Examination of Witnesses (Questions 60-83)
MR MERVYN
KING, MR
CHARLIE BEAN,
MR SPENCER
DALE, MS
KATE BARKER
AND PROFESSOR
DAVID MILES
15 SEPTEMBER 2009
Q60 John Mann: Governor, how much
of a danger is this attitude that is building up (it has had quite
an airing recently) that "business as usual" is what
is required; let's carry on, not quite as before but let's just
carry on as now, as if nothing had ever happened? How big a danger
is it that that mindset is re-emerging with some key figures in
the City and in industry, talking as if nothing had ever happened?
Mr King: It is not very surprising
that financial institutions will argue for what they think is
their own self-interest. What matters is what we (and by that
I mean not just us on the official side but you, in Parliament)
do about it. We have a unique opportunity now which future generations
will, I think, criticise us for not taking if we do not put in
place a regulatory structure that tries to deal with some of the
lessons that we learnt from the crisis. Perhaps I am just getting
too old (where the question: "Are you socially useful?"
is not one that you should ask too often), but the real question
about the financial sector is: "Should we subsidise it?"
If you put it that way, why would you start by saying: "Let's
think of the bits of the financial sector that we want to support
and give some guarantee to?" I can see the case that some
aspects of banking are utility by their nature and that we want
ordinary people and families to be able to use their bank accounts
and make payments without having to worry about whether the institutions
in which their payments are moving around are actually susceptible
to suddenly disappear overnight. So giving deposit insurance and
guaranteeing the payment system makes a lot of sense, but nobody
in their right mind would ever say: "Let's find this range
of utility banking. Would it not be fun if the money put in it
could be used to finance all kinds of crazy, risky activities?"
Nobody in their right mind would suggest that we would use the
guarantee that we would give to the utility aspect of banking
to fund risky, proprietary trading. I do not think we need worry
about whether that proprietary trading is socially useful or not;
I think one of the great lessons of this crisis is that in the
last 12 months hardly anyone has got terribly excited about hedge
funds. Why? Well, hedge funds may or may not do things which are
socially useful—I do not think it is a question I need answer—but
the reason I do not need to answer it is because the taxpayer
is not guaranteeing them.
Q61 John Mann: Your question is:
"Should we subsidise it?" that is one important question.
There is a second one, for the consumer and the country, which
is: "Can we trust it? Can we trust the banks?" Is that
not part of your remit?
Mr King: It is not our remit,
at present, to be precise, but for the public sector as a whole
it is important, and that is why we have deposit insurance, to
enable people to trust the banks and other institutions in which
they work. In that sense, there is an implicit or an explicit
guarantee, in the form of deposit insurance, which is a subsidy
to that kind of activity, and a perfectly sensible subsidy to
give to them. What does not make sense is to allow that subsidy
to finance a range of very risky trading and position-taking activities
of an investment banking nature. That kind of activity should
not benefit from the implicit or explicit subsidy. They are able
to raise capital more cheaply in the market now by using the utility
part of banking with that guarantee and carrying it across to
the risky part. I cannot see any reason, in principle, why anyone
would think this was a sensible starting point, and I think it
is something that we need to deal with it; it is the "too
important to fail" issue. It is one of the two questions
I mentioned to the Chairman at the beginning and it is very important,
and we will be failing future generations if we do not tackle
it now. From that point of view, it cannot be back to business
as it was.
Chairman: Those issues that are "too
big to fail" we will be looking at, Governor, as you identified.
Q62 Jim Cousins: Mr Bean, how likely
is it that the pay cuts, restraints and freezes we are seeing
at the present time are simply postponing job losses rather than
avoiding them?
Mr Bean: I think one of the interesting
things about how this downturn has evolved is precisely that we
have seen pay restraint which has helped to limit the job losses
in the near-term. There is a box in the Inflation Report that
discusses this. Certainly if you looked at behaviour in past recessions
we might have expected to see rather more jobs lost than we have
witnessed so far. There are some rather encouraging signs that
actually the rate of job loss might be starting to ease off at
the current juncture. As to the question about whether it is just
postponing the evil day, a lot depends on what happens to activity.
If activity recovers reasonably smartly, then businesses which
have kept on the labour, by virtue of holding down their costs,
will then say: "Okay, we need the labour we have hung on
to." On the other hand, if the level of demand were to remain
depressed for a substantial period, then I think you might see
businesses which have held on to labour now thinking: "I
will just have to let some of these workers go" and you will
also see more firm closures. So it really all hinges on what happens
to activity.
