Examination of Witnesses (Question Numbers
1-83)
Mervyn King, Paul Tucker, Andrew and Andrew Haldane
1 March 2011
Q1 Chair: If you
are ready perhaps we will get started. Thank you very much for
coming and thank you for agreeing to this split session so that
we can cover these two very important issues that are on your
plate at the moment; one the complete re-regulation of the financial
services industry and the other, of course, the inflation issue,
which we will come on to later on this morning. On regulation,
will you tell us whether you think that the arrangements that
need to be put in place in order to secure better prudential supervision
can be achieved by amending the Financial Services and Markets
Act or do you think the Government need to take a new approach?
Are you confident that new approach is being taken?
Mervyn King: I
think this is something on which you are more expert than us—the
precise legislative process. I think it can be achieved. There
are still issues to be debated and resolved in the new framework
and it will take time to do that, and that is why I think it is
still 18 months or two years before the new framework will come
into effect. It can be done through amending FSMA. I think our
preference would have been for a new Bill and Act, because I think
it is easier to understand what is going on with the drafting
of a new Bill, but I mean, to be honest, I think it has to be
in your hands to suggest, because you are the people who have
to go through the process.
Q2 Chair: I am asking
you for a view. Are we going to get anywhere?
Mervyn King: I
think we will get the right approach through the course on which
we are proceeding. I think we feel it would have been easier had
it been done through a new Act, but we are where we are, and I
don't think there is much point going back.
Q3 Chair: Just to
be clear, you say, "We are where we are," so we are
not getting new legislation; we are getting amendments to existing
legislation?
Mervyn King: As
far as I understand, we are going to get amendments to FSMA as
the vehicle by which the new regime will be introduced.
Q4 Chair: You think
that is the second best option, don't you?
Mervyn King: Yes,
I think it would have been better had we had a new Act but, as
I say, we are not experts on that and it is those involved in
Parliament directly who are better placed to make that judgment
than we are.
Q5 Chair: Just on
the question of timing, you just said 18 months to two years.
Two years isn't an option, is it? The Government have said that
they want to bring the shutters down on this and have everything
in place by the end of next year, which is now less than two years
away.
Mervyn King: The
difference between 1 January 2013 and 1 March 2013 is only two
months, so 18 months to two years is the period that we are planning
to achieve. I think there are good arguments for trying to make
this sooner rather than later in terms of the management of the
process. The Government have announced a major change in the way
regulation will be conducted, and in order to give us a chance
to change the culture and style of regulation and to prevent the
resources in the FSA drifting away, from a management point of
view there are some advantages in doing this quickly. One has
to balance that against the advantages of taking time to get the
legislation right.
Q6 Chair: I am asking
you for your view on that balance. Thank you for setting out the
question, but I would like the answer.
Mervyn King: Again,
I think those with greater experience of parliamentary legislation
should give that answer. I think if we can reach the big decisions
by around the summer and have a very clear framework, then I hope
Parliament could debate this legislation and introduce it over
the course of the following 12 months, so it could be passed by
the end of the parliamentary Session 2011-12, and then it will
come into effect towards the end of 2012. I think that is a reasonable
timetable, but I have no experience of the length of time it takes
to take legislation through Parliament, whereas you do.
Q7 Chair: You are
giving us very political replies. What I am after is something
that means we can understand where you are on all this without
having to read between the lines of the transcript afterwards.
Are you saying that at the moment we have a process in place,
which you are confident is going to deliver us what we need, even
though we don't have a new Bill, and that we are going to try
and do this by amendment?
Mervyn King: We
are only part of the way through the process, so I can't be 100%
confident at the end of it that we will produce something that
we think is satisfactory. But so far, I think, the right decisions
have been made, and we are part way through that process, which
will culminate in legislation coming before Parliament.
Q8 Chair: If it turns
out over the coming months that there are still a lot of big issues
to resolve, do you think it is reasonable to say that we should
take a look again at the 2012 deadline and let there be a bit
of slippage to get this right?
Mervyn King: Well,
it is certainly important to get it right, which matters more
than anything else. If it turns out to be the case that taking
longer is the only way to get it right, then, of course, that
would be the case.
Q9 Chair: And you
are going to speak up?
Mervyn King: It
is not the case, so far. I think we have to wait and see, but
clearly the important thing is to get the big questions right.
Q10 Chair: Let us
turn to the big questions. Is there something fundamentally defective
about the way the FSA has been doing this work?
Mervyn King: I
think we have all learned from experience. In 1997, I was in favour
of the change to transfer supervision to the FSA, and I have changed
my view about the benefits of trying to put in one organisation
consumer protection and market conduct on the one hand, and prudential
supervision on the other. I think with the best will in the world
it is very hard for any organisation to have those two very different
types and styles of regulation in one organisation. I am in favour
of splitting them—the so-called twin peaks approach. There
are many ways you can implement that. The way we are doing it
in this country is to create a new agency, which is going to be
called the FCA, Financial Conduct Authority, and the PRA, which
will be a subsidiary of the Bank. I think that is a perfectly
sensible way to go. You could have a separate prudential supervisory
authority, which doesn't have to be in the Bank.
Q11 Chair: I am concentrating
on the FSA's role on the prudential side here in my question.
Maybe I will pose it in a slightly different way. Do you think
it is possible to do that part of regulation more effectively
simply and cheaply than the FSA has hitherto?
Mervyn King: Yes,
I do, and I think that is because having put the two types of
regulation in the same body the mistake that was made with prudential
supervision was to regard that as similar in style to conduct
of business. There was a large amount of detailed investigation
of relatively small things that weren't going to have a lot of
impact on the overall riskiness of the Bank's balance sheet. There
was a failure to look at the big risks that were being taken,
and I think that what we aim to do in the PRA is to focus on the
big questions, to have more senior people in the supervisory body
interacting regularly with the large institutions to challenge
the structure and nature of their balance sheets, to avoid getting
bogged down in excessive detail, and to reduce some of the costs
of regulation that resulted from a combination of an excessive
focus on detail and, in particular, the cost of the IT systems
that were there to support that.
I think we have a vision, which is being worked
out now, in our transition planning that will lead us to assist
and that in the longer run will reduce costs. We hope that that
will focus on what turned out to be the important questions when
it came to the concerns that led to the financial crisis.
