDREW LARGE, MS RACHEL LOMAX, MS KATE BARKER AND MS MARIAN BELL

  Q80  Chairman: Do you have anything to say on that, Governor?

  Mr King: I think one of the difficulties which the US has got into in this area is the belief on the part of many market participants that the organisation set up to guarantee and make feasible the market in long-term fixed-rate mortgages has a government guarantee, and if you start doing that, you are giving an implicit public subsidy to an activity the value of which moves around. That is not something that I think would be sensible to encourage. I do think that if a market in long-term fixed rate mortgages were to evolve, it should be because the lenders and the borrowers decide that that is how they would like to structure the relationship. I think it is reasonable to feel that, as the period in which we have a degree of macroeconomic stability continues, it should be more attractive for people to take out fixed-rate mortgages than has been the case hitherto. But I think it would be a mistake to try artificially to encourage that by offering some kind of government guarantee or subsidy. We have been through a period in which,—to go back to the question that was asked earlier by Mr Plaskitt, when thinking about what was causing problems in the housing market,—for a long time the fact that there was tax relief on mortgage payments was regarded as a major difficulty. We have managed to get rid of that now. It would be somewhat ironic if we were to go back and find another one, which has caused very serious difficulty in terms of volatility, as you said, in long-term interest rates, Chairman, and I think we would be well advised to stay away from that. As Marian says, if it were the case that we had more long-term fixed-rate mortgages, and there was a smaller impact of interest rate changes on debt servicing and hence on consumption, we would have to move interest rates by more than we presently do. So what you gain on the roundabouts you lose on the swings. I do not think that this is an issue that we feel terribly strongly about, but certainly I would like to see the full range of mortgages made available to people. I think the point David Miles was making in his report is that maybe many households have not thought through the benefits that they would get from taking out a fixed-rate mortgage in terms of having some insurance against subsequent movements in real interest rates.

  Q81  Mr Cousins: I wonder if I could also take you back to paragraph 14 of the minutes and draw your attention to the first sentence rather than to the last. That is the one that refers to "Total lending to individuals was growing at some 14% on an annual basis." You have perfectly properly drawn a distinction between secured lending and unsecured lending in your answers to us. Do you have any idea as to what proportion of this growth is secured and what proportion is not secured?

  Mr King: Of the total stock, I think it is something like two-thirds to three-quarters secured, that is, three-quarters secured and one-quarter unsecured. The growth rates have been changing recently. There was a period over the last couple of years when unsecured was growing more rapidly than secured. Now the growth rate of unsecured lending is falling and the growth rate of secured has picked up. There was indeed some suggestion last year that, because of the increase in house prices, it became possible for people to substitute secured lending for unsecured lending, and of course it is much cheaper.

  Q82Mr Cousins: You used the figure of 10% in some of your earlier remarks, Governor, 10% of households potentially at risk.

  Mr King: That was the survey that we carried out. We commissioned a survey of almost 2,000 households to look at their position vis-a"-vis unsecured lending, and of that sample, about 10% felt they would have some difficulty were interest rates to rise in the way that the market now expects. But they were primarily people with credit card lending, and with smaller amounts of lending. They may be large relative to their incomes, but smaller relative to the average figure for unsecured lending. So most unsecured lending, the survey showed, was actually being undertaken by people with higher incomes who could afford to repay it, and indeed were repaying it. Nevertheless, there was this minority of 10% of those individuals in the survey who might have difficulty, but it was associated very much with rapid growth in credit card borrowing, which itself is only a small fraction of unsecured borrowing.

  Q83  Mr Cousins: The clear view you are expressing to us here this morning is that it would be quite wrong to take decisions about the macro economy, about the levels of interest rates, solely on the basis of some abuse or some speculation or some bad practice on behalf of a small minority of both lenders and borrowers in the unsecured section of the market.

  Mr King: Yes, and without taking a position about whether or not there is an issue and what should be done about it in terms of that small number, it is a separate issue. And it is something which you, I know, have been interested in on this Committee, and I would not discourage you from pursuing it. But we do not feel that it is sufficiently quantitatively important to be a major factor for macroeconomic policy.

  Q84  Mr Cousins: Thank you very much for making all of that clear to me.

