Examination of Witnesses (Questions 2400-2419)
MR MERVYN
KING, MR
PAUL TUCKER,
MR ANDY
HALDANE AND
MR ANDREW
BAILEY
26 FEBRUARY 2009
Q2400 John Thurso: Following on from
that, if I may, Governor, because you have said some very interesting
things today, earlier on you told us that we need to be focusing
on credit and burrowing and leverage as an important indicator.
You talked about risk and the balance of risk and you talked—and
this is something you and I have discussed before—about
remuneration and how inappropriate it has been. You have also
talked about the difficulty of finding regulatory levers for all
of this, which brings one back really to whether this is not a
question of culture and philosophy. The problem is that the City
thought of itself as the masters rather than the servants of commerce,
and that we have actually moved from the old-fashioned, traditional
British banking model of 20 or 30 years ago to taking in a great
deal of the American model, that greed is good and short-termism,
and above all we need a return to a culture which is more of the
old and traditional and less of the new. Is that not a fundamental
part of the problem?
Mr King: The one thing I would
pick out from that that I think is very important is short-termism.
I think the nature of banking is bound to change over time as
the world economy develops and evolves, and banks are very different
institutions now than a hundred years ago but what is very important
is that I think this pressure, this incessant pressure to achieve
quarter on quarter increases in profits cannot possibly make sense
in an economy which itself is inevitably somewhat volatile. What
it does do is to undermine the ability of managements to put in
place credible long-term strategies for building up business.
It is no accident that many of the companies outside the financial
sector that I meet when I go around the country that impress me
most are those that are not subject to the so-called discipline
of quarterly reporting to the City and the judgement of analysts
on that. I do think that you have to have some method of accountability
of managers to the owners of the company. It is not an easy system
to devise and make work but the short-termist response I think
has been damaging.
Q2401 John Thurso: Can I put a point
to you, and it goes from culture into the whole concept of what
is being called narrow banking and the Glass-Steagall. This is
something we have discussed and I put it yesterday to Lord Turner.
It seems that there are quite a lot of very intelligent commentators
and witnesses who favour a return in that direction. He said himself
that whilst he saw the validity of the argument, he was not convinced
by it at the moment. Is not the problem that, if you go back to
risk, risk itself is not bad? Zero risk equals zero return. Taking
measured risk, and it is the measure bit that is important. The
culture that is required in the whole investment banking side
is a riskier culture, giving greater rewards. The culture that
should be in clearing, retail banking is a culture that is more
prudent, and the problem is that it is the joining of the two
cultures rather than any institutional problem that is really
at the heart of the problem there. What are your views on that
argument?
Mr King: I think you have summarised
the nature of the problem well, and I think the difficulty is
that if you try to legislate to have two kinds of banks, you cannot
legislate to have culture A in one type of bank and culture B
in the other. All you can do is try to define it by types of activity.
Instinctively, I find the narrow bank idea very attractive but
the argument that is put against it, which I have reluctantly
over the years come to accept has some real validity, is that
if you try to restrict deposit protection and regulation to the
narrow banks and say to people that if you put your money into
a narrow bank it is safe whereas if you put your money into a
wider bank, you take your own pot luck, the problem is that the
wider banks, precisely because they are not regulated, will be
able for most of the period to offer higher returns, and many
depositors will not be strong enough to say to themselves "I
don't think this is really prudent in the very long run. I will
stick with my narrow bank." They will switch their deposits
to the wider bank, those banks will be less well regulated, they
will expand much more rapidly than the narrow banking sector,
and indeed, they will become so big that when the crisis does
come, the government will be forced to step in for concern about
what will happen to the economy through a collapse of these big
institutions.
Q2402 John Thurso: Following that
through, a point that is often made—and I remember we discussed
it in June—is that we do not want to stifle innovation.
As they say in Scotland, "I hae my doots about that one,"
because innovation has got us where we are, one might argue. There
is a view that a certain amount of innovation is actually quite
good but there is an element within the whole financial market
that you do want to act in that way. At the same time, that whole
element of trust and confidence which is so important is required
for the everyday banking. Should we be saying that if you wish
to engage in the taking of deposits, you will be regulated on
your leverage at a far higher degree than if you wish to forego
that and actually operate in the other areas? In other words,
can we disaggregate, as we have so often said here, the money
utility from the casino?