Q12 Chair: That is
a radically different approach, isn't it?
Mervyn King: It
is a radically different approach, and that is what we have been
asked to do, I think.
Q13 Chair: Are you
meeting resistance from the FSA on delivering this?
Mervyn King: No,
we have discussed this very openly with Hector Sants. He has bought
into this vision and that is what we intend to deliver.
Q14 Mark Garnier:
Governor, a number of us were in New York and Washington a couple
of weeks ago meeting with people and talking about the Dodd-Frank
Act. As you know it is ferociously complex, but one or two commentators
were saying that the Dodd-Frank Act is probably the Act they wish
they had written in 2003 rather than one that is necessarily dealing
with the issues that are facing financial regulation in the States
from now on. What is your opinion on what we are doing now? Do
you think that these proposals deal with financial regulation
for the future or do you think that we are addressing what we
wish we had done in 2003?
Mervyn King: Inevitably
there is a need to look at what went wrong and correct that. I
don't think that necessarily means that you either are pretending
that the next crisis will be similar to the one we have been through,
or that the regulatory system should be focused entirely on the
problems that we faced in the run-up to 2007-8, but I think that
one of the lessons is that the kind of regulation that is needed
to avoid a BCCI-type problem, which is to do with fraud, poor
conduct and the need to have an intrusive regulator looking at
conduct issues and the enforcement side of regulation, naturally
goes with what will be the FCA.
Prudential supervision is rather different.
This is about saying that most banks are all taking the same kind
of risk, that leverage ratios have reached a point when we ought
to be deeply concerned about the fragility of the system, and
that is something that I hope the new arrangement of a combination
of the PRA focusing on the big questions for individual banks
and the new FPC focusing on system-wide developments will be able
to give us a better chance of dealing with these problems than
happened last time.
Q15 Mark Garnier:
One of the things that crossed my mind on the many occasions during
the course of this investigation into financial regulation is
what the rule book is going to look like. I acted as a compliance
officer under the old Securities and Futures Authority, I acted
as a compliance officer under the Financial Services Authority,
but under the new system what will the rule book look like? How
is it going to be different from the one we have got at the moment?
Mervyn King: To
be perfectly honest, I am not sure whether good supervision, as
opposed to regulation of conduct and enforcement, is ever going
to depend upon the detailed rules. It is going to depend on judgements
exercised by supervisors, about the risks that are being taken
on the balance sheets, particularly at the major institutions—
Q16 Mark Garnier:
Supervision is the key, isn't it? Because if we don't have enough
supervisors then you can have as many rules or guidance, or whatever,
but you need to have sufficient supervision.
Mervyn King: You
need to have the right kind of supervisors. I don't think it is
a question of numbers. I think it is a big mistake to think that
the right response to this crisis is to say, "Oh, we should
have had twice as many regulators or twice as many rules or twice
as many requirements to submit data to the supervisors, just make
the thing more bureaucratic". That isn't the answer. The
answer is to have the right kind of people supervising, and that
is one of the things that we are looking at in the Bank and that
Paul, Andrew and I have discussed, which is the need to build
up a cadre of people who are willing, able and sufficiently self-confident
and experienced to exercise that judgment, to confront banks and
say, "Well, come on, don't put us off with detail here, let's
just focus on the big risks that you are taking," and have
that conversation.
To be honest, many of the bank chief executives
that I have talked to about this are themselves worried that in
the past when they have had meetings with the FSA they have met
levels of staff who are, to be honest, too junior to engage in
that kind of conversation and don't challenge the senior management
in a way that they feel they ought to be challenged to defend
what they are doing. I think that is one of the important changes
of style that we would like to bring about.
Q17 Mark Garnier:
Can I just ask one last question? We have a twin peak model, which
sometimes looks like the Alps, depending on which way you are
looking at it, but we have got the FPC, which you are the chairman
of, the MPC, which you are the chairman of, the PRA, which you
are the chairman of, but you are not chairman of the FCA. If there
is another financial crisis who do we pick the telephone up to?
Who takes control of sorting out the mess?
Mervyn King: If
it is a mess in the financial sector to do with risk and balance
sheets, and financial issues, it is very clearly those bodies
in the Bank of England that will be responsible for it and will
be accountable to you.
Q18 Mark Garnier:
If it is not?
Mervyn King: If
it is to do with an issue of conduct or mis-selling or an issue
of that kind then it is clearly the FCA.
Q19 Mark Garnier:
I have to say this bothers me quite deeply, because at the beginning
of a financial crisis, when the wheels start falling off the wagon,
you don't necessarily know what has gone wrong, and if there will
be one person saying, "Well, my department is prudential
regulation and balance sheets," and the other saying, "Mine
is conduct of business," how will we know where the problem
started?
Mervyn King: I
think it was always pretty clear what the nature of the problem
was.
Q20 Mark Garnier:
But you don't know in the future—
Mervyn King: When
Equitable Life occurred—when there was mis-selling of pensions—everyone
knew that it was a consumer protection issue. When Northern Rock
got into trouble, it was not a question of consumer protection;
it was a question about the balance sheet and the funding of the
Bank. That clearly was to do with what will in future be the responsibilities
of the PRA, which will raise issues to the FPC.
Q21 Mark Garnier:
Governor, a nervous population were potentially 48 hours away
from not being able to get their cash out. They have got to be
absolutely confident that somebody will be standing at the helm
of the next financial crisis being in control of the whole thing,
irrespective of—
Mervyn King: No,
if it is a financial crisis of that kind, it is the Bank of England,
without any doubt. One of the things that will help us in future
was not available at the time of Northern Rock. It was the single
most important impediment to dealing with that problem, and it
was the lack of a statutory resolution regime for the banks. We
were the only G7 country that did not have such a resolution regime.
When I came before this Committee days after
the failure of Northern Rock I made that point very clearly and
your Committee—different members largely, but not all—took
the initiative on that, produced a report, which led to legislation,
and we now, in the UK, have what I think is probably the best
resolution regime in the world, because we were able to put it
in fairly recently. We need to think about whether it should be
extended to other types of institutions and licensed deposit takers,
but we now have a statutory resolution regime. That would have
enabled us to deal with the Northern Rock problem over a weekend—the
situation couldn't be dealt with over a weekend, because of the
absence of that regime. These are the things that matter. We have
put some of them in place, and we think the new regime that we
are debating now will take us up to two years to put in place,
but we must get it right first. That is the next set of steps
that we will need to take. The Independent Banking Commission
will report later this year. There are many things that we need
to do to ensure that this crisis does not occur again, and it
is very, very important that we do that. But we have got lots
of building blocks, and the ones that we are discussing this morning
are part of it.
