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CORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 874-iii

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

Treasury Committee

Accountability of the Bank of England

Monday 20 June 2011

Professor Rosa Lastra, Professor Bob Garratt, Dr Andrew Hilton and Jane Fuller

Evidence heard in Public Questions 256 – 312

USE OF THE TRANSCRIPT

1. This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.

2. The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Treasury Committee

on Monday 20 June 2011

Members present:

Mr Andrew Tyrie (Chair)

Mr Andrew Love

Mr George Mudie

Jesse Norman

Mr David Ruffley

John Thurso

________________

Examination of Witnesses

Witnesses: Professor Rosa Lastra, Professor in International Finance and Monetary Law, Queen Mary, University of London, Professor Bob Garratt, Cass Business School, Dr Andrew Hilton, Director, Centre for the Study of Financial Innovation, and Jane Fuller, CoDirector, Centre for the Study of Financial Innovation, gave evidence.

Q256 Chair: Thank you very much for coming this afternoon. I am sorry there has been a slight delay-we had some private business which we had to get through. I regret that we are a little depleted today because there is an urgent question in the House on a related matter-the eurozone. As you can imagine, several colleagues have decided that they want to participate in that.

Could I begin perhaps with Professor Garratt, and ask him, given that there has been no satisfactory review of where the Bank went wrong in this crisis, whether it is a good idea to give the bank more powers to try and prevent the next one?

Professor Garratt: That is an important question to start with. I am a corporate governance specialist, and in truth I can’t answer that question. I have opinions but they are not necessarily worth anything, and I am shocked that there has not been an investigation at national level as to what occurred there. My experience comes mainly out of the banking field in relation to this Committee, and I shall mention briefly that for 10 years I worked with Sir Brian Pitman at Lloyds, and then Lloyds TSB. He took me aside in the very early days when I was going to run their director development programme, and said, "You will never be a banker and you shouldn’t be a banker. That is not what you are here for. The only thing you need to know about banking is there are two bits to it. One is called retail, this is the high street stuff, and there you know your customers, you lend them not quite as much as they want and then you track them like hawks. The other side is called investment banking, and it is very simple: you never trade for yourself", and that is all he ever said to me about banking.

Chair: Paul Volcker would have been very happy with that.

Professor Garratt: In relation to your specific question, I am amazed-and a lot of my work is international and overseas folk I know are just astonished-that we have never had a proper investigation as to what went wrong. I can say a little bit more perhaps later in the session about when I was brought into one of the banks that failed, literally a couple of weeks beforehand.

Q257 Chair: Since you are amazed, does that bring anything to bear on your view about whether the Bank should be given more power?

Professor Garratt: I think the Bank could fulfil a crucial national role in the way it is proposed to be set up, with a few modifications, particularly around the committee area, but I see no reason why it should not be the major player in that area, provided that it behaves as a properly constituted company and has the checks and balances within it?

Q258 Chair: Okay. Does anybody else want to add anything to what has been said?

Professor Lastra: Yes, I would like to add something. In the aftermath of the crisis it is clear that there were supervisory failures. There were supervisory failures in this country, in the United States and in other countries. In the United States at the moment there has been a great deal of criticism directed at the Fed, the central banking system in the United States, which leads me to think that the failure was not so much in who was supervising, but in how they were doing it. Supervisory failures stemmed from the fact that supervision was not done correctly. So from that perspective, the view that has now been embraced in different fora of macro-prudential supervision looking at systemic risk is a sound idea, because although supervisors were looking at individual trees-not necessarily always very well-they didn’t have a view of the forest. That is the concept of systemic risk control, the concept of macro-prudential supervision.

The remit of your inquiry is the accountability of the Bank of England but somehow there are two interconnected issues. One is the issue of governance-on which Professor Garratt is giving evidence-and that is how an institution is governed and directed, and what role the Court of Directors would have and what should be the interaction between the Prudential Regulatory Authority and the Bank of England. The other more pertinent one for the remit of this inquiry is the issue of accountability. That is to whom is the institution accountable; to whom does it have to give an account, to explain and justify its actions, decision or omissions? I think that the Treasury Committee has a very important role. If you look at the accountability from the perspective of agency theory, in fact the Bank of England is much more an agency than a bank these days. Like many other central banks, it fulfils a number of state functions delegated by the Government with a degree of independence. In that sense, it must be accountable. It must be accountable to the Treasury and to a Treasury committee. So it must be accountable to the Government, to the House of Commons, to Parliament, and also to the National Audit Office and to the judiciary; but the powers, per se, in terms of macro-prudential supervision are all right, as long as there are adequate mechanisms of accountability.

I am much less sure about the powers of the Special Resolution Regime. The Bank of England has a danger of becoming a ‘regulatory Leviathan’, doing everything, and some things the Bank of England, the Central Bank, is very good at; other things it might not be as good at. That is just the beginning. I do not want to take too much time.

Chair: We will come on to that in a moment. Everybody wants to chip in now.

Dr Hilton: Two brief points: one is that before the crisis, the Bank did have a responsibility for macro-prudential supervision. It was the financial stability wing of the bank. As one senior bank official said to me, "That is the collapsed left lung of the bank". It simply wasn’t of great interest to the Governor at the time. He permitted it to wither, because he was more interested in the monetary policy arm of the bank, and he was more interested generally in monetary policy. So this isn’t quite as new a focus on macro-prudential supervision as people suggest. Secondly, while I guess over the last 10 years I have never heard anybody in the City say a good thing about the Financial Services Authority, at the same time I have never heard anybody ask that it should be folded back into the Bank. I had a rather unpleasant vision that putting financial regulation back into the Bank of England was rather like taking a six-month-old baby and trying to stuff it back into the mother. It is not something that would work. They were not happy with the FSA but they had learned to live with it. This is a huge change that was not demanded by the market that it is being regulated or supervised.

