Banking Crisis - Treasury Contents

Examination of Witnesses (Questions 2380-2399)


26 FEBRUARY 2009

  Q2380  Mr Tyrie: You are proposing a second tool.

  Mr King: The second tool is really about credit as a whole and not about asset price bubbles, where I think it is very hard to be confident that there is an asset price bubble, and anyway you only have one instrument. Using interest rates, using the bank rate, is not, in my view, the appropriate tool to deal with concerns about asset price bubbles or concerns about the growth of credit. I think you can design an instrument to deal with the growth of credit. I think it is harder to do that with asset price bubbles, though I do accept that it may be worth debating. I do not want to form a judgement on that today but I know some people have said, given what happened, maybe we should just put some real obstacles in the way of mortgages in excess of 100% loan-to-value ratios being granted. That goes back on the idea of free and open capital markets and individuals making their own decisions about how much to borrow and lend, and it may not be the right thing to do.

  Q2381  Mr Tyrie: But you are going to give us an early paper on this second instrument?

  Mr King: We will give you a paper. I do not want to commit to a date now but we are thinking about these issues and we will come back to you on it. I do think this is part of the really important debate that we have as a country about what kind of financial system we should have. I do think that one of the benefits is that we must use this to learn some lessons. Rapid expansion of what appears to be a highly profitable industry, paying massive salaries, was damaging. It sucked in large numbers of young people from other professions which could not offer the same kind of compensation, under the illusion—and it has now been seen to be an illusion—that these bonuses could be paid for ever. That will adjust itself of its own accord now. People will go to other careers. The financial sector will not be as big and it will not grow as rapidly. So we have time, I think, to try and think through how to prevent our successors facing this problem. I do not think you on this Committee will face this problem again. I do not think I will face this problem again. It will be the next generation, and we need to leave behind some clear institutional memory of what happened and what lessons we drew, just to give them some ammunition to resist the calls that will inevitably come 15, 20, 25 years down the road: "Those fuddy-duddies in 2009, they all got over-excited about financial crises, they put blockages in the way of the expansion of the financial services industry and we must remove that." It is handing on to the next generation some of the lessons that we have learned from this crisis.

  Q2382  Chairman: Governor, I was going to ask you about the over-dependence on the financial sector and the rebalancing of the economy. You have made statements about that before and I think your answer ties into that issue.

  Mr King: Yes.

  Q2383  Chairman: As a Committee, we want to look at the issue of rebalancing as well.

  Mr King: Well, we are coming back to you in a month's time.

  Chairman: Exactly, so that will be very helpful.

  Q2384  Jim Cousins: Mr Haldane, I wonder if I could take you back to a very interesting point you made right at the beginning, that you saw a distinction between assessing risks and imposing a requirement to control those risks. You drew a very good clear distinction between those two things. Could I ask you if you think that they are two different roles for regulatory and supervisory authorities to have?

  Mr Haldane: The current institutional apparatus clearly assigns those two distinct roles to two distinct institutions. That is certainly true. That is to say, it is not the Bank that currently exercises control over the regulatory apparatus. I think, as the discussion has gone on to second instruments, were regulatory policy to have an explicitly systemic or macro prudential as distinct from micro prudential dimension, then that begs the question about whether the macro analysis could not be brought together in one place with a macro regulatory instrument. I think that would be easier to achieve if there were this second instrument.

  Q2385  Jim Cousins: Mr Haldane, let me be clear about this. That points to the fact that you see the assessment of the risks and the deployment of the controls to deal with those risks being dealt with by a single institution.

  Mr Haldane: I think that is one potential configuration. I do not think it is in any way, shape or form the only one that could be made to work. If you are to have a tool that is serving a macro prudential systemic role, it is likely that the Bank, by dint of its role in assessing macro risks, would have some influence, some judgement to bring to bear on the implementation of that tool. Whether that tool is actually in the Bank's hands I think, as the Governor has said, is an issue for another day. I think first base is establishing, first of all, that there is a case for such a tool, and I think the emerging consensus is that there is; secondly, what operational form that tool might take, on which I think there is a lot of work to be done to get underneath what would be a suitable instrument, and how that instrument should best be calibrated to achieve its end objectives; the third question is who does it, and in some ways, for me, it is the least important of the three. I think establishing first, that there is a case and second, what form that rule should take are sensible next steps.

  Q2386  Jim Cousins: That is very interesting. Mr Tucker, I wonder if I could ask you, would you visualise, in the deployment of a future control, yet to be designed, that control having to apply to a category of enterprises or banks, or could it be deployed in the case of a single bank? That would affect the design of the sort of control you would have.

  Mr Tucker: I think it is quite hard to envisage the application of controls that have not been designed. I do not mean that as a cheap shot.

  Q2387  Jim Cousins: The decision about whether the control applies to a category or a single institution will affect the design.