  Mr King: There is one other point I would add on the first sentence, which has been a key part of our deliberations. 14% is a very high number for the growth rate of total lending, and the question is what is happening to it, where it is going. What has been interesting is in the last couple of years,—if you look at the household sector as an aggregate for the moment,—there has been also a very rapid build-up in the financial assets of the household sector. So although, obviously, you cannot pretend that the household sector is like one big, happy family making a common decision, it is not the case that all this borrowing is going into spending. It has also been matched by a build-up in assets of the household sector, so both assets and liabilities are rising. The balance sheet as a whole is rising. This is a phenomenon which is true of a number of countries, that the size of the balance sheet relative to incomes is increasing. Of course, that does raise questions about the sensitivity of spending to changes in interest rates on those assets and liabilities, and it also raises the question that if the composition of the balance sheet, and particularly the asset side, is becoming more liquid, a more liquid asset structure for the household's portfolio may well lead them to spend more. These growth rates can affect total spending in ways which I do not pretend that the economic profession really understands. There is plenty of speculation about how all this works. But the idea that somehow there is a well-defined model that economists have which tells them how these changes in balance sheets feed through to spending is not true at all. Since the numbers here are large, there has to be uncertainty as to what this does mean for spending.

  Q85  Mr Cousins: But if that argument is correct, Governor, would you not agree that is a pointer to having smaller changes in interest rates rather than larger ones, because there is more liquidity, more sensitivity, more awareness of the effects of these changes?

  Mr King: It is certainly the case that if you are uncertain about how interest rate changes will feed through to the economy, or more uncertain than you were, then that is a case,—you are right,—for being somewhat more cautious. That is precisely the reason that we had in our minds—and said in the minutes—for our being cautious when we started to raise interest rates at the end of last year. There was some uncertainty given the new balance sheet position of households as to how interest rates would feed through. So a cautious approach seemed to us appropriate, and we said so at the time.

  Q86  Mr Cousins: I wonder if I could ask Sir Andrew a couple of questions. I shall not tempt you into designing headlines. In the banking and financial sector that you must be particularly watchful over, are you concerned about the growth of special-purpose vehicles, the use of "offshore-ing"—by that I do not mean the location of offices; I mean the offshore-ing of assets.

  Sir Andrew Large: There are lots of things we look for, obviously. We look at ways in which concentrations of risk might be being built up and of course, if you are worried about where concentrations may be being built up, you are worried about transparency, and clearly, build-ups of assets in less transparent jurisdictions are ones that you wonder about, because you do not have all the answers. So in that sense, yes, it is an aspect of financial stability work that we do think about.

  Q87  Mr Cousins: Has there been any recent increase in the scale of the transactions that are located in what you have described perfectly properly as less transparent jurisdictions?

  Sir Andrew Large: It is very hard to say. One of the problems is that you do not know what the numbers are. There are some types of transactions which take place in somewhat less regulated environments, and they tend to be less transparent, but I would be very hard put to answer you as to whether there has been an increase or not recently.

  Q88  Mr Cousins: You will forgive me for saying I am actually a little bit disturbed that you do not have a handle on it, because I do think it is very important that someone does have a handle on it.

  Sir Andrew Large: This is one of the things, for example, that are discussed in a number of international gatherings of people who are involved in financial stability, both central banks and supervisory authorities, and indeed, ministers of finance. It is the sort of issue, for example, that is discussed at the Financial Stability Forum, which meets twice a year. Efforts are being made to improve the transparency. I can assure you of that, and I think it is fair to say there has been some success in that direction. What I was trying to say is that the more opaque it is, the more it is a matter of concern. I think that efforts to reduce the opacity are being made and with some success.

  Q89  Mr Cousins: Could I finally ask you about the insurance part of that. Are you concerned about the stability of the insurance industry?

  Sir Andrew Large: That is asking, I think, a very long-term question. Are you talking about life assurance or are you talking about general insurance? I should have asked you that question first.

  Q90  Mr Cousins: There are questions about both, but let us take them separately. Let us take general insurance first, because that follows on more naturally from my earlier question.

  Sir Andrew Large: The question is the stability of that industry? Of course, you have to consider the type of shocks it might be exposed to and its financial strength. It is certainly true that that industry has been subjected to some fairly unpleasant shocks over the last few years and is quite vibrant. I think from that point of view we can take quite a bit of comfort. But if you take a long-term view, it does not give me a large amount of concern, no. I think that there is going to be a demand for insurance services and there is going to be a supply of capital that will be devoted to it, and I think we have seen that that has been really quite effective over the recent past, and I do not see why that should change.

  Q91  Mr Cousins: Finally, life insurance.

