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To be published as HC 874-vi





Accountability of the Bank of England

Tuesday 5 July 2011

Rt Hon George Osborne MP and Sir Nicholas Macpherson

Evidence heard in Public Questions 420 - 516



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 5 July 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Stewart Hosie

Andrea Leadsom

Mr Andrew Love

Mr George Mudie

Jesse Norman

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: George Osborne MP, Chancellor of the Exchequer, and Sir Nicholas Macpherson, Permanent Secretary to the Treasury, gave evidence.

Q420 Chair: Chancellor, thank you very much for coming today. With your agreement we will try and run the session for no more than two hours and for the last part there may well be questions from one or two of us about topics other than accountability of the Bank, but I am sure you would expect that coming before a parliamentary committee. Can I begin by asking you about the MOU, the memorandum of understanding that you intend to prepare, which is designed to set out who is in charge when taxpayers’ money comes on the line? Do you really think, given all the experience we have had with the tripartite MOU, we should be relying on such a document for something so important?

George Osborne: I certainly don’t think we should be relying on an MOU, which is why the MOU that we will produce in the autumn supplements the statutory responsibilities that are on the face of the Bill and, obviously it is up to Parliament, I hope become law. So I would say that the central powers, the central responsibilities are set out in statute and the MOU is simply going to explain how, in practice, the different institutions should go about the exercise of their statutory functions. I would draw a distinction between the MOU, which assumed an enormous importance in the tripartite arrangements, and what I see the memorandum of understanding doing here, which is explaining how very significant statutory powers and responsibilities are to be exercised. If I could just briefly draw your attention, in the draft legislation we have published, to clause 42. There is a very clear statutory duty on the Bank of England to inform the Chancellor when, for example, public money is materially at risk.

Q421 Chair: How should a crisis warranting your very direct engagement be defined? Should it be when liquidity support becomes solvency?

George Osborne: I would say in a way the crisis is defined by this clause. It is defined by the moment when the Governor has a duty to inform the Chancellor of the day, and he has a duty to inform the Chancellor of the day when public money might be materially at risk, when there potentially needs to be a loan to the Financial Services Compensation Scheme, and also when an institution is going to be put into the Special Resolution Regime. So there are a number of triggers. I think in all those circumstances you are talking about a crisis. Now, it depends what magnitude. It could be a big crisis or a small crisis but, to answer your question, I think clause 42 establishes what I would define as a crisis.

Q422 Chair: You are not going to want to find yourself at the eleventh hour having to take a decision of this magnitude without having been deeply engaged in the run-up to the crisis while it appeared to be a liquidity crisis, are you? You are going to want to be very closely informed, are you not?

George Osborne: Well, as I say, first of all the duty on the Governor is when there is a material risk. So obviously that will be for the Governor to decide in the sense that he has to fulfil his statutory obligations, he has to comply with the law, but I would be fairly clear in my conversations with him that that would be when there was the possibility of any use of public money down the track. I think, of course, we have also built into the arrangements here formal statutory meetings between the Governor and the Chancellor of the day on financial stability where a high-level minute is produced of that meeting. On top of that-and in a way this is something you can’t legislate for but depends on the people doing the jobs at the time and the goodwill of the institutions involved-I meet, as indeed did my predecessor, the Governor of the Bank very, very regularly, not just because it is prescribed by legislation, just because it is prescribed by good governance.

Q423 Mr Mudie: I have listened very carefully to you but, putting aside the statutory meetings, you will be aware that in the crisis over a weekend banks were going down, it was non-stop meetings, which led to the Bank of England Governor being asked by Lord McFall, then Chair of this Committee, who was in charge. That is almost a question in terms of who do you see in a crisis will be in charge? As I read the document, and you have said it, "He will keep me informed". I am really adding to what the Chairman says; will you be involved, not informed?

George Osborne: No, I would draw a distinction here between the build-up to a crisis, in which case I would or my successor would hope to be informed, which is the requirement of the legislation, but I am absolutely clear and the legislation is clear that in a crisis, if there is the requirement that public money is put to use, that is a decision of the Chancellor of the Exchequer, accountable to Parliament. So the key decision-maker in a crisis in that sense is the Chancellor and if you look at events over recent years-and the Permanent Secretary on my left here was the Permanent Secretary during that period so he could speak in a way I can’t for events during that period-during that period in almost every case public money or a public guarantee, the promise of public money, was involved and it is absolutely clear in this legislation that the Chancellor of the Exchequer of the day is the person who takes that decision. I would say if a crisis is identified on the horizon, the Governor of the Bank informs the Government, and then in the crisis itself the key decision-maker-and obviously there are other important decision-makers not least the Governor of the Bank-when it comes to the use of public money is the Chancellor of the Exchequer, accountable to Members of Parliament.

Sir Nicholas Macpherson: Can I just add-

Q424 Mr Mudie: Sorry, I will let you come in, Sir Nicholas, but just let me keep on track. In the crises, both here and in the States, it is not just a question of saying to the Chancellor that public money is needed. There are some judgements that can be exercised before they hand you a bill in a crisis and they are often hourly judgements, the situation is moving that fast. Will you be round the table?

George Osborne: The short answer is yes.

Q425 Mr Mudie: The actual Bill suggests, Chancellor, that he will simply keep you informed. The machinery, the FPC-

George Osborne: The key decision, Mr Mudie, is the use of public money and that would be my decision or my successor’s decision. So in the crisis, as was the case for my predecessor, I suspect it would be a 24 hour, seven day a week job for the Chancellor to be on top of what is going on. I think the key difference, what we are doing here, is looking at the period in the build-up to the crisis and making sure that Government, the British State, has better tools for identifying systemic risks, trying to address them before they become a crisis. If you can call it in peacetime, what this legislation makes absolutely clear is it is the Bank of England that is in charge of the macro and micro-prudential regulation of the financial system. In a crisis when public money is on the line, public guarantees are on the line, it is the Chancellor.

Q426 Mr Mudie: Overrides the FPC?

George Osborne: In fact, the Financial Policy Committee is not really the crisis body. The Financial Policy Committee is there to identify systemic risks over a long period, spot the build-up of leverage, apply, for example, countercyclical capital requirements. In the actual crisis, the tools available to the Government and the Bank of England are things like nationalisation, putting it into the resolution mechanism, recapitalising the banks. These things would not necessarily go anywhere near the FPC. They would be decisions for the Bank Governor-we will come on to how the Bank Governor is accountable within the Bank to the Court but also to Parliament-and for the Chancellor of the Exchequer in terms of the use of public money or the nationalisation of a bank.

Q427 Mr Mudie: That is reassuring. Let us take your peacetime role. Your peacetime role, apart from twice a year, I think it is, meeting the Governor, seems to be that the Treasury can give them a remit, an annual remit of where you would like them to develop or tweak their stability objectives, but you are also are putting in the Bill that they will have the ability to reject any recommendations with which they don’t agree. Now, let me just add a second question to that. We asked the Governor this and got a dusty response, and I am not sure I don’t expect the same but we live in hope. If the Treasury and the Government felt fundamentally strongly about something and put it in the remit and they rejected it, what action could you take?

George Osborne: I want the Bank of England to be in day-to-day operational charge of financial stability, identifying risks in the financial system, which was not being done, and also the macro-prudential regulation of institutions. I don’t want the Chancellor of the day second guessing. I am trying to get away from the confusion of responsibilities that was the case under the tripartite regime. So the Bank of England Governor is in charge. There is enormous power, if you like, for the Chancellor of the day to appoint the relevant people. All the people we are talking about are people appointed by the Chancellor, from the Governor to the members of the Financial Policy Committee, to the members of the Court. They are all appointed by the Chancellor. The Chancellor of course sets, with Parliament, the overall framework for financial regulation, which we are discussing today. There is a remit that is produced that the Chancellor sets. There is a requirement to inform the Chancellor when things go wrong and the Chancellor has the decision on the use of public money. I don’t think there is any shortage of power for the Chancellor but what I don’t want is a system where every day people do not know whether to look to the Treasury or the Bank. On a day-to-day basis in peacetime it is the Bank of England that is in charge.

Q428 Mr Mudie: No, we are not suggesting that, Chancellor, no, no. I think that is all very sensible, but this is an annual remit. This is your one chance, as you have put it, to tweak or develop their objective, fairly reasonable and sensible to put in but you are giving a right of veto to the Governor. Where does that place you as Chancellor? If you feel something and you put it in print, as you have perfectly entitled yourself to do, and the Governor says no, where does that place you with authority?

George Osborne: When you are dealing with an institution like a central bank and a bank governor whose independence, most people accept in most countries, is an important thing to preserve, I have been careful about not inserting powers of direction. There is a general power of direction in the 1946 Act, so Chancellors since then have been able to direct the Bank Governor. They have never used that power and that is because, of course, the use of a power of direction can itself cause all sorts of problems and give rise to all sorts of confidence issues, so I have been careful about trying to avoid that. I think the responsibilities are clear. The day-to-day responsibilities, monitoring risks in the system, are not, under these arrangements, the Chancellor of the Exchequer’s. They are the Bank Governor’s and the Bank of England’s and the Financial Policy Committee of the Bank of England.

It is precisely because I don’t want to recreate the tripartite system that I have headed in this direction and asked Parliament whether they agree with me. I have read the evidence of previous witnesses before your Committee and I thought the Bank Governor was pretty revealing about the truth of the tripartite system in peacetime. It met twice in 10 years with the principals. The truth is, as the Governor points out-and it is a truth, I can see now doing my job-that if you are relying on the Chancellor to be there day in day out during peacetime financial stability, it is just not going to happen, and it didn’t happen, and that is why it is much better to clear the lines of accountability and clear the lines of responsibility. The Bank of England is in charge, but when it comes to a crisis the Chancellor is in charge when public money is at stake.

