Banking Crisis: regulation and supervision - Treasury Contents

5  Reform to the institutional framework of financial stability

The case for change

104.  We were critical of the operation of the Tripartite system established in 1997 in our report on The run on the Rock. Although in our Report we concluded that the Tripartite system should be kept, but reformed, others have argued for more radical changes, with some favouring a reversion of banking supervision from the FSA to the Bank of England.

105.  The Treasury stressed in its White Paper that the institutional structure of regulation was not so much a problem as the judgements and decisions made by the authorities. The White Paper noted that many different institutional frameworks existed in different countries around the world, "but no model of regulation has been successful in fully insulating a country from the current crisis".[165] As such, the White Paper made no radical changes to the Tripartite arrangements. Smaller changes were, however, set in motion to strengthen the Tripartite through "increased powers for the Bank and FSA, better coordination between them, and strengthened governance and greater transparency".[166]

106.  A further reason for re-evaluating the Tripartite system is that a decision will need to be made in the medium term about which of the Tripartite bodies wields the tool(s) of macroprudential supervision. On the one hand, the Bank of England would seem well placed because it has a responsibility for considering system-wide risks. On the other hand, the FSA is the body with the specific knowledge of individual firms, so might be better placed to implement supervisory judgements. The Treasury argued that it would be "premature" to decide on the institutional responsibility until it became clear what the news tools would be, and how they should be used.[167] This stance was supported strongly by both the Bank and the FSA. The Governor explained that allocating responsibilities at this stage would be putting the cart before the horse:

We have not solved the "too big to fail" problem or worked out how to handle it, we have not sorted out what the macro-prudential policy instrument or instruments, in the plural, would be ... There is a lot of things that need to be thought through before we can decide what are the set of regulatory instruments that need to be available to the authorities, and only then, I think, is it sensible to ask how that should be allocated among the various players.[168]

107.  The White Paper announced the provision to the FSA of a statutory objective for financial stability, with additional rule-making powers "to give it clearer legal authority to set rules whose purpose is to protect wider financial stability".[169] The Treasury argued that this would "support greater focus on prudential supervision, enable greater attention to system-wide risks and establish explicit legal authority to support financial stability".[170]

The Bank of England—responsibility without power?

108.  The Banking Act 2009 formalised the Bank of England's existing responsibility for financial stability in statute:

An objective of the Bank shall be to contribute to protecting and enhancing the stability of the financial systems of the United Kingdom.[171]

Although the Bank had been charged with this new statutory responsibility, the Governor had "not really received any adequate answer" to his question of what the bank was actually expected to do in order to discharge that responsibility.[172] At his earlier Mansion House speech, he noted the limitation of his powers:

To achieve financial stability the powers of the Bank are limited to those of voice and the new resolution powers. The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between. Like the church, we cannot promise that bad things won't happen to our flock—the prevention of all financial crises is in neither our nor anyone else's power, as a study of history or human nature would reveal. And experience suggests that attempts to encourage a better life through the power of voice is not enough. Warnings are unlikely to be effective when people are being asked to change behaviour which seems to them highly profitable. So it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials.[173]

The Governor did not, at present, see a clear alignment of the Bank's responsibility and powers, he acknowledged that the current system was a "mess", and was adamant that this must change:

[Reports and speeches] are important things, but, in the end, I do not believe that people change their behaviour simply because we publish reports. That is fine by me, I am very happy with that position—if you want us just to publish reports, I am very content with it—but I do want it to be absolutely crystal clear before Parliament that you in Parliament understand that the Bank of England can do no more than publish reports or make speeches. If you are content with that, that is fine by me. What you cannot do is turn round afterwards and say, "But you had the statutory responsibility. Why did you not do something?", when there is nothing that we can actually do. All I am saying is just align carefully the powers and responsibilities…[174]

109.  The Treasury's White Paper noted that one of the Bank's existing responsibilities under its financial stability obligation, was to "analyse and warn of emerging risks to financial stability in the UK, principally by means of its Financial Stability Report, published twice-yearly".[175] But the Treasury are now asking the Bank to be more explicit in its warnings and identify:

  • risks to the UK financial sector and the UK economy;
  • specific actions which could be taken to counter the systemic risks identified in the Report;
  • an assessment of their likely effectiveness; and
  • consideration of whether these actions should be implemented by the Bank, the FSA, the Government, or whether they require internationally coordinated action.

