Examination of Witnesses (Questions 900
TUESDAY 13 NOVEMBER 2007
Q900 Mr Simon: You are talking to
all these people all the time. You must have a sense of whether
there is movement likely.
Professor Buiter: They may simply
limit themselves to informal arrangements. I do not think you
are going to see new legislation but the memorandum of understanding
is just that; it is just a bit of paper, as somebody else once
famously said. They may just have some clarifications in a footnote
that says the Bank of England will henceforth start looking at
the liquidity positions of UK registered banks and deposit institutions
Professor Wood: That would be
a change because at the moment the Bank does not have the resources
to do that.
Professor Buiter: Nor does it
have the people.
Professor Wood: In addition I
think it should be done soon simply because it is important to
have these institutions run in before the next problem hits. An
example is in the United States where arrangements were changed
and also some key people had died just before the financial crash
of 1929-31 and it was largely because of the absence of experience
that that turned into such a disaster.
Q901 Mr Simon: Any more?
Professor Buiter: No.
Mr Simon: Thank you.
Q902 Chairman: Professor Wood, can
I take it from your comments that the Tripartite system worked
Professor Wood: That would be
going too far, Chairman; it worked but not too well.
Q903 Mr Love: Professor Buiter, you
threw away a line earlier on suggesting that the Monetary Policy
Committee should be taken out of the Bank and that effectively
the functions of the FSA ought to be merged with the remainder
of the Bank. I think that was the suggestion you were making.
I just wonder how Professor Wood would respond to that.
Professor Buiter: Only the FSA's
liquidity supervision function.
Q904 Mr Love: I understand. I wonder
if you would respond to that because you have been suggesting
that we could do one of two things. I would like to press you
on which of the two; do you think the Bank should be the major
institution or should it be the FSA?
Professor Wood: Quite clearly
the Bank should be the major institution in the provision of liquidity.
Unlike Willem, I do not think we need to take the MPC out of the
Bank for that purpose. The MPC is for all practical purposes out
of the Bank anyway. It is involved in only one set of decisions;
it plays no part in others. I think it is convenient administratively
to have it in the Bank; and there is from time to time some connection
between monetary policy and financial stability policy, and under
such circumstances it is convenient to have them together.
Professor Buiter: One quick footnote
to that. The problem at the moment is that the MPC only sets the
bank rate, but that is meant to be the target for the overnight
inter-bank rate, and in fact the overnight inter-bank rate moves
violently around. If you are going to have this clearer separation,
then the Bank of England should change its policy in the overnight
market and actually peg the rate, at least the rate at which it
repos, does its sale and repurchase operations, and it should
always stand ready to repo at its target rate at any amount all
of the time, as opposed to its current practice of trying to target
both price and quantity a little bit. They really have to change
their operating procedures otherwise the liquidity management
policy inextricably gets tied up with interest rate setting. You
have to be fair to the MPC. If they set the Bank Rate then they
should, except for a little default spread for the inter-bank
rate over the policy rate, peg the overnight rate. That requires
a change in operating procedures at the Bank.
Q905 Mr Todd: Can we turn to depositor
protection. There is an argument for saying that depositor protection
introduces a moral hazard by transferring risk but not straightaway.
How do we set appropriate depositor protection to ensure that
that does not happen?
Professor Wood: You cannot do
that; deposit insurance inevitably creates some moral hazard.
The starting point has to be to think why do we want deposit insurance.
It was introduced in 1933, if I recollect, in the United States
in very special circumstances. The Federal Reserve had failed
to act as lender of last resort. The US had many small banks financed
entirely by retail depositors and deposit insurance works in such
a circumstance. It was a substitute for a lender of last resort.
Nowadays what we might call flighty liquiditybanks' liquidity
that disappears quicklyis in wholesale markets, and deposit
insurance, therefore, cannot prevent the important wholesale runs.
It seems to me we should therefore think of deposit insurance
as a social provision, to protect what used to be called in the
banking industry the widow and the orphan, and it should therefore
be accessible immediately if a bank closes, and it should be set
at a fairly low level. If it were set at a low level this would
have the incidental benefit that first of all large depositors,
other banks, might pay closer attention to those they lent to.
Secondly, if it were set at a lower level it could again continue
to be financed by a mutual scheme and thus the taxpayer would
have less interest in propping up banks.
Q906 Mr Todd: You are agreeing with
that by the sound of things; is that right, Professor Buiter?
Professor Buiter: Yes, but I would
make a specific point that it should only extend to retail deposits,
that is deposits by natural persons, not wholesale deposits or
business deposits, unlike what we have now.
Q907 Mr Todd: So it has no purpose
as a financial stability tool?
Professor Buiter: No.
Q908 Mr Todd: It is purely, as you
have said, social policy?
Professor Buiter: Yes.
Q909 Mr Todd: Okay, if that is the
case, what sort of rate should it be set at? Is the current rate
reasonable? There have been suggestions of raising it to £50,000,
or is that just simply a political decision to be made, you draw
a line somewhere which seems fair at the time?
