Banking Crisis - Treasury Contents

Examination of Witnesses (Questions 2320-2339)


26 FEBRUARY 2009

  Q2320 Chairman: Governor, welcome to you and your colleagues to this Banking Crisis inquiry. Can I ask you to introduce yourself and your colleagues for the shorthand writer, please?

Mr King: Yes, thank you, Chairman. On my right is Andrew Bailey, the Executive Director for Banking, who led the work on the resolution of problems in Bradford & Bingley. On my left is Paul Tucker, the new Deputy Governor for Financial Stability, who is just two business days away from taking up his duties. On his left is Andrew Haldane, our new Executive Director for Financial Stability who took his post on 1 January.

  Q2321  Chairman: Governor, you may be aware there is a statement by the Chancellor on the Asset Protection Scheme today at half past 11, so one or two colleagues will depart for that but we will keep the session going and I will be here along with other colleagues. When you were before the Committee in November you did say that the "single most pressing challenge to the domestic economic policy" was to get bank lending going again. I wonder if you still hold this view, although today's RBS statement after some terrible news indicated that new lending was going to take place. Are you more confident now? In answering the question, given the RBS situation, how can we ensure that we get confidence back into the banking system and trust restored to the banking system? It was obvious from our session with the chief executives that they readily admitted that trust has been lost and it is a very important point to be able to keep the public with us on this.

  Mr King: I think you have hit the nail on the head in the word "confidence". The developments since last September/October have demonstrated the extraordinarily damaging consequences of a loss of confidence. We have seen this in two quite distinct areas, one of which is relevant to today's hearing and the other one of which is more relevant to the hearing we will come back to in March on the Inflation Report. The first is a lack of confidence in the banking system which became extreme in the difficult days of mid-September to early October last year. The other is lack of confidence in the world economy, which fell off a cliff in October/November last year. Let me stick to the first. I think the three key principles around the January banking package to try to restore confidence, of which today's announcement is the logical extension and, indeed, you can see it as putting the flesh on the bones of that announcement in respect of RBS itself, are, first, to actually find out what really is on the balance sheet of our major banks. That is not something that is easy to do or can be done quickly. The Government has made a start on it now, the assessment today is a preliminary assessment and it will require a much longer and more detailed assessment contract-by-contract to find out exactly the position of the balance sheet. That has to take time and, of course, it is affected by the fact that the losses that could arise on any of the assets on the banks' balance sheets may change as the nature of the world downturn becomes either more or less severe. It is not a fixed picture, it changes over time. There needs to be a continuous process of finding out what is on the banks' balance sheets to give confidence to investors and prospective investors in banks. The second is that having done that it is important that the Government underpins the balance sheets of the major banks, and it has made quite clear that it will do that. It can do that in a variety of ways. One is by injecting capital directly, the other is by providing insurance for a fee against a certain group of assets and the third is just by being willing in the end to ensure that if a bank finds itself in a position where the level of its capital threatens to fall below the absolute minimum, and what matters here is not the fancy regulatory capital ratios but just equity, the amount of core Tier 1 equity, if that falls below a critical level then the Government will step in and put enough capital into the bank to ensure it is a going concern. Those two aspects, to my mind, are about all a Government can do to ensure that confidence comes back into the banking system by first of all making it absolutely clear that there has been a thorough, independent audit of the balance sheets and, secondly, that there is a promise of enough capital to maintain our largest banks. In return for that and in return for access not only to the Asset Protection Scheme but also to the Credit Guarantee Scheme, which is a fundamental part of the package that was announced in January, which is to enable banks once they have got enough capital then to go out and obtain the funding that they need to finance the lending, banks should then sign a lending agreement. If you put those three principles, if you like, together, together with detailed proposals for the mortgage market, the ability of Northern Rock to extend mortgages and the lending proposals for the corporate sector, that is the asset purchase facility that we are involved with, those are the five point plan that was announced in January.

  Q2322  Chairman: Just to be realistic, Governor, you mentioned what is on the balance sheets and that will take time.

  Mr King: Yes.

  Q2323  Chairman: We have found in this Committee in terms of statements and accounts of banks it is very hard to read and when the KPMG chief auditor said that he could not fully understand after a night's reading, say, HSBC's accounts, there is an issue here.

  Mr King: It requires a detailed forensic analysis of exactly what is on the balance sheet.

  Q2324  Chairman: This will take quite a bit of time, six months or a year maybe?

  Mr King: It will certainly take many months in my view. You can form a preliminary view and you need to put in a provision to underpin the balance sheet now. How much capital banks will need in the end is impossible to tell because in large part it will reflect developments in the world and our own economy that are impossible to predict with any precision. There needs to be this combination of underpinning the balance sheet and getting this process going of an independent exhaustive analysis of what is on the balance sheet.

  Q2325  Mr Fallon: Governor, looking back over this mess, it was the Tripartite—yourselves, the FSA and the Treasury—that were supposed to be holding the system together. Sir John Gieve, the Deputy Governor, said "The Tripartite's footwork may have owed more to John Sergeant than Fred Astaire". John Sergeant became a joke, was the Tripartite a joke?