Jane Fuller: I was just going to make that point, that it is very important to remember that the Bank of England has always been responsible for financial stability, and in that context perhaps there should have been a report, a post-mortem as to why it didn’t discharge that duty very well, and the FSA has done better on that count. We have had a report on Northern Rock, and, albeit dragged out kicking and screaming, we are going to see a version of the report on Royal Bank of Scotland and bank silence.

Q259 Jesse Norman: So far you have highlighted two failures of the Bank in regard to its dealing with the financial crisis and in the run-up to the crisis. One is a failure of supervision, and I suppose in a sense that is the same as, or similar to, a failure of its own operations in the area of financial stability. Now, can we be clear about if there were any other ways in which you think the Bank failed in its operations in the run-up during and after the crisis? Perhaps we could start with you, Dr Hilton.

Dr Hilton: The only point I would make is that an awful lot of the Bank’s success over the years has been either informal or semi-formal; people used to talk about the Governor’s eyebrows. What the Bank was enormously good at was putting feelers out into the City, and the establishment of the FSA left the Bank of England with a responsibility for financial stability but took away a lot of these links that it naturally had into the City. There were efforts. I can’t remember who the executive was at the bank who instigated these grey panthers. I used to like the idea of people being licensed to lunch: recent retirees in the City, who I always felt ought to be given a lunching budget to report back to the Governor and to the senior executives of the bank heard the rumours-that was a capability that the Bank had in previous years that to a large extent it lost.

I think the Bank was culpable in letting that slide, because after the FSA was established, its focus moved very much to the Monetary Policy Committee. The focus of the Bank is almost exclusively on monetary policy in this country, but if someone were to tell me what the FOMC was doing in America on American foreign policy, and what the ECB was doing on European monetary policy, I would tell you pretty much what the UK ought to be doing on monetary policy here. So we spent an awful lot of time and put an awful lot of effort into something that is largely market determined.

Q260 Jesse Norman: Would anyone else like to add their own feelings on the failure of the Bank?

Professor Lastra: Yes, I would like to say that-

Jesse Norman: Briefly, if you could, because we are a little conscious of the passage of time.

Professor Lastra: The Bank of England was influenced by group think with regard to monetary theory, and I think that the narrow focus on inflation control measured by the CPI ignored asset prices, ignored property prices, and I think that that was a failure. In the years of the boom, it was perceived that perhaps the Bank of England was operating with great moderation, but in fact it allowed the bubble to continue and when it burst it was even more severe.

Jesse Norman: Thank you for that.

Professor Garratt: My feeling from the papers I have read is that the Court wasn’t fulfilling its full duty of horizon scanning in this area.

Q261 Jesse Norman: The Court? The Court did not discharge its duty of horizon scanning?

Professor Garratt: Yes, that is exactly what I feel at the moment, so that builds on what Dr Hilton has said. The only bit I would add to that is for me horizon scanning is much wider than macro-economic policy, and that is why you need some diversity in the Court to bring in some of those other issues, which would include social, economic, environmental, and so on; that element.

Jesse Norman: Thank you. Did you want to add anything?

Jane Fuller: It was producing financial stability reports, and Mervyn King said it was like preaching from the pulpit and then you lose control of the congregation as soon as they leave, but it was still a very powerful body with this financial stability remit. We are still part of the tripartite arrangement, so I think there were things it could have done and did not and, as usual, it is not just a question of architecture-it is the will to do something about it.

Q262 Jesse Norman: Thank you. So is it your common view that there should have been a report by the Bank of England into its own deficiencies before and during the crisis?

Jane Fuller: Yes, or by somebody else about it.

Q263 Jesse Norman: Yes, but commissioned by them in some sense?

Jane Fuller: Yes, like the FSA.

Q264 Jesse Norman: Okay, that is helpful, thank you. Is it your common view that the Bank should not be given more power, given how poorly it has discharged its existing powers?

Jane Fuller: That would not be my view, because I think that the twin peaks model does make sense-prudential regulation does sit better within the Bank than alongside consumer protection, so what you are going to discuss in the proposed legislation is how to get that right through the Financial Policy Committee and the Prudential Regulation Authority. I think there are difficulties in splitting them up, but I think it is still the best place to put it.

Dr Hilton: I would endorse what Jane says; it is a step too far. There are criticisms to be made of the Bank, there are criticisms to be made of the FSA, and nobody really wanted the disruption, but to a large extent the disruption has already taken place.

Q265 Jesse Norman: Historically, has the Bank ever been held properly accountable for its decisions? Was there ever a point in the Bank’s history where it could be said to be held genuinely accountable; for example, after the gold crisis in the late 1920s?

Jane Fuller: There have been some excoriating reports, for example, after BCCI; I think after that.

Q266 Jesse Norman: Does Parliament have adequate resources to hold an enlarged and re-empowered Bank to account, especially if its own self-regulatory institutions are not working?

Jane Fuller: Well, why not? It is an interesting question as to how much input the Treasury has into what is happening at the bank. There is obviously a problem, because the Bank of England is supposed to be independent. Having said that, we are all shareholders in what is going on and-

Q267 Jesse Norman: I guess I am thinking not of the Treasury but of Parliament itself.

Dr Hilton: Certainly, many of the criticisms that have been made are that the new regulatory structure is not directly responsible to Parliament, to the Treasury, the Select Committee, and so on and so forth. There is a wonderful case to be made that our regulatory system is now so big, so complicated, so diverse and so important, that it warrants a special committee of its own to provide oversight on a regular basis. I think the argument for that is pretty overwhelming.

Jane Fuller: Isn’t that what the Treasury Committee has spent a lot of time doing over the past three years?

Dr Hilton: I would assume the Treasury Committee has many other things on its plate. This is financial regulation, financial supervision. It is Brussels, it is IOSCO and it is Basel. It is thousands of interactions that the regulatory system has internationally. All of those are important enough to warrant their own committee.