Q429 Andrea Leadsom: Chancellor, this has been something of an extraordinary inquiry into the role of the Court of Directors, and the inquiry has come up with all sorts of odd points. We have established that there are three roles of oversight of the Bank of England in management, processes and policy. Can you tell us what would you see as the lines of accountability between the Bank of England, the Court of Directors, the Treasury Select Committee and the Treasury?

George Osborne: I think ultimately where it really counts, that is, the exercise of policy, monetary policy to control inflation and manage demand, financial stability policy, the Bank and its different components, the Financial Policy Committee, the prudential regulator, and the Governor, are accountable to you, Parliament, they are accountable to me as the Chancellor of the Exchequer, appointed to do this job. But within the Bank we also have, like many public organisations, a board-it is called the Court-and that is responsible for the overall internal strategy of the Bank, the resources of the Bank, managing the balance sheet risks to the Bank and so on. When it comes to the big questions as far as members of the public would be concerned, and I suspect Members of Parliament, then I would see those bodies, both through the person of the Governor but also through the individual members of these different bodies, to be directly accountable to you and also, as I say, accountable to me in my meetings with the Governor.

Q430 Andrea Leadsom: So do you think that the Court is fit for purpose?

George Osborne: Yes I do. I think they clearly had a challenging session with you, and that is not a complaint about the way you asked your questions. I would point out that they are people of very considerable experience. Now you happened to have, and I don’t know how you went about choosing the witnesses, the people with the non-financial service expertise and I think it is important to have people, for example a representative of the trade union movement, on the Court of the Bank, representatives from broader industry, not just financial services, and you met those people and interviewed those people. There are also people with very considerable financial services expertise; people who have run the Pru, Legal & General, Deutsche Bank. I think in your inquiry you have to ask yourself what different group of people would you get in our country to do this sort of job. By all means, you will, of course, make recommendations about whether they have the right tools and whether the Court is the right body to do this, but if you ask yourself who should be doing it and you look at the members of the Court and you look at their very, very considerable expertise-one is the President of the CBI, one is the current head of Legal & General, one ran the Pru, one ran Deutsche Bank-who else in Britain are you going to get to sit on the body that keeps an eye on the central bank? By all means, recommend improvements on how to do it but I don’t think questioning the competence of the people, to my mind, is the right line of inquiry because I think those are the sorts of people you would want. Whether you called it a supervisory board, whether you called it a court or whatever, those are going to be the kind of people you would want sitting on it.

Q431 Andrea Leadsom: Yes, I agree with you and I think there would be a lot of agreement around the Committee that it is not about the individuals, it is about the structure and whether that is the right structure. You will be aware that we have had some representations, including from Willem Buiter, who say that the Court should be abolished and there should be a new oversight board, perhaps set up within the Bank of England. In other words, it is the structure that is at fault. There have also been a lot of questions over whether the FPC should in fact be a committee of the Court rather than run along the same lines as the MPC. So the issues are around structure rather than the individuals who are involved, and I would appreciate your thoughts on that.

George Osborne: I don’t personally have a complaint with the way the Court has done its job. I think it has helped manage the Bank of England’s resources. It has not allowed a big increase in bank spending. It has dealt with the very significant balance sheet risks, which are almost unique for the Bank in recent years, the scale of the challenge, and so on. So I have confidence in the Court. There is a question you have asked, I can see having read your previous sessions, about whether the structure could be improved in some way. I am very happy to listen to recommendations but I have confidence in the current Court, both in its structure and in the people who do the job. I think the Bank Governor did a good job before this Committee of explaining the difference between the policy functions of the Bank of England, which are the executive responsibilities, and then the role of the Court in managing those resources. Sir Nicholas deals with the Court on a pretty regular basis. I don’t know whether you want to say something?

Sir Nicholas Macpherson: I think just to come on to your point about the FPC, the fact is that the Bank has a range of responsibilities in relation to payment systems, in relation to intervention and so on, and those all are legitimately guarded by the Court so I think it is sensible for the FPC to be anchored within the Court structure. For example, when there was emergency liquidity assistance to Northern Rock, the Court of the Bank did meet to agree that that should take place, and those sort of governance structures, I do think, do create a degree of accountability. So one way or another I think you do need some sort of board structure.

Q432 Mr Love: When the Governor of the Bank of England came before the Committee in this inquiry last week he repeated once again that his first preference or the Bank’s first preference would be to have a completely new Financial Services and Markets Act. This Committee is on record as saying we should be thorough in whatever we do, yet currently you are not listening to those concerns. Why not?

George Osborne: Obviously I have had this discussion with the Bank Governor and he said what he said to your Committee. My judgement was that we could achieve what we needed to achieve by amending FSMA, that it would be an enormous exercise that would take several years to rewrite FSMA. I didn’t think that was necessary. Almost all the people who responded to the Treasury consultation from the industry on this point thought it was unnecessary, for example, the ABI, the Association of British Insurers. The final point that draws all this together is that obviously we are undertaking quite a lot of substantial changes to the regulation of financial services. We are changing the way these institutions are regulated, changing the structure of regulation. We have the Independent Commission on Banking due to report in September. These are all big changes and they create, inevitably, some uncertainty around the industry and that is, again, inevitable after what we have been through as a country. I thought rewriting FSMA would be yet another piece of uncertainty; it was not necessary; it would delay the whole process by potentially at least another year. So my judgement was we could achieve what we needed to achieve through amending the existing Act rather than completely rewriting it.

Q433 Mr Love: The Governor did say to us that he questioned whether you could avoid the sort of delays that you are concerned about and he said so because he characterised the original FSMA, and I quote, as being, "To create an all singing and dancing regulator covering everything", the FSA. You are moving to a completely different structure, with added complexity. Don’t you worry about the possibility of unintended consequences if you just bolt on a quick fix Bill to amend FSMA?

George Osborne: I wouldn’t describe it as a bolt-on. I would describe it as a pretty substantial rewrite. The reason why this document is so big, by the way, is because all the 50 pages of it are the draft legislation that the Committee asked us to produce in advance and the explanatory notes. As you can see, it is a pretty major rewriting of the legislation and what we have also produced in the last week is a sort of consolidated version so you can read now the Act as it will look if it is passed by Parliament, and I think it does the job. If people want to go through it and point to specific problems, please do that, that is the whole purpose of the pre-legislative scrutiny, but I have not yet heard a convincing argument of why we should start from scratch. I think this does the job. In terms of the delay, or not, we are completely on course for achieving this change, subject to the view of Parliament, by the end of 2012 and that is quite a significant achievement in a reasonably short period of time.

Q434 Mr Love: When the original FSMA was put through the House there was a great deal of comment, discussion, controversy; that is likely to emerge again, even with the amended Bill. Don’t you see the force of the argument that rather than end up with huge numbers of amendments coming forward to amend the amended version, it would be more sensible to, as this Committee has suggested, go through in a comprehensive, thorough manner everything related to this particular complex change that you are intending to make?

George Osborne: I would hope that ultimately it is judged that we have done this in a comprehensive and thorough way. The facts that I remember as well of FSMA, its original passage-I was working in Parliament but I was not a Member of Parliament at the time-it just showed that even when you start from scratch there are a whole load of amendments and we could try and reduce that this time. That is one of the reasons for undertaking the pre-legislative scrutiny, to try and flush these things out before we get there.

But can I make a general observation? I am also trying to-and I think the Bank Governor is trying to do the same thing here as well-get away from thinking you can prescribe in legislation every scenario and every problem you might encounter in financial services regulation. We are trying to move towards more judgement-based regulation. Let me give you an example of what I think was a shocking failure of regulation. In the end of 2007, there had been a bank run on Northern Rock, after the credit markets had frozen the UK regulators allowed the Royal Bank of Scotland to buy ABN Amro. In other words, this was not at the height of the boom they bought it; they bought this after the run on Northern Rock and it led to the biggest bank failure in the world.

The reason why they allowed that merger to take place was because there was nothing that RBS was doing wrong. It complied with all the regulations, it ticked every box, FSMA was fully complied with, but there didn’t seem to be-obviously I was not there at the time-anyone saying, "Hold on, are we really going to allow, in this period of financial uncertainty, the Royal Bank of Scotland to buy this enormous Dutch bank?" What I am trying to do is get to a position where the Bank Governor, or the institution that he heads, exercises that kind of judgement. Yes, we can have a debate, and I will certainly pay close attention to your conclusions on the sort of nature of the legislation, but in the end what we have to do is get some judgement, some discretion, some common sense into the system and stop assuming that if you have complied with points 1 to 10 of the law that is it; you want someone also asking the bigger question.

Q435 Mr Love: In a sense, the response to that response you have just given is that we need to get the right people; this is a great deal to do with the right people rather than particular structures.

George Osborne: That is equally important.

Mr Love: But I won’t pursue that because I am still on my FSMA point. It is going, as you said, to a Joint Committee for pre-legislative scrutiny. They will, of course, look at the Bill but, as you mentioned, they will undoubtedly, because of all the work that has been done round about this for the last year or so, come up with further amendments. If that Joint Committee recommends that they should look at the whole of FSMA, will you take that into account in your judgements?

George Osborne: I will certainly pay attention to, and I mean this seriously, the recommendations of the Committee and, as this hearing has demonstrated, I don’t think this is a sort of particularly partisan or heated, in parliamentary terms, discussion. We all want to get this right and we are all trying to learn the lessons of what went wrong. But on FSMA, specifically on your point, it would-and I think the Committee has to ask itself this question now-massively delay this process and I think you have to ask yourselves whether that would be a good thing.