Additionally, the Treasury have suggested new arrangements to make the evaluation of risks identified by the Bank, and its proposals for required action, more transparent.[176] The principal mechanism for this would be through the new Council for Financial Stability.[177]

110.  When we asked the Bank how close their links with financial institutions were now, and what work would need to be done to restore those links should the Bank be granted new powers in an institutional shake-up, the Governor reassured us that the Bank currently had close contact with people in the financial sector. He acknowledged that, prior to 2007, the Bank "made a mistake" in not "treading on the toes" of the FSA, especially with the smaller firms. The Governor was keen to enhance the Bank's understanding of all financial firms, irrespective of whether the Bank was granted new powers.[178]

Council for Financial Stability

111.  The Tripartite Standing Committee (composed of The Chancellor of the Exchequer, the Governor of the Bank of England and the Chairman of the Financial Services Authority) currently serves as a forum for discussing and coordinating financial stability work.[179] The Treasury's White Paper announced that legislation would be brought forward to transform the Standing Committee into a new Council for Financial Stability (CFS), set up on a statutory basis, with a published terms of reference and clearer responsibilities. The CFS would meet regularly to discuss systemic risk issues highlighted by the Bank's Financial Stability Reports and the FSA's Financial Risk Outlooks, and to consider actions required. It would also meet on an ad hoc basis when particular risks to financial stability arose. Minutes of the CFS would be published quarterly. The key differences between the new CFS and the old Standing Committee are that the CFS operates on a statutory basis, and will have published minutes. The Treasury has also pledged to "consider mechanisms for increasing the democratic accountability of the CFS, through greater Parliamentary scrutiny".[180]

112.  We sought from Lord Myners an answer to the question which the Governor had posed two weeks earlier, regarding how the Bank could satisfactorily discharge its new financial stability responsibility in the absence of any tools other than the power of words. Lord Myners replied that:

The Governor will discharge his statutory responsibility by participating fully in the process in accordance with the terms of reference that are ultimately set and reflected in legislation for the Council for Financial Stability.[181]

113.  We cautiously welcome the replacement of the Tripartite Standing Committee by the Council for Financial Stability (CFS) in respect of the publication of clear terms of reference for the new body and the fact that minutes of its meetings will now be published. We look forward to engaging with the CFS over how Parliamentary accountability might be improved. However, we view the change as one which is largely cosmetic. Merely rebranding the Tripartite Standing Committee will achieve little by itself; what is required is an improvement in cooperation amongst its members, and a simplification and clarification of responsibilities for each of its members.

114.  Devising an appropriate institutional framework for macroprudential supervision is extremely important and should not be rushed. We agree with the argument made by each of the Chancellor, the Governor and the Chairman of the FSA that it is necessary to reach an agreement on the precise instruments needed in the macroprudential toolbox, before considering which organisation should wield those tools.

115.  Whatever the final outcome of any institutional arrangements it is absolutely imperative that responsibilities are clear. The biggest failings of the Tripartite's handling of Northern Rock were that it was not clear who was in charge, and, because the Tripartite took a minimalist view of their respective responsibilities, necessary actions fell between three stools. We are not confident that this issue has yet been adequately resolved. Where before no-one had a formal responsibility for financial stability, now many do—the Bank of England, the FSA, the Treasury, the Council for Financial Stability and the Bank's Financial Stability Committee. Where responsibility lies for strategic decisions and executive action was, and remains, a muddle. The Treasury's design of the institutional framework for financial stability must bear in mind that, when the dust eventually settles on a new system, the question that we, and others, will ask is "Who gets fired?" if and when the next crisis occurs. It is a blunt question, but one which is necessary. Only if we have such clear responsibilities can we expect good decisions to be made and the right actions to be taken. Once those responsibilities have been clarified, the appropriate powers must be properly aligned.