Jesse Norman: Thank you. Before I close, could I get a view from Professors Garratt and Lastra as to whether or not they share that view: that at the moment Parliament is greatly under-resourced in reviewing these issues?

Professor Lastra: I do agree. The main source of accountability in a democracy is parliamentary accountability, and in order for it to be exercised effectively you need proper resources, including dedicated personnel and a dedicated committee, so I would second that. I would also second the view expressed that, although some of the powers that the Bank of England will be given are a step too far, general responsibility for financial stability has a great deal of synergy with monetary policy. Indeed, part of my criticism of the Bank is that had it had a view of the forest, rather than individual trees, with regard to the financial system, it could have maybe acted earlier and better.

Professor Garratt: I agree with that. I am not a specialist in this area, but what I see is that, however it does report to Parliament, the actual corporate governance structure at the moment needs a lot of tidying up, and the committee structure especially needs a lot of focus.

Q268 John Thurso: Can I pursue the question of accountability to Parliament; and just to let you know that I think my colleague Andy Love is going to ask some questions around the Court, so it is not that particular area I am looking at. To perhaps start with you, Professor Garratt: when Charles Goodhart came before us he made it very clear that, above all else, the FPC needs a very clear dashboard and a set of four or five clear guidelines. This would very much correspond to your comments in May of the dashboard and KPIs, I would think. Are those KPIs the same as targets?

Professor Garratt: In the short term, yes, but in the long term-I was looking at the trends coming out of those, and that is why I think the notion of the Court as the key oversight body within the Bank is so important, because it is meant to be looking at those internal and external trend lines that come out of the dashboard.

John Thurso: Those dials, I will call them.

Professor Garratt: Yes, sure.

Q269 John Thurso: Because what one is looking to see is whether it is closer to cold or hot or empty or full-

Professor Garratt: Yes, exactly. That is exactly what it is.

Q270 John Thurso: -and possibly where several of them are going. I need not ask you, because you have already said that you think this is absolutely vital for the FPC to have these. What is the counter-

Professor Garratt: Sorry, could I interrupt just for a second? I think it is vital that the Court has them, and then there are subsets within the committees.

Q271 John Thurso: Right, so your point is: all relevant parts of the bank and that that comes together with the Court viewing the whole thing?

Professor Garratt: Exactly.

Q272 John Thurso: I am particularly interested in the FPC, the reason being that the MPC, it seems to me, is very clear: there is a remit from the Chancellor with an absolutely clear target. They discuss it; they take a decision; they report publicly to us; write to the Chancellor, and everybody knows where they are but, since nobody can define financial stability, at the early part of this is everybody trying to work out what on earth they are doing, how they are going to do it and who is going to take charge?

Professor Garratt: Yes.

Q273 John Thurso: Therefore my next question is the other side: if a suite of dials on a dashboard for the FPC are put together, is there a danger that they then say, "Right, we have cracked it. We have our four dials. We don’t need to worry about anything else" and they take their eyes off the general picture that is so important?

Professor Garratt: That is why I was so keen to stress that the Court has the overall view on those trend lines. In a lot of companies now it is called "the PPESTT analysis", and it is: politics, physical environment, economics, social trends, technology. They are doing that stuff at the highest level and then the committee structure within it is doing the checks, through dashboards and other trend lines, and so on, but feeding in. It is the Court in the end that has to take the final judgment on whether they are keeping their eye on the ball or not.

Q274 John Thurso: Which is quite different, of course, from the MPC, where the Court is specifically excluded.

Professor Garratt: Yes, exactly, and that is a very odd structure and I find it quite alarming, but I will leave that aside.

Q275 John Thurso: All right. To what extent is financial stability almost an audit, in the sense that you want somebody almost outwith the day-to-day grind who is saying, "Well, notwithstanding everything you are doing, when I stand above the fray and look at it, there is a real growing systemic danger". If it is of that nature, is it, to a certain extent, to put the auditor into the Executive by putting it into the Court or reporting to the Court?

Professor Garratt: Reporting to the Court, yes.

Q276 John Thurso: Should it perhaps report more in the way that the auditors report to the Audit Committee, rather than via the Executive?

Professor Garratt: I notice that the Audit Committee name and function has changed-so Audit and Risk Committee-and I guess part of what you are talking about is assessments of the macro risk as well as the micro risk within the Committee itself. I do not have a simple answer to that, but I know it is possible to set up systems to do that.

Q277 John Thurso: One quick question, if I may, to Professor Lastra. You have said that one of the key things was not so much who but how things should be done, but you then went on to ask the very pertinent question, "To whom should the FPC be accountable?" Is there an argument to say that financial stability is a political rather than a mathematical judgment and it is a prime task of a Government and the head of the money and finance Ministry, whoever that may be, and that the FPC ought to be under the auspices of the Chancellor, rather than the Bank?

Professor Lastra: Can I take the two questions on the point that you mention and refer to the point made by Charles Goodhart, a former mentor 20 years ago. I think it is a very important issue, because there are two dimensions to accountability: one is performance and the other is the institution that checks and balances. Necessarily, you need to have some targets, some way of quantifying it, and the point that he made refers to the criteria of assessment and the content of the obligation. So you have the accountable, the accountee and the criteria of assessment. It is true that, with regard to financial stability, we are still trying to define what systemic risk is. So, in the same way as we say that monetary stability is the control of inflation, we say that financial stability is the control of systemic risk, but we still haven’t figured it out-although a lot of literature is developing-and that will be a very important element of the obligation, of the criteria of assessment for a Committee like yours and for parliamentary accountability generally.

As for your other question, yes, financial stability is not only a central banking goal. I agree that it is also a political goal. Through the crisis we saw the importance of financial stability for peace in society and the economic situation. So, financial stability is a goal that transcends institutional mandates. It is also for the Financial Services Authority-the FSA-for the central bank and for the Treasury. It even traverses geographic boundaries, which brings it into the international dimension. Nothing that is done in this country alone would be sufficient to control systemic risk unless we have a view of how much leverage is developing in the financial system generally, given its interconnectedness. So now there is the model that has been followed in the United States with the Financial Stability Oversight Council, which includes the Treasury but also includes the regulatory authorities, including the federal regulation system, the central bank, so that would be my answer to your question.

