Banking Bill

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Mr. Hoban: The hon. Gentleman makes a good point. I did not wish to regurgitate everything that was in the Treasury Committee report—just 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 recognise—I 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”—
costs—of 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 that—the 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 Bank’s 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 John’s 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 and—we all accept this—it 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 events—low probability scenarios—rather than central projections. It is about aberrant rather than normal behaviour and situations: less predictable and harder to model.”
That presents us with a challenge—how 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 Governor’s 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.
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 Bank’s role. Indeed, the Bank’s 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 stability—events 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 week’s 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 regulation—participation 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 tools—I am mixing metaphors horribly here—in its armoury—
Angela Eagle: Weapons.
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 prices—such as financial innovation that allows risks to be better matched to investors’ preferences—are 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 Bank’s 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 Bank’s 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 objectives—inflation 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 England’s tools for maintaining financial stability, which is why we need to look more broadly.
The Bank’s 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 committee—the subject that I started on at about quarter to 10 this morning—and the structure add to the Bank’s 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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