Mr.
Hoban: The hon. Gentleman makes a good point. I did not
wish to regurgitate everything that was in the Treasury Committee
reportjust perhaps most of it. This dual aspect of financial
stability is what is really important. It is about how the systems
function and their resilience, but it is also about the allocation of
risk. Narrowing the definition of financial stability could potentially
lead to ignoring the risk aspect of that stability. It is important to
reflect on that. As the Bank comes to terms with its new role and looks
at its financial stability objective, I hope that it will consider
actively the allocation of risk and the price that risk gets in the
marketplace.
It is
difficult to define financial stability. I expect that explains why the
Government moved from their policy in July of wanting a definition in
the Bill, to just saying that it is a high-level concept. Sir John
Parker, in his memorandum on this to the Treasury Committee, suggested
that there could be a qualitative objective for
financial stability, rather than a quantitative objective, which might
be developed to identify factors that could be used to define far
better what financial stability would be. In his evidence, he suggested
five factors that might be helpful in coming up with a qualitative
objective: First,
the Bank cannot and should not seek as its objective the elimination of
all instabilities...within the...system. That could only be
achieved by suppressing the financial intermediation...Second, the
tools available to the...banks...are
limited, which
implies that the elimination of financial instability is unrealistic.
That is important to recogniseI shall come on to tools later
on, but there is a limited range of policy levers available to the Bank
to tackle financial instability. I shall propose one additional lever
that the Bank might be able to use. To
continue: Third...the
objective of the...authorities should be to ameliorate the
effects costsof
failure, which goes back to the definition that the hon. Member for
South Derbyshire quoted. How can we build resilience into the system to
ensure that, where there is a failure, the system continues to function
effectively? Some of the clauses in the Bill tackle thatthe
reforms to the Financial Services Compensation Scheme will help the
system perform better when there is a banking
failure. Sir
John also suggested, fourthly, that the Banks role with regard
to financial stability would be strengthened with its new
responsibilities for oversight of payment systems, which we debated on
Tuesday, and the operation of the special resolution regime, which we
will come on to in part 1 of the Bill. His fifth comment was that,
while financial stability might focus on the banking sector, there are
non-banking activities that have an impact on financial stability. In
our debate this morning on clause 214, the Minister explained the
rationale for Government amendment No. 28 in the context that
non-banking institutions can have a significant impact on financial
stability, given the intermediation in the system and some of the
business models that have been employed over the past few
years. If
the Bank were to look at Sir Johns comments about the factors
that could be used to set up a qualitative measure, that might help
flesh out the definition of financial stability beyond
that stated in the Bill. It would also help provide a framework for
assessing how well the Bank met its objectives. Part of the challenge,
in how the Bill is structured, is how to hold the Bank to account for
deepening financial stability, when we only have a vague definition of
financial stability andwe all accept thisit is
difficult to
measure. I
am sure that there will be a rash of research into the definition of
financial stability. We may be able to reach a
consensus in time, but the absence makes it harder to hold the Bank of
England to account. As I said earlier, we shall know where there is a
lack of financial stability, but the problem is in determining it. Sir
Andrew Large, a former deputy governor of the Bank, said:
There
is neither a clear over-arching analytical framework nor a commonly
agreed set of indicators of incipient financial instabilities...We
are dealing with tail eventslow probability
scenariosrather than central projections. It is about aberrant
rather than normal behaviour and situations: less predictable and
harder to
model. That
presents us with a challengehow do we measure financial
stability? The Governor alluded to this in the evidence that he gave to
the Treasury
Committee: I
think therefore the danger is that financial stability looks like a
period in which you are merely sowing the seeds of the next crisis and
it appears to be a tranquil time but in fact beneath the surface those
seeds are germinating and will produce the crisis down the
road very
eloquent. I happily give
way.
Angela
Eagle: It might be eloquent, but it is a rather
pessimistic view. Does the hon. Gentleman not agree with
me? 1.15
pm
Mr.
Hoban: The Minister makes a very interesting comment and I
will come to that later with remarks about the tools that the Bank has
to deliver financial stability. Some activities in the financial
markets may be acceptable at a low level but as they grow in scale they
cause wider risks to the economy. The Governor might have been
pessimistic but I think he was right in what he said about relatively
low-level activity in a particular area. When things such as credit
default options and credit default swaps were first thought about they
were seen as valuable financial instruments, but as their usage grew a
risk to the economy arose. I think the Governor is being realistic
rather than pessimistic when he says that what we might accept as
normal at one point might become a threat to financial stability in the
long
term. Ms
Sally Keeble (Northampton, North) (Lab): Would the hon.