Q278 John Thurso: The critics of the American system say that it has one of everything in it. It is like a bag of liquorice allsorts, there is somebody from everything, and therefore it is just becoming a talking shop because nobody is responsible for gripping it, and the argument for the FPC being in the bank is: everything is in there. If it goes wrong, it is your fault, end of story.

Professor Lastra: Yes. However, the Treasury still has an important role, because it is the Treasury that will commit public funds, so definitely. In the same way as there were failures in the tripartite arrangement, it was recognised that, at the end of the day, public funds come from the Treasury and therefore any decision that involves public funds must take into account the Treasury view.

John Thurso: Okay, thank you.

Q279 Mr Love: Dr Hilton, can I come back to the responses you gave earlier? I am going to characterise what you said, so you can disagree with it if you so choose. I rather gathered that you had expressed scepticism about the need for all of this change and the uncertainty that is created, recognised the benefits of forming the PRA and the FCA, but I wasn’t clear as to how you felt; you expressed some scepticism about the Bank of England’s role. Can I just be clear, if you were given the option of putting the structure together, how you would see the Bank of England operating within that structure?

Dr Hilton: I suppose, had I been put in the position where I was going to design the architecture, I probably would have said, whatever shortcomings the FSA has, it is better to work within the framework of the existing FSA and make it work better, which is not by any means impossible. I would have accepted that the Bank of England always had a role in financial stability, but it required a shift of attention within the Bank from the monetary policy wing to the financial stability wing, and much closer links between that wing and the FSA.

I accept what my colleague, Jane Fuller, is saying. That there has always been an argument for a twin peaks regulatory structure, where we take prudential and conduct of business rules and we put them in different institutions, or at least in different bodies within perhaps the same institution, but I think there is a huge cost to the kind of disruption that we are going through. The end result may be acceptable-I am sure it will be acceptable, because it is largely going to be the same people-but there is a cost of getting to there from here, and that I think is something that has perhaps been under-costed. At a time when the UK’s role as a financial centre is under threat, at a time when European rules and regulations are starting to impact, we needed to have a lot more attention on what was going on in Brussels, and a lot of attention has been looking at our own internal structures and not really at how we are going to be affected by what is in going in Brussels, in Basel and elsewhere.

Q280 Mr Love: I could almost characterise that as being the position that was taken up by the last Government, but I shall not pursue that line.

Let me turn to Professor Garratt. You have expressed a view about the role of the Court. Why should the Court be given a role in terms of policy in relation to the Financial Policy Committee?

Professor Garratt: That is a very tricky one for me to answer, because in corporate governance terms policy is very clear: it is the highest level at which the directors of the organisation state their political will to go forward, so it is a very high-level concept. One of the problems I have had, in reading the few papers that I have had access to, is that policy seems to be operating at least three different levels, some of them around the committee area, and some at a very high level such as the national policy debate. My concern is that the Court is the highest level of policy decision-making for the Bank of England. It has three or so committees reporting to it with recommendations on policy, on which it takes the judgment, and then in turn it is accountable and responsible to Parliament, with you, as the Treasury Committee, being the intervening variable and the oversight there. I am arguing very strongly that the Court needs to have a very strong policy role in itself as an organisation, as well as playing it out at the national level.

Q281 Mr Love: Is that how it has been envisaged? It is after all termed a supervisory board that manages the Bank of England. It certainly does not have a role in terms of monetary policy, and it hasn’t been presumed that its membership would include people who had the relevant skills and expertise to form a financial stability role.

Professor Garratt: That has been my puzzle, because you have a unitary board, not a two-tier board. There isn’t a supervisory board, and that is why I gave the response I just gave because, at the moment, it is structured under the company law as a company with a unitary board.

Q282 Mr Love: Can I ask Ms Fuller, do you think they have the qualities, the experience and the expertise to undertake a policy role under the current construction of the Court?

Jane Fuller: In the Court, as you have just described it as a supervisory board, the managerial role has become much more important. So an Audit Committee will put in a report about the Bank’s operations and not financial stability. I think there is some confusion here between governance of the Bank of England and how you run financial stability through the Executive. I think the Court is to do with the governance of the Bank of England, in which case the Audit Committee is very important. For example, we now have an enormous balance sheet to look at following QE 1 and 2. It was only reformed a couple of years ago. So I think to push it and to make it a very good supervisory board with the governance committees, like the Audit Committee, the Nomination Committee reporting to it and to make those work really well, with lots of independence, would be what I would be looking for in the Court.

If you let yet another body have its sixpenny-worth on financial stability policy and monetary policy, I think everybody is going to go mad. If there were some sort of dispute-and I suppose the interesting thing, having said that, is that it has been assumed that you can separate monetary policy from financial stability policy, but you can’t-and if the problem is too much credit expansion, and for some reason the MPC isn’t raising interest rates, then you could look to the Financial Policy Committee for some specific problem; for example, if there was a bubble in the housing market, to impose a loan-to-value cap or something. If it is not being done by interest rates, it could be done by one of the tools of the FPC, but this is going to have to be really well co-ordinated because to some extent they are both going to aim at the same thing.

In terms of the political issues, it is going to be difficult for the FPC because it too-like the MPC-is supposed to take account of the economic situation, and maybe it should not do something if it will suppress economic growth. So I would like to see more clarity in terms of the role of the Court, conventional governance, the FPC and the MPC, how they work together, with awareness of some of the political difficulties that they will be operating under.

Q283 Mr Love: I presume you don’t subscribe to the view that has been put to us by others that, because of this co-ordinating role, the two committees should in fact be one committee?