  Mr King: I thought John Sergeant was rather popular actually so I think it is a rather inapt comparison. You need to recognise that the Tripartite is not a decision-making body, that is the most fundamental thing to recognise. It is a body which communicates among the three players involved in this, each of whom have distinctive responsibilities and you hold accountable for the decisions that they take. You cannot have the Tripartite taking decisions which are the proper responsibility of each of them. It is a body which shares information and communicates what each player is doing, but it is not a decision-making body.

  Q2326  Mr Fallon: There were ten big banks and at the end of it five have now collapsed. Whatever the system was it did not work, did it?

  Mr King: That has been true around the world. Around the world, wherever you find people doing banking supervision, running finance ministries and running central banks, they all have to talk to each other. That is true in the United States or Canada or Germany or France. You have got to have some mechanism by which these bodies talk to each other. We call it the Tripartite, but it exists in every other country and in every country these same problems have been observed.

  Q2327  Mr Fallon: It does not seem to have done anything, does it?

  Mr King: I hope in this hearing we can try and get to a discussion of what were the problems that arose. I do not think that you should see either the cause of the problems or the answer to those problems in terms of a process, a process of communication or committee.

  Q2328  Mr Fallon: It was nothing to do with the architecture then. Andrew Haldane, in your speech last week you talked about the credit boom and you said: "A collective blind eye was turned to the resulting risk". Does that include the Bank of England?

  Mr Haldane: I was referring in there very largely to the private sector banking community rather than the authorities. Certainly within our Financial Stability Reports from 2003 onwards we spoke with increasing volume and force about the build-up of risks within the system. Looking back at that, all we had really was our communications through things like the report but in those reports we tried to lay bare what we thought were the emerging build-up of system-wide risks.

  Q2329  Mr Fallon: You do not accept that the Bank has any collective responsibility for the blind eye that you referred to?

  Mr Haldane: The Bank has a responsibility for contributing to the assessment of system-wide risks and through our reports that what was what we did. As I say, the limit of our actions are that we can communicate about those risks rather than necessarily impose different outcomes ourselves on individual institutions, that is not our responsibility. I think we played our part in alerting the banks and the wider world to what some of those emerging threats were. There is a natural limit to how far those words can take you in addressing those risks, I think.

  Q2330  Mr Fallon: So you are not accepting collective responsibility for the blind eye that was turned?

  Mr King: I think the Bank of England has accepted responsibility for those things for which it was responsible. I do not think we can be responsible for actions taken by others.

  Q2331  Mr Brady: You now have a statutory responsibility to protect and enhance the stability of the financial systems in the United Kingdom. Once the current crisis is over where do you see the main thrust of that work being?

  Mr King: I think the first thing I would like to say to the Committee is that it is pretty clear that you and others will expect the Bank to play more of a role than in fact we did, but you also need to recognise that we do not have any powers at all other than dealing with banks that have already failed. In terms of dealing with banks that are growing and living, we do not have a single power now that we did not have before. We literally have the power only of our speeches, our reports, and the words that we use when speaking to others in the Tripartite process. I hope you will remember that when you try to hold us accountable for things where we simply have absolutely no powers to take any actions. We have clearly put in place a mechanism now for implementing the special resolution regime, for which we are statutorily responsible. We have a new responsibility for the oversight of payment systems, or will have when that comes into effect later this year, but insofar as ongoing banks are concerned we do not have any more powers at all. We are still very much at the point where we will have to channel our thoughts and views through the Financial Stability Report and through speeches.

  Q2332  Mr Brady: Are you saying you should have additional powers in that respect?

  Mr King: That is a matter for you to decide. I hope that your inquiry, when you reflect on this—

  Q2333  Mr Brady: As part of that inquiry I want to know what your view is.

  Mr King: I do not want to judge that and it is not really for me to say. I do think what does matter, and this is a point I have made before, is that there has to be a matching between responsibilities and powers.

  Q2334  Mr Brady: Governor, you said that when we seek to hold you accountable for any future events that may take place we must be aware of the fact that you have not got these powers. What powers would you like to have?

  Mr King: I am not saying necessarily the Bank should have powers. First of all, we should ask ourselves what are the lessons from this and are there powers that someone should have that did not exist before. We had the same process, if you remember, after Northern Rock when I said to you that the most important lesson from that was that Britain did not have a special resolution regime which other countries had. I went out of my way to say I am not saying the Bank should have that power, but somebody should have it. You then wrote your report, it was very influential and we have the Banking Act now which creates those powers and means that the trigger is with the FSA and the actual decisions on how to resolve that are with the Bank of England. That may or may not be the right outcome, but at least it is clear who has got the responsibilities. All I am asking you to do is to be very clear, going back to Mr Fallon's question, that you hold people accountable for things for which they have powers, not for things over which they have no influence or control at all.