Now, you may argue we shouldn’t have started from here-I believe we are starting from the right point of amending FSMA-but you have to ask yourself the question whether you are really recommending that I tear all this up and we start again and we presume it will take at least another year, take a couple of years, to come up with a completely new piece of legislation, and that is certainly not where the industry is at. I won’t read them all out but we can certainly provide you with some of the comments from people in the industry, like the ABI, like the International Financial Data Services organisation. They have all said it will lead to an easier transition to the new regime and it can be done in a measurable period of time rather than delaying the whole process, but obviously that is a decision for the Committee.

Q436 Mr Love: Just one final question, and it relates to this issue about the amount of time that it will take. The Governor has expressed his concern that even under the process that you are instituting there will be considerable delays. If the Joint Committee gets into all sorts of areas that aren’t included in the Bill, that will lead to significant delays. There must come a point-even if they don’t recommend, even if you don’t follow what this Committee is saying-where it would make sense to do the full FSMA again, rather than try to continue to just have some amendments to some parts of the original Bill.

George Osborne: I would argue that we are where we are. I think we are in the right place, obviously I think this is the right approach, and the alternative is really saying, "Well, I wouldn’t have started from here", but it does mean a very considerable delay and means going back to the drawing board. I don’t think that’s good for the financial services industry and, by the way, I want to move to this new system because I think it is the right system, so I want to get the legislation through.

In a way, the pre-legislative scrutiny process, your Committee’s hearing, these are all opportunities to raise issues and flush them out before the legislation is produced in final form. If there are specific points that you think would have been better addressed if we had had a brand new piece of legislation, make them and we can make the amendments.

Q437 Chair: You have said that the regulators shouldn’t have allowed RBS to buy ABN Amro. As you know, the FSA didn’t look into that, or if they did they didn’t publish anything to give us evidence that they had, and so we have asked for it as a committee and sent in independent assessors to make sure that the job is being done properly before that is published. You presumably agree with what we are doing there.

George Osborne: Yes, I think you have undertaken a sensible course of action.

Q438 Stewart Hosie: You said, Chancellor, there is a level of accountability to yourself and to Parliament through this Committee and the legislation will provide the mechanisms for Treasury Ministers to satisfy themselves that the regulation is appropriate and the regulatory system is functioning properly. In terms of this Committee first of all, we look at the decisions of the MPC and the FPC in its macro-prudential role, the PRA in its micro-prudential role. I am sure we will also look at the FCA because we know that consumer risk can morph into systemic risk. If this Committee says we need significantly more resources in order to do this job properly, because it is detailed and complicated, I take it you will be happy to sign the cheque.

George Osborne: I am generally trying to avoid signing cheques at the moment, which is what I say to almost everybody who asks me for more resources. Ultimately that is a decision, I think, for Parliament, how this Committee is funded. Since I have to take responsibility for how most other things are funded in the broadest sense of the public sector, I think I will not intrude on the privileges of Parliament.

Q439 Stewart Hosie: Let me just say that was a little marker. More specifically, you said the Bank is accountable to you through your meetings with the Governor. What role or what additional role, though, do you see the Treasury playing in terms of accountability of the Bank of England and other bodies within the Bank of England?

George Osborne: As I say, we are accountable for the overall structure of regulation, obviously, because we have asked Parliament to pass this legislation. We are accountable for the appointments. We are accountable for the remit we set. We are accountable-we haven’t discussed it yet-for the tools that are going to be given to the Financial Policy Committee, these new macro-prudential tools, and ultimately I am very aware, as the Chancellor, that the buck stops with me. I think that is all ways in which we are accountable.

I think there is another thing-I don’t know whether I would be intruding on Nicholas’s territory here-that it is also true that in the build-up to the financial crisis, certainly my observation then in Opposition was that the Treasury ran down its financial services capability, it wasn’t the strongest part of the Treasury, there weren’t as many people as were needed. One of the things we have sought to do as an institution-but I will get Nick to say more about this-is learn the lessons of that and make sure that the Treasury retains a strong competence in financial services, partly so that we can deal with a crisis, partly so we get the appointments right and the remit right and so on, partly so that I and other Ministers go into meetings well informed and asking the right questions and demanding the right material, and partly also because, as well as passing legislation through Parliament, we are engaged almost weekly in negotiations on European and international regulation, which is becoming increasingly important in this sphere. Nick, do you want to say something?

Sir Nicholas Macpherson: I am very happy to. The Treasury undoubtedly has built up greater expertise in this area. I think it is quite valuable expertise and it has shown on a whole range of issues how we can deliver reasonably quickly. A good example recently was the Irish loan where the expertise we developed during the financial crisis meant that we didn’t have to employ investment bankers whereas a few years ago we would have done, thus saving the taxpayer money. I do think we are in a better place there. I think it is also important that we learn the lessons internally from the crisis and indeed, following a recent PAC recommendation, we are doing work on that.

Q440 Stewart Hosie: You are responsible for the appointments, the remit, the tools, competence, the experience within the financial services and you said that this was so that you and others can be informed properly to ask the right questions when you go into the meetings. Is that the way in which you see, in practice then, Treasury Ministers informing themselves or satisfying themselves that the regulatory system as a whole is functioning properly by being informed properly to ask the right questions of the right people?

George Osborne: It is both asking the right questions and also coming up with the right suggestions and recommendations and getting the remit right, as I was discussing with Mr Mudie earlier. As I say, I don’t want the Treasury to be second guessing every single day the peacetime task of monitoring overall systemic risks and managing individual institutions. I think that is partly what went wrong last time, that no one was clear who was in charge. I am very clear the Bank of England is in charge of that job and they are the people who must take responsibility for that task. But obviously it is my job, and indeed Parliament’s job, to make sure they are doing that job properly.

Q441 Stewart Hosie: That is where I want to get to, because in the 2007 Financial Stability Report from the Bank it was extremely clear, this is only four months or so before Northern Rock and the start of the crisis, "Weakened credit risk assessments, impaired risk monitoring, low premia for bearing risk, high and rising leverage in the corporate sector, rising systemic importance of large complex institutions, impaired market liquidity", which was brushed under the carpet by lines like, "Conditions are likely to remain favourable and the UK financial system remains highly resilient", neither of which were true. I am trying to understand how Treasury Ministers, not second guess, will be absolutely satisfied when they get one of these bits of paper they can say, "Yes, we believe it" or "Heavens, that’s wrong". Are you satisfied all the tools are in place for your Ministers to be able to understand what is being said?

George Osborne: Yes, I am, but I think more to the point, the big difference, once the regime is up and running, is that the Bank of England won’t just identify those risks, it will have tools, it will have policies available to it to deal with those risks. This is for them to recommend over the course of the next few months to me, and through me to Parliament, tools that they should be given to deal with things like excessive leverage or maturity mismatch. Let me give you some examples of things that are commonly talked about. It doesn’t mean they will necessarily be the tools but they are ones that are commonly talked about; things like loan-to-value caps, countercyclical capital requirements, liquidity tools. They are going to have these tools, stress tests, they can require forward provisioning. These are all talked about as macro-prudential tools.

The Bank of England won’t just be producing this report; it will also have a responsibility to do something about it. In a way the biggest innovation we are undertaking with all of this is not to move bank regulation from the FSA into the Bank of England but to create a new task, which is monitoring overall levels of risk in the financial system and creating new macro-prudential tools to deal with those risks. Those tools don’t currently exist. The academic literature on this is much less developed than it is on monetary policy. One of the big challenges for the Bank of England is going to be, over the next few months, identifying what those tools are and then the big challenge for me and for Parliament is to decide whether they are the right tools for the FPC to have.

These are very substantial things. These, in the end, come down to questions about whether your constituents or my constituents can get mortgages at certain loan-to-value ratios or what the availability of credit in the economy is. These are very significant issues, but these tools did not exist before in one place. They were spread across the system and most of them had never been identified as tools, and I think this is a big innovation. The Bank of England, I would argue, and the British Government and the British Parliament are at the forefront of developing this in the world. Other systems are trying to develop something similar but we are right at the cutting edge of this. Unfortunately, there is not an off-the-shelf guide to how to do this; it is one of the things we are all seeking to do post the crisis.

Sir Nicholas Macpherson: Could I just add to that? I was at the Treasury when that report you read out was produced and it was very striking in those days that the Bank of England could produce reports, it could make speeches, and that was it, and sometimes they would get reported and sometimes not. The big difference under the new regime is that these things will be internalised within the Bank of England. If they are going to set out things like that in the report then they have a responsibility to take action, to direct the PRA and so on. I do think this will strengthen the system as a whole because decisions that they could argue were a matter for the FSA will now be their responsibility. It will be internalised within the Bank and the Bank will be accountable for implementing the framework.

Q442 Stewart Hosie: Just one final question in terms of the tools then. I know they are being developed and I don’t want to get into a debate as to whether or not the FPC will take away some of the fiscal levers the Chancellor might normally have; it is a debate or questions for another time. But when are we likely to see a recommended toolbox this Committee and the public can have a look at and say, "That’s an interesting set of levers that are likely to be enough to do the job" or, "The Chancellor is keeping too much power and the FPC is still denuded"? When will we have the toolbox?