Jane Fuller: I think they could have been. In Asia, they are not going down this road and they don’t seem to have the same trouble curbing credit growth. The Central Bank uses the tools that have traditionally been at any Central Bank’s disposal.

Q284 Mr Love: I assume you all agree that there is a role for the Court-a supervisory board role to monitor and manage. What I want to be clear about is where you all stand in terms of the policy aspect and stability-which is of course a role for the Bank and, as you indicated earlier, always has been-whether the Court should have any responsibility, as has been suggested.

Dr Hilton: I am not sure. I agree entirely with my colleague on the role of the Court: the Chairman of the Court has 35 years in the metal-bashing industry. He does not know that much about financial stability and I don’t see why he should. The role of the Court seems to be the management of the bank. Whether we make a mistake by drawing too clear a comparison between the MPC and the FPC, I worry slightly, as they are very different. We have already talked about the fact that monetary policy is much easier to determine: the tools that apply; the indicators that the committee would look at. Financial stability is a much more nebulous concept. However, I do think that crises occur on a Friday and have to be resolved over the weekend, and I think a committee that meets four times a year is probably not best adjusted to meet the crises as they come up, so I worry about that.

There is obviously a lot of overlapping membership, at least as it stands at the present time, with the interim Financial Policy Committee and the MPC. To that extent, there will be shared experience between the two. I think there probably should be because, as Jane points out, the two committees, if they were truly independent of each other, might conceivably, under realistic circumstances, head in different directions. I do worry that the Financial Policy Committee needs to operate almost day-to-day because when crises occur, they occur unpredictably and they require intervention immediately. You cannot say, "Okay. Well, we will put that off for a month". You can conceivably put off interest rates for a few weeks but you can’t put off crisis resolution, even for a day.

Q285 Mr Love: It sounds like a return to the old days of the Bank of England deciding things over drinks in the Executive suite. How would you answer that question? How should they be structured at this point?

Dr Hilton: That obviously is unacceptable in contemporary regulation, but I think that the Financial Policy Committee has to have continuing resources. It has to have a staff that meets regularly. I think the times that the committee meets formally, is irrelevant. The question is: how quickly can you put the committee together informally? Can you bring it together either in body or virtually? Can you bring it together at a couple of hours’ notice? When these crises come up, there has to be the capacity to pull that committee together and to put in front of it all the facts, which means that it has to be resourced with real staff with real information. This is the debate that we have that you have already raised about the equivalent of the American office of financial reporting. Should there be a data-gathering part that has a continuing obligation to put the important facts-the data-in front of committee members, but on a very immediate short-term basis?

Q286 Mr Love: Professor Lastra, you wanted to comment?

Professor Lastra: Yes. I am not so sure about the role of the Court. I read the testimony that Willem Buiter submitted. From the comparative experience of other central banks around the world, the role of the Court is somewhat odd. It is clear that we need financial stability-that was one of the lessons of the crisis-and the quintessential central banking role is monetary policy. It is also clear to me that if there are going to be two committees, they should have equal weight and they should have close co-ordination. But corporate governance, which is what Professor Garratt was talking about, has a great deal of importance when you are dealing with a company corporation. I think-and I agree with Willem Buiter-that the Bank of England has evolved much more and become a quasi-autonomous agency, so it needs to be accountable to the system of checks and balances, to Parliament, to the Executive. Therefore, I think that the role of the Court sits where it can have a useful role in the supervision of the management of the bank, but not in actual policy making.

Q287 Mr Love: You would not abolish it, as Professor Buiter has said, and replace it with some accounting and supervisory-

Professor Lastra: I would not go that far, but I can see the point that he makes and, from comparative central banking experience, there is a fair point in what he says. Still, from the point of view of management of the Bank, it can have a useful supervisory role in the management of the Bank itself.

Q288 Mr Love: Professor Garratt, accepting what has been said about the critical importance of monetary policy and financial policy, do you stick by your-if I may say so-traditional view that the board of directors of the Court should have responsibility in these areas, when clearly that has not been an aspect of the way in which they have been chosen in the past?

Professor Garratt: Yes is the simple answer to that.

Q289 Mr Love: What do you think could go wrong with what is being suggested that would lead you to say, "Please be careful in the way that you structure this, and give responsibility to the Court"?

Professor Garratt: The key thing for me-the great puzzle for me-is the fact that the Monetary Policy Committee of the Bank of England doesn’t report to the Court, apparently, according to the paperwork I was sent. I have asked a few people about this and the answer seems to be, "No, it doesn’t". It reports to you folk is the very clear answer I have had from three people so far, remembering that I only arrived in from France less than 24 hours ago. So I am very worried that you have apparently three committees effectively of a board, namely the Court, one of which does not report to the Court. That alarms me greatly, because you can see all sorts of fun and games, in power politics terms and policy terms, going horribly wrong there.

Q290 Mr Love: Let me put to you, as I suspect others would, that the price that had to be paid for giving responsibility for the decision on such an important issue as interest rates to a group of independent people on the Monetary Policy Committee was proper accountability to the people who had taken the decision before the Government and Parliament. That is why it was set up in that way. You are asking us to put in a second lens, not just have a Monetary Policy Committee but have a Court that intervenes before-

Professor Garratt: Yes, that is exactly what I am saying.

Mr Love: Even in the circumstances where I am-

Professor Garratt: Yes.

Mr Love: You are indeed a true academic.

Professor Garratt: I hope not. I have been a company chairman for years.

Q291 Chair: Could I just ask Professor Lastra a question? You said a moment ago that the Court can have a useful role in the management of banking staff. When the Court oversees a reduction in the number of staff responsible for financial stability or international financial issues, as took place in the six years prior to this crash-in the successive years, you can see this from the accounts-are they taking a policy decision or are they taking a staff management decision?