Mr King: I think is worth having
a serious debate about this. My concern is not about the objective
or the desirability of doing it. My concern is about the feasibility
of doing it, because I think that what you call the casino type
institutions will eventually find it quite easy to create deposit
accounts into which people will find it very attractive to put
money and it will be very hard to stop that. That has been the
nature of the problem so far, that where you have two types of
institution—in a sense, we have been through this for a
very long time. If we go back to the 1970s, there were licensed
deposit takers, there were unlicensed, there were some kinds of
banks and second-tier banks. We have always struggled with these
boundaries and in the end the trouble is that the bit that is
not regulated very much always grows very rapidly because it can
offer higher returns, and in the end enough people have their
savings in those institutions that you and other parliamentarians
feel we cannot just abandon them to their fate, because they did
not decide what the risks were in these institutions. They were
not really knowledgeable about what was going on, and these institutions
are so important that, for systemic reasons, we have to rescue
them. That is the problem, I think, and it certainly goes to the
heart of the danger of having too big institutions.
Q2403 John Thurso: It is not just
about investment bankers at one end and retail bankers at the
other. In the middle there are these guys who are playing roulette
with weird instruments. If you look at long-term capital management
and its collapse in 1998, it was basically all the arbitrage guys,
who had made all the money, who then lost it, and of course, that
was headed by the same team as the guy who was booted out of Salomon
in 1992 for having done exactly the same thing. How do we get
that lot out of the rest? Does it actually perform any function?
Mr King: I am not sure if that
would solve all the problems because there are plenty of imprudent
and risky decisions that banks make which are not of the kind
that require a degree in higher mathematics. Indeed, as someone
said not so long ago, it is amazing that banks go to such trouble
to find new ways of losing money when the old ones seem to be
doing perfectly well, thank you. Look at all the losses in HBOS
on commercial property lending. It takes us right back to the
late 1980s/early 1990s, when a lot of money was also lost on commercial
property lending. I think very high leverage inevitably entails
significant risks. That is why banks are risky institutions.
Q2404 John Thurso: So what we are
back to is that we just legislate and say, "That's it. You
can't leverage that much. End of story."
Mr King: I think it is difficult
to say there is one simple answer which means, if implemented,
we can go away and forget about the problem. That will never be
the case. When you get to a period in which—whether you
call it the word culture or whether you call it the prevailing
degree of animal spirits, that people are willing to take risks,
then there are likely to be problems, and it is difficult to know
whether you should stop them in terms of legislation or whether
you should try to advise people and draw their attention to the
risks. What would you have said, for example, to the young woman
I saw on television some years ago saying, "I have decided
to give up my company pension fund because shares go down in value
and I have taken out a 100% mortgage to put all my money into
a buy-to-let flat because houses only ever go up in price"?
That is a very risky decision. Do you want to legislate to say
that someone cannot do that of their own free will if they want
to, or do you try to find a way of advising them not to, or do
you in the end say that they have to accept the consequences of
their own actions? These are not easy questions.
Q2405 John Thurso: That is a good
point. Is there not a significant difference between allowing
one person, whether it be me or the lady on television, to make
a catastrophic error of judgement, which is my problem and not
the nation's, and allowing a number of large institutions and
a system to take some catastrophic errors of decision which actually
bring the country down? There is surely a difference between the
two.
Mr King: There is but of course,
one of the most remarkable things about this crisis—and
let me take Citibank as perhaps the best example here, the biggest
bank in the world. When we went to New York four or five years
ago all the banks in New York were saying "We will probably
have to follow the Citibank model." "That is the question:
do we follow the Citibank model?" Who were the people running
Citibank? Some of the cleverest and brightest people you can imagine,
with a wealth of experience in Wall Street, in government, in
investment banking, in academia and in emerging market debt crises.
They knew a lot about what had happened in the past. It was not
in their interests to take risks that would turn catastrophic
later on. They did not set out to destroy Citibank but they were
as aware as any regulator of what they were doing and what the
risks were, yet the outcome was a disaster for the bank. They
did not intend it, and it is very hard in this situation for those
kinds of institutions ever to guarantee that you can avoid what,
once in a generation, looks like a catastrophic outcome. That
is the challenge we are facing. How do you decide the infrastructure
and legislation around institutions to trade off their ability
to innovate and create new financial instruments and to avoid
the catastrophic risks that can occur when things go badly wrong?
I do not think it is easy to do that. I think we have to try.
We have to learn the lessons from this and try to improve the
system but, as I said in that speech in 2007, are we really so
much wiser than the financiers of the past? Do we really think
that we are going to come up with the answer that will prevent
hundreds of years of banking crises, suddenly come to a halt?
No, we are not going to be able to that. We can try to make it
less likely, we can try to diminish the damage, we can try to
get into a position where we can deal with the consequences more
easily, but these are really fundamental questions about the nature
of risk-taking in a market economy.
Q2406 Mr Love: Governor, can I come
to the Asset Protection Scheme? There has been some concern expressed
by the banks that to pay the insurance fees related to the protection
scheme will either cause further significant dilution of their
shareholdings or lead to—and the words that are used are—"creeping
nationalisation." Are you concerned about that?