  Mr Tucker: The debate is about categories of institutions, and that goes precisely to the point that the Governor, Andy, and Andrew Tyrie as well, have made about the international dimension. Because, as the Governor said, sometimes the credit cycles across the world will not be synchronised but sometimes they will. The short answer: the question is about categories of institutions. The other thing I would say, if I may, is that, first of all, I think this is a first order issue and it is absolutely vital that our generation of policymakers nails this. It has been around as an issue since the mid-1980s and it comes and goes as an issue. This time I hope it will not slip away: that we will resolve this time whether or not it can be operationalised or not. The second point I would make about it is that it is absolutely vital that we, the regulators, and you, do not become fixated that this is some kind of silver bullet. Financial stability policy is not like monetary policy. Your successors in 20 years' time will not be talking about one instrument that has been found to solve the problem of financial stability. It is of its essence a whole series of levers. Some of them micro prudential, some of them may be macro prudential, to do with the credit cycle. Some of them are to do with the design of the capital markets infrastructure. Some of them are to do with accounting rules. Some of them are to do with insolvency law. All of these things need to be in place in order to ensure the system is stable. The third thing I would say, if I may, is that one of the glaring lessons of this episode is that when the authorities, domestically or internationally, identify fault lines in the financial system, things that will matter if very low probability but very big impact events occur, then it is vital that those fault lines are addressed. Examples would be mono-line insurers in the United States, money market mutual funds, the role of Fannie and Freddie. This episode would have been slightly, somewhat better if those fault lines had not existed. But none of them is to do with the macro prudential instrument that we are discussing. The reason I go through that is that while we absolutely must pursue what you and Andrew Tyrie and others have been talking about, and I am extremely keen on that and have talked about it publicly, we absolutely must not become fixated with the idea that it is some kind of cure-all. We will have to operate on lots of fronts, "we" being the plurality of institutions domestically and internationally.

  Q2388  Jim Cousins: Governor, do you see future controls that we are now discussing as being symmetrical in the same way that monetary policy is, that is to say, that they could involve increasing lending at certain points as well as requiring perhaps a reduction of exposure?

  Mr King: Yes, and I think that, in a sort of de facto way, that is where we are, in that at the same time as regulators around the world are talking about the long-run need to raise capital requirements, they are also stressing very clearly that capital requirements now, if anything, should be lower to enable the banks to use a buffer between the capital that they have and the minimum that they have to keep as available to underpin lending. Anything that is thought of as a countercyclical approach is bound, I think, to have an element—not of perfect symmetry because cycles do not form perfect sign waves but certainly cases where you would be tightening capital requirements at one part of the cycle and easing them at other parts of the cycle in order to prevent an unnecessarily large reduction in lending by the banking system.

  Q2389  Mr Cousins: I just want to ask a question of fact essentially. You will be aware that the Committee has had handed round the outline of the Asset Protection Scheme, and I have not had a chance to look at the absolute detail but you made it clear that you thought there should be a rigorous audit of the underlying assets before the Asset Protection Scheme kicks in.

  Mr King: Not quite. What I said was that before the details of the actual value of the assets and the price to be paid for them are determined, this needs to be done, and that is exactly what is happening, as I understand it, that the Treasury has started on the process of this rigorous audit, they are part of the way through it, they have not yet completed all of it but it is still important—and I did stress this—that the actual underpinning of the balance sheet you put in place now, so that the Chancellor has underpinned the balance sheet of the Royal Bank of Scotland, but precisely what this will mean in the future depends on the assessment of the evaluation that will continue to take place over the next few months. Mr Bailey has been very close to this because he has been involved. We have not seen the final details. This was decided last night.

  Q2390  Mr Cousins: On the understanding that that is happening, there is this very important issue raised by my colleague, Sir Peter. In the case of RBS, a lot of the assets that are going to be protected—in fact, probably the great majority of them—are outside UK jurisdiction so how does the Treasury carry out an audit of assets that are beyond its reach?

  Mr Bailey: You have to take what I would describe as a whole bank approach to this, and that is what the bank's own auditors have to do. They have to audit the whole bank. The Treasury will not be using the bank's own auditors to do this precisely for the point that the Governor made that this has to be independent but you have to do exactly the same thing. To get RBS to the point where it is stable, its future is clear and it can start to undertake the lending commitments that it has entered into, you have to look across the whole balance sheet. You cannot say, "We are not going to look at that because it is somewhere else in the world." This is a bank that, of course, went on a global strategy. I think you will find, from the announcements that the Chief Executive has made today that that strategy will of course change but we inherit the assets that we inherit and therefore we have to deal with all the assets. There is just no choice on that matter.

  Q2391  Mr Todd: There are lots of uncomfortable moral messages in this crisis. We highlighted earlier the fate of one pensioner. Some other pensioners who did what would seem the prudential thing of making savings for their retirement, early retirement in some cases, have found themselves losing out substantially as interest rates have fallen. They have ended up as rather innocent victims in this. What sort of message do we give to people who are taking personal prudential action?