Q22 Jesse Norman:
Governor, I was surprised by your somewhat modest response, if
I may say so, to the question of new arrangements; and the focus
on process that you described in reaction to the Chair's first
question. If there is going to be new regulation, and amendments
to FSMA, will you spell out where you expect most material differences
to be?
Mervyn King: Yes.
I don't see it as a question of process. Indeed, I think many
of the problems that we have faced in recent years have involved
an excessive focus on process and putting in place procedures
that people have to go through. We want to ensure that the individuals
making judgments about what needs to be done to the major financial
institutions in this country to make them sufficiently safe, are
made by experienced people, such as Andrew Bailey here, who has
played a major role since the crisis occurred, and a team of people
that we are going to build up to make those—
Q23 Jesse Norman:
What I mean is what substance is going to go into the new legislation?
Introducing Andrew into legislation would be doubtless excellent
for this country's regulation, but I don't think it is appropriate—
Mervyn King: Let
me give you one specific example that I think will make an enormous
difference. At present, before any individual regulatory Act can
be made or changed, there has to be a detailed cost-benefit study
and often consultation with the industry. Now that makes no sense
for a regulator to have to go through all those steps. We should
be accountable to you, and if people think the way we are conducting
regulation is inappropriate, then we should be held accountable
by you for not regulating the industry in an appropriate way.
But we shouldn't be accountable to the industry itself. That is
one of the things that have gone wrong in the past. Our job is
to make prudential judgments about the risks on the balance sheet.
The point of regulation is simply—this
is a very obvious point—that we don't think the banks on
their own will necessarily make the right decisions in aggregate
for how risky their balance sheets are. Our job is to make sure
that there are limits on how much risk is being taken, which is
one of the major functions.
Q24 Jesse Norman:
Can I just clarify something on that for a second, and then obviously
bring in Mr Tucker? The thought is essentially this: the PRA will
be devoid of industry contamination, which has been taking place
within the FSA at the moment?
Mervyn King: In
part.
Q25 Jesse Norman:
In part. Okay, that is helpful. Did you want to add something,
Mr Tucker?
Paul Tucker: I
just wanted to add another important example of change to the
legislation. The objective of the PRA will be different from the
objective of the FSA, in particular, in respect of bank supervision.
This is on page 46 of the Government's consultative document.
It frames the objective of the PRA in terms of supervising firms
to ensure stability and that if and when they fail, the failure
is orderly. That will move us away from a world in which the job
of the supervisor is to crush the probability of failure, come
what may. Firms will fail from time to time—maybe even the
biggest firms will fail—and the job of the PRA is to ensure
that that should happen in an orderly way. This is an absolutely
profound change that Parliament will need to debate, but if Parliament
agrees that, it will be something that only you in Parliament
can do, and it will change the face of banking supervision for
the next quarter of a century, frankly, compared with the previous
quarter of a century.
Mervyn King: This
is of fundamental importance. The objective of supervision is
to recognise that banks will fail. Our role is not to stop them
failing. Our job is to make sure that if they fail because of
poor management, then they do not contaminate the rest of the
financial or economic sector, but they are still allowed to fail.
Q26 Jesse Norman:
In other words, the FSA, as it is currently constituted, has essentially
been reinforcing a culture of "too big to fail" by not
allowing an orderly failure regime to take place?
Mervyn King: The
FSA wasn't easily able to allow orderly failure in the absence
of a resolution regime, and it was pushed to the point of a no-failure
regime. One of the most important functions of this Committee
is to try to educate Parliament and the public about the need
to have a regime, which is not seen as a no-failure regime but
a regime that does countenance failure, where the regulatory set-up
is there to ensure that if an individual institution fails, it
does not cause havoc with the rest of the financial system or
the economy as a whole.
Q27 Jesse Norman:
Right, but does that not point to a need for new legislation?
How can FSMA possibly discharge the radical change in regulatory
thrust that you are contemplating?
Mervyn King: It
clearly requires new legislation, and there will be new legislation.
It is just the form of it, as we understand it, will be to amend
FSMA, which will include changing the objectives of the PRA and
setting up the PRA. It is up to you to decide the form of that
change in legislation, but it is not in doubt that there will
be new legislation.
Q28 Jesse Norman:
But I can't imagine the Bank not wanting to make some kind of
recommendation itself formally to the Government as to what form
the new regulation it is expected to discharge will take. I mean
Montagu Norman would not have felt this degree of punctilio, I
think.
Mervyn King: No,
it's not that at all. You often say to us that we are straying
into politics, well, this is legislation. You are the experts
on this. What we are saying is that there has to be new legislation,
that there has to be a new body and new objective and that that
needs to be put into statute. Now the form in which that is done,
whether that is an amendment to existing legislation or a new
Bill and therefore Act, is not our area of expertise; it is yours.
Q29 Jesse Norman:
Your criticisms of the FSA, by implication, paint it as a mildly
dysfunctional organisation targeted on the wrong goals. Are you
concerned that the current pace of financial regulation is too
fast at the moment, given, for example, that the Banking Commission
has not yet reported and therefore we don't even know what, as
it were, the units of account to be regulated are going to be?
Mervyn King: No,
I think in some ways you can argue the opposite, that since we
feel the need to see a new system put in place, with new objectives
and a new culture and style, there is much merit in doing that
as soon as possible. But against that, of course, is the fact
that, as you point out, that can't be done without legislation
and it is very important to take the time to get the legislation
right. These two things point in opposite directions and trying
to get the right balance is not easy.
Chair: Before I bring
in Andy Love, Chuka Umunna wants to come in on this point about
"too big to fail".
Q30 Mr Umunna: Can
I just follow up on what you were saying? You said our role is
not to stop them failing. Are you concerned, Governor, that last
year Hector Sants seemed to be suggesting that the PRA should
have a low tolerance for the failure of high impact firms?