Q63 Jim Cousins: Mr Dale, seeing
the connections between the real economy and banking, the report
presents evidence that major UK banks over the next five years
have to refinance long-term money of about £1,000 billion
in the private sector and up to £500 billion with the public
sector. How difficult is it going to be for banks to do that?
Mr Dale: I think significantly
difficult, and that is exactly the five-year challenge the Governor
was just referring to; the pressures on the banking system to
both raise more capital and to change their funding to a more
sustained position is a very significant challenge they are facing
and is one of the significant factors which is affecting their
willingness to supply credit to companies in the way they used
to, and is causing exactly the stresses that we highlight in the
report.
Q64 Jim Cousins: Some of the key
foreign bankers who were making a lot of credit available through
the banking system two or three years ago are now not in the British
market at all. How likely is it that they are going to come back?
Mr Dale: You are quite right,
and I think that is particularly the case in terms of lending
to companies rather than to households—lending to companies
where foreign banks are a very, very important component. What
we are seeing is a pretty much worldwide phenomena where international
banks are going home and are focusing their lending on their home
markets. I would imagine that process of focusing on the home
markets will continue for as long as the time it takes until they
can repair their balance sheets to a point where they are able
to carry on lending as normal. So I would expect that process
of focusing on their home markets to persist for several years
yet.
Q65 Jim Cousins: Governor, are you
learning Chinese?
Mr King: No, I am not learning
Chinese, but if I were a young man (which sadly I am not) then
I would.
Q66 Jim Cousins: Governor, that is
a very thoughtful reply. I would expect it of you. The fundamental
imbalances of the British and American economies have not changed.
The need to raise money in wholesale markets and the need to engineer
yields that look attractive in order to suck in that money still
remains as a fundamental feature of our economies. The Chinese
are showing signs of getting fed up with all of this and raising
money denominated in their own currency rather than in British
and American currencies. So are there not clear signs that the
game is up unless those fundamental imbalances—that reliance
on sucking in money from abroad—are addressed?
Mr King: I think I would put it
rather differently. You used the phrase "having to engineer
yields high enough to attract funds". Of course, the most
striking thing about the past five years or so was how low yields
were, and I think that is one of the pieces of evidence I would
adduce to suggest that this was at least as much a product of
very high savings in Asia as inadequate savings in the West. I
think what you are absolutely right to suggest is that so far,
in the process of a deep recession, it is true that many countries'
imbalances have reduced, so our current account deficit has fallen,
that of the US has fallen and the Chinese has fallen. However,
if we were to get back to the same levels of activity that we
had before the crisis started then I think it is far from obvious
that the imbalances would not reappear. The fundamental problems
in the international economy are still there. However you describe
those problems or imbalances, whether you think this is a question
of excess savings coming out of Asia or whether you think this
was inadequate savings in the Anglo-Saxon world—there are,
surely, elements of both—what matters is not so much the
cause of that but how we deal with these imbalances and what that
means. Actually, if emerging market economies were able to finance
a lot more borrowing or investment in their own currencies that
would be, I think, rather a welcome development. The difficulty
has been that for very many countries the money has gone into
US dollars. So one of the problems that China faces is that a
very large proportion of its national portfolio is invested in
US dollars at a point when they are reluctant to see a dramatic
change in the exchange rate against the US dollar, and the US
itself is determined to reduce its current account deficit, which
will come about through individuals and companies spending less
as they reduce their debt. So I do think that we have significant
problems that will re-emerge at the international level once we
get through the recession—it may take several years—but
the challenges that we face with the international imbalances,
which we have spoken about for many years at international meetings
and at this Committee—we have not dealt with the fundamental
problem of the generation of those imbalances.
Q67 Mr Love: Governor, could I come
back to an issue you touched upon in answer to a question from
Graham Brady? It relates to the timing of the withdrawal of the
stimulus. You have said on numerous occasions, both here today
and previously, that that will depend on the state of the economy.
I wanted to ask you: does the state of the economy now warrant
a start to the withdrawal of the stimulus?
Mr King: When you say "the
stimulus", you mean in terms of the monetary policy stimulus,
which is our responsibility, and I think you can judge from our
actions that we do not think that, because we have not reduced
the monetary policy stimulus. In terms of the fiscal policy stimulus,
that has to be a matter for government.
Q68 Mr Love: Let me ask you that
another way round: if you were to meet at the next Monetary Policy
Committee, the Government having taken the decision to withdraw
the stimulus, what impact would that have on the decision of the
Monetary Policy Committee as regards quantitative easing?
