Banking Crisis - Treasury Contents

Examination of Witnesses (Questions 2340-2359)


26 FEBRUARY 2009

  Q2340  Ms Keeble: Right through this crisis, and I have listened very carefully, every time there has been a suggestion that there should be some other measures or steps taken or something should happen you have been very resistant to that, I have to say, and it has given the impression that the Bank is running after the event rather than shaping events.

  Mr King: Can you give me an example of where you think that? I argued earlier than anyone else that the banks in Britain needed more capital.

  Q2341  Ms Keeble: You argued against the provision of any extra lever to influence the system and you argued against that quite consistently, I have to say.

  Mr King: When you say "any extra lever", what lever do you mean?

  Q2342  Ms Keeble: Anything. It is in the evidence. I asked would you favour anything other than the setting of interest rates and you said that is all that the MPC does because it has responsibility for inflation and that lever is not working. The impression that is given through all of that is that the Bank is running after the event rather than shaping events. I think this was the question that Graham was asking. We are going to want to fight the next war, not the last one.

  Mr King: With great respect, I totally disagree with your suggestion. In September 2007, a matter of five days after Northern Rock failed, I came before you and spelt out what I thought should be our response. Very largely what I said to you at that session appeared in the Banking Act, we do now have a special resolution regime. I said that the banks in Britain needed more capital and they have now got more capital. I do not think the Bank has been running behind this at all. What I was very clear on was that the role of a Monetary Policy Committee was to set monetary policy and the bank rate and I did not think that other instruments were appropriate to the setting of monetary policy, but that is not to say that other instruments are not appropriate for dealing with financial stability questions.

  Q2343  Ms Keeble: When we get to dealing with the aftermath of what is happening now, not looking at it with a vast amount of sophistication. it is likely to be high levels of unemployment, public spending cuts that will depress demand, very low levels of interest rate deflation and manufacturing limited, therefore presumably increased pressure for imports. What are you going to suggest? What proposals do you have for dealing with the real challenges of ensuring financial stability? What are you going to ask us for?

  Mr King: What you have described is not financial stability, it is what is happening in the economy at large.

  Q2344  Ms Keeble: I know, it is macro.

  Mr King: If you want to talk about the economy at large—I think this is why we are coming back in March—we have already spelt out the right plan of attack on that front. One is considerable monetary easing, and we are now moving into a situation where the Bank will be conducting asset purchases to increase the amount of money in the economy. Secondly, the measures designed to ensure that banks will lend in a more normal manner than they have been. Bank lending halved in 2008 relative to 2007. The commitments that have now been made will significantly increase that. There has been a measure of fiscal relaxation. Most importantly, and I would say most importantly of all, this is a worldwide downturn and it is absolutely vital that every country around the world plays its part in dealing with that problem. I went to the G20 meeting last Sunday in Berlin and every leader round that table was committed to playing his or her part in taking measures to reflate their economies in order to limit the length and severity of the downturn. All of them were very, very clear that this a worldwide downturn which hit with extraordinary ferocity last October.

  Q2345  John Mann: I hear what you are saying, Governor, and it is easy to pick quotes from the past, et cetera and say you got it wrong.

  Mr King: I am sure we got things wrong, and obviously so.

  Q2346  John Mann: I want to choose just one, not to say you got it wrong. You were dancing around a little bit in terms of Graham's question on what powers you should have or who should have them. In July 2006 the Bank's report stated: "Several structural developments have helped strengthen the system over time, including continuing improvements in risk management and more sophisticated ways of distributing risk". That did not prove to be particularly accurate. The power to actually get behind that and see what was happening has to rest with somebody.

  Mr King: Absolutely, and it was the prudential supervisor.

  Q2347  John Mann: Are those powers there in your view?

  Mr King: No.

  Q2348  John Mann: Are there things we need to be doing?

  Mr King: The powers to set prudential supervision for individual institutions are there. What is not there, I think, is the ability for the supervisor to say, "Without forming a judgment about your individual bank, we think that the speed at which banks as a whole are expanding is creating risks and we think that all banks should have higher capital requirements, if you like as an effective tax on the growth rate of the banking system". That is the idea behind so-called counter-cyclical capital requirements and I think there is a very important debate to be had about the precise form that they should take, but I do think there is a strong case in principle for introducing something like that. I am not saying that the Bank should necessarily have that power, that is an issue to be discussed down the road, but it is worth working out first what is the right form of the additional prudential supervision that is needed and then asking the question who should actually do it.

  Q2349  John Mann: What sort of timescale would you put as being pressing in relation to that?

  Mr King: I do not think it is pressing, we have time to think this through carefully. The reason I do not think it is pressing is I do not think you will find many banks engaging in wild risks for some considerable time. Until the people who can remember this episode have disappeared from the scene, only then will we find ourselves back in the same old cycle.

  Q2350  John Mann: There appear to be a number of loose ends that no-one wants to pick up. I will pick up one, the credit rating agencies and who supervises them, one can see why they are loose ends, but offshore, not least with British Dependencies—

  Mr King: All of these things are crucial.