George Osborne: The interim Financial Policy Committee’s-because obviously we haven’t set it up yet on a statutory basis because the law has not been passed-first major task is to identify what those tools might be, to make a recommendation to us. We will have to take that to Parliament in secondary legislation, so Parliament ultimately will get a choice about whether it wants to give these tools or not. This is a major innovation in public policymaking in the world and I would venture to suggest it is an important task for this Committee to look at this in the autumn when we get the recommendation. It is certainly an important task for me as Chancellor and for the Treasury.

Q443 Michael Fallon: You have decided that both the Financial Policy Committee and the Monetary Policy Committee should be chaired by the same person. Why is that?

George Osborne: I don’t usually like the word "joined-up" but in this context it is appropriate. It is joined-up, that you don’t have different parts of the British State pulling in different directions. The person who is ultimately responsible in peacetime for the systemic risks in the financial system is also the person who is monitoring individual institutions and undertaking monetary policy.

Q444 Michael Fallon: So it is to some extent because you think that the macro-prudential tools can’t be deployed in isolation from monetary policy?

George Osborne: Obviously all these things have an impact on the economy but the inflation target is very, very clear, and that is the task of the Monetary Policy Committee. Of course, in this context the Bank Governor is only one of a number of members and can be outvoted, just has a vote equal to everyone else on it. I am certainly not suggesting a weakening in any respect of the MPC’s role on inflation targeting and, if anything, the other parts of the system have to operate around that central MPC inflation target.

Q445 Michael Fallon: The Governor chairs your FPC and he chairs the MPC and he is then accountable for that chairmanship to the Court on which he himself sits. How does that work?

George Osborne: He himself, the current Governor, took the decision that the Court was better chaired by David Lees, so he has himself, with the help of the previous Government’s Act, I think improved governance in the Bank of England. Ultimately a bank governor is a powerful independent figure in any political system or any state where they have an independent central bank and he is ultimately accountable to Parliament and to the public.

Q446 Michael Fallon: But he is also accountable to the Court on which he sits.

George Osborne: In many companies the chief executive and the executive chairman sit on the board and are accountable to the board, and I don’t think that is a particular problem with these arrangements. He is accountable to the Court for the strategy and the resources and efficiency of the Bank outwith the statutory duties that are imposed on it.

Q447 Michael Fallon: One of the other criticisms we have had is that you are heaping quite a lot of responsibility and power on to the Governor; he sits on the Court, he sits on the PRA, he chairs both the FPC and the MPC, he is on the European Systemic Risk Board. It is an awful lot to put on to one person, is it not?

George Osborne: Of course the Governor of the Bank of England has an important job to do, but since the recommendation from people who don’t want this to happen is normally that they should give this as an additional responsibility to the Chancellor, Chancellors usually cope with the tasks that are heaped upon them; I am sure the Governor of the Bank can cope.

Q448 Michael Fallon: A further criticism we have had is that because all this is now being done inside the Bank, and you have just explained how they should have sole responsibility for doing this, there is a danger of kind of group-think or Governor-think within the Bank itself. How do these proposals guard against that?

George Osborne: I think the importance is obviously to get the right executive members of the Bank. That is a decision for the Chancellor of the day and a lot of effort should go into getting the right people. I wouldn’t say it goes without saying but it is a very key point. The second thing is that we have built into the Financial Policy Committee external members, like with the MPC, and the job of the external members I think is to challenge group-think.

I should say to you, Chair, that today we will be appointing a new member to the FPC, Robert Jenkins, who is someone with enormous experience in markets and investment management, a former Chair of the IMA, a person with enormous experience, and that fills the place that Richard Lambert would have filled. Getting the right external members with a lot of experience is crucial and I think the job of the externals-and, by the way, you see them. I would suggest the job of the Committee is to say to these people, "This is not a sinecure. You are there to do a very important job of challenging, if there is a risk of group-think, the group-think".

Q449 Michael Fallon: We do see them and we do have some influence over that; what we don’t do is see the Governor. You have given this Committee a veto over the appointment and dismissal of the Chair of the OBR. Now that the Governor will be even more powerful than he is, is there a role here for Parliament to extend its influence over that appointment?

George Osborne: I would be against giving the Treasury Select Committee a veto on the appointment of the Governor of the Bank, for the reason that the Governor of the Bank is carrying out executive functions on behalf of the State; the setting of monetary policy, monitoring financial stability. By all means call him to account, but he is an executive appointment by the Queen on the recommendation of the Prime Minister and the Chancellor. I think the OBR is materially different. The OBR is providing an independent audit, in effect, of the Government’s numbers and there is a crucial tool for Parliament to scrutinise the executive, and I think that is different. The independent audit function is something that is quite legitimate, and that is why I offered the Committee a veto on that appointment. I think the Bank Governor should continue to remain something for which the Government is accountable to Parliament for. If you think I have appointed the wrong Bank Governor by all means hold me to account but I have not yet had a chance to appoint a Bank Governor.

Q450 Chair: Are you accepting our recommendation that, although Alastair Clark has a huge contribution to make to the FPC, he shouldn’t score as an independent and therefore for the period of the interim FPC another appointee will be found?

George Osborne: I am filling the vacancy that Richard Lambert created by not taking up the post. I know what you say about Alastair Clark, although I think he brings considerable experience.

Q451 Chair: 37 years of experience in the Bank of England to be an independent. A bit tricky, isn’t it, Chancellor, don’t you think?

George Osborne: He knows all the tricks of the trade and how the institution operates. Sometimes it is good to have someone who knows all that as the watchdog, or here not the watchdog, the external challenge. I have not announced the statutory FPC, although I would certainly hope that some of the members enjoyed being on the interim FPC and agree to serve on the statutory one.

Q452 Chair: I am just asking whether you are accepting our recommendation in that report or not.

George Osborne: If the recommendation is to appoint an additional external-

Chair: It is.

George Osborne: I am not accepting that recommendation, although I have moved-

Q453 Chair: And to accept with us that Alastair Clark is not an independent external.

George Osborne: I think you have made your views fairly clear about whether you think it is appropriate for him to serve on the statutory FPC that will be established at the end of next year.

Q454 Chair: So you are ignoring the Committee?

George Osborne: No, I have heard those views.

Q455 Chair: No, I know you have heard them; I can tell because you are replying to them. What I am asking you is whether you are ignoring the recommendation of the Committee or accepting it?

George Osborne: Let me just put it this way, I don’t think it is likely that Alastair Clark is going to be a member of the permanent statutory FPC.

Chair: That is helpful. Thank you, Chancellor.

Q456 Mr Ruffley: Chancellor, you have accepted that there was evidence of group-think in the run-up to the crisis at the Bank and at the FSA; we can agree on that?

George Osborne: Yes.

Q457 Mr Ruffley: Do you think that the presence on the FPC, just focus on the FPC, of high quality, independent, external members is the best means of preventing group-think?

George Osborne: I think it is one of the-

Mr Ruffley: But is it-

George Osborne: I don’t think that is the only check. I think it is partly the job of Parliament to challenge group-think; it is partly the job of the Chancellor to challenge group-think; I think we have all learnt a lot from what happened over the recent years. But I think the presence of external members is an important check on group-think.

Q458 Mr Ruffley: But externals are on the FPC; Parliament, with respect, is not. So we can make all sorts of noises challenging group-think but we might not always know group-think is going on. It is actually members of the FPC that I think this Committee is most concerned about. Could I just come back to the question of the externals? We have nine members of the MPC, four of whom are externals, yet on the FPC we have 11 members, 10 voting, one not, but we have only four externals. Why the difference?

George Osborne: There is also the Chair of the Financial Conduct Authority. Currently that post-

Mr Ruffley: No, just on the FPC.

George Osborne: Yes, but the head of the Financial Conduct Authority will also be on the FPC. He is not internal to the Bank. The Bank has a narrow majority of one, I think, but that is the case on the MPC as well I think. I would be interested to hear the Committee’s views on this but-

Q459 Mr Ruffley: Perhaps if I could reframe it. On the interim committee at the moment we have the Governor, two Deputy Governors, we have the Chairman of the FSA at the moment. Then we have two executive directors appointed by the Bank, that gets us to six, and then we have four externals, all those that are voting members. This is on the interim FPC. We have also heard that one of those four, Alastair Clark, has had nearly four decades experience as an insider and yet he is scored as an external, as an independent. I think most people in the City, Chancellor, would say, "We have at the moment now, with the interim, seven out of 10 voting members who are, in some sense, guilty men". These are people who were on the bridge in the run-up to the crisis and I just wonder, having regard to what the Chairman said and having regard to what this Committee has reported on, that you still don’t think it sensible to look again at the number of externals on the FPC.

George Osborne: First of all, there are actually 11 voting members; there are six from the Bank, five not from the Bank, but the five includes Adair Turner, certainly includes Alastair Clark, then there was a vacancy, which I am filling today. Obviously, it is for you to judge, but I think the quality of the appointments to the FPC has been high. We have people with enormous financial services experience, not insiders, practitioners in the financial services market. We have someone from the Federal Reserve who will be a challenge as well as bringing central bank experience, and there is a new appointment to the Financial Conduct Authority, the markets and consumer regulator, Martin Wheatley, who comes from Hong Kong. I think there will be the quality there to challenge. I completely agree with you that it will be their job to challenge and our job, collectively in our different roles, to make sure they are doing that job.

Q460 Mr Ruffley: It is just on the numbers, Chancellor. We have seven people who one way or the other-whether we like it or not it is a fact-were part of the regime that saw the British financial system crash. I wonder whether you still think it is acceptable and whether or not it inspires confidence that seven of those people, as we speak, who were implicated in that disaster are now on your interim FPC. Do you think it inspires confidence?