Mervyn King: I
don't think that is where we are now, and I think it is very clearly
understood that the purpose of the legislation and the approach—I
think the consultative document makes this pretty clear—is
that our objective in regulation, as Paul has said, is not to
put in place a no-failure regime; our objective is to put in place
a regime in which, if there is failure, then our job is to make
sure that it doesn't contaminate the rest of the financial sector
and the economy as a whole. That is our purpose. It isn't to protect
management from its own failings.
Q31 Mr Umunna: So
he was wrong when he said that.
Mervyn King: I
can't remember the words that he said, and I don't like to say
things to people when words are quoted possibly out of context.
What I do know is that Hector is completely in line with the document
and the position that we have taken here.
Paul Tucker: And
there is an international debate on how to improve resolution
regimes in order to handle the largest, complex global firms.
There is a G20 debate, a European debate and a national one. The
technology still needs to improve on that front.
Q32 Mr Umunna: How
do you see the PRA's approach significantly differing from that
of the FSA to date?
Mervyn King: In
terms of—
Mr Umunna: In terms of
this issue of failure and whether to allow—
Mervyn King: I
think as we have said, since the objective will clearly be different
if you pass the legislation, because the objective has to be framed
in legislation, then it will be possible to behave in a different
way and to adopt a different style of regulation, as I have explained,
in which we are focusing on the big risks that institutions are
taking and spending less time worrying about some of the details.
Paul Tucker: It
means in respect of each firm supervisors have to think with a
resolution team in the Bank, "What will happen if this firm
fails? Is this firm organised in a way that will permit failure?
Is the statutory regime there that will enable smooth failure?"
A crucial element of this—this applies not just to the biggest
and most complex firms but to small ones—is rapid payout
under the deposit insurance scheme? If one of your constituents
has got their current account with a small bank or building society,
but it took three months or six months to get a payout from the
deposit insurance scheme, then your constituents would be in a
terrible situation. It is incredibly important that the insurance
scheme should be able to pay out, we think, within a week. That
debate is carrying on in Europe.
My point is that when the objective changes
the supervisors have to come into work and think about those things,
the end game, as well as thinking about, "Does this firm
look healthy today?"
Q33 Mr Umunna: Can
I just ask, linked to that, about something that came out of our
trip to the US, the importance of liquidity management? There
has been a lot of talk about capital reserves, but not quite as
much talk about liquidity requirements. I am presuming the PRA
is going to have a quite big role in this. Do you agree that when
Basel in 2008 was looking at the issues that needed to be addressed
to prevent a crisis from reoccurring, you see liquidity as being
a pretty critical issue too?
Paul Tucker: Yes,
absolutely. I mean this is one of the great gaps in the international
apparatus over the past 25 years. Historically there was an attempt
to fill it in the mid-1980s that failed. There is now a proto
Basel accord on liquidity, and that will be refined and put into
place over the next three to four years.
Q34 Mr Umunna: Do
you think the FSA's current requirements, which in some senses
go further than Basel because you have to have a liquidity buffer
sufficient to maintain three months' stress as opposed to 30 days—which
Basel requires—are appropriate? Do you think they go too
far? Do you think it is a problem that there is a disjunct between
what Basel is requiring and what the FSA is requiring?
Paul Tucker: The
details of the new Basel accord in this area aren't pinned down
yet. As they become pinned down then the FSA will need to think
about how it wants to converge its regime into the Basel regime,
but it's quite hard for them to do that when the Basel regime
hasn't got all the i's dotted and t's crossed.
Q35 Mr Umunna: No
doubt you are aware that many of the banks are quite concerned
that the requirements, which are being imposed by the FSA in this
respect, seem to be tougher than Basel III. Do you think they
protest too much?
Paul Tucker: Well,
I think they raise a legitimate point in general. I think it's
quite hard to evaluate who has the better side of the argument
when, as I say, the details of Basel are not finalised.
Q36 Mr Umunna: Finally,
do you think the emphasis on how a bank can be wound down is likely
to lead to quite large restructurings of our banks going forward
as the rules change?
Paul Tucker: I
think it could over time, yes. I think that's possible.
Q37 Chair: Governor,
can I just take you back to what Hector Sants said. It is very
important here that, if we have a radically different approach,
it is clearly understood and accepted, and it does seem that you
are coming forward now with a radically different approach, which
is more targeted and less costly.
Mervyn King: That
is what we want to do, yes.
Q38 Chair: What he
said was, and I am quoting, "For high impact firms, even
with resolution tools—"
Mervyn King: Sorry,
who is this quote from?
Q39 Chair: Hector
Sants. I just want to be clear whether this is no longer policy
and that, at least once you are running the show, this is not
going to be how things will be run, "For high impact firms,
even with resolution tools, the PRA will have a low tolerance
of failure".
Mervyn King: We
will not set out to have a specific tolerance of failure. We will
set out to ensure that we can resolve firms in such a way that
if they were to fail because of bad management, rather than being
protected by the taxpayer, they will be allowed to fail and we
will try to minimise the damage that might be caused by that failure
on the rest of the financial sector and, most importantly, on
the economy as a whole.
Q40 Chair: So we
can shred that part of the speech.
Mervyn King: I'm
not shredding anyone's speech. I've just stated our approach.
Q41 Chair: That is
what it looks like to me. What we now need to know is who is running
the policy in the interim?
Mervyn King: It
is very clear that FSA has a statutory and legal responsibility,
including to you, for supervising banks until the new legislation
takes effect.
Q42 Chair: Does that
policy hold until we get the new legislation?
Mervyn King: That
is a question you have to ask them. We are not doing supervision,
and we will not do so until the new legislation takes effect.
Q43 Chair: Do you
think there might be a merit in having a memorandum of understanding
to sort out who is running the policy in the interim?
Mervyn King: I
think the difficulty with that—I have some sympathy, as
I said before, from the management point of view, if you are thinking
this as the Government announce a big change in policy, which
Parliament endorses, then the sooner you get on with it, the better.
From that point of view the faster we make the switch the better.
The difficulty is, of course, getting the legislation right to
support that.
I am not sure that an MOU in and of itself could
change the problem we face but, again, you're the experts. The
FSA and its board have a statutory responsibility for discharging
responsibilities for bank supervision. It is not obvious to me
that they can get rid of that simply by signing an MOU. You would
haul them up here and say, "Come on, you have got the statutory
responsibility. You can't just give that away through an MOU."
