To be published as HC 764-i

House of commons



Treasury Committee

Bank of England liquidity reviews

Tuesday 20 November 2012

Bill Winters

Ian Plenderleith CBE

Evidence heard in Public Questions 1 - 101



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Oral Evidence

Taken before the Treasury Committee

on Tuesday 20 November 2012

Members present:

Mr Andrew Tyrie (Chair)

Stewart Hosie

Mr Pat McFadden

Mr George Mudie

Mr Brooks Newmark

Jesse Norman

Teresa Pearce

Mr David Ruffley


Examination of Witness

Witness: Bill Winters, Chief Executive Officer and Managing Partner, Renshaw Bay, gave evidence.

Q1 Chair: Thank you very much for coming in this morning, Mr Winters, and, on behalf of Parliament, thank you very much for conducting this review. You were very well placed to have done such a review and on a technical subject. Can I begin by quoting what you say at an important point, "There appears to be some tendency within the Bank for staff to filter recommendations in such a way as to maximise the likelihood that senior staff will find the recommendation palatable." Why don’t you translate that for us into undiplomatic language?

Bill Winters: Okay. First of all, good morning and thanks for taking the time to take a look into the review that we spent the summer doing, my piece in particular. A little bit by way of background. I spent about four months in and out of the Bank, having had, of course, exposure to the Bank for years in my various professional capacities but never having really been inside. Through that process, I spoke to pretty much all of the senior members of staff and a few that were, I would say, more middle level but specifically in the area of the liquidity operations of the Bank.

Through that process I gathered lots of impressions. The meetings were effectively confidential, so we were not taking minutes and reporting back to anybody. By the same token, it was clear that what people said to me would eventually be synthesised into some sort of a review that most likely would be public, and of course it has become public. I think I got a reasonably candid sense because of the relatively broad number of people I spoke to, both current employees and former employees, including current and former Governors, a member of the Court and members of the external committees and so on. I think I gathered a sense, but certainly not either a perfectly objective or clear or unbiased sense. Through that I was able to benchmark what I noticed in terms of people’s behaviour, the way they expressed decision-making processes and so on, compared simply to other things that I had seen, which for the most part for me has been in the private sector in the banking industry.

A little bit more by way of background and just so you have my context. I worked for one company for 26 years, but over that period it was really four or five different companies owned by different people, run in very different ways, and it started small and ended up very big. I have an idea of how different organisations work from the inside and, of course, I have seen many other organisations-my clients and others-from the outside. I noticed a tendency towards centralisation and hierarchy in any large organisation, public or private sector. There are some good reasons for hierarchy in organisations, particularly where there is an element of crisis response or where the risk of a bad outcome is a particularly bad risk; so one thinks immediately of the military and things like that where hierarchy is perfectly accepted.

At the same time, I noticed that hierarchy and centralisation tends to stifle free thinking and innovation. It tends to occasionally strip out good ideas that should be fully explored and debated. Of course, each potentially good idea that gets explored and debated but is not ultimately acted upon can be viewed as a waste of time because it was explored, debated and not acted upon, but I do not think that anybody would suggest that that is an optimal outcome. You want to have a diversity of views and opinions, and you certainly want the decision-makers to be exposed to as much diversity as possible in as efficient a way as possible.

As I spent time with various people in the Bank it became clear to me that there was, particularly during the crisis, although perhaps it was before the crisis as well, a tendency for the staff to ask the question, "What is going to get through? If it is not going to get through let’s not put it up because, first, that means we won’t get any action or at least we won’t get directionally the action that we want; and, secondly, in some cases it may not be good for us from a career perspective". This is not unique to the Bank of England, but I found it to be pronounced in the Bank and something that, since it was Court that asked me to review the liquidity operations of the Bank and associated governance and so on, I thought it was appropriate to highlight.

Q2 Chair: That was quite a long translation of one sentence. Why don’t I have a go? You are grinning broadly now, Mr Winters. What you are really saying, are you not, is that the top of the Bank, that is the Governor, is stifling the expression and consideration of dissident views and that the structure of the Bank is inimitable to internal challenge and debate?

Bill Winters: The first observation is it is not limited to the top of the Bank. I think this is a cultural trait that probably exists in the Bank independent of the Governor.

Q3 Chair: Let us clarify; is what I have said right or wrong? You are saying, no, it is not just the Governor, but is there any aspect of what I have said that is wrong?