Professor Lastra: I think they should not take policy decisions, but whether they have taken them is something that I am not sure about. However, I would think that going forward, given the importance of having proper decision making, both with regard to monetary policy and financial stability, and considering that there are linkages between the two going back to the twin goals of central banking. For instance, Vera Lutz Smith wrote in 1936 that they are stable money and sound banking. For some time in the last two decades, there has been-maybe with the transfer of supervision away from the Bank of England-a loss of attention to financial stability, which is the modern equivalent of sound banking. It is an extension of that.

So I think these decisions are so important, so time-consuming and require so much constant access to technical data that, to me, the times that the Court meets, the composition of the Court and the commitment in terms of full-time work cannot be policy decisions. The decisions of the Court are like an internal audit, but you still need external audit. That is why I say that the Court sits oddly because it is not a company like any other company-it is much more like an agency. An agency that has delegated powers needs to give an account of those powers to the sources of democratic legitimacy, which is mostly Parliament.

I am not sure that I have answered your question but, as you can see, I am not a great believer in giving more powers to the Court. I think we need clear decision-making, with regard to monetary policy and financial stability, and the arrangement of having the Financial Policy Committee as a committee of the Court is something I don’t believe in.

Q292 Chair: It is a very sophisticated reply, but I am not sure that I am any the wiser because they did take that decision. This is not a hypothetical example, and many argue it did have the effect of reducing the Bank’s capability to respond to this crisis.

Professor Lastra: They reduced it to nine, but there used to be 12.

Q293 Chair: No, that is the number on the Court. I am talking about the number of staff that the Bank itself devoted to the task of monitoring financial stability in international financial issues.

Professor Lastra: Well, to financial stability, very little. They dedicated a lot of time and attention to monetary policy but, going back to your question, part of the failure of the Bank of England is that, in the years preceding the crisis-and here I would disagree with my colleague, Dr Andrew Hilton-they did not pay a great deal of attention to some of the financial stability issues that were definitely showing signs of a bubble.

Dr Hilton: That would not be a disagreement. That would be in agreement with me.

Professor Lastra: Okay, then-

Dr Hilton: Normatively, they should have done.

Jane Fuller: The short answer is that the supervisory board should make sure that the Bank has the resources to do its job. It will oversee the strategies being implemented, including running financial stability properly, and it has to make sure that the resources are there to do it and it has to accept responsibility if it has had some responsibility in undermining that.

Dr Hilton: The Chairman of our little think-tank, Sir Brian Pearse, used to be a member of the Court. In the old days the Court was largely staffed with-not staffed, what is the word?-the members of the Court were former bankers or senior bankers, and they had those networks into the City so that they could indeed make a judgment on systemic threats. I think it is a more recent development with the Court that it has lost that kind of talent and instead taken on people whose skills are really corporate governance skills-the skills of a generic board as opposed to specifically a board made up of people interested and knowledgeable about financial stability issues.

Q294 Chair: Before I hand over to David Ruffley, it does sound-listening to you all and picking up on quite a bit of the written evidence we have had-that wherever we place it, a body with a good deal of experience needs either to be created or the Court needs to be buttressed in a form that can play quite a sophisticated supervisory role, and that what we think of as policy, and what we think of as process or resources, inevitably are going to overlap to some degree, and that this body has to be given some discretion to engage with a high level of support in thinking through whether the Bank is doing a proper job. Is there anybody disagreeing with that?

Professor Lastra: Not disagreeing, but I would say that the concept of governance and internal governance is different from the concept of accountability: who guards the guardians? So I would still favour giving further resources to Parliament and to a parliamentary Committee, like this Committee, because the accountable and the accountee cannot be the same, and somehow in the Court you also have some of the people who are taking the decisions.

Q295 Chair: So you think Parliament should be doing this?

Professor Lastra: Definitely.

Q296 Mr Ruffley: Dr Hilton, you have painted a picture that really runs like this: financial stability was the collapsed left lung. You think macro-prudential regulation would better sit in an improved FSA. It should not necessarily go back to the Bank, but I think you have nevertheless conceded-I think we all have to concede-that the FPC will sit as a subsidiary or as an entity of the Bank, and then the PRA will be a subsidiary of the FPC. The FPC has to get tooled up properly, doesn’t it, and you have given two examples of where best practice might point us in the direction of amendments to the Government proposals. As I understand it, financial crises and unstable events can come at virtually any time, and you have implied there should be more frequent meetings than is perhaps envisaged. Do you think that should be a weekly meeting?

Dr Hilton: I think I would like to get away from the idea of separate, discrete meetings. This is a continuing party. I am not sure even if the word "committee" is quite right; it is a body. It should be a continuing body that deals with systemic stability issues going forward. That might mean that it should be staffed almost on a full-time basis. It certainly should have a full-time staff backing up whoever are the key people on that body.

Q297 Mr Ruffley: I think you also referenced a US practice where a specific-I forget the name of it now-body is responsible for the data collection.

Dr Hilton: The financial reporting office, which is a very interesting initiative. I assume that this has been raised by other people. Nobody quite knows how it is going to operate. It is a creature of the Treasury, but it is independent of the Treasury and it is going to have responsibility for collecting, collating and disseminating data on the stability of the financial system. It will be staffed. The head will probably be an academic, not a career Treasury official, somebody whose experience is in data collection and data management. Most people in the financial regulatory world are looking at this with great interest to see if it works and whether we should bring it in over here.

Q298 Mr Ruffley: Forgive me, but historically the Bank of England has had a very prominent role in financial regulation in this country generally. Why do you think there would not be adequate officials in the Bank of England to do that kind of work on financial data?

Dr Hilton: Because there is so much financial data now. It is at a European level; it is at an international level; it is also at a UK level. There are many competing bodies in this space: the National Audit Office is obviously one; the Treasury has a lot of information; there are all the Brussels agencies and IOSCO. There are dozens of acronyms stacked up to the ceiling, all of which have behind them bodies of data. I think certainly we could piggyback on the work of the office of financial reporting in the US. I don’t think the intention is that any of this data should be proprietary. It is public data. Some sort of co-operation agreement with the OFR would make a lot of sense for the UK. We are dealing with international banks and international data.