Q44 Chair: Have you
discussed an MOU with the FSA and the Treasury?
Mervyn King: We
haven't, no, because we thought there was not much point in it
unless we could. There has to be some form of legislative transfer
of responsibility from FSA to the Bank. Now there was initially
some discussion about just transferring the whole thing, lock,
stock and barrel, to the Bank, but I think that would have been
a very bad idea, because the idea that the Bank could take charge
of consumer protection, independent financial advisers and enforcement
conduct is absurd. We don't have the ability or capability to
do that. What we want is to split that kind of supervision from
prudential supervision at banks.
Q45 Mr Love: Governor,
I want to try and pin you down on this issue of legislation. You
keep telling us we are the legislative experts. You have answered—
Mervyn King: I
hope you are.
Q46 Mr Love: Let
me say that in our interim report we come down fairly firmly—in
fact, very firmly—in favour of both taking the time necessary
and having a completely new Act. We are clear about where we stand,
but I am not clear about where you stand, because you mentioned
a few moments ago we need to get on with it. Of course, that is
the challenge, because a balance needs to be struck, but you need
to be clear, because you are at the centre of this new framework.
What do you think? What does the Bank think?
Mervyn King: We
would like to move as quickly as possible consistent with your
judgment about how long it will take to get the legislation right.
In the long run, it is very important that the legislation is
right here. It is very unlikely that you will find lots of spare
time to amend or change legislation in the future. We need a clear
legislative framework that will serve us for many years. If you
think you need more time to get that legislation right, I defer
to your judgment.
Q47 Mr Love: But
what we are looking for is your judgment on the matters related
to making sure that we get the legislation right.
Chair: Come on then, Governor,
you are doing negotiations and we want to know whether this is
going to be okay or not.
Mervyn King: Every
now and then when I come to this Committee, you point out in a
very polite way that I am involved in this and that and something
else. You are trying to lure me into something where you are the
experts.
Q48 Mr Love: We are
trying to lure you into giving your expert opinion as to the person
and the organisation that will be at the centre of this new framework.
Mervyn King: I
don't think I can be clearer than the following: other things
being equal, I would like to move quickly, because that will enable
us to put in place a better and improved regulatory regime, but
I accept that we need to take the time to get the legislation
right. We have to get the legislation right. If the experts in
this think we need to take longer than is currently proposed,
I defer to that judgment, but I am not an expert on how long it
takes Parliament to debate a Bill or amendments, or how much time
you can create for the legislative process. This is your field,
not mine.
Q49 Mr Love: I understand
that, but there is a clear difference of view. The new consultation
document, which I think you have in front of you, states quite
clearly that there will be amendments to the Financial Services
and Markets Act and that we will go at the speed that is necessary.
This Committee, and therefore through us Parliament, thinks that
we ought to take time in order to get this right. As you say,
we won't come back and re-amend the amendments, so we need to
get it right. Which do you favour?
Mervyn King: Our
instinct in this process was always to have a new clean Act of
Parliament that is set out in words that we—and possibly
the general public—might understand. That is much harder
to do when there is big change in the regulatory regime that takes
the form of amendments to an existing piece of legislation that
was introduced to put in place a wholly different style of regulation.
Now we are told by those who know that it is possible to bring
about this new style of regulation through a process of amending
existing legislation. I am not an expert on whether that is right
or not; you are. But I am quite happy to defer to the judgment
of this Committee if you feel it is better to have a new Act and
to take time. I certainly wouldn't challenge that.
Q50 Chair: We are
going forward on the basis of these amendments. We are not going
forward on the basis of what—
Mervyn King: Indeed,
the Government have decided that they are going to proceed on
the basis of amending FSMA, and they have set out a way in which
the changes described in this document can be achieved by amending
FSMA.
Paul Tucker: The
bits that are completely new—the bits of legislation on
the Financial Policy Committee—will read like a new Bill
or a new Act, because there is nothing in FSMA to amend. It will
just be a whole set of new clauses. On prudential regulation and
conduct regulation, there will be a series of amendments. Will
we engage with the Treasury clause by clause on that? Yes, of
course we will. But we don't know whether it's easier for you
to scrutinise amendments or a new Bill.
Q51 Mr Love: The
reality is—our view is very clear—that we want to
look again at the whole area and, yes, of course, there will be
new parts to that. What I am anxious to get from you, Governor,
is having heard what the Committee has to say, will you take that
into account in the responses you make to the consultation document
and the discussions you will have with the Treasury?
Mervyn King: We
have already made it clear that our preference would have been
for a new Act, which was clear from the outset. There is nothing
new in that. But we didn't win the day on that argument, and now
we are going down a different path. Probably the best thing to
do is to carry on down that path but leave you to ensure in Parliament
that the process of legislation is effective. I am sure we can
rely on you to do that.
Q52 Chair: Having
just had a colossal financial crisis where, partly as a result
of defective legislation, it sounds as if we are creating the
very conditions for another crisis, aren't we, with further defective
legislation? You are describing a pig's ear of a legislative process,
aren't you, Governor?
Mervyn King: I
have a set out a very clear vision of what the new system of regulation
should be. How we put that in legislation is not for us. That
is for you and the Government to discuss. If you have a clear
view that it should be done in a different way I am not going
to gainsay that. But you have to take that up with the Government,
not with the Bank.
Q53 John Thurso:
Governor, I have one last question on this vexed issue. May I
say that I am touched by your idea that we are experts in legislation,
as we are more often the masters of unintended consequence? The
critical thing in this is that we get it right.
Mervyn King: Absolutely.
Q54 John Thurso:
In order to achieve that, the people drafting the legislation
in the Treasury have to get it right to start with. Are you confident
that you and your team have put to them sufficient information
that they can deliver a first draft that is workable? That is
the critical question. Has your input gone into where it matters
at this stage?
Mervyn King: We
made the input, and I am happy with the input that we have made.
Whether it will be accepted is something I can't say.
Q55 John Thurso:
Would you come before us and tell us what has not been accepted
that you would have liked to have seen?
Mervyn King: We
will certainly do that once we see the Bill.
Chair: Write to us immediately.
