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".
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".
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.
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.
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".
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
The Bank of Englandresponsibility
108. The Banking Act 2009 formalised the Bank
of England's existing responsibility for financial stability in
An objective of the Bank shall be to contribute to
protecting and enhancing the stability of the financial systems
of the United Kingdom.
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.
At his earlier Mansion House speech, he noted the limitation of
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 flockthe 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.
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 positionif you want us just to publish
reports, I am very content with itbut 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
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".
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;
- 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.
The principal mechanism for this would be through the new Council
for Financial Stability.
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.
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
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".
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.
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 dothe 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:
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
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".
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
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.
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".
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".
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".
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".
This statement appears to be at variance with the Governor's comment
that he had "no idea" what was in the White Paper.
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
Ibid., p 11 Back
Ibid., p 15 Back
Q 125 Back
Reforming financial markets, p 11 Back
Reforming financial markets, p 51 Back
Banking Act 2009, section 238(1) Back
Q 117 Back
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
Qq 117-118, 121-123 Back
Reforming financial markets, p 11 Back
Ibid., p 12 Back
Ibid., p 89 Back
Q 144 Back
Memorandum of Understanding between HM Treasury, the Bank of
England and the Financial Services Authority, March 2006 Back
Reforming financial markets, p 12 Back
Qq 209-215 Back
Q 112 Back
Q 184 Back
Qq 168-177 Back
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
Q 167 Back
Q 184 Back
Q 185 Back
Q 187 Back
Q 175 Back