Q299 Mr Ruffley: I will get on to the Court in a minute, but could I ask for your views on the composition. The shadow FPC has the Governor, two Deputy Governors and the current Head of the FSA. That is four voting members. The Governor can appoint two executive directors on top of that, who will be bank creatures. So that is six insiders and only four externals who will vote, and I think the 11th man is non-voting, but would be from HM Treasury. Does that seem to you an optimal mix: effectively, six insiders on the FPC plus four externals? One might even argue that one of the externals is a bank insider. I think you know who I am referring to. What are your thoughts on that?

Dr Hilton: My thoughts are there are not enough externals, and we have probably at the moment, if the interim FPC is an indicator of what the permanent one will be, probably the wrong outsiders. I think one is an investment banker and one is a former Fed official. So one is a regulator, an American regulator, and one is an American investment banker. I think this is not representative of the kind of skill set that we ought to have from the outsiders on this committee, but I defer to others on this.

Q300 Mr Ruffley: It brings me to my final question. Given that all these things need chewing over in some detail-the frequency of the meetings, the adequacy of the resourcing so that good policy decisions are made, whether it is a permanent body following things in real time, or a secretariat at least, how the externals are performing or whether or not there are enough externals-it seems to me that there are a lot of questions that you have referenced today and that this Committee has looked at, and doesn’t that argue for a really high-powered technically informed Court? Because the Court is tasked with being the body under this regime responsible for the FPC. Doesn’t that worry you, because in the Court, as currently comprised, there is a lot of room for improvement when it comes to the technical adequacy of some of the members who will, if nothing else changes, be the body to whom the FPC is accountable? Does that really worry you, because it rather worries me?

Dr Hilton: In my opinion, there has to be that body. Whether it should be the Court, I don’t know, or whether it should be a parliamentary committee. There are various ways of skinning that particular cat. The Court, as currently constituted, would not be a satisfactory body for that kind of role, but I am inclined to share the view of my colleague that perhaps that is not is the role that the Court should really be filling.

Jane Fuller: I think you need more external input on two counts. One is to get the right sort of expertise as the external members of the FPC. Arguably, I think that it should be at least as many external members as internal, and that they should be people more from the real world, in terms of spotting credit bubbles. That is the thing we are most worried about.

The second thing is that you do need a counterweight to the bank. Mervyn King chairs virtually every committee. He and his executives dominate, they are in the majority and they have all the resources, and from a governance point of view it looks as though we are lacking challenge and counterweight to the Executive.

Q301 Mr Ruffley: I agree but, given that this structure or something very like it will be enacted-let us just assume that-the role of the Court becomes even more important. I wondered what sense any of you on the panel have as to how we could beef up the technical adequacy and proficiency of the overseers of the FPC, monitoring the performance of the externals and the resourcing of the Secretariat that will supply FPC members with data. It seems to me that to understand whether the FPC is doing a job or not-and the Court has been tasked with that-would require the Court members to be technically more adept and competent than certainly we have reason to believe they are at the moment.

Professor Garratt: As statutory directors of the Bank of England, they have a 24/7 responsibility and I think their commitment to that is as important as some of the technical skills. I am not saying that technical skills are not important, but it is the whole ethos that is created around that Court and the whole way in which you fight that was mentioned in the papers-the group think and all those elements-that is so important. I can think of many ways in which it is possible to build really effective boards like that. In my limited experience of central banking, the most extreme was in Saudi Arabia but there it was wonderful. They simply said, "We will choose the best people in the country and it will be an honour for them to be invited to join in this activity. They will be heavily monitored." They also had some sense of being able to say, "And money is no object". It was key to getting really motivated people into those roles, then to get those folk excited about the development of the banking supervisors and then below them the banking inspectors, so that the whole thing began to work as a hugely proud and committed organisation.

Professor Lastra: On your question of the composition of external/internal, I think it should be finely balanced. I think the externals are very important to avoid the group think. At the same time, you need the internals because you need intimate knowledge of monetary policy. There are synergies between monetary policy and financial stability that perhaps were missed before the crisis-let us make sure that we do not miss them again.

At the same time, the Court needs to be responsible to Parliament. It is like having a layer in between that goes, "Who guards the guardians?" and that is why I keep coming back to what is the standard in other countries, which is to have-particularly in the United States-greater mechanisms of parliamentary accountability through reporting, through witnesses, and sometimes through having a dedicated committee of people who are technically competent to match the expertise of the Bank people who will be coming here to give evidence to you on how well or how badly they have managed to conduct financial stability. I would say that financial stability is as important as monetary stability, and that the neglect of one or the neglect of the other can be very detrimental for the country.

The Banking Act 2009, which gave the Special Resolution pretty much to the Bank of England, is one power too much, because now the Bank of England has four hats: it is the monetary authority; it is the supervisor both of macro-prudential and of oversight of macro-prudential; it is a lender of last resort; and it is in charge of the Special Resolution Regime. I have always worried that if an institution wants liquidity assistance from the Bank of England, it may be wary of doing so if the Bank of England is going to exercise the Special Resolution powers, which were given to it by the Banking Act. I know that the debate is about accountability, but that is what I think, although it goes beyond your question: it is one power too many.

Q302 Mr Ruffley: Again, to focus the question, do any of you think that the Court of the Bank of England, as currently composed, is adequate, is up to the job, is a body fit for purpose, to scrutinise the work of the FPC?

Dr Hilton: I think I can summarise for all four of us: the answer is no, but we do not necessarily think that the Court is the appropriate body to do that. If you take the decision that, regardless of whether it is in a perfect world, it will be the body, then the Court has to be re-engineered and re-staffed.

Q303 Chair: You want us to have a look at this financial reporting office, don’t you?

Dr Hilton: I am certainly very attracted by it. I know that a lot of hope is being put in better information. Better information produces better decisions, but it has to be better information produced in a timely way that even politicians can understand it.