  Q2335  Mr Brady: Is there a danger that after this crisis has passed that financial stability might drift away from being the focus again? How do you stop that happening?

  Mr King: No. I think it will be a very long time before that would happen. It will be very much part of our focus. Mr Tucker is thinking hard about the increased resources that we need in order to do that and we have already allocated more resources to that work. To repeat, all I would say is that apart from the special resolution authority and the oversight of payments system, more involved though we might be, we are still limited in the end merely to writing reports. I want that to be clearly understood because it is no good coming back to us in a few years' time saying, "Why didn't you do this, that and the other?" when you in Parliament—it is your vote, not ours—voted for an Act that very clearly defines our powers. I am happy with that, but do not hold people accountable for things for which they are not responsible.

  Q2336  Mr Brady: Conversely, in the past one of the things you have perhaps been criticised for was being excessively focused on monetary policy. Are you at all concerned at the moment that there is not sufficient focus on monetary policy and the danger of inflation coming back in the future?

  Mr King: I certainly am concerned that people who try to influence the way the Bank evolves may say, "This is a great opportunity to change the focus of the Bank". Our clear and unique responsibility is for monetary policy and we must never, ever forget that. I can give you my personal assurance and that of every member of the Monetary Policy Committee that we are totally focused on that and we are not going to allow a great inflationary surge. The problem at present is not that the amount of money in the economy is growing too rapidly threatening a big inflationary surge, it is that the amount of money in the economy is growing too slowly. That is why we have asked the Chancellor for powers to engage in asset purchases in order to increase the amount of money in the economy and I would expect that to happen over the next few months.

  Q2337  Chairman: Governor, just to clear this up because I have heard murmurs from some of my colleagues, you did say "we only have the power of our words". Mindful of your comments to us when you came on Northern Rock and the limitations, legal impediments, EU directives and whatever, if you are not clear with us at the moment and legislation is put in place which is inadequate you or your successor can come back and say, "Well, my hands were tied because of A, B, C, D or E". Are there more powers that you would like?

  Mr King: There are two things I would say at this point. One is that the Act does not give the Bank the right to request information from banks. I regret that. I think the FSA have clearly said that they will try hard to give us the information that we want but I find it very hard to see why, if people feel the Bank should play a major role in financial stability, we should not have the right to request information from banks. We do not have that. We have to persuade the FSA that the data to be collected are appropriate and they have to make their own mind up on that. More important, I suspect, looking ahead, and I hope this will be the subject of your inquiry, is that we should ask ourselves what are the lessons behind this financial crisis, are there powers that somebody needs to have in order to try to lessen the risk that this will recur, and once that has been sorted out then and only then should you come back to the question of who should exercise those powers. In some ways it is less important who exercises the powers and more important to think through the question of what those powers should be.

  Chairman: That has been helpful.

  Q2338  Ms Keeble: You said that you had the power of words and you said just now you needed to know what is on the balance sheets of the banks and there needs to be the promise of enough capital to protect the major banks and, of course, there is the announcement that is coming later today. At the end of 2007 you said: "The UK banking system as a whole is well-capitalised. They have a large capital cushion, they can take the conduits and vehicles that they set up in recent years back onto their balance sheets. It will take a little time and the banks will have to make lower profits than they would have wished, but there is no threat to the stability of the banking system". Given that you might not get all the information that you want, but you do get an awful lot of information, how could you have got it so wrong?

  Mr King: All the central banks asked the regulatory bodies around the world, not just the UK, we asked the US regulators, the European regulators, the Japanese regulators, and their view at the time was very clear, that in August 2007 they said banks are well-capitalised and the losses that will occur are not large enough to erode the capital cushion. What I think no-one anticipated at that point was that the risks to the balance sheet as a whole became larger during 2008 and became horrendously high in September 2008 after the failure of Lehman Brothers. The leverage in the banking system was sufficiently high that what started off as looking a well-capitalised banking system quite quickly became an under-capitalised banking system. One of the lessons from this is that the amounts of capital that banks were required to hold were simply too low.

  Q2339  Ms Keeble: As my constituents tell me always you are not responsible for global, you are responsible for here. Given that we have a very sophisticated banking sector, and I have always thought of it as being the best in the world and that puts you in a very privileged position as the Governor of the Bank of England, were there no discordant voices in the Bank or was the information not analysed properly that you did not see the storm that was coming and said there was no threat to the stability of the banking system?

  Mr King: That was the view of the regulators who were looking at the capital around the world. It was not a UK view and we were not the regulator. This was the view of the people who actually had the information about the balance sheets and the losses at that point. At that point, if you worked out the potential losses on sub-prime lending then they were not large enough to erode the capital cushion of banks, but what happened was that the risk premia in the world changed and that reduced the value of the assets to the banking sector and meant that their liabilities had not fallen but the assets had and that clearly eroded significantly. If you remember, I came to you in January 2008 and said that the banks at that point needed more capital.

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