  Sir Andrew Large: Life insurance: I think, the long-term question really in the industry is quite how it will be structured, and here, this really falls outside our remit, but there has been reference recently to the changes that the FSA are introducing to bring in realistic measurements and reporting in relation to life assurance so that it is clearer to customers and indeed the marketplace exactly what is going on within life insurance companies. My own view is that if that is done, and as that is introduced, it actually will be very positive for the long-term future of that industry.

  Q92  Mr Cousins: It is difficult to raise these issues without either sounding pompous or scary, and I do not want to sound either, but there clearly are now groups of political extremists who have been turned loose in the world and they are seeking to engineer brutal destabilising shocks, not least to the economic system. How far do you intend to take that or to guide the Committee into taking that into account in making your decisions?

  Mr King: Of course, we did think about this carefully after September 11th, and there was a debate, including at international level, about whether the new concerns about terrorist activity would add to the costs of international trade and travel and depress economic activity. Looking back, it is not easy to discern any significant effect of that kind. The world economy has recovered and grown pretty robustly, and that has been very much on the back of growth in international trade particularly in Asia and outside Japan. So I do not think it would be sensible at this stage to think that concerns that have been raised, particularly in the wake of the Madrid bombing, have really changed the outlook for the world economy, though it is something that obviously we will keep in mind and we talk about with our international colleagues when we meet. More to the point is that, in terms of the Bank of England itself and our responsibility for payments and settlements and stability of the financial system as a whole, and in terms of our involvement in the City, we are working very closely with all concerned to ensure we do have proper business continuity frameworks in place. If there were disruptions of any kind, we would be able to ensure that financial payments and economic activity could carry on. That is an important part of the Bank's work, but I do not think for the time being it is a major issue for the Committee, though we obviously keep a watch on this question and if the prospects were to change, we would take it into account. But I do not think either September 11th or one incident in itself will make a major change. The world economy has continued to grow healthily, as indeed has the British economy.

  Q93  Chairman: Sir Andrew, on the insurance aspect, following up what Jim said, in the recent Article IV consultation the IMF considered that "weaknesses remain" in the insurance industry and went on to say "although the authorities indicated that they affected mostly firms with little systemic impact." What do you think they meant by that phrase?

  Sir Andrew Large: Quite what one means by "systemic" you can discuss at length. Basically, I think what that means is that if there were to be a major problem in an insurance company, it would not spill over into having an impact on the banking system and the financial system more generally. I suspect that must be what was in their minds when they made that comment, though I am afraid I do not recall the exact words.

  Q94  Chairman: Taking that aspect of systemic risk, if Equitable Life became insolvent, are you confident that it would pose no systemic risks across the financial system?

  Sir Andrew Large: Of course, this is a hypothetical question, but I think that the spill-over of that into the banking system and the liquidity in the banking system would be quite limited, and so in that sense I think it would pass the test that you are asking me about.

  Q95  Chairman: The Governor mentioned credit card lending, and you mentioned transparency. Given your background in the banking system for many years and your concerns about household debt in your speech last week, I suppose you would agree we need an informed customer in the financial services and a level playing field for the customer to understand what the products and the issues are.

  Sir Andrew Large: I read your report with great interest, and I think that the demand you are making for greater transparency is one that would be very helpful to people making more informed decisions.

  Q96  Chairman: As you know, in our report we mentioned the two different ways of calculating APR, ten different ways of calculating interest rates, low minimum repayments of 1% or 2%—which means that it would take over 20 years in a number of cases to pay off the debt, and the customer is not informed—and the lifting of credit card limits by companies without the approval of customers. Why do you think this industry has been so sluggish for reform and has kept the customer in the dark for so long, and what advice would you have for the industry?

  Sir Andrew Large: I think it would be wise for the industry to take very seriously your request for greater transparency.

  Q97  Chairman: Excellent! On that good note, Sir Andrew, let us finish on a high with your news headline.

  Sir Andrew Large: I have to say, Chairman, I do not regard myself as an expert in headline writing. You said I could have six words. I can offer you one with five or one with four. The one with five would be "Increase your debt with care" and the one with four would be "Increase leverage with care." I said I was not an expert in tabloid headlines.

  Q98  Chairman: I think you should stick to the MPC advice.

  Mr King: You know our aim is to be boring, so I would suggest "`Think before you borrow', says Boring Bank."

  Sir Andrew Large: I defer to the Governor!

  Chairman: Thank you very much, all of you.





 
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