Professor Wood: Basically it is
a political decision. It is linked to vulnerable persons' deposits.
In the United States you can insure as much as you like simply
by opening enough deposits; it has to be individuals.
Q910 Mr Todd: Do you think consumers
are well enough awareand I think the evidence was in this
crisis that they were notwhere the current limit actually
lay? I think most people thought that deposits either were not
guaranteed at all or they were guaranteed almost infinitely, and
to hear there was a particular limit set on it was news to most
people, so is there associated with this an important function
of public education so that people understand clearly?
Professor Buiter: Absolutely.
Every bank should have large signs when you walk in "Your
deposits are guaranteed up to ... "
Q911 Mr Todd: "Do not deposit
more than £35,000 here".
Professor Buiter: Or "do
so at your peril"!
Q912 Mr Todd: Right, so the effect
of that would be presumably to persuade consumers to spread risk
so if they have large amounts of money to deposit they would deposit
it in a number of institutions?
Professor Buiter: Yes, that would
Q913 Chairman: If I could come back
to you on that. There have been figures starting off at £100,000
down to what the level is in the United States at 50,000, and
the British Bankers' Association have come in and said that £35,000
is an appropriate level because 90% of the population would be
covered by that. Could you give us an indication of where your
sympathies lie in terms of the level? Would it be 100% of that
Professor Wood: If we are protecting
the widow and the orphan it has to be 100% since we cannot expect
that such people would have the time or the knowledge to police
their banks. In terms of the level it seems to me the British
Bankers' Association point (which I had not heard before) was
quite a good way of thinking about the question.
Professor Buiter: A second reason
for having 100% is if you have anything less it is still an invitation
to run. Unfortunately while co-insurance is a good idea for most
insuranceyou cannot have a run on your life insurance company
but you can have a run on the bankI really would not recommend
anything less than 100% and probably between £35,000 to £50,000.
Certainly £100,000 would be way in excess of the widows and
Q914 Jim Cousins: The Chancellor,
when he spoke to us on this issue, said that the 100% guarantee
that was given by the Treasury was a case-by-case guarantee and
each case would be assessed on its merits, but the Governor in
his very interesting radio broadcast last week said something
rather different. He said that the existing system of deposit
insurance we have trapped retail depositorsthe word "trapped"
was his and "that's why we could not allow Northern Rock
just to fail." Do you think that the Governor in saying that
has undermined the Chancellor's promise to us that this guarantee
to depositors was only a case-by-case one?
Professor Wood: I am not quite
clear what the Governor meant by saying it trapped depositors.
If he meant that when the institution failed the depositors were
then trapped because they could not get their cash out right away,
that is right, but that has no bearing at all on what the Chancellor
Q915 Jim Cousins: I am inviting you,
Professor Wood, to see the implications of the Governor's remarks.
He described retail depositors as being trapped by the present
system of deposit insurance.
Professor Wood: That statement
is to me only meaningful if the Governor is saying after their
bank has closed they are trapped in the sense they cannot get
their money immediately.
Professor Buiter: I have no idea,
I cannot make sense of the statement.
Professor Wood: Apart from that,
I cannot see what he means.
Q916 Jim Cousins: You cannot make
sense of the Governor's statement?
Professor Buiter: Of the statement
you are quoting. I did not hear the interview, I just read excerpts
from it and that was not part of it. I find it hard to see what
it could refer to.
Q917 Jim Cousins: What the Governor
said was this: "We need a system in this country in which
we can prevent the retail depositors from being trapped."
Professor Wood: That becomes much
clearer. What he plainly meant was that retail depositors should
get their money out immediately if the bank fails rather than
being locked in for some months, which is part of the present
system, and a very bad part.
Professor Buiter: In the United
States they get paid within two working days so that was what
he was referring to obviously.
Q918 Jim Cousins: The point I am
putting to you both is that the Chancellor said the guarantee
he gave to depositors in Northern Rock would not be extended anywhere
else, it was a case-by-case system. The Governor's doubts about
the overall system seem to indicate that it must be more general.
Professor Buiter: The Governor
is talking about the long-term reformbut hopefully it will
be done very swiftlyof the deposit insurance system which
should be one that allows you to get your money out immediately.
It did not refer to this one-off or ad hoc (if there is more than
one bank) series of individual bank deposit guarantees that the
Chancellor created for the purpose of this specific crisis. They
are two different things; there is no contradiction.
Q919 Jim Cousins: Professor Buiter,
while such a system, whatever it might be, is being put into place,
which is not the case now, do you think it is credible that we
could say in the event of another difficulty in another bank that
the 100% guarantee to depositors could not be extended if retail
depositors are, as the Governor says, trapped?
Professor Buiter: I do not understand
the question. I was surprised by the Chancellor's statement because
as I understood his original announcement it said that any bank
that found itself in similar circumstances to Northern Rock would
get Northern Rock treatment, both on the funding side and on the
deposits side. There might well be individual fine-tuning if the
banks have very different funding policies or very different compositions
of deposits but, as I understood it, effectively the deposit risk
for the entire British banking system has been socialised.