Mr King: Let me answer the question
another way round and tell you what I said before, really, which
is that every time we form a judgment about the right degree of
monetary stimulus we form a view about the outlook for inflation,
which depends upon the outlook for demand and supply in the economy,
and any fiscal policy announcement will affect the judgment and
feed into our decision. So we always take as given the latest
stated intentions for fiscal policy, and we do that until that
has been altered. So fiscal policy enters into our decisions through
its impact on the level of demand and spending, and it may affect
financial prices and yields in financial markets as well. All
that feeds into our decision but, in the end, as I said before,
it is our judgment as to what the outlook for inflation is that
will drive the monetary policy stance and, hence, decisions on
asset purchases and Bank Rate.
Q69 Mr Love: You said, in answer
to an earlier question (I think it was, again, from Mr Brady),
that you thought that the recovery may be slower and more protracted.
In the context of that answer, is it economically wise to be withdrawing
the stimulus at this particular time?
Mr King: We are not withdrawing
the monetary policy stimulus; you can tell that from our actions.
Indeed, I think the fact that we have taken these extraordinary
actions, in the literal sense, to cut Bank Rate virtually to zero,
to engage in substantial amounts of asset purchase, illustrates
how seriously we took the position we faced, and we will withdraw
the stimulus when we think it is appropriate to do so. We clearly
have not done that so far.
Q70 Mr Love: Let me cast forward
just a little bit. Lord Mandelson has already indicated that the
car scrappage scheme at £300 million will be capped at that
level. I think his quote was: "At the moment, we have no
plans for extending this". The VAT reduction will come to
an end—there seems to be some debate about whether it will
be on 31 December—at the turn of the year. In the context
of where the economy is going at the moment, do you think there
is a need to continue to monitor carefully whether or not the
economy is beginning to really turn round before any further measures
are taken in relation to the stimulus?
Mr King: I am sure that any set
of measures when they are introduced will reflect the state of
the economy at the time. That is the sensible thing to do, and
I cannot prejudge what that state will look like when the next
Budget comes. I would point out to you that one of the reasons
for thinking that a temporary cut in VAT will stimulate spending
is because it is temporary, so you would expect the biggest impact
of the temporary cut in VAT to come in the few months running
up to when it will be reversed. So you would expect the biggest
impact to come in the next few months. The question of what is
the right timing—that has to be a matter for government.
We can reflect, in our decisions on monetary policy, the decisions
taken by government.
Q71 Mr Love: Can I move you on to
the cost of financing government debt? I know that is not your
responsibility but it has to be something that you take note of.
There have been some concerns that the level of government debt
is at such a high level that that is going to cause real difficulties
in terms of the cost. You talked earlier on about a "clear
and credible" plan to reduce government debt and plenty of
time. Is this a concern to the Bank—the cost of debt—or
are you more sanguine going forward?
Mr King: The current cost is not
a concern, but I think everyone is concerned that we get back
to a position in which the public finances are clearly on a sound
footing. That has to be something that everyone now accepts is
the right thing to do. The timing of the actions needed to ensure
that will have to reflect the state of the economy, but to have
a clear plan to get back to that sound footing is very important.
A failure to do so might create risks in terms of the cost of
funding, but we have not seen that yet. I think the current level
of rates does not give rise to any particular concern.
Q72 Mr Love: You mentioned earlier
on, in talking about a "clear and credible" plan that
there was (and I quote your words, I think): "plenty of time".
You have said there is not any problem now, but are we talking
in terms of months or years?
Mr King: It is not years. It is
difficult to have a credible plan when you keep saying: "We
will tell you what the plan is three or four years down the road".
That does not mean to say it has to be there tomorrow but, of
course, the plan, to be credible, has to have some substance to
it. It is not for the Bank to comment on that; it has to be a
decision for you, for the political decision-makers to decide.
I think it is reasonable there is a debate, and I think what is
pleasing is that there is now, apparently, a clear debate about
what is the right way to bring the public finances on to a sound
footing.
Q73 Mr Love: Can I ask you, finally:
when you were before the Committee before and they talked about
the possibility of a set in fiscal stimulus, you indicated that
you would prefer alternative measures, including what has happened
with the Monetary Policy Committee in terms of quantitative easing.
Do you think the balance of fiscal stimulus and (if I can put
it that way) monetary policy—have we got an optimal balance
between those two measures and the economy, or would you prefer
them to move in one direction or another?
Mr King: No, I think it works
pretty well. I think the Treasury knows how our thinking has evolved
(they have a representative at our meetings) and they can judge
how our thinking is moving, and they know that whatever actions
are taken on the fiscal front we will take into account, through
its likely impact on the inflation outlook, in setting monetary
policy. So I think all that works very well.