  Mr King: I have immense sympathy for people who were engaged in saving and acted prudently, which was everything that we would have wanted them to do and they, and millions of others—it is not just savers who have lost; many people who worked for Royal Bank of Scotland were not receiving the multi-million pound bonuses that the senior management were, they did not decide the strategy, but it is their jobs that are going now. There are millions of people who are being affected by this downturn. Some of it you can link to individual decisions in banks, some of it is the consequences of a very sharp, sudden and serious worldwide downturn. For all of those people I have immense sympathy.

  Q2392  Mr Todd: I understand that, but you will appreciate the longer-term implications of some of the moral messages that we are handing out at the moment.

  Mr King: Can I go back to the point I made in the January speech? I referred there to what I called the paradox of policy at present. Everything that we are doing now in order to stop the downturn and to get back to normal is absolutely opposite to everything that we know we should do in the long term. That does not mean to say it is wrong. It means to say we have to explain to people why it is that collectively, if we all started to save now, we would be worse off in the short run. It is important that we get the economy back on track again and then, at that point, we can turn to implementing the moral messages about the need to save.

  Q2393  Mr Todd: That is a really complicated message.

  Mr King: It may be complicated but it is crucial.

  Q2394  Mr Todd: I am not saying it is wrong but I am just saying it is one that we need to express consistently and clearly, and I do not think the media helps us to do that.

  Mr King: I will redouble my efforts to try to explain it, and it is very important that people understand. In the long run we will all, as a nation, need to save more. We need to reduce our borrowing, but if we now move to that position too quickly, we will merely exacerbate the speed of the downturn.

  Q2395  Mr Todd: Agreed. Can I ask about the future of banks in private ownership? They are inherently unstable. I think we all accept that and there is an argument for saying that RBS, with its minority private stake, has a rather confused and complex future ahead of it. Do you take the view that there is a long-term future for private-sector ownership of banks?

  Mr King: Banks engage in significant amounts of maturity transformation by borrowing short and lending long. It is that that creates the instability, not whether they are owned privately or publicly. They would be just as unstable if they were owned publicly. Of course, knowing that there would be some underpinning is important, and that is why, even with privately owned banks, you would have a framework in which the government offers deposit insurance to prevent bank runs and provides regulation and supervision in such a way as to ensure that the banks do not take too many risks and ultimately will have to underpin the banks of those that are central to the functioning of the economy. I do not think that is an issue about private versus public ownership; it is a question about how we can ensure banks are able to engage in sufficient maturity transformation to yield economic benefits without taking excessive risks.

  Q2396  Mr Todd: One of the difficulties of getting a consistent picture of asset values is the dispersed ownership that is there. The model in Scandinavia was easy, of setting up a bad bank, because virtually the entire banking system ended up in the state's hands.

  Mr King: I think they had the same problems in many ways as we face now but on a smaller scale. Their banks lost enough that they were no longer viable as institutions without public-sector support. They needed a period of restructuring and then they were floated back into the private sector. If you take the case of Germany, where the banks were in the public sector, even there both the owners and the supervisors did not know about the offshore activities of some of the activities of their banks.

  Q2397  Mr Todd: Would you perhaps concede if there is a private sector future for banks that the corporate governance models of banks will need to be redesigned in the circumstances of our current knowledge? Some of the discussion we had, and I do not know whether you heard it, of the different governance models that applied to HSBC, Santander in its governance of Abbey, and the banks that are now causing us the greatest problem produced interesting differences in the way in which they chose to govern themselves. Are there experiences that we can seek to apply as a legislative framework for banks if they are to remain in private governance?

  Mr King: I find it very hard to believe that a particular process of corporate governance is going to guarantee people behaving prudently.

  Q2398  Mr Todd: But it may happen.

  Mr King: It certainly helps, and there is no doubt that there are elements of corporate governance which it is worth reinforcing to make it more difficult for one or a small number of individuals to engage in massive risk taking but in the end what we have to have is a culture in which people on boards are willing to stand up and say—take Dennis Weatherstone, who ran JP Morgan. He basically said to anybody who worked in JP Morgan, "You've got 15 minutes to explain this new instrument to me. If I don't understand it after 15 minutes, we are not doing it." It is the willingness to be tough and not to get sucked into the culture of saying, "The other banks are doing it. We must take part as well." That requires great strength of character.

  Q2399  Mr Todd: To take a classic example, which I am sure you will have followed, was the debate about risk management within HBOS and the models that were applied there and the individual appointments that followed from those models. Perhaps we need to look harder at how banks govern risk themselves and set clear criteria for how to separate executive and risk functions.

  Mr King: That is certainly part of it but I think it goes beyond that. I remember even after August 2007 receiving pretty strident comments from people in the industry, and indeed elsewhere, about the importance of not disturbing the distinctively British model of banking of wholesale funding. That model of wholesale funding was in large part responsible for the degree of risk that was incurred, yet, because it was seen as the key to success of the expansion of the City of London, large numbers of people thought this was a good idea and woe betide anybody who stood up and argued against that because they were seen as being disloyal to the need to see the success of the City of London. It is difficult in those circumstances to expect people to stand up and argue against something which has become conventional wisdom.

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