Mr King: I do not think in first
order I am particularly concerned about that. I think the banks
need to have this protection scheme and I think the taxpayer is
entitled to take their share of the returns if they put in money
to underwrite the balance sheet. The person who has been working
most closely with the Treasury on the design of this is Mr Bailey,
so perhaps he can comment.
Mr Bailey: I would just echo the
Governor's point that I think the taxpayer is entitled to expect
that when the banks come out of this situation—which they
should and will—when they recover, the taxpayer will be
able to recover the amount of public money that has been put in.
Q2407 Mr Love: Can I interrupt you?
I do apologise. In relation to the Royal Bank of Scotland, it
was widely trailed that the level of fees would be 4%. It has
turned out to be 2%. Are you surprised at that decision?
Mr Bailey: There are a number
of variables in the equation by which you arrive at the overall
outcome, of which the level of fees is one, and the so-called
attachment point, which is the level of the first loss that the
bank bears and the level of loss beyond that that the government
shares with the bank, but in a ratio that is heavily towards the
government, so you have to look at the whole thing to get the
essentials of that.
Q2408 Mr Love: Let me look at the
whole thing. According to the scheme, they are taking on what
the public certainly think—I do not know what the Bank thinks—are
very high-risk assets: collateralised debt obligations, collateralised
loan obligations, and included within this, the first loss, according
to the RBS, is roughly 6% of the overall assets included. The
residual exposure is 9% so the total bank exposure is 15% of the
assets. That leaves a potential maximum of 85% for the public
purse. Clearly, that will not all materialise but are you concerned
about the balance that seems to be being struck in this deal?
Mr Bailey: The balance that is
being struck is the one that has to be struck to get the bank
to a position where it is stabilised. Let me be clear. The amount
of the pool of assets that has been announced is £325 billion.
We do not expect £325 billion of assets to go bad. The whole
exercise—and it is subject to the point the Governor and
I made earlier about the need to do this very thorough due diligence
over the coming period—is to isolate those pools of assets
where the losses are most likely to be.
Q2409 Mr Love: Can I stop you there
because I want to come to the due diligence point in a moment.
According to the scheme, the Government will charge £6.5
billion. It is providing an additional £13 billion of further
capital and a potential further £6 billion. That is £25.5
billion potentially of additional capital. Does that not mean
that in effect RBS has been nationalised? Governor, I would like
your views on this.
Mr King: I am not going to comment
on the details because we did not get them until quarter to nine
this morning. What I will comment on is the principle of this,
which is that most of the major banks do need a very significant
support, and in the case of RBS and Lloyds, that support essentially
amounts to the Government putting in a majority of the base equity
capital that is needed. In that sense, the Government owns more
than 50% of the equity of the bank and it can make its decisions
accordingly. I do not see a significant difference between that
and outright nationalisation, except in the sense that the system
we have now, which is that the Government puts in money and take
shares, has the great merit of trying to make clear to everybody,
particularly in the rest of the world, that nobody thinks that
the Government should be involved in running these banks indefinitely
and that the shares will be put back on to the private market
and the banks will be back in the private sector. I think avoiding
the actual process of formal nationalisation has great merit from
that point of view but the economic substance is clear: the taxpayer
has had to put in so much money to ensure the viability of these
banks that it is now contributing a majority of the equity capital
as well as a vast amount of public support in terms of lending
to the banking system.
Q2410 Mr Love: Can I just quote briefly
from the press release, because it comes to a point that you raised
earlier, I think in a response to Mr Cousins. It says, "In
determining the pool of assets, banks will be subject to extensive
due diligence on the identified assets." I would interpret
that as meaning that we are at the start of the process rather
than either halfway through or near completion. We do not want
to get into semantics about that but are there any concerns that
the due diligence process will take so long when we really need
to get on with re-establishing trust in the banking system?
Mr King: No, but the point I have
been making very strongly to the Chancellor now is that you have
to take the time to do the due diligence. The fact that we need
to do something to shore up the balance sheet of the banking system—and
that has to be done quickly, I accept—is not a reason for
not starting the process of due diligence. You have to start it
at some point in order ever to complete it. We have to do that.
It will take time. They have already started it and have got some
way down the road. This is a continuation of a process that has
already begun, but it is vital, as you suggest, that the underpinning
of that balance be put in place now, without any ambiguity, so
that anyone that is thinking of lending to a bank will be able
to do so secure in the knowledge that the capital position of
that bank is completely secure, underwritten by the Government,
and that the bank has access to the credit guarantee scheme to
fund its lending. Only in that state can we possibly expect banks
to start lending again.