George Osborne: What I would say, and maybe I should have said this right at the beginning, is that I do genuinely want to hear your recommendations. If you have recommendations we will take them very seriously. This is not the last word. This is draft legislation. If you have views, strongly expressed, on the number of external members of the FPC, of course I will look at that. I am not sure I should say this to you, but when you come immediately after you have delivered a Budget, you are not likely to reopen the Budget even on the sage advice of the TSC. I think this is a different kind of hearing and these are a different set of recommendations in the sense that we certainly want to take on board the best ideas that are expressed by you and there is a genuine prelegislative scrutiny process underway. If the Committee decides that we should look again at the balance and the number of externals, I would be very happy to do that. That is not a promise that I am going to change things, but it is a promise that I will take a recommendation very seriously.

Q461 Mr Ruffley: That is very useful. Final question, it is a question posed by people I speak to in the City, and they say, "How many of the senior officials at the FSA, the Bank and HM Treasury who were making policy decisions in the run-up to the crisis have been fired or have resigned?" Do you know the answer to that question?

George Osborne: The short answer is I don’t have the answer except that I suspect the answer is-I can’t think of anyone who has been fired, so I suspect the answer is zero.

Q462 Mr Ruffley: But do you think that answer is surprising? The people I speak to, who are inveterately private sector, say that if they had made the duff judgement calls and the poor decisionmaking that many in the FSA, Bank and HMT had done in the runup to the crisis, which contributed to the crisis, they wouldn’t be in jobs in the private sector. You are a good free market man and you believe in the importance of the private sector.

George Osborne: Well, some of them surprisingly have managed to stay in jobs but-

Q463 Mr Ruffley: Don’t you think it is unusual that no one in any of those three bodies I have listed-you said so yourself-has either been fired or resigned? Where is the accountability if the answer is zero?

George Osborne: First of all, the accountability is through the elected Government of the day, which changed, partly I suspect because of what happened in the financial system. Of course-

Q464 Mr Ruffley: I think you are being very diplomatic here, Chancellor. In any other walk of life, people would be fired for those mistakes.

George Osborne: I am tempted to ask my Permanent Secretary to answer the question, but that might be a little bit-

Q465 Mr Ruffley: I know the Chancellor is being very diplomatic.

George Osborne: Permanent Secretary, what is your answer to this?

Q466 Mr Ruffley: There is a serious question here, Sir Nicholas, and I think we are in agreement on a lot of things, but don’t you hear from people in the City, because I hear it all the time, senior people saying no one seems to have been fired or moved on or resigned from the FSA, the Bank or HM Treasury as a result of poor decision-making? Don’t you find that surprising? The private sector does.

Sir Nicholas Macpherson: Well, I don’t think, strictly speaking, that is accurate.

Mr Ruffley: Which bit isn’t?

Sir Nicholas Macpherson: You will recall a very hard-hitting internal audit report, which to their great credit they published in the FSA, setting out their findings of the collapse of Northern Rock and there were consequences for individuals there. I think it is fair to say there have been changes of personnel at the Bank of England and, dare one say it, also at the Treasury. I think the big-

Q467 Mr Ruffley: That is encouraging.

Sir Nicholas Macpherson: Well, no, Mr Ruffley, the Treasury, as I said, is very keen to learn the lessons of this pretty extraordinary set of events and we need to deploy our resources more effectively. I think there have been consequences, but perhaps the biggest consequences are these changes that we are discussing today. The fact is the FSA as an organisation will cease to exist. The Bank of England, coming back to Mr Hosie’s point, is going to be reconstructed to give it responsibility and power in this area.

Q468 Mr Ruffley: And thus make it more accountable?

Sir Nicholas Macpherson: Indeed, and the Chancellor has set out the accountability that-

Mr Ruffley: You gave that in an earlier answer and that was very helpful.

Q469 John Thurso: I want to follow up the questions that George Mudie was asking, but can I first just ask, we are legislating to achieve a state of improved financial stability. Does the Treasury have a definition of financial stability other than the lack of instability?

George Osborne: I guess I would define financial stability as a financial services industry that is serving the broader interests of the economy, that is not requiring taxpayers’ money to support it, that is not contributing to excessive leverage nor to excessive credit contraction.

Q470 John Thurso: Are those not all areas that are a fine balance of part fact and part political judgement?

George Osborne: I am not sure I would use the word "political" judgement, but I think they are areas of judgement. One of the challenges here is that with inflation targeting and monetary policy we reached a point in the academic literature and in political thinking across the world that enabled us to set a number of an inflation target, which the MPC is asked to hit. We have not been able to do that with financial stability; we don’t have a number; there is not a simple target. I thought it was quite interesting evidence you had from Paul Tucker saying that maybe over the next 10 years or more thinking will develop and we will be able to come up with some very specific indicators, but at the moment the world doesn’t have the answer to the question of what the number is that you should be targeting. He advised us all to look at leverage and maturity mismatch and so on, but there is not a single target. That is why we have to develop a range of tools and in the end these are judgements about what level of risk you are prepared to tolerate. Obviously, a graveyard is a pretty stable place but it is not necessarily the place you would want to live in.

Q471 John Thurso: That leads me on to a question. I think in your answers to George Mudie you pretty well defined that in peacetime it is the job of the FPC and the Bank but in times of crisis that will pretty automatically revert to the Treasury. Would that be a fair assumption, because public money will be involved?

George Osborne: I think the Chancellor of the day will be centrally involved because the biggest tools available to you in a crisis, recapitalisation, public ownership, taxpayer guarantees, are ones that only the Chancellor can take the decision on. Obviously there are other tools that the Bank Governor will also be deploying on liquidity support, use of the Bank’s balance sheet and so on, but the big tools available to the Government, or the State rather, in a crisis are ones that the Chancellor would take the decision on within the context of Cabinet Government and accountability to Parliament.

Q472 John Thurso: The realistic probability is that in a crisis it will be the Chancellor, the Government, Prime Minister who will de facto be in charge? It would not be a crisis otherwise.

George Osborne: Well, as I say, the answer is yes, because these decisions are ones that use public money and ultimately are accountable to you and through you to the public for the use of public money.

Q473 John Thurso: Can we come, therefore, to the peacetime scenario? In effect, the legislation proposes to outsource the responsibility to the Bank and the new structures. Is there not some responsibility that should reside within the Treasury and Ministers to at least oversee that that process is operating properly and well?

George Osborne: I would certainly think we have that responsibility to make sure the process is, to use your words, proceeding well and according to the legislation and so on, absolutely. That is why, for example, there are these statutory meetings with the Bank Governor twice a year on financial stability where we publish the highlevel minutes of that meeting. We certainly accept that. Many, many years ago British Governments accepted that day-to-day financial regulation should be with some other body, so the Bank of England used to regulate the banks, then the FSA and so on. What we are doing here is combining that. We are returning to the Bank of England the power of regulating banks and giving it additional parts of the financial services sector to regulate on a macro-prudential basis, but we are also explicitly giving it the task of monitoring broader systemic risks and holding it accountable for that.

Q474 John Thurso: I am assuming that we would not simply be depending on two meetings a year as the control?

George Osborne: No.

Q475 John Thurso: How would you envisage that control being properly exercised? Would it be by officials reporting to you or would it be a ministerial responsibility?

George Osborne: First of all, Treasury officials sit on the FPC, like they sit on the MPC, and they are not voting members but they, of course, report back. Second, I have certainly made it a practice, and I think from my knowledge my predecessor, Alistair Darling, made it the practice to see the Bank Governor at least once a month anyway, sometimes more, so there is regular discussion about all sorts of economic issues. There is also then events like the stability report, which of course we will see after it has been decided by the committee, but we are kept informed like that, as you are. I think in all sorts of ways we are going to make sure that the Bank of England fulfils its statutory obligations. That is my responsibility. I or my successors are responsible for the system, the system that I have asked Parliament to legislate for.

Sir Nicholas Macpherson: Can I just add quickly-

Q476 John Thurso: Can I just-and then you can add away. If you look at, say, America and what they have done, they have set up their financial oversight, whatever it is called, body and they have put Timothy Geithner in charge of it as the chairman on the grounds that the equivalent of a Minister needs to be at the heart of this. We have taken the opposite decision, which is to take all the Ministers right out of it. I think it is a very legitimate area to ask a question as to why we have done that when so much other opinion or some other opinion goes the other way.

George Osborne: My observation on the American system, though maybe you should ask Mr Geithner what he thinks, is that they have partly taken this approach because they have so many regulators that their only way of bringing them together, post the crisis, was to create this board. The obvious person to chair a board where there are lots of regulators, all with different jurisdictions, all very jealous of those jurisdictions, might be an appointed Treasury Secretary.

We are in a different situation here. We have the Bank of England as basically the main regulator. There is also a markets and consumer protection regulator, but the main regulator when it comes to financial stability and risk and prudential regulation is the Bank of England. The answer to the question your predecessors asked, and some of you were on the Committee, who is in charge, the answer is the Bank of England in peacetime. Now, when a crisis develops and, of course, the use of public money is at stake then the Chancellor steps in. But what I wanted to get away from, and what this Committee advised us to get away from a couple of years ago, was the tripartite arrangement. The clue is in the title; there were three organisations and three sets of people who thought they were all in different ways responsible or not responsible.

Q477 John Thurso: I concur with that in the sense that the actual doing in the ordinary course of events should be divorced, which is what is happening. The thing we observed in 2007, just prior to Northern Rock, this Committee was in Washington and met with Hank Paulson and with Ben Bernanke. I remember well all of us saying how worried we were about the build-up of risk and so on and them all telling us that there was not that much of a problem and we shouldn’t worry our pretty little heads, basically, and it is all okay. It was quite clear that there was a serious problem building but it was very difficult to get a handle on it. If we take that build-up and apply the new mechanisms we are putting in place, the critical test is, will somebody somewhere recognise that buildup and take action, which was missing both in the States and this country before? At what point does it become political and who will have that responsibility?

