Regulating off-balance sheet
vehicles
212. We have already discussed the contribution of
off-balance sheet vehicles to the financial turmoil since mid-2007.
In particular, we noted that some investment banks had kept these
vehicles off-balance sheet, whilst others had brought them on-balance
sheet. In some cases, such decisions were made to protect the
investment bank's reputation, rather than because of any legal
considerations. During out inquiry we considered what role public
authorities might take in ensuring a consistent treatment of off-balance
sheet vehicles, so as to minimise any confusion about the liabilities
incurred by banks in relation to such vehicles.
213. Peter Montagnon argued that there was a need
for greater transparency in the reporting of off-balance sheet
vehicles, asserting that "we need to know with much greater
clarity what is on, what is off, and what has potential to come
back onto, the balance sheet than perhaps we did in the past."
He also wanted to see a close examination of the role of audit
committees and risk committees in managing off-balance sheet vehicle
risks and deciding how they should be reported.[315]
214. Professor Wood cautioned however that additional
regulation might create yet more problems:
It was, of course, in a sense, regulatory requirements
that led banks to put these things off balance sheet. Because
the requirements were formal and in place, they knew that if they
were not on the balance sheet they did not have to count against
capital. So you have to think very carefully about the kind of
regulation you have so as not to encourage that kind of behaviour.
All regulation is not good regulation; all regulation does not
produce improvement.[316]
Professor Buiter's view was that the UK needed to
have:
principle-based bank regulation that basically says
it looks like a bank, it lends like a bank, even though it may
not take too many deposits, we will treat it as a bank for regulatory
purposes. So you make an institution pass the duck test when you
decide to regulate it, but that is more easily said that done
because the principle still has to be translated into actual operational
rules. The principle versus rules debate is a false dichotomy;
both have always been necessary. It is not easy, and you can do
better than we are now, but most of the activity that caused the
trouble took place out of the view of the regulators.[317]
215. As
with many other elements of today's financial architecture, the
UK must consider the international context in contemplating a
regulatory response to the problems arising from off-balance sheet
vehicles. Bearing in mind Professor Buiter's assertion that the
development of off-balance sheet vehicles was itself driven by
regulatory arbitrage,[318]
banks might have an incentive to shift towards foreign jurisdictions
if the UK's existing regulatory framework were to change. The
Chancellor of the Exchequer told us that he considered this to
be an international problem requiring an international response:
I am all in favour of innovation, but what we need
to be wary is of innovation that means that people do not actually
know the true picture in relation to a bank. I think there are
two aspects of this. One is our own domestic legislation, and
that is something that the FSA is looking at, but crucially also,
I think this is something where the international work is very,
very important because this is an international problem. The Forum
for Financial Stability is looking at this, it is also being looked
at the European Union level, I will be discussing it with my French,
German and Italian counterparts next week and, when the Financial
Stability Forum reports at the G7 in Japan in February, I hope
we will have proposals in front of us not just in relation to
the off-shore SIVs but also in relation to credit rating, in relation
to early warning systems, a whole range of matters which need
to be looked at and which, frankly, we can deal with to some extent
here in the United Kingdom but we actually need international
co-operation.[319]
216. Ambiguity
and confusion regarding the ownership of risks associated with
off-balance sheet vehicles have contributed to the financial market
volatility since mid-2007. The FSA, working with international
partners, must ensure that banks report their exposure to off-balance
sheet vehicles appropriately. The FSA should also consider whether
banks have been using these off-balance sheet vehicles for genuine
economic efficiency reasons or as a smokescreen to hide behind,
given that the capital, reporting and governance requirements
on these vehicles are lighter than those incumbent on banks themselves.
309 