Bill Winters: I think the effect is correct. I would not have said that the Governor or the office of the Governor stifles dissent because, at least as far as I noticed, there was no active stifling of dissent at all. In fact, there was a reasonably strong encouragement to challenge up the line. I chose my words carefully because there was a time in the early stages of the review that I wrote some notes to myself saying, "There is a lack of challenge culture in the Bank". Since I thought that was quite a substantial conclusion to reach early on, I tested it as we went through the review. I concluded that, in fact, there was not a lack of challenge culture in the Bank; that there was a challenge culture. Subordinates regularly challenge their superiors. What they did, though, was to effectively filter or preselect a range of recommendations to bump up the line that they thought had the greatest likelihood of getting through.

Q4 Chair: That is not much of a challenge culture, though, is it, to only challenge the things you think that your superior wants to hear?

Bill Winters: Sorry, I think there are two elements to the challenge culture. One is during the debate phase and two is during the recommendation phase. Importantly, I think during the debate phase there is a very open discourse. I found the Bank to be an extremely intellectual organisation. That is overwhelmingly a positive thing but, of course, it has some negative connotations as well in terms of a sense that it can be over-intellectual at times; but a very intellectual organisation and the debates were full and complete, particularly at the staff level, and the recommendations that went up the line were viewed as appropriate recommendations. It seemed to me as well that they were often clipped or tailed to fit into what they thought the most senior members of the Bank’s staff-the decision-makers ultimately-were likely to accept.

Q5 Chair: What is the cure?

Bill Winters: The cure is a complicated one and I think every organisation is faced with this challenge. It starts with the very clear identification from Court and other external stakeholders, obviously including yourselves, to the Governor, or the new Governor as it will be in the next few months, that this is an area for focus. I think the responsibility for assessing continuous improvement resides with Court. Of course, the Governor and the Governors are always responsible for the management of the culture of the Bank and they should be held directly responsible but, in terms of oversight, I think there is a very clear role for Court to play. It starts with identifying the processes that Court will undertake to make sure that the information that is making its way up to the Governor is not being filtered.

Q6 Chair: Do you really think Court is up to this?

Bill Winters: Yes, I do.

Q7 Chair: Is there any evidence you have seen that Court historically has been up to this?

Bill Winters: The period of the review that I was asked to do is an interesting one because it started with a Court that-the review period, that is-by its own admission, and certainly the observations of this Committee and its predecessor compositions, clearly identified a lack of robustness of challenge and, in some sense, a lack of skills in Court. I think that has been accepted and that is certainly consistent with what I have seen. The Court that I interacted with today is very different in composition. It is more technical. There is more financial services expertise. It is smaller and I certainly sensed a real willingness, starting with the fact that Court commissioned these reviews in the first place, to explore issues that perhaps there was less willingness to explore-

Q8 Chair: Only after a huge dingdong, to put it mildly, and the best part of two years of exchanges of difference of view with this Committee. It does not sound very willing, does it?

Bill Winters: I only know when I got involved. I got involved when they said, "This is the review that we would like to do. Would you be willing to do it", and I said, "Yes". I am well aware of the back and forth leading up to the request for reviews. I think your question was: is Court fit-for-purpose for the task at hand, so consistent with the recommendations that I have made in the review? Yes, I think Court is well under way to being fit-for-purpose. There is a natural-well, not natural actually it is quite calculated, both turnover of members of Court and evolution of capabilities on Court that have already-

Q9 Chair: You are such a diplomat. It would be hugely helpful if you just told us straight. Do you think Court is fit-for-purpose? The answer must be, "No", because at the moment it is only well on the way to being fit-for-purpose. At the moment it has not reached this nirvana.

Bill Winters: Mr Chairman, I have never been accused of being diplomatic before, so I will try to strip that out now. I think Court is well on its way to being fit-for-purpose and there is a process, with which you are involved that has Court members revolving out. I think this is the right time, though, given the Financial Services Bill that is working its way through Parliament and the substantial addition to powers in the Bank, to have a fundamental rethink of the composition of Court. I believe that that has been under way and will continue to be under way.

Q10 Chair: We should have confidence that things will be okay, although they have not been okay up to now?

Bill Winters: I think that has a lot to do with the direction coming from the external stakeholders to Court, with the appointment of new members of Court, and the specific responsibilities that are identified for Court, the accountability in which Court is held in terms of demonstrating migration and evolutionary progress on these cultural issues, which are all tall orders. But are they capable of executing? Absolutely.

Q11 Jesse Norman: To be clear, Mr Winters, you have described the Bank’s decision-making and management as involving filtering and pre-selection of views, lack of diversity, centralisation and hierarchy, or rather stifling centralisation and hierarchy. Court you have said has had little challenge and low skills and is not yet fit-for-purpose because it is en route to being fit-for-purpose. Is that right? I am just summarising what you have said.

