Accountability of the Bank of England: Response from the Court of the Bank - Treasury Contents


1  Response by the Court of the Bank of England


Introduction

1.  We published our report on the Accountability of the Bank of England on 8 November 2011. This has received extensive support from financial institutions, commentators and the press.[1] The Joint Committee on the Financial Services Bill also supported all its main conclusions. On 12 January 2012 we received a response from the Court of the Bank of England, on which we took evidence from the Governor of the Bank, Sir Mervyn King, Michael Cohrs, an external Member of the Financial Policy Committee and a non-executive member of the Court of the Bank of England, and Robert Jenkins, an external Member of the Financial Policy Committee, on 17 January 2012.

2.  The Government plans to publish the Financial Services Bill at the end of January 2012. Therefore, the Bank's memorandum requires a swift initial response from us in order to assist the Chancellor of the Exchequer in drafting that legislation. We may return to the matters raised in this Report after the legislation has been published.

3.  In some areas, for example the term of office of the Governor, the Bank agrees with our conclusions. In some other areas, particularly with respect to the identification of the accountability problem, the Bank has now moved towards accepting the analysis in our Report. We welcome the Bank's acceptance that with the major new roles and responsibilities must come new, stronger forms of accountability and governance,[2] and that, in particular, accountability of the form constructed for the Monetary Policy Committee will not be sufficient in the field of financial stability policy.[3]

4.  However, there are some crucial areas where, although accepting our analysis, the Bank's memorandum comes to very different conclusions. We concentrated on these in our questioning. We discuss these matters in the paragraphs below.

The Bank's proposed 'Oversight Committee'

5.  The Treasury Committee recommended that Court should be reformed into an appropriately qualified and resourced Supervisory Board with, among other things, the remit to conduct ex-post reviews, both internally and externally, of the Bank's performance in the prudential and monetary policy fields.

6.  The Bank agreed that it is possible for monetary policy to be challenged effectively from outside the Bank, but that financial stability policy "is different", as the decisions may need to be made irregularly, in a crisis, or in secret; there are many policy instruments the Bank may use; and there is no single quantifiable objective against which to measure performance:

Together, these differences will make it more difficult for an authority outside the Bank, like the Treasury Committee, to challenge and question individual financial stability policymakers.[4]

This reflects what appears to be a similar analysis to our own of the difficulties of effective scrutiny of the Bank's financial stability objective. However, the Bank's proposed remedy, despite appearances, is not at all similar:

Court is of the view that an Oversight Committee for financial stability is needed within the Bank to supplement the direct accountability of the Bank to the Treasury Committee.[5]

7.  The proposed Oversight Committee would be a sub-committee of Court. It would scrutinise the financial stability processes of the Bank. This proposal falls well short of our recommendation in a number of important respects.

8.  The Oversight Committee would only be able to conduct reviews to assess whether the processes used in making policy decisions "can be reasonably judged to have considered a full range of options and to have taken account of the relevant information, analysis (including of the lessons from the past), differing views amongst policymakers, and challenges from outside the Bank".[6] The Bank memorandum proposed that the Board would commission expert authorities outside the Bank, for example the International Monetary Fund, to conduct reviews of the merits of the policy decisions themselves.[7] The purpose of such reviews would be:

to supplement the role of external members of policy committees in bringing outside challenge and ideas into the Bank's financial stability policymaking. The reviews would allow the Oversight Committee to challenge the Bank to consider fully in its policymaking processes the lessons from particular episodes or issues. The Oversight Committee would assess whether the Bank had properly thought through and responded to the conclusions of the reviews that it had commissioned.[8]

In evidence to us the Governor said that expert individuals, as well as organisations, might also be called upon to carry out the external reviews.[9]

9.  The Court of the Bank proposes that the Oversight Committee be responsible for approving the terms of reference of peer reviews of microprudential supervisory activities commissioned by the Board of the new Prudential Regulation Authority. The PRA will have a statutory duty to investigate and report on instances of possible regulatory failure. Court believes such investigations "should normally be led by an external authority".[10]

10.  The proposed role is therefore quite different from the Treasury Committee's recommendation, that a new Supervisory Board replace the Court with the authority to conduct reviews of the Bank's performance:

We recommend that the new Supervisory Board conduct ex-post reviews of the Bank's performance in the prudential and monetary policy fields normally not less than a year after the period to be reviewed. This would be consistent with avoiding second guessing at the time of the policy decision. The reviews should among other things enable lessons for the future to be learnt. They should strengthen the Bank's collective memory. There should be no presumption that the commissioning of a review implied that the episode or function in question had been badly managed: successes and failures should be reviewed alike. It would be a matter for the Board itself to determine when and how such reviews would be conducted, and into which issues.[11]

11.  The Court memorandum said that:

It is vital that the Oversight Committee does not seek to second guess the decisions of policymakers themselves. The passing of such judgements could threaten the relationship of trust that is necessary between policymakers and the Oversight Committee. Were the Oversight Committee to be seen to 'take sides' in the policy debate, those policymakers from whom it differed would be less likely to trust as independent its judgement of whether proper processes were followed. And if the Oversight Committee can give assurance that the processes followed took proper account of the relevant information, options and challenges, there would be little to be gained from knowing whether its members differed from the policymakers in their resulting policy judgement.[12]

In oral evidence the Governor reiterated that the Court was:

adamant that it did not want to be in the position of second-guessing whether those individual decisions were correct or not, either at the time or ex-post. Other people will do that and, of course, in monetary policy it happens all the time. It is already beginning in financial policy as well. There is plenty of room for ex-post review, but I do not think the oversight committee should set itself up as a body and say, "We are more expert than the FPC or MPC." Who is going to oversee them?[13]

12.  The Court's reference to the Oversight Committee's "taking sides" in the policy debate appears not to take full account of our recommendation that policy reviews should be conducted well after the event, precisely so as to avoid the risk of "second-guessing" of current policy. The suggestion that the Court would not want to be in a position to review performance ex-post was raised with Michael Cohrs at our hearing.

13.  Mr Cohrs, the other (non-executive) member of the Court present, considered that while it was possible to weigh the quality of a decision by focussing on the process, "you could have had a great process but still have come, in retrospect, to a decision that wasn't fantastic".[14] Internal second guessing of the policy committees would be "dysfunctional", but "just looking at process becomes a bit too sterile and may not get you to the heart of the issue".[15] He believed that there should probably be an internal investigation by the Bank of its own role in the financial crisis which should in due course be published, although he added that the crisis was still continuing and the Bank was busy dealing with it.[16] Mr Cohrs also echoed our Report in calling for proper resources to support the work of any Oversight Committee.[17] Adequate staffing is essential.

14.  The Bank proposes that reviews would only be carried out in the financial stability area.[18] We recommended that ex-post reviews should be carried out in both the prudential and monetary policy fields. The Governor believed that the work of the Oversight Committee did not need to include monetary policy, since that was already examined by NedCo, the committee of Court made up of all non-executives. However he was open to the idea that the Oversight Committee could perform the same functions in relation to monetary policy as the Court proposed it should undertake on financial stability policy.[19]

15.  The Court memorandum suggested that the Oversight Committee should have its Members and Chairman nominated by the Nominations Committee of Court, but should be composed only of non-executive members of Court. Executives might be invited to attend its meetings to assist its work.[20] In evidence to us the Governor said that the Chairman of the Oversight Committee should be chosen on the basis of his or her qualifications for the task.[21] This echoes the point we made in our Report about the need for members of the Supervisory Board/Court to be eminent individuals with suitable financial and other professional experience.[22]

16.  The Governor was dismissive of any parallel between the Bank and the IMF, whose Independent Evaluation Office is an arm's length body which evaluates both policy and processes of relevance to the mandate of the Fund. This was on the grounds that the Bank had forms of accountability, including to the Treasury Committee, which the IMF did not have, and because the IMF had no oversight board at all. He did "not think this is a model that has a great deal to offer the Bank, because its set-up is really very different."[23] We disagree with the Governor on this point. However, it is this Committee which has suggested internal ex-post review of policy and processes, in part because, as the Bank itself has acknowledged, we are not in a position to examine all aspects of financial stability policy ourselves.[24]

17.  The authority of any Oversight Committee will depend on its statutory remit far more than its structure or membership. We welcome the Governor's flexibility as to the remit of the proposed Oversight Committee, which he has said could also include monetary policy. Such a Committee should also examine the work of the Prudential Regulation Authority.