George Osborne: I think in the environment that you are describing, 2005-2006, there is not at that point a material risk that public money is going to be at stake but there is clearly the build-up of broader risk in the system becoming over-leveraged. You would expect the Financial Policy Committee to not just produce the report that Mr Hosie alluded to but then do something about it, have the tools. Instead of just getting up and saying, "Look, there is a problem. Will the Government do something about it?" they are going to have available tools like loan-to-value ratios, potentially countercyclical capital requirements and so on, margin requirements. These are all going to be things they are going to be able to exercise. Parliament will decide what tools to give them but they will then be independent in the exercising of those tools.

I think there is a bit of a parallel here with monetary policy. It has been known to be the case that when Chancellors were in charge of interest rates that they didn’t always put interest rates up in the run-up to general elections and sometimes they announced interest rate cuts in their party conference speeches. We moved away from that world. Some of these tools the FPC are going to have are taking away the punchbowl. They are about the availability of mortgages, the availability of credit and so on. Now, I am sure we are immune to these pressures as elected politicians, but many elected politicians are not and will, in other words, succumb to the pressure not to take the punchbowl away, not to try and curb a housing boom or whatever. The Financial Policy Committee is going to have these tools available to it. Of course, we have to get those tools right, that is a big public policy challenge for us all, but the reason we are making this body independent, the reason we are not giving the Chancellor of the Exchequer the power and the responsibility to monitor systemic financial risks and take these actions, is that Chancellors sometimes succumb to electoral temptation.

Q478 John Thurso: There is a broad consensus that we don’t want inflation. There is a broad consensus now on monetary policy. There is a broad consensus that around 2% CPI is the right target and that the Monetary Policy Committee will use interest rates and QE to eventually achieve their target. There is a quite a lot of academic work around that. It is back to my original question. We can’t even define financial stability. We don’t have the tools. Is this not automatically going to be political rather than a matter of independent judgement of facts, which is what the MPC is, and how do we get out of that?

George Osborne: We are trying to make it a matter of independent judgement, not what tools they have, that will be a matter of political judgement, but how they exercise those tools. I freely accept that we are trying something new here. This is not unique to the UK that we are looking at this area. The American arrangements that you referred to are their response to that; the eurozone and, indeed, the European Union has created a Systemic Risk Board of central bank governors. There have been various international responses to the same policy challenge. We are all trying to work out how do you spot the risks developing in the broader system and how you do something about it. I think we can be proud of the arrangements we are proposing to put in place because I think they are at the cutting edge and we are leading the pack, not following it, but it is going to require a lot of work from the Treasury and from Parliament to get this right over the coming months. The big decision we all have to take in the autumn will be what tools to give the Financial Policy Committee. The Monetary Policy Committee has a very big tool; it can raise or cut interest rates. What tools are we going to give the FPC?

Q479 Chair: Chancellor, can I take you back to what you were saying a moment ago about your powers in wartime? You said that in wartime-and I am quoting what you said-you would be centrally involved and that the Chancellor would step in. What exactly does this mean? Are you going to be chairing the crisis meetings that are going to be running this crisis?

George Osborne: The response to every crisis is not necessarily to set up a committee.

Q480 Chair: Someone is going to be deciding whether to-

George Osborne: The big decision-

Chair: Who are you going to put round the table before you decide to write that cheque?

George Osborne: I suspect the Bank Governor and the Chancellor of the day-

Chair: You don’t have to call it a committee. Call it what you like.

George Osborne: -will be in near permanent session, but we do not have to speculate about the future, we can look at the recent past. The decision to recapitalise the Royal Bank of Scotland, the decision to nationalise Northern Rock, the decision to set up the Credit Guarantee Scheme; these decisions were legitimately decisions taken by the Chancellor. That is absolutely clear in the new arrangement. What was not in existence before was a system for identifying risks across the financial services, spotting them develop, doing something about them, taking away the-

Q481 Chair: We have just been discussing that. What I am trying to clarify is what happens-I am just going to stick with the Chancellor for a moment, Sir Nicholas, then I will come back to you in a moment if you want. I want to be clear what is going to happen in this crisis. You are going to be in charge, so you are not just stepping in or being centrally involved. You are actually running this; is that correct? You are running the policy to deal with the crisis?

George Osborne: Yes, in the sense that the principal tools available in the crisis will be the ones that the Chancellor has to deploy but obviously there are-

Q482 Chair: What happens when the Bank differs in its view from yours? Will the Bank have and will you consider it acceptable for the Bank to dissent publicly from the decision that you are taking?

George Osborne: The Bank Governor is an independent figure and I certainly am not going to be in a position to muzzle the Bank Governor.

Q483 Chair: So the answer is yes?

George Osborne: The Bank Governor, whoever the Bank Governor is at the time, will have to make their own decisions about how they conduct themselves within their statutory requirements, but the Chancellor of the day can’t impose a speaking ban on the Governor.

Q484 Chair: What if there is a package of measures, some of which you have direct control of and some of which you think the Bank should take, which the Bank dissents from taking? Don’t you think it is worth at least considering having some much more restrictive power of override to enable you to ensure that that coherent package is implemented rather than have these institutional differences end up getting in the way of handling the crisis?

George Osborne: I think the tool that is a classic central bank tool, not a Treasury tool, is liquidity support of the bank’s balance sheet. That is an absolutely standard function of central banks since Paget onwards. Obviously, that is a tool available to the Governor. It is worth noting that large-scale liquidity operations need a Treasury guarantee anyway because the Bank’s balance sheet will not be large enough to do it by itself. Second, the Treasury, in fact, in the previous crisis did create its own liquidity tools through the Credit Guarantee Scheme. I have already said what I have said to the Committee about powers of direction. There is a general power of direction in the 1946 Act. I will, of course, listen to the recommendations you make. I would just point out that sometimes if you propose some additional powers of direction, the exercise of those powers of direction in a crisis, that is, the Chancellor overruling the Bank Governor, can in itself be a confidence-diminishing moment. We will bear this in mind.

In the end, yes, we can prescribe the lines of responsibility, the lines of accountability, who is in charge of what, and I have been clear that the big tools available in a crisis are ones that the Chancellor has at his disposal or her disposal. But I would hope that we would conduct the whole thing in the spirit of co-operation between the Bank Governor and the Chancellor. I think if the Chancellor and the Bank Governor are at war with each other in the crisis they are taking a bad situation and making it worse, so there is also an obligation on whoever is the Chancellor and whoever is the Bank Governor at the time to work together and cooperate and that is their obligation.

Q485 Chair: Chancellor, you and I have both had enough experience of Government to know that cooperation can often become institutional tension and even rivalry, particularly at times of crisis. What we are trying to do-

George Osborne: I have done my best in this job to take classic institutional rivalries between Number 11 and others and reduce them.

Q486 Chair: I am sure you have. What we are trying to do here is put in place something that has a chance of coping with those tensions. I don’t think it is a good idea to rely on the hope that we will have this full cooperation.

George Osborne: Well, it is not hope.

Chair: Hope is the word you used.

George Osborne: As I said, large-scale liquidity operations require the consent of the Treasury. The Treasury created the Credit Guarantee Scheme off its own balance sheet, but ideally you want a Chancellor and a Governor working together rather than at war. Of course, you are dealing with a situation where they are at war with each other, and I am pointing out there are tools available to Chancellors in that environment. I would just hope you would not have to be in that situation and because you are relying on human nature there is an element of hope involved.

Q487 Chair: There is a huge raft of difference between being in full cooperation and being at war, and it is very likely that we will be somewhere in between in these scenarios.

George Osborne: You are speaking to a veteran of these encounters.

Sir Nicholas Macpherson: Can I just add to this? The thing that you have to understand is that the Bank of England’s balance sheet, by central banking standards, is small. That means if they are going to contemplate pretty much any action in a crisis-

Chair: The Chancellor has already made that point.

Sir Nicholas Macpherson: -they have to get in touch with Treasury. Well, I am just-

Chair: Reinforcing.

Sir Nicholas Macpherson: My experience through 2007, 2008, 2009 was they were not slow to draw attention to those issues, which means you do get quite early engagement on these matters.

Chair: Quite keen to make sure liquidity becomes solvency so that someone else is picking up the tab. We’ve got the point, Sir Nicholas.

Q488 Jesse Norman: I think on the last question the issue is whether the Chancellor can procure the Bank to behave in a certain way rather than merely, as it were, act as underwriter.

George Osborne: The Bank is the Government’s agent and I think the current Bank Governor has made it clear that he is very happy to act as the Government’s agent if the Government or the Treasury stands behind the cost of the policy. What I don’t have, unless I were to invoke this power of direction in the 1946 Act, is to force the Bank to use its own balance sheet, but that would be an extraordinary intervention into an independent central bank and it would have its own consequences.

Q489 Jesse Norman: Yes. Chancellor, you have been very eloquent about, as it were, sticking with the Court as it presently is. Were you surprised that the Court did not conduct an inquiry into the performance of the Bank during the crisis? There obviously were areas in which its own performance was not ideal.

George Osborne: I guess it is easy for me to come in after the event and say something should have happened or should not have happened. I think the way I would put it is I think the FSA did a very good job in conducting its own pretty candid inquiry and publishing that inquiry, and that is a model for all institutions to pay attention to.