Bill Winters: The most important thing is that the purpose that we are measuring against fitness is evolving and it is evolving in not small ways. There are major, major changes that the Bank is expected to undergo. It is in progress. The PRA is not yet formally part of the Bank of England but it is operating, at least in part, as if it were. The Court is evolving in much the same way as the nature of the Bank itself is evolving.

Jesse Norman: Do you think that might be another one of your overly polite moments?

Bill Winters: No. I am perfectly happy to be critical.

Jesse Norman: You have said all those things in your descriptions earlier. You do not dispute that?

Bill Winters: Certainly elements of all those things. Yes.

Q12 Jesse Norman: Okay. Thanks. What are the three changes to management that you would make if you were the Governor of the Bank of England?

Bill Winters: Changes in management process?

Jesse Norman: Yes.

Bill Winters: I would regularly hold meetings in small groups or with individuals that are two or three levels below the Deputy Governor to hear directly how people feel about their experience in the Bank, their working environment, the degree to which their views are valued and accepted, the degree to which they feel able to be open, and also to form some views on who the next generation of leaders are. I do not know that that has not happened in the Bank, but I certainly would suggest it could happen more. That is the human touch. The human touch is critical in complicated organisations.

The second is a less human approach but, nevertheless, trying to get at the same questions, which is surveys. Surveys are always derided in organisations-they were in mine-but nevertheless serve a useful purpose in terms of giving people an opportunity to anonymously or candidly share views in an aggregated way. That would be the second thing.

The third would be to make examples. Where there are examples of good management practice and two candidates for a particular position are otherwise tied in every regard, you give the edge to the person that has demonstrated good management skills. The more effective examples go the other way, where you penalise someone for demonstrating poor management skills. We have all been in situations where you have had outstanding technicians in an area, the best in the world at what they do, but could not manage their way out of a paper bag. Those people should be fired or put into jobs where their lack of managerial skills are less harmful. Those are the three things I would do.

Q13 Jesse Norman: That is very helpful. Are you a fan of 360-degree appraisals?

Bill Winters: I am. I find them occasionally bureaucratic and diluted through overuse but, certainly at the outset in terms of making a bit of a shock adjustment to culture, I find it very useful.

Jesse Norman: That would be quite helpful, presumably, for parts of or all of the Bank?

Bill Winters: Yes.

Q14 Jesse Norman: Thank you. How important do you think very good management skills should be in choosing the next Governor?

Bill Winters: I think very important.

Jesse Norman: Very important?

Bill Winters: Yes.

Q15 Jesse Norman: That is very helpful. When you prepared this very interesting report how far did you consult outside the Bank?

Bill Winters: Reasonably broadly. We spoke to the senior management and/or treasury operators of all the banks, so the users of bank facilities. We spoke to a number of-

Jesse Norman: This is all the big clearers?

Bill Winters: Sorry?

Jesse Norman: All the big clearing banks?

Bill Winters: The big clearing banks as well as some foreign banks. We did a compare and contrast of the Bank of England approach, in particular to the Fed, the ECB and the Bank of Japan, just as other developed country Central Banks who face similar challenges. No direct comparisons, but much of the information in the review that I wrote was informed by either mistakes that these other banks had made or successes that they had had. We spoke to a couple of foreign banks, in particular two banks in the US, in the context of the Fed not in the context of the Bank of England. We spoke to a number of academics, current and existing external members of the FPC and the MPC, and I think that is it.

Q16 Jesse Norman: What was the general view from those contacts about how the Bank ran its liquidity operations now and before the process?

Bill Winters: I think there was a general consensus that the toolkit the Bank had developed prior to the crisis was not fit-for-purpose. That became clear. It was well-articulated in this Committee’s report on The run on the Rock. It was generally accepted that the Bank has made tremendous strides since The run on the Rock to bolster its facilities, put up a pretty complete arsenal and to demonstrate ongoing flexibility. I should say I also discussed with members of the Treasury and the FSA. I received mixed views from the external parties on the degree to which the Bank was leading that change versus being led by some combination of public opinion, Treasury or this Committee. I would say probably an evenly mixed sense of what was driving that change, but no one suggested that there was not substantial change. Then there was a long list of impressions that I have summarised in my review around the things that are discouraging banks from accessing, in particular, the discount window facility.

Jesse Norman: So stigma?

Bill Winters: The stigma issues.