18.  Parliament's practical ability to hold the Bank to account will rest, to a substantial degree, on the extent to which the Court develops into a proper board, with adequate scrutiny and review powers. Court lacks much of what is required under present arrangements. The Oversight Committee, as proposed in the Court's memorandum, does not plug that gap. The Oversight Committee's role, as proposed by the Court, would be so heavily circumscribed that it could not be relied upon to provide adequate scrutiny. It is unrealistic to suppose that an oversight body could plausibly be expected to commission an external review of a policy decision without assessing the substance. Nor could such a body be expected to avoid engaging with the implications of the policy conclusions of that external study.

19.  We are unconvinced by the Court's argument that internal review of policy, as distinct from process, is undesirable in principle. On the contrary, internal review is essential. Most public and private institutions have the capability and self-confidence to debate and review policy internally without damage to the institution concerned. We do not exclude a role for external review; it should occur when the Bank does not itself have the skills to conduct such a review, or for other reasons thinks that an external review would be better than an internal one. We reiterate our view that the body commissioning internal and external reviews should be adequately resourced and staffed within the Bank.

Provision of information to Parliament

20.  In our Report we said that:

The House of Commons and, on its behalf, the Treasury Committee will scrutinise the policy and processes of the Bank of England. To that end, it is important that requests for information and data from this Committee to the Bank are met. [...] The Court should be willing to provide all information required by this Committee to meet the requirements of parliamentary accountability [...]. The new Supervisory Board should be required to ensure that the requests for information are met, as long as they are not unreasonable. An unreasonable request might be one which was untimely, vexatious or disproportionately costly.

We recommend that the new Supervisory Board be responsible for responding to requests to the Bank for factual information from the Treasury Committee and the Treasury.[25]

21.  The Governor assured us that the Bank would meet requests for information from the Committee, and that Court had not included this in the memorandum because it had taken for granted that the Bank would do so.[26]

22.  The Governor also said that in future lender of last resort operations where secrecy was required, he and the Chancellor would brief the Chairman of the Treasury Committee and the Committee of Public Accounts. He conceded, however, that in the case of RBS this had been overlooked.[27] The Bank's track record is mixed. When asked last year to disclose the minutes of the Court's meetings on the Northern Rock crisis, it took refuge in the unacceptable position that, since there was no requirement under the Freedom of Information Act for it to provide such information, there was no need to do so to Parliament. We commented in our previous report that:

The fact that a reasonable request to the Court to scrutinise the functioning of the Bank during a time of exceptional crisis has been declined is a reflection of the problem with the accountability of the Bank of England that our inquiry has sought to address.[28]

The request for Court minutes is outstanding.

23.  We welcome the Governor's assurance that the Bank will respond to requests from this Committee for information. The Court/Supervisory Board should be responsible for monitoring the way this duty is carried out. Parliament needs prompt and full responses to such requests in order to hold the Bank to account.

24.  It is important to avoid cases where significant operations are undertaken by the Bank without any accountability at all. On one recent occasion the Bank failed adequately to inform the Chairman of this Committee about a secret operation. The Chairman of Court should have the duty to inform the Chairman of the Treasury Committee and of the Committee of Public Accounts where the Bank acts as a lender of last resort, or where the Chancellor is notified by the Bank of a risk to public funds but the crisis is resolved without recourse to public funds.

Crisis management

25.  We recommended that the Chancellor be given statutory responsibility for a crisis after the formal notification by the Bank of a material risk to public funds. We further recommended that the Bank give the Chancellor an early warning, in the event that it considered such a notification was likely. At this point the Chancellor should, we said, have a discretionary power to be able to direct the Bank if he or she so chose.