Q74 Chairman: Governor, can I ask
you just a bit about the quantitative easing? When you were before
the Committee—I think it was last November—you said
that bank lending was the biggest issue facing the economy. Have
things got better or more grave (I am thinking in relation to
the discussion you had with Mark), and are banks holding on to
their capital? You mentioned Sweden where they have imposed negative
interest rates. Is there something we need to do here, in this
lending area?
Mr King: A lot of water has passed
under the bridge since then, and it may be rather late now to
think of measures to improve the lending from the banking sector.
I think it is pretty inevitable now that the banks that have gone
their own way will gradually, over time, want to build up their
capital buffers; they will be cautious about the lending. We are
starting to see more discrimination among banks in the minds of
the market than was evident at the end of last year. We still
have two of the biggest banks owned, effectively, by the Government.
That will be the area where one would look to for action, I think,
if you were looking to try and do something more on the lending
front. Otherwise, I fear we are in a world where we have to be
patient now and hope that the balance sheets of banks improve
and get back to a point where they will be naturally more willing
to lend. However, there is an awfully long way to go there because,
as I said, we have still got more losses to be announced because
the recession has been deep, and we have got this very significant—what
I hope will be significant—increase in capital and liquidity
requirements coming not immediately but over, say, five years
or so, to ensure that we have a more robust and resilient banking
sector.
Q75 Chairman: David Miles, when he
was before the Committee before his appointment here, mentioned
that the banks were on "life support", but it still
seems that this is the case.
Mr King: Yes, our major banks
are still very heavily dependent on large amounts of support from
the public sector, in different forms.
Q76 Chairman: In your opening statement
you mentioned the long, hard road to restructuring the financial
sector. Do we need a debate on that issue? Should that debate
concentrate on the issue of "too big to fail" and the
matter of potential tools? Are those relevant? Is there anything
else we should be considering?
Mr King: In my judgment, those
are the two big questions—the "too important to fail",
it is not about size but it is about allowing people to use an
implicit or explicit guarantee to obtain capital from elsewhere
cheaply in order to finance excessive risk taking. In a sense,
that is also the answer to the compensation issue, too, because
the question is: if banks have got money they want to pay to people
they will find a way to do it. The question is why do banks think
they can afford to do it? Answer: because they have an implicit
guarantee which enables them to obtain cheap funding—or
in the past they have obtained cheap funding—in order to
undertake very risky activities, where the upside stayed entirely
with the bank and the downside, if it became extreme, would stay
with the taxpayer. We have got to a point where I think we need
a range of issues to deal with that "too important to fail"
question. I think it is not enough to look at any one measure;
I think, myself, it will be a triangle of three measures that
will be needed. One is higher capital and liquidity requirements.
The second, as I mentioned in my Mansion House speech, is making
systemically large banks or important banks have "wills"
which make it feasible to run them down and break them up, if
necessary, if they do fail, so that it is credible that, if something
happens to that bank and not to the system as a whole, it can
be wound down. The sheer complexity of Lehman Brothers shows when
you have a situation when the person in charge of the administration
says: "We hope to break the back of the work in three years
and it will take at least a decade", you recognise that there
is something wrong with the winding-down process; you have got
to have something which is simpler to wind down, or essentially
we are going to be underwriting it. You cannot have institutions
in the private sector which, essentially, cannot fail. That is
not the definition of what the private sector is. So I think the
wills are very important, and I stressed that in the Mansion House
speech. The third (and I think it is very important), is that
we do need to return to this question of why on earth have we
allowed to expand a financial sector which set itself up in such
a way where the implicit and explicit guarantees are used to fund
activities for which it was never the intention of insurance or
these guarantees to support? That is worth looking at and I commend
to you John Kay's piece on regulation, which came out either yesterday
or today.
Q77 Chairman: Today.
Mr King: It was probably the most
important piece written on the subject in 10 years, and I think
this is a debate we have to have. People did debate the structure
of banking after the Great Depression and we ought to be debating
the structure of banking now. I do not want to come up with a
simple blueprint, but surely we need a debate now, and the idea
of pretending that we can just go back to where we were when we
have dealt with the crisis overlooks the enormous severity of
this crisis and the fact that the cost of the crisis fell, largely,
on the non-financial sector—unemployment and businesses
going out of business—which had absolutely nothing to do
with the causes or problems that led to this crisis.
Q78 Chairman: With modern IT systems
do the economics favour small banks now? If they do, what can
the Government do to increase competition in this area?