Q490 Jesse Norman: Sir Nicholas, would that be your view also for HMT since you, as far as I am aware, didn’t publish a report?

Sir Nicholas Macpherson: HMT have the very good fortune of being audited by the National Audit Office, who did a very thorough report on Northern Rock. But, as I said earlier, we are keen to learn the lessons of the crisis ourselves and we are going to do some work for the PAC on that.

Q491 Jesse Norman: That will be published, will it?

Sir Nicholas Macpherson: Yes.

Q492 Jesse Norman: Thank you. Just to go back to the question that the Chairman raised a moment ago, imagine we are in a situation with Northern Rock, the crisis is starting to escalate; what happens differently now versus what I think the Chancellor referred to as a confusion of responsibilities previously?

Sir Nicholas Macpherson: I think I can answer that question very well because I can remember having conversations with the Governor and Chairman of the FSA in late August 2007. What you had at that point were two very differing views on the way forward on Northern Rock, which in some ways it fell to the then Chancellor to seek to internalise and take a view on the way forward. I think one of the real benefits of the proposal set out in this paper is that those debates will be internalised within the Bank. There is lots of governance around them but ultimately it will be for the Governor to come to the Chancellor and say, "This is the way forward". I think that will result in clearer and better decision-making.

Q493 Jesse Norman: That was a very elegant high-level view. Was the argument as to whether or not it should be nationalised at the time, the Bank saying yes, the FSA saying no?

Sir Nicholas Macpherson: In August 2007 the issues were whether there were liquidity measures that could be taken to support Northern Rock and whether there were measures by which other institutions could be supported in seeking to buy Northern Rock. There was a separate debate through the autumn of 2007 around nationalisation, which was more of an issue in terms of the internal decision-making within Government. It wasn’t that the Bank of England and FSA had radically different views on the benefits and the costs of nationalisation.

Q494 Jesse Norman: Thank you for that. You have referred to clause 42, Chancellor. I take it there is nothing to stop you stepping in in advance of a clause 42 activation, the Bank warning you that public money was at risk?

George Osborne: Well, no, because there is also the biannual meeting with the Governor explicitly required by statute and minuted and where we discuss financial stability. There will be plenty of other occasions during the year, but that is a kind of fallback in the legislation.

Q495 Jesse Norman: But if alarm bells were ringing before any formal notification, the Chancellor could step in or could take action?

George Osborne: Yes, of course. The Chancellor would use the channel available through the contact with the Governor to make this clear. The Chancellor also, as we were discussing earlier, sets the remit.

Q496 Jesse Norman: An example, I suppose, would be the one you have mentioned of RBS’s purchase of ABN because presumably at that time there was no money put at risk, and yet there certainly were plenty of voices who thought this was an extraordinary bridge too far for a cash offer, which it was.

George Osborne: I think we have to be careful here. That was a decision by the regulator, a commercial decision by a regulator. Sorry, a decision that had huge commercial implications by the regulator on a company. I don’t think you want Chancellors of the day deciding whether one bank can take over another or if one institution can take over another. I think it would be a pretty slippery slope, and we keep Chancellors out of things like people’s tax affairs for good reasons as well. The PRA, the prudential regulator, would make those decisions, but I think one of the advantages as well, as Nicholas was just talking about, of what we are doing is all these decisions about systemic risks, regulation of individual firms and so on, they are all brought together in one institution now. We don’t have the Chancellor faced with the FSA saying one thing and the Bank of England saying the other and they have to make a decision between the two of them. The Bank is forced to internalise these decisions. The principal reason why we put prudential regulation into the Bank, prudential regulation of individual firms, is precisely so that there is that connectedness. You don’t have some separate institution and the Bank Governor saying, "Well, I saw all this happening but unfortunately the regulator refused to listen" and the regulator saying, "We were doing our job but no one was looking at the systemic risk". You will have the Bank of England sitting before you as the institution responsible for all these things.

Q497 Jesse Norman: The problem in a way with the point you are making-I had not understood it-with the RBS ABN purchase was that that would have been cut off by the regulator acting on substantive supervisory grounds to look at the implications of-

George Osborne: With something as big as that you would expect the Bank Governor-and there will be a Deputy Governor responsible for PI, but the Bank Governor chairs the board of the PRA and sits on the FPC. The Bank Governor would take a view. The Bank Governor and I both absolutely agree that what is required is judgement. There is plenty of regulation in this area; it just needs to be good regulation. There has to be scope for judgement and discretion by independent regulators. As I say, I would not want an elected politician to get engaged in individual decisions.

Q498 Jesse Norman: Whereas just to be clear, as matters actually panned out it was waved through as a matter of box checking, with the Bank of England having no formal role in assessing the wisdom or no of the decision?

George Osborne: I was not there at the time so-

Q499 Jesse Norman: Sir Nicholas, that wouldn’t be an unfair characterisation?

Sir Nicholas Macpherson: My recollection is there was some competition to take over this great Dutch bank, which turned out to be a very bad buy indeed. That would have been an issue for the FSA at the time. I think what this legislation is seeking to do is to introduce a different form of legislation as well as rearranging the architecture. I would expect under this regime a different approach to be taken.

Q500 Jesse Norman: But the competition would not have been a reason itself to have allowed it to go through. A Governor acting in the way that is contemplated now could perfectly properly have said, "We would permit this share offer but would not permit this cash offer".

Sir Nicholas Macpherson: I think that under this regime the Governor will be very much involved and I would expect them to be influencing events both behind the scenes and more visibly.

George Osborne: Let me pick up on that point. What you might well have in the situation we are talking about in late 2007, certainly I would hope to have-this is the purpose of this legislation but ultimately, as I say, the actual individual decision must be one for an independent regulator-is the awareness in the Bank that there is a state of heightened financial instability, funding markets have closed, we have had a run on Northern Rock; this is not the moment when we are going to nod through huge takeovers by one UK bank of one foreign bank and that big questions are going to be asked about the funding position of the bank that is doing the taking over. Asking those big questions, informed by a view of the broader financial climate at the time, is what we want to see and that is why we are internalising it in the Bank of England. So you don’t have the Bank of England saying, "We are responsible for the overall system but not the individual regulatory judgements" and the FSA saying, "We are responsible for the individual regulatory judgements but we don’t have a view on the overall environment".

Q501 Mr Mudie: I just want to come back. I think we are trying to do you a favour, which you resolutely appear not to want. There is real worry about the powers you are giving the Bank that can affect ordinary people out there. I will give you word for word what the Bank Governor said to me. I said, "We are giving you great powers" and he cut in, "Yes, you are". I said, "And we have little power to force you to rethink". His response, and it should make you sit back and just think for a second, is, "You have the power to take back". That is the second time he has said this here. When you challenge the Governor over his powers, his answer is, "Well, don’t give me them", not middle way, "Well, we will think about it", "Well, I hear your pain", et cetera. From politicians, it is just amazing. The Americans have done it. They put the Secretary of State chairing the board. If you don’t want that-it is just putting a default power in the Act that allows you to have your way. Now, it will be transparent, it will be public, it will be a nuclear act if you wish, but we think you should put it in because the very fact of it being in is a bargaining power when you really feel strongly about things. What is wrong with that?

George Osborne: I will listen, of course, to your recommendation, but there is already a power of direction. There is already a power in the 1946 Act for the Chancellor to override the Bank Governor, but there is also a good reason why that has not been exercised since 1946. You could make a bad situation worse.

Mr Mudie: Yes, exactly.

George Osborne: In a way, we are not dealing with a hypothetical situation because we have just been through the biggest banking crisis in our history. You have to ask yourself, let us ask ourselves a real question, which is if Alistair Darling or Gordon Brown had overruled Mervyn King in 2007 and 2008 would that have improved confidence in our country’s management of the crisis or would it have-

Q502 Mr Mudie: Chancellor, the answer is they should have because-

George Osborne: But I would daresay, Mr Mudie, I-

Mr Mudie: -Hector and Mervyn should have acted and did not. If the politician had had the power to say to them or used the power it might have improved the situation.

George Osborne: I would say, Mr Mudie, they did have a power of direction. My judgement, but this is only with hindsight, I think overruling the central bank governor in the middle of a financial crisis would have added to the sense of chaos rather than diminished the sense of chaos.

Q503 Mr Mudie: Are you saying, then, because it is specific, that there is a power that will be unaltered by this legislation in the 1946 Act that will give you and any future Chancellor the ability to actually instruct the Bank of England?

George Osborne: Nick will read it out for the Committee.

Sir Nicholas Macpherson: Yes, clause 4 of the Act says, "The Treasury may from time to time give such directions to the Bank as, after consultation with the Governor of the Bank, they think necessary in the public interest".

Q504 Chair: That is considered a nuclear option, though, isn’t it?

George Osborne: It is considered a nuclear option because, and I guess this is the tension that the Committee has to wrestle with and certainly a Government has to wrestle with, central bank governors are independent. We seek to make them independent. We seek to protect them from elected politicians. On the other hand, we as elected politicians are the people who are ultimately accountable to the public and there is always that tension. I think we have the balance right here. I think we have created a system where the Bank Governor is accountable, where in a crisis and the use of public money the Chancellor is responsible. But we are not trying to second guess the Bank Governor in his day-to-day job of maintaining the stability of the financial system.

Q505 Chair: I think you have agreed this area needs some more thought and we are going to do our best to give it some more.

George Osborne: I think I agreed that I would listen to the recommendations you make, yes.

Q506 Mr Mudie: It is not personal, is it? It is not just mine; it is the Committee.

George Osborne: No, I thought you asked some very good questions of the Bank Governor in the previous session.