  Q2351  John Mann: How are we going to get who should be taking the responsibility for getting behind them?

  Mr King: It depends on which issue you look at. If you take the question of offshore tax and regulatory havens, I am now convinced, I think, that Government leaders for the first time in my experience are determined not just at G7 but at G20 level to do something about this. It is very important and requires governments to work with other governments to do something for which there will be significant lobby groups that will lobby hard against it. I think the experience has been sufficiently uncomfortable that governments will now work and take action, but it requires international agreement.

  Q2352  John Mann: Similarly with credit rating agencies?

  Mr King: In the Bank I think we are going to think very hard about the extent to which we and other central banks rely on credit ratings as an indicator of access to our operations. We do not allow anyone with a given credit rating automatic access, we always do a second check, but there is a good deal to be said for downplaying the role of credit ratings in its entirety. The credit rating agencies did move into areas where they did not have appropriate expertise and there were conflicts of interest. The difficulty with them is the last thing you want is to have government-owned credit rating agencies because if you do that the government that owns it will never find its debt ever valued in any way that is accurate and people will lose faith in the rating. Who rates the raters is a very difficult question. There are a very small number of them. It is like accounting firms, we have a tiny number of accounting firms, so that creates difficulty in having independent switching between them, and it is even worse in terms of rating agencies. These are issues that are very important. It would be a mistake to rush into judgment about the answers to it, but what is very important is that we ensure that these items do not disappear from the radar. The danger with taking too long is that people get bored and forget the question and we must not do that, but equally we must not rush decisions on it.

  Q2353  John Mann: Clearly people can blame politicians, Parliament, governments, for not highlighting these questions more succinctly and as a higher priority previously, so we should not be ducking our responsibilities. My final questions are on the Financial Services Authority where the Bank has a place on the board. In their Financial Outlook it seemed to me that Lord Turner is trying to do your job. They seem to want to go into governance and your role rather than their role. There seems to be an inherent reluctance there to have regulation as if in some way regulation is a dirty word that must be avoided. Do you have concerns about the way in which they are attempting to usurp your role?

  Mr King: I do not think it is to usurp the role. Up until 2007 I worked very hard with Callum McCarthy to ensure that we did not have the sort of traditional turf battles that I have seen very often in government. I thought it was very important that we not have those turf battles. In retrospect, I rather regret that because I was held accountable by this Committee and many others for things which had absolutely nothing whatsoever to do with the Bank of England. The fact that it was not on paper our responsibility made no difference at all to whether you thought we had played a role in it or should be held accountable for it. It would have been better had we probably played more of a role. To that extent, having some overlapping responsibilities in an area where if things go wrong it proves very critical maybe better with two people looking at it than just leaving it to one person. What are the incentives? When we produce a macroeconomic assessment for monetary policy we are concerned to look at the most likely outcome and the balance of risks around it. When the FSA look at the macro outlook they are bound to want to focus on the worst possible outcomes and what could go wrong. That very easily leads into the press being able to say, "Oh, these are different assessments". They are not different assessments. We have to look at all the range of outcomes when setting interest rates; they are only concerned with the worst possible outcomes. I am very happy to engage with the FSA in a debate about what the outlook is and what the consequences would be for the banking system. I think, and I have talked to Adair Turner about this, that he would welcome the Bank's team under Andy Haldane saying to the FSA, "Look, our judgment is that this group of banks or the banking system as a whole seems to us to be facing some quite serious problems which you have not really taken on board" and maybe that will be a better way forward.

  Q2354  John Mann: My final question is on the same theme. Adair Turner used the term "mis-selling", which the FSA uses a lot. Should they not have been looking at mis-lending, in other words a consistent policy in certain financial institutions to be mis-lending to consumers, the totality of which has created a particular problem, only one part of the problem but a significant part of the problem? If they had regulated properly, and if they do regulate properly, would not that element of it be rather easy to do something about if the regulation is strong enough?

  Mr King: I agree with the objective, I am not so sure how easy it will be to do it. In some ways we have been through a natural experiment. We have been through a period in which the UK had light-touch regulation, the Americans had pretty intrusive regulation, hundreds if not thousands of bank examiners sitting and working full-time inside the banks, in Europe we have had governments deeply involved in the banking system and different systems in Asia. Every single one of them failed to spot the seriousness of the risk-taking that was going on. The lesson I would draw from this is not to expect too much from regulators. The real problem that any of them would have faced was that if they had said to banks in the City before 2007, "You are taking big risks", they would have been seen to be arguing against success. The people in the banks would have said, "Well, who are you to say we are taking too big risks? We have got far brighter and more qualified risk assessors than you have got. We have made massive profits every year for almost ten years. We have paid big bonuses. The City is the most successful part of the UK economy. How dare you tell us that we should stop taking such risks. Can you prove to us that the risks we are taking will necessarily end in tears?" and of course they could not. For an ordinary regulator going about their business, they would have been confronted with this massively difficult task of actually persuading people, persuading you, that they should have been taking action against institutions that looked very successful and highly profitable. I think the same was true of employees inside the institutions and from anyone outside. Any bank that had been threatened by a regulator because it was taking excessive risks would have had PR machines out in full force, Westminster and the Government would have been lobbied, it would have been a pretty lonely job being a regulator.