Q56 John Thurso:
Can I turn to Mr Tucker? In the list of strategic goals that the
court approved for strategic priorities for 2011 is No. 3, which
is to discharge the Bank's enhanced role for financial stability.
What is your key priority in delivering that strategic objective?
Paul Tucker: Of
the key priorities over the past year, the main one has been what
we have ended up talking about this morning, which is regulatory
reform. Another one has been the complete reform of resolution
regimes internationally to handle the largest and most complex
companies. Another one has been an outcome from the Basel capital
accord review in the G20, which was a step forward. A fourth internal
priority was to ensure that the different directorates of the
Bank are joined up. Financial stability is all about synthesis;
it is not just about markets, analysis or supervision. If we are
to make a success of this, the approach has to be porous and co-operative.
Q57 John Thurso:
One of the bullet points it is interesting you didn't mention
just now is to design and promote more resilient financial market
infrastructures. What do you regard within the market infrastructure
as being insufficiently resilient at the moment?
Paul Tucker: As
more over-the-counter derivative activity goes through the so-called
central counterparties, we are going to need to ensure that the
central counterparties are more robust than in the past and, in
the event of a counterparty failure, can unwind very complex derivatives
books without unleashing chaos. The central counterparty brings
all the risk together in the centre. It would be a cataclysm,
frankly, if one of them failed, and we need to ensure that there
are standards that make them resilient, and international standards
to that end, which Andy's people lead on, within the UK and with
the FSA are being developed.
Q58 John Thurso:
Do you think that the Bank's arrangement for scrutiny of the markets
for that purpose is sufficient?
Paul Tucker: As
things stand today, the responsibility for supervising clearing
houses and settlement systems lies with the FSA. The Bank of England
oversees payment systems and the payment system bit of other pieces
of infrastructure—LCH central counterparties. We feel that
we have sufficient powers to do our statutory responsibility.
In the context of the Bill, we have been seeking an amendment
to the powers that the FSA currently has, so that we can oversee
central counterparties more effectively in the future. In terms
of human capital, I think our markets area, our banking area and
our analytical area puts us in a fairly good position.
Q59 Michael Fallon:
Mr Tucker, the Government have proposed an additional power to
balance financial stability with the effect on medium and long-term
growth expressed in this rather torturous double negative in paragraph
121; how is that going to be workable in practice?
Paul Tucker: We
didn't resist this for the following reason: when we are doing
monetary policy, we don't believe that there is a long-term trade-off
between inflation and growth and employment, but in financial
stability it is different. We could ensure that there wasn't a
financial crisis in this country over the next 100 years by completely
repressing financial activity. There is a trade-off that we have
to balance, hence these words.
The other thing that the consultation document
says—we welcome this—is that the Government will ask
Parliament to make a provision for the Government to give us a
remit on our financial stability objective. A point that you made
in your report is that no one on the planet knows enough about
financial stability to boil this down into a quantitative target.
We have felt strongly that the regime should make scope for learning
on our part, on the Government's part and in the broader community.
I can't give you, Mr Fallon, a precise answer to that today, but
what we and the Government are planning to do is make provision
for the Government to articulate where they see the trade-off,
and for us to respond publicly to that remit.
Q60 Michael Fallon:
It is for the Government to strike the balance between financial
stability and medium-term growth, and for you to work out how
to accommodate that.
Paul Tucker: It
is for the Government and Parliament to decide what the objectives
of any regime are, yes. We feel completely comfortable with that,
otherwise we start to abrogate to ourselves the responsibility
for deciding society's end objectives. I mean that is exactly
analogous to the monetary policy regime. We don't choose the target.
The Government choose the target and report it to Parliament,
and we in the MPC have the job of meeting that target.
Q61 Michael Fallon:
That is now how it is worded, is it? It says, "This does
not require or authorise the committee to exercise its functions
in a way that, in its opinion, would be likely to have a significantly
adverse effect on medium or long-term growth".
Paul Tucker: The
objective—the trade-off—is made here. We, on the FPC,
would have to say, "We've got a problem. There are two ways
of curing this problem. Do we think one can deliver the objective
of stability with least impact on the trend growth rate?"
Q62 Michael Fallon:
Governor, the additional powers that are proposed in paragraph
237 include a broad power of recommendation. You used to complain
to this Committee that your power previously was limited to what
I think you described as sermons in church. This is a recommendation.
How will it have a binding effect on other regulators?
Mervyn King: Because
what it will do, I think, is to force. It says here that the PRA
and the FCA have either to comply with the recommendation or explain
in public why they have not done so. That didn't exist before.
I think if it had been the case that regulators had had to defend
what they were doing and ignore the recommendations of the FPC
then I think that would have changed the incentives for regulators.
Q63 Michael Fallon:
Can't you do better than that? Aren't we just going to get back
into this blame game between the Bank and the PRA and the FCA?
I thought the whole point of this was to put you in charge. Wouldn't
you rather have the power to direct? Aren't you going to be the
super-regulator?
Mervyn King: There
is a power of direction, which will allow the FPC to require the
PRA or the FCA to implement certain macro-prudential tools. To
the extent that Parliament delegates certain instruments or tools
to the FPC, we will have the power of direction to require the
regulators to implement that on individual institutions. That
is a pretty powerful weapon.
Q64 Michael Fallon:
What is the point of the recommendation? Could you explain to
us the difference between these two sub-paragraphs?
Mervyn King: Because
I think the recommendations would be there. Let's suppose, to
take the example Paul gave, that all of us learned that there
was an area of financial behaviour that we thought was posing
a risk. It hadn't been anticipated when you in Parliament chose
the instruments that you wanted to delegate to the FPC and it
was something that we wanted to raise. We could immediately recommend
that something be done about it, even if there FPC didn't, at
that stage, have the power to direct the PRA to use specific instruments
to deal with it. As Paul has said, new instruments will be devised
in the future that we can't even imagine today—let alone
frame the regulation of—and we need to have the ability
to talk about and recommend to regulators that they deal with
some of these problems.
Subsequent to that, if we think it's important
enough, we might come back to this Committee and say in our judgment
the set of instruments available to the FPC should be expanded,
and we would like you in Parliament to consider adding those extra
instruments. But short of that, before you have done that, I think
we do need the ability to have a broad power of recommendation,
and I think it is quite important that the PRA and FCA must either
comply or explain.