Gentleman not accept that the Governor was speaking widely about the
general issue? I do not see how the hon. Gentleman can relate the
Governors remarks to a discussion about how either an executive
committee or a sub-committee of the Bank of England can work. A number
of the issues that the Government are talking about are dealt with by
regulation or by the
FSA.
Mr.
Hoban: I apologise. I have moved on. I moved on before
lunch from the discussion of the group of amendments to the more stand
part nature of this
debate.
Ms
Keeble: Yes, I understand
that.
Mr.
Hoban: This is about how one measures the objective of
financial stability and whether the financial stability committee has
an executive or non-executive role. That is not relevant to this
discussion. It is something that either model of the FSC or the hybrid
model in the Bill will have to come to terms
with.
Ms
Keeble: I understand what the hon. Gentleman is talking
about but, having sat through all that evidence that the Governor gave,
what he was talking about were
pressures that build up within the system. Most of those pressures are
properly dealt with by the FSA or by other forms of regulation. They
are not necessarily matters that the financial stability committee
would ever deal with, whatever model was taken for its
structure.
Mr.
Hoban: Yes. One challenge in looking at the risks
identified in the financial stability report published by the Bank this
week is to understand when the Bank identifies a risk who responds to
it and how. I agree with the hon. Lady that some responses may be
within the remit of the Bank of England, some within the remit of the
FSA and some within that of the Government. We can all agree that the
horizon-scanning role of the Bank in identifying risks is really
important but we need to think about who will tackle those risks once
they have been identified and that is not exclusively the Banks
role. Indeed, the Banks role may be quite limited. I will touch
again on some of this in a minute.
I was trying
to make the point that it is difficult to measure when there is or is
not financial stabilityevents that appear to be normal might
hold the seeds of a potential future crisis. We need to accept that
that could be the case. In the evidence that the Governor gave to the
Treasury Committee he referred to the creation of products such as CDO
squared and the relaxation of credit criteria as potentially sowing the
seeds of the crisis before us at the moment. Even actions such as the
relaxation of credit criteria have a dual edge to them. One effect is
to enable more people to have a home of their own but another could
lead to sub-prime lending. In looking at some of the seeds we need to
think carefully about what the impact might be, and the pros and cons
of tackling some of the risks that have emerged to financial
stability.
I want to
talk about the tools that the Bank has to deliver its objective of
financial stability. In last weeks evidence session, Nigel
Jenkinson listed tools available to the Bank. He referred to the bank
being the ultimate supplier of liquidity to the economy, its roles on
payment systems and financial infrastructure and, under the Bill, the
operation of the special resolution regime. He also mentioned some
areas where the tools available to the Bank are more of an advisory
nature rather than direct action. The financial stability report is
part of that role: flagging up the risks to the economy, the advice
that the Bank can give to the FSA on prudential
regulationparticipation in international forums such as the
Basel Committee on Banking Supervision and the Financial Stability
Forum, for example. These tools are all available to the bank. The
extent to which they lead to action depends on whether it is an
advisory role or a more executive one for the Bank as an institution,
putting aside the debate about what the committee might do. Although
the list is not exhaustive, it gives the Committee a flavour of the
tools available to the Bank.
However, one
of the challenges we have to think about is whether the Bank has
sufficient toolsI am mixing metaphors horribly herein
its
armoury
Mr.
Hoban: Tools at its disposal to maintain financial
stability might be a better phrase. I want to dwell on this for a
moment, because it indicates the problems that the
Bank of England has in delivering its objective. We would all agree that
one of the causes of the current crisis was the asset price bubble. In
one of its reports in 2006, the Bank
said, asset
prices have risen considerably over the past few years, dwarfing recent
price falls...Some of the drivers of rising pricessuch as
financial innovation that allows risks to be better matched to
investors preferencesare likely to endure. So risk
premia may remain lower on average than in the past. But other factors
that may have boosted prices, such as low global risk-free yields and
benign macroeconomic conditions, may not last indefinitely. Against
that backdrop, and despite recent market falls, the price of risk in
financial markets still appears somewhat low. Certainly, risk premia on
a number of financial assets remain low by historical
standards. That
was a very prescient warning of the causes of our current
problems.
The question
is then, What could the Bank have done at that point?