26.  Again, the Bank has provided an alternative proposal which, although apparently in broad accord with our views, does not deliver what we recommended:

  • the Court suggests that crisis management, including the Chancellor's temporary power of direction, be encapsulated in a Memorandum of Understanding.[29] We recommended amending the Bill to make arrangements statutory;
  • the Court agrees that the Bank should alert the Treasury to an increasing risk of use of public funds. However the Bank's proposal excludes the use of the Chancellor's discretionary power of direction at this time.[30] We said that the Treasury needed to know "as early as reasonably possible" that it might receive a formal notification of a material risk to public funds, in order to give the Chancellor "enough time to consider other policy options". Such an early warning should trigger "a discretionary power for the Chancellor to be able to direct the Bank if he or she so chooses";[31]
  • the Court has added an additional condition to the Chancellor's power to direct. It proposes that the power should be triggered when there is a "material risk to public funds and the Chancellor, having consulted the Governor, is satisfied that there is a serious threat to financial stability" [our emphasis];[32]
  • even once the Chancellor has been formally notified of a material risk to public funds and has taken control of the Bank, the Court proposes that he or she should be restricted to directing the "crisis management operations of the Bank" using "instruments of crisis management" (which are defined as the provision of liquidity support and the operation of the Special Resolution Regime).[33] Our recommendation was that, during a crisis, the Chancellor, accountable to Parliament, should have the power to direct any appropriate operations of the Bank.

27.  The Governor was unwilling to go into detail about the memorandum of understanding that was being prepared alongside the legislation, but said that it would provide clarity and that we would be pleasantly surprised by the proposed arrangements.[34]

28.  The Chancellor, accountable to Parliament, must have the discretionary power to direct a crisis where a material risk to public funds is developing. He or she should not, as was the case in the Johnson Matthey rescue in 1984, be faced either by a fait accompli, required to accede to an emergency request for support at the time a crisis is breaking out, or, as was the case in 2007, by a refusal on the Bank's part to provide additional funding to the banking system in order to alleviate a developing liquidity crisis.[35]

29.  A memorandum of understanding may be needed to govern some of the arrangements between the Bank and the Treasury in a crisis, but it should not be relied upon for determining how a crisis will be addressed. As much detail as possible about the Chancellor's power of direction should be set out in statute. This will greatly improve the clarity of the responsibility of the Chancellor for conduct of a crisis and thus his or her accountability.

30.  We welcome the Court proposal that any Oversight Committee should monitor whether the Bank has notified the Treasury of a risk to public funds "at the appropriate time": this should help ensure that the Bank does so as early as reasonably possible.

31.  The legislation must define the trigger for the Chancellor's assumption of the power to direct the Bank. The Court's proposal for a double trigger is unacceptable. A material risk to public funds alone should be enough to pass responsibility for affairs to the Chancellor.

32.  Legislation should also define the scope of the power of direction. Court's suggestions are too circumscribed. The extent of the Chancellor's authority should not, in a crisis, be restricted to certain instruments of crisis management. He or she must have a general power to direct the Bank when public funds are at risk.

The role of external members of the MPC and FPC

33.  The Treasury Committee recommended that a better balance between internal and external members of the FPC and MPC be found. We proposed that the ratio of internal to external members alter so that externals were in a majority, in order to promote debate and creative tension, and to discourage groupthink.

34.  The Court's memorandum, however, disagreed. It claimed that it was neither "necessary or desirable" for the FPC or MPC to have a majority of externals. It claimed that historical voting showed that "sustained dissent has come from internal as well as external members".[36] The Governor stated in oral evidence that the MPC had "a demonstrable track record of not having groupthink".[37] We, however, heard evidence (some from ex-MPC members) which said that groupthink was a problem in the Bank.[38] The fact that internal members have dissented at times does not tell us whether or not the hierarchy of the Bank in some degree inhibits debate.

35.  The Court also argued that changing the ratio of external to internal members of the FPC and MPC would dilute internal membership "to the point where the Committees could not be presented as distinctively Bank Committees", which would "undermine the Government's purpose of asking the Bank to undertake these activities in the first place".[39] The Governor said in oral evidence that without a majority of Bank executives these committees would not really be Bank committees.[40] He was also concerned about the FPC growing too large for fruitful discussion if it had more external members than internal, given that five of its 11 voting members were Bank executives.[41]

36.  We are not convinced by the arguments of Court for the retention of a majority of internal members on the MPC and FPC. A bare majority of externals would not in our view dilute the Committees in the way, or with the consequences, that the Governor claims. A majority of externals is a necessary and sensible precaution against groupthink.