Q65 Michael Fallon:
I understand that, but I just want to be clear whether you think
a broad power of recommendation is strong enough.
Mervyn King: I
think it is strong enough in the areas that we can't at present
define sufficiently clearly to put into legislation. Where we
can, then of course the power of direction will apply.
Q66 Chair: Just to
be clear, it will be extremely important for you to have some
means of communicating with this Committee, if you feel that the
power of direction you have is inadequate.
Mervyn King: I
think one of the regular conversations, which the FPC or the team
from the Bank representing the FPC, will want to have with your
Committee as we go forward is precisely on that point.
Q67 Mr Ruffley: Just
on that point, Governor, what is the role of the Treasury if the
policy tools that you have are insufficient and the PRA and the
FCA are not taking you seriously? I can't imagine that would happen,
but suppose they disagree with you. What role would the Treasury
have? You would be able to go to the Chancellor and say, "Listen,
I need some more powers."
Mervyn King: Yes,
that is exactly what we would do, and we would say that openly
to your Committee. Either the Chancellor would disagree and not
put proposals to Parliament or he would put proposals, and I think
the view of the members of this Committee would carry a lot of
weight when the matter was debated in the House.
Q68 Mr Ruffley: I
don't see a problem. You could just make a big fuss with the Chancellor,
and it would be very public.
Mervyn King: It
wouldn't be a big fuss. We would just go along and say, "Look,
the world has changed. We think we need a new power. These are
the arguments for; these are possibly the arguments against. Will
you please decide?"
Q69 Mr Ruffley: Sure.
Part of this discussion is about accountability. You have spoken,
and your colleagues have spoken rather well, about the new improved
accountability, but I am not entirely sure whether the buck stops
with you or whether you are the super-regulator to which Mr Fallon
has alluded. Can I just get one or two things straight? In the
old regime—the regime that we are operating under at the
moment—when the crisis happened, we saw there was a failure
of regulation. How many senior regulators either in the Bank or
in the FSA were dismissed, retired or were otherwise moved on?
Can you give me a number—not their names, just a number?
Mervyn King: There
were no regulators in the Bank of England, because we had no regulatory
responsibility. On the FSA, I think that's a question you will
have to put to the FSA. I think it is pretty clear that some people's
careers were certainly affected, but I think that is a question
you have to put to the FSA.
Q70 Mr Ruffley: You
said at the time of Northern Rock that if you had had a resolution
regime you could have sorted it in a weekend.
Mervyn King: Yes.
Q71 Mr Ruffley: I
think we all agree that that was a huge policy tool that was not
at the disposal of the Bank at the time of Northern Rock. Who
did you speak to about the absence of that resolution tool, because
it was a huge gap in British policy making—you have said
yourself that we were the only country in G7 that didn't have
it? Wasn't it your job, as Governor, to point that out? It was
a huge hole.
Mervyn King: And
we did. Indeed, we had various war games with the FSA and the
Treasury in the years running up to the crisis where we made that
point. I remember very clearly making that point forcefully at
the end of one of the exercises, and the FSA and the Treasury
completely agreed. Indeed, work was going on in the Treasury to
create a resolution regime. That work stream had been started,
but I certainly didn't say, "You know, hang on, unless you
put this in place by July 2007, I know that in August there is
going to be a major problem."
Q72 Mr Ruffley: But
we were an outlier. We were the only country in G7, so well before
2007 didn't some bell ring in your mind—
Mervyn King: Absolutely,
and we said this very clearly. But there are enormous questions
of priority when it comes to introducing new legislation. I think
it was not unreasonable for the Government to take the view that,
important though that was in principle, there were many more urgent
things to do with the health service or defence that required
legislative time.
Q73 Mr Ruffley: I
was struck by your comment that we were the only major industrialised
western economy not to have that—
Mervyn King: There
is one very interesting aspect of that, which is every other G7
economy introduced a resolution regime only after problems in
their own country. Not one of them learned from the experiences
of the others.
Q74 Mr Ruffley: I
merely make that point because that was a whacking great gap,
and everyone's wise after the event. But it could have saved a
lot of misery.
Mervyn King: Absolutely.
Q75 Mr Ruffley: Could
I just move on from that and refer to something you said a few
moments ago? On the new resolution regime, which is good and important
to have, you said that there are lots of building blocks, so other
key policy tools will be given to the Bank under this new regime.
Will you identify the big building blocks that we don't have at
the moment?
Mervyn King: I
think, from our point of view, the most important was that it
became clear with the benefit of hindsight that there were gaps
and missing instruments in the policy framework. That monetary
policy was able to keep the economy growing at a sustainable rate
with inflation low and close to the target. There were undoubtedly
improvements that could have been made in the individual regulation
of banks, but we have discussed that and this consultation document
is designed to improve that. That is one of the building blocks.
But an absolutely key one was that we didn't take any action on
the enormous expansion of the financial sector balance sheet.
In the five years running up to the crisis, two thirds of lending
by UK banks did not go to households or companies; it went to
other parts of the financial sector. What we were seeing was an
enormous expansion not so much in employment in the financial
sector but in the size of the balance sheet based on borrowing.
Leverage went up to extraordinary levels. That was the area that
nobody was given the task of looking at and dealing with, which
is why the Financial Policy Committee, in my view, is there to
fill that gap between the macroeconomic management of the MPC
and the microeconomic, microprudential supervision of individual
banks.
Q76 Mr Ruffley: That
is the other—
Chair: One last very quick
question and a quick reply, please, Governor.
Mr Ruffley: On the "too
big to fail" argument, I am not talking about the cash bailouts
to RBS and Lloyds, but you did a very good paper suggesting that
there was a £100 billion a year guarantee in 2009 that basically
the British taxpayer gave to the big banks as a result of not
allowing them to fail. They could borrow in the money markets
cheaply and they could lend much more expensively. How is that
going to be unwound, do you think, so that we do get to a position
where banks can fail?
Mervyn King: Let
me bring in Mr Haldane, because he is the author of that work.
Q77 Chair: A brief
reply. I am sorry we are running tightly to time.
Mr Ruffley: It
is an important question.