Chair: Oh my goodness gracious me.

Dr Andrew Hilton: Sorry.

Chair: With that, we are cautious about asking any more questions, but I know Andy Love has one more, and then I have two more quick questions.

Q304 Mr Love: I just wanted to follow up on this issue of group think. While I think most people around this table will accept that we don’t want to change the Court in the very radical ways that would be necessary if it wanted to indulge in policy issues about stability, it performs a role in relation to the Monetary Policy Committee of ensuring that members can speak openly and honestly, and it provides them with back-up. Are there any additional measures that might be taken in relation to stability, where they can try and ensure that group think doesn’t take hold at an early stage?

Dr Hilton: When DeAnne Julius was a member of the Monetary Policy Committee, I think she was the first member of the Monetary Policy Committee to effectively demand her own staff, and a staff-

Q305 Mr Love: The Court played an honourable role in that process.

Dr Hilton: Yes, and I think if the Court could play that sort of role for the independents, to ensure that they were adequately staffed and that if they felt they needed the resources to go to Basel and have a look for themselves, that they would get it. I think the Court there would play an important role on the Policy Committee.

Q306 Mr Love: Let me ask you, Ms Fuller, whether there should be a role for members of the Stability Committee to go through the Court if they feel that they are being hemmed in regarding what they can say in relation to the issues that they will discuss?

Jane Fuller: Yes is the short answer. They have a supervisory role, and I may have painted a slightly narrow picture of a supervisory role, so yes.

Dr Hilton: The key is that the external members of the Financial Policy Committee should be people who are willing to rock the boat.

Jane Fuller: Yes, and they need that support from that counterweight-type body, which is what the Court is as well as overseeing the management.

Professor Garratt: Then the quality of the chairing becomes absolutely crucial, as a neutral activity-it is fundamental. Behind all that, we find the Court governance codes and so on, but the notion of the annual appraisal of both the board and the Court, each of its committees and any subsets that it has, is very important indeed. It is built into the secondary legislation. Most people don’t bother with it, but it is there. I think the Bank could be a very interesting exemplar in future as to how that might work.

Q307 Chair: Very helpful. I have a couple of further points I wanted to raise, just to wind up, first of all to Jane Fuller. When you-I think it was you-said that the Governor had all these powers and responsibilities, as he is chairing so many things, have we inadvertently created a single point of systemic risk?

Jane Fuller: Possibly, but to be fair, some inactivity on the financial stability part before created systemic risks, so you certainly need to have some responsibility and you need to have some clear management. However, I think it just looks as though there is dominance by the Executive and dominance by the Governor as the head of Executive.

Q308 Chair: Changing the balance of externals to internals might help?

Jane Fuller: Yes, and I think it also may mean that Court has to be left out.

Q309 Chair: So five/four in favour of external on the MPC; something similar on the FPC?

Jane Fuller: Yes, and I suppose it is also in terms of the-sorry.

Q310 Chair: Just to be clear for the record, are you agreeing with that?

Jane Fuller: Yes, I think it would be better to have-[Interruption.]

Q311 Chair: I am getting agreement from Professor Lastra.

Jane Fuller: Yes, there should be at least as many, if not more, externals as internals.

Q312 Chair: Okay. So it is the equal numbers plus one that you see in the corporate governance code that you would like to see replicated.

One last question that we are giving some thought to. We don’t have an answer to it, so if you can provide us with one, we are very interested. It is topical in a number of things the Committee has been looking at recently, which is: how should Parliament, and this Committee in particular, scrutinise decisions on the basis of evidence that has been collected confidentially? Take, for example, the work of the FPC. In order to work out whether the FPC is doing a good job, it is necessary to take a look at the evidence base and some of that material is commercially, and in some cases in a sovereign sense, confidential.

Jane Fuller: I know that that is part of the argument for the FPC not meeting too often-that you have to see some trends emerging. It is a very important question, but if the Governor of the Bank of England has to write to the Chancellor when inflation goes way over target, then at what point would he as Chairman of the FPC have to write to you or the Chancellor or the Chairman of the Court? It will be important that there are some measures of that, in terms of whether it is, I don’t know, credit expansion or-

Dr Hilton: I think you have a really important issue, but it must come up with every other Select Committee, with security issues, with other issues. Certain information must be held confidentially, I would have thought, and inherently information on financial stability is going to be potentially dangerous if it got out.

Jane Fuller: That is why it is difficult to choose and find external people.

Dr Hilton: Right, but there are security committees that deal with this kind of thing all the time.

Professor Lastra: I think this is a fundamental issue, because for transparency in this area [financial stability] the general principle is the same, but sometimes the untimely release of information can trigger the very negative consequences that you want to avoid. So I agree you are dealing with very sensitive data and I am not surprised that you are struggling with it, because I think the US and most other countries are struggling over these issues: how to balance adequate transparency-a lot of the content of accountability is also transparency-with the need for confidentiality that you need to maintain. Sometimes it is a matter of timing, and sometimes it is a matter of priorities. Sometimes it is like what they did in the US when they wanted to take away the stigma of going to the lender of last resort. Some of the facilities that the Fed created encouraged all institutions to go to the Fed, so that-

Dr Hilton: Required.

Professor Lastra: Required to go the Fed, otherwise there was the feeling that only the desperate go to the Fed, as when Northern Rock came to the Bank of England, so it was trying to take away the stigma. I certainly don’t have an answer for that one. I think it is one of those issues where you will need to continue to fine-tune because it will be a very important part of any parliamentary inquiry that you hold.

Dr Hilton: A super-injunction.

Professor Lastra: Certainly to have the press in some of those moments might not be suitable.

Chair: Thank you very much, all of you, for giving evidence this afternoon. It has been extremely interesting. I have to say, for the most part, you seem to have confirmed most of our prejudices, but that doesn’t always happen when people come to give evidence and thank you very much indeed for coming this afternoon.

Prepared 7th November 2011