Mr King: I think this is part
of the debate. We certainly want a less concentrated banking sector
and with more competition. I think that, as John Kay points out,
if you can actually separate the institutions that receive this
guarantee from the utility element of banking then, actually,
you might find organically that you would find more competition
in the provision of good banking services to retail customers
and business customers. We do need, I think, to look at how we
can lower the length of time it takes to create a new bank. The
United States has managed to create a world in which there are,
clearly, more bank failures but, also, more new banks are being
set up. They have a resolution mechanism for dealing with bank
failures, so that those banks can fail without it causing a problem,
and they get new banks, often community banks, being created.
A little more of that would, I think, be helpful in our banking
structure too.
Q79 Chairman: I suppose implicitly
what you are saying is: how do we prevent the payment system from
being infected by excessive risk that takes place in investment
banks?
Mr King: Absolutely, and if you
allow them to be carried out within the same institution you have
to guarantee that institution, because you are concerned about
the payment system, and you end up subsidising excessive risk
taking. It does not matter whether it is socially useful or useless,
you should not subsidise something where the risks go entirely
in one direction to the private owners and employees of the firm
and the losses go to the taxpayer. That is asking for trouble
and is not something that we should encourage, and we should learn
from recent experience and try and find ways to get back to a
system where we do not extend the guarantees to that kind of activity.
If we do the only answer, in the end, is that those institutions
should not be in the private sector.
Q80 Chairman: In terms of cross-border
institutions or relations, have we made sufficient progress on
that whereby governments can protect themselves from the failure
of overseas banks, or is there still a lot to do in that area?
Mr King: There is a massive amount
to do in that area. I think one of the difficulties of relying
just on a resolution mechanism is that we have not found a resolution
mechanism yet to which all the regulatory authorities have signed
up. It is complex but this is one of the real benefits of having
a will, where you can take a complex international bank and have
an agreement among the regulators in the main countries where
it operates that it will be broken up and each regulator could
take control of one part of it so it could be credible that it
will be allowed to fail. However, more generally, I think the
whole question of allowing banks to branch into other countries
as opposed to setting up subsidiaries has raised, in this country
and in other countries, serious problems, and it makes a lot more
sense to think that an authority can credibly regulate a bank
in its own territory if it is based on a subsidiary which is separately
capitalised with its own liquidity pool. Short of that, you are
relying on what happens to overseas regulators, and, as many of
the smaller countries of the world have pointed out to us over
the years, a bank that may not be systemic to the home country
may turn out to be important to the host country, and the host
country government will really care about what happens to a bank,
even if the other country does not. I think this is a major question;
we have identified the problem, it has been discussed, but there
are no practical solutions on the table yet. That is, clearly,
another area where progress needs to be made.
Q81 Mr Breed: Just a brief one, Governor.
About 20-odd years ago we used to have the concept of licensed
deposit-taking institutions which were monitored and authorised
by the Bank. They were abolished, and that was the beginning,
I think, of the concentration as such that they had to become
banks or they ceased to be deposit takers. Is there a case for
re-thinking, perhaps, a new, more modern licensed deposit-taking
institution which is not actually a bank but provides some real
competition for deposits and loans at the smaller end?
Mr King: There is certainly a
case for thinking through what the ideal structure of banking
would look like and the way in which governments should interact
with that banking—the kind of guarantees and regulation
that is required. I am reluctant to use any description from the
past because, inevitably, that reflects particular circumstances,
but I think we do need a debate about how we should regulate the
structure of banking. I think one of the most important points
that John Kay makes in his article is that it is very easy to
fall in the trap of thinking that banking is somehow obviously
very different from everything else. Banks have done a great deal
to inculcate that view. It is not obviously true and there are
systemic problems arising in other industries that we regulate,
like electricity supply, which are just as important as those
in banking. We have solved them in other areas; we need to find
ways of solving it in banking. I think we can do it, but it requires
a debate that is prepared to go back to first principles and ask
the kind of questions which certainly many banks would prefer
that we did not ask. We cannot let those questions not be asked;
they have to be asked after a crisis of this severity.
Q82 Chairman: That is a powerful
message for us in terms of what the shape of the financial sector
should be, and we have time to debate that.
Mr King: Yes, indeed.
Q83 Chairman: On the issues of "too
big to fail" and the potential tools, the Committee will
certainly keep an eye, Governor. Can I thank you and your colleagues
for giving us such a lucid explanation this morning and helping
us in terms of our agenda?
Mr King: Thank you very much,
Chairman. Thank you.
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