The Government White Paper and co-operation between the Tripartite bodies

116.  The financial media have been awash with rumours about an emerging rift between the Tripartite bodies, with talk of personality clashes and turf wars. We put this issue directly to the Governor:

Chairman: Is your working relationship beyond repair, as the Sunday newspapers would indicate, or are they just making a mountain out of a molehill?

Mr King: I certainly do not see any relationship between the headlines in the newspapers and the reality. I have a good working relationship with Alistair Darling. That is almost as true now as it was before. We talk often to each other and there is no problem with that working relationship whatsoever.[182]

117.  Lord Myners also considered the relationship between the Treasury, Bank and FSA to be very good: "I have seen it at first hand since I became a minister last October in these three bodies coming together to take vital and necessary and confident action both in support of the system and to handle individual institutions which have been experiencing difficulties".[183]

118.  We were therefore surprised when in oral evidence on 24 June the Governor told us that, despite the good relationship he had with the Chancellor, he had not been consulted on the draft Government White Paper, which was to be published on 8 July. He had "no idea" what questions would be asked by the White Paper, nor when it was likely to be published. He believed that the Chancellor would show him the consultation paper prior to its publication, but added that "White Papers tend to get written somewhat faster these days than they used to!"[184]

119.  That the Treasury failed to consult with the Bank of England is a surprising development. In 2008, the Treasury, Bank of England and FSA not only consulted each other, but actually co-authored a trio of consultation papers on financial stability and depositor protection.[185] In advance of the publication of the Reforming financial markets consultation paper, the Governor speculated that the Tripartite Committee would not be bringing forward joint proposals, because it was "not a decision-making body".[186] But this was equally true of the 2008 consultation papers.

120.  Lord Myners told us that the White Paper represented the Treasury's proposals for reforming financial markets going forward and was a document which had "been informed by close engagement on a continuous basis with the Bank of England and the Treasury over several months".[187] He ascribed the Governor's comments to the fact that at the time of the Governor's appearance, the White Paper was "still in early stages of preparation".[188] Lord Myners sought to reassure us that there had been "very, very extensive consultation, engagement, discussion, review of possibilities, working with other agencies in the preparation of this document, so this is not the work of the Treasury alone working in isolation or in a vacuum, this represents considered opinions drawing on international bodies including the FSB, the IMF, et cetera".[189] This statement appears to be at variance with the Governor's comment that he had "no idea" what was in the White Paper.[190]

121.  We are extremely perturbed by the statement by the Governor of the Bank of England that he was kept in the dark over the contents of the Government's White Paper on Reforming financial markets to the extent that he had "no idea" what it would contain, or even when it would be published, only a fortnight before publication. The Chancellor must set out why consultation papers on financial reform are now no longer jointly published, or even shared, with his Tripartite colleagues. Failure to do so will only add further cause for concern to those worried about the state of the crucial relationships between the Tripartite principals.

165   Reforming financial markets, p 4 Back

166   Ibid., p 11 Back

167   Ibid., p 15 Back

168   Q 125 Back

169   Reforming financial markets, p 11 Back

170   Reforming financial markets, p 51 Back

171   Banking Act 2009, section 238(1) Back

172   Q 117 Back

173   Speech by Mervyn King, Governor of the Bank of England at the Lord Mayor's Banquet for Bankers and Merchants of the City of London at the Mansion House, 17 June 2009 Back

174   Qq 117-118, 121-123 Back

175   Reforming financial markets, p 11 Back

176   Ibid., p 12 Back

177   Ibid., p 89 Back

178   Q 144 Back

179   Memorandum of Understanding between HM Treasury, the Bank of England and the Financial Services Authority, March 2006 Back

180   Reforming financial markets, p 12 Back

181   Qq 209-215 Back

182   Q 112 Back

183   Q 184 Back

184   Qq 168-177 Back

185   Financial stability and depositor protection: strengthening the framework, Cm 7308, January 2008; Financial stability and depositor protection: further consultation, Cm 7436, July 2008; Financial stability and depositor protection: special resolution regime, Cm 7459, July 2008 Back

186   Q 167 Back

187   Q 184 Back

188   Q 185 Back

189   Q 187 Back

190   Q 175 Back

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