Q2411 Mr Love: Can I take you a step
further? Although bad banks have been rather cast in a shadow
because of the real difficulty of pricing the assets at this particular
time, there is a lot of people that think that the insurance scheme,
which is being replicated, I think, in other parts of the world,
is only a first step towards a bad bank. What is your view on
that matter?
Mr King: I think the Chancellor
has been clear on that and wishes of range of options. The important
thing to do at this stage was to start the process, which had
already begun, and began before today, of examining the balance
sheet, underpinning the capital position of the bank. Once we
know what the balance sheet is like, then it is possible to think
about how you would price assets, whether you want to split the
bank into good bank, bad bank. There are a range of options that
will become available at that point but you cannot wait until
that point; you cannot do nothing; you have to underpin the balance
sheet now. A split between good bank/bad bank is certainly a feasible
option down the road. That remains to be seen. The differences
between that and insuring assets are a matter of degree; they
are not qualitatively different.
Q2412 Mr Love: From the sound of
things, you are attracted by the idea that when we get further
down the road, when we know better what the shape of these assets
is, a bad bank purchase scheme may be the sensible way to go.
Mr King: I am not sure if I am
keen on the taxpayer rushing in to buy assets without knowing
what the price is. That is why we have to wait for the end of
the process. At the end of it, I am certainly attracted by a process
that cleans up and restructures the bank's balance sheet. That
is absolutely vital. That was the lesson from earlier banking
crises. We have got to get to grips with this and realise that
balance sheets have to be cleaned up, and only at that point will
you have a good bank that people will have confidence in and can
return to normal. The sooner that happens, the better but we have
to be prepared to take the time to do the forensic analysis of
the balance sheet first.
Q2413 Chairman: Thank you. Paul Tucker,
with regard to the financial stability responsibilities, how many
extra staff have you taken on or are you taking on?
Mr Tucker: We are taking on just
over 20 staff to run the special resolution regime and half a
dozen to support the payment system oversight function, because
that is being put on a statutory footing. That is where the increase
in resources is being focused so far.
Q2414 Chairman: Are you content with
those arrangements?
Mr Tucker: In terms of the new
statutory functions, I am content. Andy's area has expanded somewhat
over the past year beyond that but, as I said in my written evidence
to you and in my confirmation hearing, this is something that
I shall want to look at with the Governor and with Andy, Andrew
and other colleagues, as I get my feet under the desk.
Mr King: The financial stability
area has already increased by around 20 people over the past year.
We have done that already in large part.
Q2415 Chairman: Governor, just on
the bonus aspect, is there a bonus or performance-related pay
structure within the Bank and are the lower paid staff on the
same scheme, with the same conditions as the senior staff?
Mr King: Yes, some years ago the
Court of the Bank decided that it wanted to increase the proportion
of remuneration that was offered in the form of performance-related
pay, and this is related not to financial performance but to very
clearly defined objectives, set for each member of staff at the
beginning of the year. We pay something like 7% of the total compensation
in the form of a bonus. The same scheme applies to everybody apart
from the Governor and two Deputy Governors, for whom there is
no bonus at all.
Q2416 Chairman: Why is it you can
get out of your bed in the morning without a bonus and the rest
of the banking industry cannot, without getting ten or 20 times
their basic salary?
Mr King: You would have to ask
them.
Q2417 Chairman: You are quite happy
to get out of your bed in the morning for a basic salary?
Mr King: I am extremely well paid
and I get out because I love the world of public policy and I
enjoy it.
Q2418 Chairman: The issue of bonuses,
certainly from the evidence we have received so far, is that there
is a recklessness about the situation, because they are dealing
in the short term, dealing with other people's money but, irrespective
of success or failure, they are rewarded.
Mr King: I think there are jobs
and jobs. One of the things I found somewhat distressing about
the lives of many people who worked in the City was that so many
of them thought that the purpose of a bonus and compensation was
to give them a chance to leave the City, to do something they
really wanted to do, having built up enough money to give them
the financial independence to do it. I think that is rather sad
because actually, there is nothing more rewarding. I am well paid,
make no doubt about it, and so are most people at the Bank compared
with many ordinary people around the country. Having more money
is not going to motivate us. We enjoy the job. We are privileged
to have this position. It is that which motivates people to work.
That is why people in the Bank worked all night and all weekend
when Bradford & Bingley was resolved without any overtime
payments.
Q2419 Chairman: Governor, the Financial
Times this morning said that you were going to announce at
our Committee the contents of your letter to the Chancellor requesting
permission to start quantitative easing. I have not heard anything
of that so far.
Mr King: No, I have not read the
Financial Times yet. I must find out. I always find it
helpful to follow the media to know what we are going to be doing.
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