  Chairman: We heard that from Adair Turner yesterday.

  Q2355  Mr Mudie: I think this has been a very thoughtful and useful session because it is unimportant now and it is not on to start looking for scapegoats and who did what to whom, it is really looking to the future to see where our institutions are best positioned to deal with it. You have only made one suggestion as to how it could be improved in terms of the Bank of England. We now have an overlap in financial stability. It is interesting how John Gieve described it in his speech. On the question of your last remarks you said that you are in a better position and you have pointed out the regulator cannot do it. You said at one stage it is for this Committee to decide what the responsibilities are or how they should be changed, et cetera, but you are in a key position in terms of being the Governor of the Bank of England, the most important position, the most influential position. It would be useful if your colleagues could put a paper up to us. You referred to discussions with the FSA. Governor, the FSA have put 300 new staff on. They are pre-empting decisions. They have spent £80 million-odd in their budget putting staff on. How does Paul deal with financial stability against that army? It would be very useful if you were prepared, with the support of your colleagues, to put a paper up to us with some discussion points that we might want to knock about and even discuss in this sort of session with other witnesses.

  Mr King: Let us start to try and put some points forward now. It seems to me there are three big lessons from the recent experience. The first one, and I have made this point before, I do not want to labour it, is I do think that failures in the international monetary system led to imbalances in capital flows between countries that created the conditions of remarkably low interest rates and encouraged risk-taking and that has to be tackled somehow. It is not a question of financial stability but it is vital. It is getting back to the objectives of Bretton Woods that were never achieved of imposing symmetric obligations on surplus countries and debtor countries. Deep down, if that had not been the problem I think we would not have seen a lot of what we are seeing in the financial sector. I think that is fundamental too. The second one is in terms of regulation. I repeat the comment I made just now that with the best will in the world I find it very hard to think that we will solve the regulatory challenges by creating more committees, processes, etc. Committees are useful and they have their place and they are important, I am not saying we should not have them, but they are not the answer to fundamental challenges to regulation. No regulatory system in the world really dealt well with what happened. Why was that? I think that was because the nature of risk is very hard to assess and you cannot easily prove a counterfactual. It is very hard to say to someone who appears to be very successful, "What you are doing is potentially damaging to the rest of the economy". The conclusion I draw from that is there is a lot to be said for trying to build in very simple, very robust mechanisms to put some sand in the wheels of the expansion of the financial sector. We have to say to ourselves one of the lessons that old-time bank supervisors always used to say, and I remember when I joined the Bank, that there are only two kinds of banks you need to look at, banks that are losing money and banks that are making a lot of money. Those are the two kinds of banks you have got to regulate very carefully. If the banking system is expanding too rapidly we must not be taken in by the promotion of, "Our financial centre is so successful that we should indulge in self-congratulation", maybe we should just say, "Hang on, perhaps there are too many risks here" and build into the system the kind of proposal that Professor Goodhart and a group that he wrote a report with made about trying to raise the capital requirements as the growth rate of the Bank increases. Keep it simple. The Basel regulation, for example, achieved nothing because it was wildly too complicated.

  Q2356  Mr Mudie: Going away from regulation, on financial stability now it is a statutory duty and it seems to be limited to bank notes or something like that. Is it not the case that this is not the time now to beef that up and explain to you what we wish of you to do in terms of financial stability?

  Mr King: Yes.

  Q2357  Mr Mudie: Giving you the responsibility and, just as we have with interest rates, giving you the independence to do it because that is the answer to no regulator, nobody would be able to cool the economy down when you thought it was "excessively exuberant", which is the phrase, is it not, but you can because you do it all the time with interest rates.

  Mr King: Yes, absolutely right. The trouble is that what you have given us now is a statutory objective of financial stability but without any instrument to use. I hope your inquiry will look at what are the right kinds of instruments.

  Q2358  Mr Mudie: Can you not suggest some?

  Mr King: We can. Counter-cyclical capital requirements and there is the business of whether you have dynamic provisioning of reserves. It is a bit glib somehow just to use these phrases because one of the things you immediately realise when you use the phrase "counter-cyclical capital requirements" is that a cycle is not the same everywhere in the world. One of the big challenges we have got is how on earth do you reconcile international banks with national regulations. Are you going to have a bank that operates in two countries where in one country the cycle is expansionary and in the other contractionary and one authority tries to ease the capital requirements because of the state of the cycle and the other one tries to tighten them. There are major issues here about the extent to which banks having become internationalised are then outside our ability to impose—

  Q2359  Mr Mudie: On a bank level, when you consider Lloyds before they took over HBOS, how they were run whilst everybody was getting exuberant, if we as a country were less inclined to get exuberant whilst the others were doing it we might end up in a better position as Lloyds did before they took over HBOS.

  Mr King: I do not think you will find a central banker will disagree with the proposition that we should never get over-exuberant.

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