37.  We do not agree with the Governor that the FPC would necessarily need to expand in order to have a majority of external members. Four, rather than five, very senior Bank executives should suffice.

Conclusion

38.  It is greatly in the public interest that the new legislation provide a satisfactory long term framework for the accountability of the Bank of England. It will increase, not diminish, the authority of the Bank. The Court of the Bank of England has gone some way towards accepting the framework of our proposals for its future governance and accountability. However, we have set out in this Report a number of outstanding points, contained in our original Report, that must be reflected in the Financial Services Bill. If they are not, we may need to ensure that the Bank is accountable in other ways, such as the use of select committee specialist advisers to undertake reviews in the Bank on our behalf and to assist us in obtaining appropriate documentation. These alternatives are likely to be less satisfactory for the Bank, Parliament and the public. They are also less likely than our proposals to bolster the authority of the Bank's decisions. We want to see a strong, authoritative Bank.


1   For example see leading article "Accountability and the Old Lady", Financial Times, 9 November 2011, p 12, and "City hails proposed Bank curbs", ibid., p 4 Back

2   Response from the Court of the Bank to the recommendations made by the Treasury Committee and Joint Committee on the Draft Financial Services Bill on the accountability of the Bank of England, para 1, appended to this Report Back

3   Ibid., paras 3-6 Back

4   Response from the Court, para 6 Back

5   Ibid. Back

6   Ibid., para 12 Back

7   Ibid., paras 14 and 15 Back

8   Ibid., para 15 Back

9   Uncorrected transcript of oral evidence taken before the Treasury Committee on 17 January 2012, HC (2010-12) 1753, Q 45 Back

10   Response from the Court, paras 24-6 Back

11   Treasury Committee, Twenty-first Report of Session 2010-12, Accountability of the Bank of England, HC 874, para 81 Back

12   Response from the Court, para 13 Back

13   HC (2010-12) 1753, Q 23 Back

14   HC (2010-12) 1753, Q 53 Back

15   HC (2010-12) 1753, Q 55 Back

16   HC (2010-12) 1753, Qq 16-17 Back

17   HC (2010-12) 1753, Q 13 Back

18   Response from the Court, para 11 Back

19   HC (2010-12) 1753, Q 19 Back

20   Response from the Court, para 10 Back

21   HC (2010-12) 1753, Q 51 Back

22   HC (2010-12) 874-I, para 62 Back

23   HC (2010-12) 1753, Qq 184-6 Back

24   See Response from the Court, para 5 Back

25   HC (2010-12) 874, paras 86-8  Back

26   HC (2010-12) 1753, Qq 64-5 Back

27   HC (2010-12) 1753, Q 67 Back

28   HC (2010-12) 874, para 87. The Committee also said in the same paragraph that "The fact that the Freedom of Information Act excludes such functions is irrelevant: Parliament should receive material from the institutions it holds to account well beyond that which would be available under FoI. The Court should be willing to provide all information required by this Committee to meet the requirements of parliamentary accountability, not hide behind Freedom of Information provisions." Back

29   Response from the Court, para 28 Back

30   Ibid., para 30 Back

31   HC (2010-12) 874, para 166, Back

32   Response from the Court, para 31. The Governor appeared to be suggesting that there might be different triggers at one point when he gave evidence, but later stated that he wished to see two criteria being met before the power of direction took effect. Back

33   Response from the Court, paras 7 and 31 Back

34   HC (2010-12) 1753, Qq 73, 77, 78, 81  Back

35   See Rt Hon Alistair Darling MP, Back from the Brink, 2011, pp. 318-319 Back

36   Response from the Court, para 50 Back

37   HC (2010-12) 1753, Q 113 Back

38   See HC (2010-12) 874-II, Q 155 and Q 244, and Ev 109 Back

39   See HC (2010-12) 874-II, Q 155 and Q 244, and Ev 109 Back

40   HC (2010-12) 1753, Q 121 Back

41   HC (2010-12) 1753, Qq 113, 119  Back


 
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Prepared 23 January 2012