It has clearly flagged up the risk to the market, and to the other
members of the tripartite authorities, but in terms of the
Banks ability to influence that, its role was reduced to having
flagged up the risk; the next measure is beyond its control. The FSA is
not required to respond formally to the financial stability report
about how it would reflect the Banks assessment of risks, in
terms of how it might supervise individual institutions.
One of the
conventional responses to the asset price bubble would have been to
increase interest rates, making credit more expensive and thus reducing
upward pressure on asset prices. However, the remit of the Bank of
England, which was introduced in the Bank of England Act 1998, is that
setting interest rates is limited to combating inflation, so its
actions are constrained by that objective. Therefore, at a time of low
inflation and weak inflationary pressures, the Bank has set a low
interest rate, but the consequence might have been the context of that
in 2006, where that helped to fuel the asset price bubble and then the
Bank was unable to cool it down.
Mr.
Colin Breed (South-East Cornwall) (LD): Does the hon.
Gentleman agree that, in tracking the inflation rate, it is probably a
good idea to have the right rate, bearing in mind that the current
target has nothing to do with house
prices?
Mr.
Hoban: Indeed, there is an argument for that. I am wary of
trying to use interest rate policy to tackle two
objectivesinflation and asset prices. We need to look to other
tools to influence asset prices, which I shall come to in a
minute.
The UK has
not been the only economy affected by the conflict between asset prices
and inflation. There have been asset price bubbles in Ireland and Spain
because they have high interest rates, and although the rates are right
for the eurozone as a whole, they are not right for the economic
conditions of those territories. The fact that interest rates cannot be
used to affect asset prices indicates a limitation on the Bank of
Englands tools for maintaining financial stability, which is
why we need to look more broadly.
We have
argued that the rules surrounding the level of capital should be
reformed to act as a check on the level of debt in the economy as a
whole. In part, reform of Basel II to deal with pro-cyclicality could
address that. I
know that the Government share that position. We also need to think
about what checks there should be within the UK regulatory system
looking at the level of debt in the economy. In our recent publication
on financial stability, we called for a debt responsibility mechanism,
which would create a linkage between the Banks assessment of
risk and the action that the FSA took as the prudential regulator. The
Bank of England would be asked to take on broader responsibility for
debt in our banking system and our economy, and for the risks that that
debt poses. The Bank would, throughout the year, send an open letter to
the FSA setting out its assessment of market-wide risk. The FSA would
need to take account of the Banks assessment when regulating
lending by individual banks. Imposing tougher capital rules, bank by
bank, during boom times would help to stop debt-fuelled bubbles
emerging in the first place. The Bank could and should be given that
tool to enable it to both look at its assessment of risks and then have
a policy lever that it was able to deploy to encourage a response, in
this case from the prudential regulatorthe
FSA. The
Banks financial stability review, published this week,
highlighted the need for improved macro-prudential arrangements to
tackle excess lending. There is a growing consensus that we may need to
take that approach, both international and, perhaps, domestically, to
enable regulation of the amount of credit available in the markets.
Certainly, countries such as Spain have looked at other tools, such as
dynamic provisioning, to build up a cushion in the good times, so that
the banks are not hit too badly when the economy
deteriorates.
I will
conclude my speech, which will be to the relief of the Committee, and
indeed to me because I have spoken for over an hour.
[Interruption.] It seems like a very long time. I
am grateful to the hon. Members for Northampton, North and for South
Derbyshire for their
feedback. We
are giving the Bank of England the statutory objective to deliver
financial stability. It is not a statutory objective that the Treasury
or the FSA have, but it is important that the Bank has it. It is not
well defined, it is difficult to measure and I am not sure that the
Bank has the tools to do the job. Furthermore, the proposed financial
stability committeethe subject that I started on at about
quarter to 10 this morningand the structure add to the
Banks difficulty in delivering financial stability. How will we
hold the Bank to account the next time that we have a financial
problem? Has it had the right tools and structure, and does it know
what it should be doing to maintain financial stability? The Committee
does not want to see a reoccurrence of the events of the past year.
This is not a once-in-a-generation opportunity, but it is an
opportunity to get it right. I am not sure that we are quite there yet
with this Bill, and I would like to see the Government, the Bank and
the FSA working a little more closely over the weeks ahead, to see
whether we can improve and clarify the arrangements so that the Bank is
clear about its role and how it will deliver
it.
1.30
pm
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