Q507 Andrea Leadsom: Chancellor, thank you for agreeing to talk on slightly wider subjects. Since you were here last, we have had the Vickers Commission in again to talk about their interim review. Specifically, they and this Committee have thought very strongly and very forcefully that competition should be a far more important agenda in the banking sector in the UK than it appears to be in the proposed new legislation so far. Specifically, I wanted to ask you whether you consider that UKFI should be looking at a possible solution that would include breaking up the banks, Northern Rock, RBS, even potentially Lloyds HBOS with the agreement of other shareholders, and parcelling them off and selling them separately in order to create a more competitive environment in the UK?

George Osborne: First of all, I would say we have listened to the recommendations of the Treasury Select Committee-and there were other external people who suggested this as well-and given the new Financial Conduct Authority a duty to promote competition, which was not the case before you made your recommendations so we have taken that on board. Second, when it comes to the individual banks-obviously I have to be a little bit careful here because they are commercial institutions with share prices-I would say this. I have always made it clear that I want to see a competitive banking system. I have always made it clear that I think one of the considerations we should have, and sadly we are not at this point yet, when we come to sell bank shares and sell banks is that we want to have a competitive banking system. That should be one consideration we have in mind. We have now put Northern Rock up for sale. Lloyds Bank is required to make a divestment by the European Commission and they have issued a market notice on that. At the same time, the Independent Commission on Banking has said they want to see a strong challenger, either a new entrant or a vastly stronger existing bank. I don’t want to preempt their final report in September, but I am confident that the divesting of the Lloyds branches, which is under way or rather they are seeking a buyer, will help create that strong independent challenger. I certainly hope the sale of Northern Rock will do that as well.

Q508 Andrea Leadsom: Thank you. Would you rule out entirely reversing the Lloyds HBOS takeover? Certainly I have heard-I am speaking personally here-that the branches proposed for sale from Lloyds are not necessarily the best, most competitive, inevitably because they get to choose which ones they sell. Do you think that there is any merit in considering reversing the takeover in its entirety?

George Osborne: No, I don’t and nor do the Independent Commission on Banking. They want a competitive new challenger. They said that either in terms of branches or in terms of the strength of the balance sheet or both we should go beyond what the European Commission were requiring. They have not spelt out in detail what exactly they want to see, but that is because we are awaiting their final report. They are in discussions, they have had a consultation period, and so on. But I don’t think it is possible to break apart the Lloyds HBOS deal. I think we now have to implement the European Commission’s requirements, which is the divestment of 600 branches, and satisfy the Independent Commission on Banking.

Q509 Andrea Leadsom: With that in mind, bearing in mind it is the European Commission who required the 600 branch sell-off, there is, isn’t there, an issue now with European regulators having more teeth than ever in the past, that what we have just been talking about, about the cooperation and hope in the relationship between the Governor and the Chancellor, that there is a third person in this marriage, which is the potential impact of a European regulator who might also seek to involve themselves and overrule what British regulators and Chancellors are trying to do?

George Osborne: First of all, in respect of competition, of course, the UK authorities at the time explicitly waived their powers to stop this merger. More broadly, it is certainly true that the European Union is developing financial services regulation and, indeed, there are new supervisory agencies, supervisory authorities, one of which is based in London, the European Banking Authority. We have been clear when we have been arguing on behalf of the UK that they should not in any way second guess decisions that require the use of public money, that they should be there to promote the single market so that British firms can operate in Europe and European firms can operate in Britain, and we are, as the home of the largest wholesale financial services centre in Europe, also the voice for making sure the regulation is competitive vis-à-vis the rest of the world. We bring that wholesale financial services perspective to the table.

Q510 Andrea Leadsom: Is Europe listening to the British view on that?

George Osborne: I think we have had some good successes, on the hedge fund regulation most recently, on some regulation on short selling. These are not the easiest of issues to get right but what we have achieved, I think, is a more stable financial system but also one where British firms can go and compete in Continental Europe and European firms can compete in Britain. That is to Britain’s benefit, I think.

Q511 Chair: Chancellor, you said earlier that this Committee should not have a veto on the Governor’s appointment and dismissal-and incidentally the Committee has no view on this issue, we haven’t discussed it-because, and I more or less quote, the Bank performs an executive function, has executive functions, whereas the OBR does not. But in your own response to our report on the OBR you said exactly the opposite; you said it was the fact that the OBR has an executive function that leads you to feel that that was an important consideration in your decision to give it dual accountability, including the power of appointment and dismissal to us. Perhaps I could just read what it actually says. I quote, "The OBR has been established with dual accountability to both Parliament and the Chancellor. This dual accountability reflects the OBR’s executive role in producing the official economic and fiscal forecast for the Government. This is the important consideration, which leads to the new accountability structure."

George Osborne: I don’t think there is any contradiction. I said that the OBR has a job, I called it an executive job, in producing the independent numbers that Parliament holds me to account for on fiscal policy and, indeed, on the economic forecasts. It is interesting, can I just point out that there is no argument in Britain at the moment about whether the GDP numbers we produce are the right ones, the GDP forecasts, that I have somehow fiddled them. They are the OBR’s and that is all accepted now a year on from the event. That is quite a remarkable change. If you mean by, though-

Q512 Chair: It is not what I mean, it is what you meant when you responded to our report, Chancellor.

George Osborne: The use of the word "executive" in that respect was its executive function in producing independent audited accounts for the British Government. That is something that is not where the Government is using policy instruments to take decisions that materially affect people on the ground. It is about producing things that enable the Government to be held to account. I think they are materially different. When it comes to the Bank Governor and the Bank of England, this is a body that sets interest rates, that will be given significant tools on macro policy, and I think it is proper that the Government of the day chooses the Bank Governor, is held accountable for that choice, but also that the Governor is given some protection, some independence, so it is quite difficult, to put it mildly, or extremely difficult, to get rid of them.

Sir Nicholas Macpherson: You will, of course, have a-

Q513 Chair: Sorry, if I may I will cut you off because I do want the Chancellor to get away on time. There are a couple of other points that I would like to raise with you that are not related to the accountability inquiry. One concerns what is happening to the banks at the moment. The banks are being encouraged to do more lending by you through Merlin, among other things, and by others, by politicians, and at the same time they are being asked to strengthen their balance sheets. Of course, there is a tension, not to say a contradiction, between these two. I just wanted to give you the opportunity to say which of these two you thought at the moment should be their priority.

George Osborne: I think they can do both. The banks are strengthening their balance sheets; they are deleveraging. That is happening anyway regardless of any new regulation. The market is demanding that; the funding markets are demanding that. At the same time, of course, new regulation, principally international regulation, is requiring higher capital, or at least higher capital in the future, so the bank balance sheets are shrinking. The purpose of the Merlin lending agreement is to shield in that process small and mediumsize business lending in the UK. If you have a big, international, universal bank, based in the UK, that has operations all round the world, lends to all sorts of different customers, I am saying, and the purpose of the Merlin agreement was, as your balance sheet inevitably shrinks post the financial crisis, I want to protect, indeed I want to increase, small and mediumsize business lending in the UK.

Q514 Chair: The other question I want to ask, which as you can imagine is a considerable cause of public concern, is over Greece. Do you consider the Greek problem to be a liquidity or a solvency crisis?

George Osborne: I think it has issues of solvency, obviously, and that is why it has proved so difficult to resolve. The Greeks, to be fair to them, their parliament has just passed a package that improves the solvency position of the sovereign, that is, measures to try and reduce its budget deficit.

Q515 Chair: But if it is a solvency crisis, then all these bailouts are just sticking plaster, aren’t they? Eventually there is going to have to be restructuring or default-

George Osborne: Well, they are sticking plaster if they are not used, if the time bought-after all, sticking plaster buys you time if it is a wound-is not used, to do something about the fundamental problems. The fundamental problems for Greece are, first of all, it is a very large budget deficit; secondly, the competitiveness of its economy; third, there is the weakness of the European banking system, and we have very important stress tests due to be published later this month across Europe. I think there is a big, big task here that Europe needs to meet and fulfil, which is to make those stress tests credible. They were not too credible last year. Finally, there is a big debate, and we can certainly be here for another two hours, which is how you operate fiscal policy in a single currency. Now, those of us who did not want to join the euro pointed out that if you joined the euro you end up having something akin to a single fiscal policy. Whether the eurozone heads in that direction or not remains to be seen, but what is clear is they need to have much better arrangements than they have had. To be fair, they are trying to develop those.

Q516 Chair: I think you are agreeing with the majority view there that the stress tests were not credible and at the moment we are in a position where we don’t have credible stress tests.

George Osborne: I think the weakness of the stress tests-

Chair: Can I just ask the question?

George Osborne: Of course.

Chair: In which case you must be doing a good deal of contingency work in the Treasury to deal with the eventuality of a possible default?

George Osborne: Well, I don’t think it is sensible to reveal all our contingency plans in public, but I would certainly be very happy to speak to you privately about those and to discuss how to share that with your Committee. We do a lot of contingency planning for a lot of different events. I would point out that, without returning entirely to our previous discussion, the Financial Stability Report-

Chair: There is a very good section on it in there.

George Osborne: -produced by the Bank of England warns us all that the greatest risk to the UK banking system comes from the sovereign debt crisis in Europe at the moment. I think it would be somewhat remiss of the Treasury if we were not taking into account some of these recommendations.

Chair: We are extremely grateful to you for coming to give evidence to us this afternoon. It has been illuminating and you have left quite a number of doors open on some very important issues. We are grateful to you for that and we will be coming back to you with some recommendations in due course. Thank you.

Prepared 11th July 2011