Andrew Haldane:
Of course. I will be as brief as I can. Let me mention three initiatives
that relate to lowering that implicit subsidy. One is requiring
the largest and most complex banks to hold larger chunks of loss
absorbing capital to lower their probability of failure. A second
initiative would be to ensure that in the event of failure there
can be wound down the parts that should be wound down, and those
parts that need to be kept upright remain upright, which are the
so-called recovery and resolution plan work streams. The third
dimension, which is one that Paul spoke to, is when those banks
are of a cross-border nature we need much better rules of the
game for knowing who goes where and who does what, and the Financial
Stability Board is working on an agenda to meet that. These are
three initiatives that speak to removing the implicit subsidy
that markets and rating agencies currently attach to the biggest
banks.
Q78 Mr Ruffley: Sorry,
I just want to ask you a question, if you don't mind. Is it possible
to get a written submission on that, because we have been cut
short?
Paul Tucker:
We could send you the FSB communiqué, on that because the
package that Andy has described was set out in the G20 summit
in November.
Q79 Stewart Hosie:
Can I go back to the issue of supervision? When you were faced
with the Hector Sants quote about the low tolerance of failure,
you said that your job wasn't to stop banks failing. Paul, you
have said that you would work with the Bank's resolution teams
effectively to prepare for failure rather than the avoidance of
failure. I understand that, but what do you imagine the general
public will think when they hear people like you from the Bank
as supervisors and regulators effectively preparing for failure
rather than engaging active supervision to minimise the risk of
it.
Mervyn King: I
think this goes to the heart of the debate about the structure
of our banking system. People putting money into deposit accounts
in banks either need to be told that the money that they are putting
into their accounts is going to be invested safely and won't be
invested in risky activities, or the taxpayer is going to have
to stand behind to give a guarantee or they may lose money. I
think this is a big question for Parliament, because this is an
issue about the structure of the banking system. Of all the building
blocks that I have talked about, we have got the FPC, the change
in the regulatory regime for regulating banks and the introduction
of the Independent Banking Commission in September. The ICB will,
I am sure, have things to say about the questions, about how on
earth we can create a system in which retail depositors can believe
that their money is safe without the taxpayer giving a guarantee
to the people who run the banks. We have to confront that question,
which is perhaps the single most important question that we need
to confront.
Q80 Stewart Hosie:
I have no problem with that at all, which is why I support our
holding larger capital reserves, minimising leveraging and all
that good stuff. I have no problem with that at all.
Mervyn King: Individual
retail depositors are protected through the FSCS, and the deposit
protection scheme, now up to £85,000 per individual account,
per individual bank, is a means of saying to depositors, even
if the bank fails your money will be safe.
Q81 Stewart Hosie:
Indeed, but it is not just the actual failure of a bank and the
potential loss of money that is at issue here. Even if the most
modest non-systemic bank collapses, it can—and it has—contributed
to a systemic crisis in confidence, which is the most damaging
thing that can happen to the banking sector. That is why I am
still concerned that the PRA, as Hector Sants said and as you
have said, will spend more of its time on resolution and less
time on the avoidance of failure. I am trying to understand why
you think that the prudential rules and regulation of the big
banks should be done at the expense of the act of supervision
lower down the chain. I don't see a contradiction.
Mervyn King: I
must have misspoken; I am sorry. I did not say it would come at
the expense of active supervision of the smaller banks. What it
will come at the expense of is excessively detailed scrutiny of
individual actions taken by the big banks. It makes no sense to
second-guess the management across the board. If we are going
to second-guess the management of supervisors it is to challenge
them about the big decisions that they have been taking.
I think resolution is fundamental, because the
failure of a small bank should not have systemic implications,
if the small bank can go through a resolution process in which
the depositors wake up on Monday morning and know that their accounts
are safe and that they have been transferred to another bank.
We have proved this. We did it—Andrew Bailey did it, leading
the resolution of the Dunfermline Building Society. If we could
have done the same thing for Northern Rock, then there wouldn't
have been the run on the bank that occurred.
Q82 Stewart Hosie:
Can I say I am very pleased with the answer you have given, that
high-level regulation and prudential supervision will not be at
the expense of active supervision? I will be brief, because I
am a little short of time. I take it that you effectively agree
with this Committee in what we said in our last report, namely
that the PRA would need to have a strong justification for reducing
the supervisory effort in such low-impact firms.
Mervyn King: Yes.
Q83 Chair: Governor,
you are a member of the Court of the Bank of England; you are
deputy chairman of the ESRB; and you are chairman of the FSC,
the MPC and the PRA board. Are you at risk of becoming a single
point of systemic failure?
Mervyn King: No,
and the reason is that the power is not given to me, as an individual;
it is given to the committees. I am member of the Court, but the
Court is there to act as an oversight body of what I and other
people in the Bank do, so it examines. I have an interview each
year with the chairman of Court who quizzes me on my performance.
He sets me objectives for the following year, which is an oversight
process. In terms of the three policy areas of the Bank—the
MPC, the FPC and the PRA—I am only one on each of those
three committees, and we have a proven track record. On the MPC,
I have been in a minority on three occasions as Governor. I don't
believe that that damaged the credibility of the committee or
my own personal credibility. We understand that in those difficult
judgments it is perfectly reasonable for people to take different
views. Unless we can devise a decision-making process that accepts
that it is reasonable for different people to hold different views
and come to a judgment about how the group, as a whole, reaches
that decision then, frankly, there is no way you will ever get
a rational decision-making outcome. I don't think that I personally
am a point of systemic failure.
As far as the Bank is concerned, I think it is inevitable
that if you are going to have something like the FPC doing macroprudential
regulation, it needs to be in the central bank, which is why the
ESRB has as its voting members predominantly central bank governors.
The area that you could think about being outside the Bank is
the PRA, which could be somewhere else. But I think for perfectly
sensible reasons the Bank has been asked to take it on, and it
will be a subsidiary of the Bank and be part of our general responsibilities.
But each of these three decision-making bodies will be directly
accountable to this committee and it won't just be me who comes;
it will be a group of people. I expect that when it is the FPC
and the PRA, there will be many occasions when I won't come at
all, and you will be talking to other members of the committee
and the PRA. I don't think that that is a point of systemic failure;
I am confident of that.
Chair: Busy though you
will be, we will still want to see quite a bit of you, Governor.
Thank you very much indeed for the evidence you have given this
morning on this. We are running a little behind schedule, so we
will take a 10-minute break and resume on inflation.
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