Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 940 - 942)

TUESDAY 13 NOVEMBER 2007

PROFESSOR WILLEM BUITER AND PROFESSOR GEOFFREY WOOD

  Q940  Mr Love: What is the implication of holding quite a lot of this stuff off balance sheet? Is there any implication directly and, if they took it all back onto their balance sheet, would there be problems that would arise from that?

  Professor Buiter: It depends on whether they are required, either through legal obligations to do so, say through a credit-line or some other legal commitment, also reputational considerations. If they are exposed, substantively exposed, then having them off balance sheet is simply a smokescreen, it is a way of hiding things. It is done generally for regulatory arbitrage purposes to reduce the capital you need to carry this stuff. Basically many of these vehicles are banks without capital or without reporting requirements and without governance, and so that is a lot easier to manage, but, of course, therefore also riskier. I think you have to think of most of these vehicles as ultimately ending up on bank balance sheets.

  Q941  Mr Love: Lack of transparency is a word used quite regularly both for off balance sheet but also for perhaps a lack of adequate reporting of all of this, and of course that leads to continued lack of confidence in the market place. Should we be doing much more? Should there be more robust regulation, regulatory requirements, relating to both transparency and in a sense, therefore, to stability?

  Professor Wood: 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.

  Professor Buiter: There is a real problem about trying to prevent accountancy and auditing tricks or mitigating them by regulation that can be easily avoided. You really have 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.

  Q942  Chairman: Can I thank you very much for your evidence this morning. It has been hugely helpful to us.

  Professor Buiter: Thank you very much. It has been a pleasure.





 
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