Q17 Jesse Norman: That is very helpful. We are going to come on to that. Final question. From what you have seen, would it have been better for the Bank to have done a more comprehensive review of this issue earlier?

Bill Winters: This Committee’s review of The run on the Rock was very substantial and was the right place to start and it was timely. January 2008 was close enough to the original crisis to have been very relevant and I am sure that it guided and shaped the subsequent evolution that took place.

The review that I was asked to do in many ways was just a tune-up or a catch-up on that original report, which I think is a perfectly appropriate thing for the Bank to want to do. Of course, I am well aware of the debate that has been had publicly, and no doubt privately, around whether a broader review should have been done. It is not the review that I was asked to do.

Q18 Jesse Norman: No, absolutely not, but from what you have seen would there have been a case for doing a broader review earlier?

Bill Winters: I think there are lots of interesting questions to be answered around how the tripartite agreement worked or did not work, at least from my perspective, but with a view to understanding how to avoid these things in what is no longer a tripartite system, but a more complicated arrangement with more consolidation of responsibility, but also more actors on the stage and more different constituencies. I refer in the review to the interaction between the MPC, the FPC and the PRA board as three bodies that have external representation. That is extremely complicated. It is not straightforward. Lessons that can be learned about the dysfunctionality of the tripartite arrangement, as it relates to what could become dysfunctionality between those three bodies, would be an important scenario to consider.

Jesse Norman: A further element?

Bill Winters: Yes.

Jesse Norman: That is very helpful. Thank you so much.

Q19 Chair: That work has not been done and you think it should be done is what you are telling us. Is that right?

Bill Winters: It certainly was not done in the context of these reviews. I would be disappointed if it had not been done by the Treasury and if you had not considered those issues in this Committee, but, no, I have not seen a formal, independent review of that nature.

Chair: You think that is something that needs some attention?

Bill Winters: There are critical questions and whether that is best executed by an independent review or best executed in Treasury with some accountability back to this Committee, I am not best placed to judge. I do think the issues are important and complicated and we have teed up a number of those issues in our review, on a very narrow subset of the broad complexity that we all face.

Q20 Chair: You are flagging up the fact that we have a more complex system, one where the lines of accountability in a crisis, which is when they come under strain, need very careful delineation now?

Bill Winters: I think that is right. I would make the point that I think it is more complex almost operationally and managerially and less complex organisationally. Obviously the effect of the Financial Services Bill and associated changes is a substantial consolidation of responsibility and accountability into the Bank of England, headed by a Governor. That is clear and obviously that did not exist to the same extent before. The flip side is that there are a number of external constituents, the three that I have mentioned: MPC, FPC, PRA, not to mention Court, together with Treasury, the Chancellor and the Select Committee; all external stakeholders of the Bank of England. We have consolidated at one level and effectively diffused accountability at the next level up.

If there is a lesson that we learned-well, we learned many lessons during the crisis and we will continue to understand those lessons-the diffused accountability at the point of decision-making was very damaging. When you diffuse accountability it is very hard to pin it back to one body. It was a tripartite arrangement. Responsibility was diffused. Decisions were not taken on a timely basis and damage was done. Now we have concentrated decision-making at one level, but with stakeholders, who themselves may still be disconnected or disjointed, sending mixed messages or contradictory messages into the Executive in terms of the decisions they should take. That process needs to be managed very carefully.

Chair: In the longer term I expect this Committee is going to want to take a continuing interest in that issue and, in the short term, it may be something the Banking Commission will also want to pick up.

Q21 Mr McFadden: To follow on from the last question the Chairman asked you, you talked about diffused decision-making and accountability during the crisis. Do you think the Bank has been in something of an institutional hump since the changes of the 1990s? After all, they were responsible for financial stability, yet every time this Committee has questioned the Bank about its role during the crisis it has said, "We were not responsible for supervision of these banks. It was the FSA’s job. It was taken away from us. It wasn’t our job and we are in a very different position from the Fed", and so on. Have they been neglectful in any way of their financial stability role because they were, to put it in layman’s terms, annoyed at the split between them and the FSA set up in the 1990s?

Bill Winters: Certainly during the course of this review I did not get that sense and in my interactions with the Bank previously, obviously coming from a different perspective, I did not get that sense either. I think as soon as whatever action is taken to diffuse accountability or to separate what, in some cases, one would want to be an integrated function, it requires extraordinary management. I found, managing risk operations in a bank for years, that if you are not very clear who is accountable for what, the buck will get passed at the time of loss. The buck is gathered during the good times, and not shared so actively, but passed in bad times. I am sure that there was an element of that in terms of the interaction between the Bank and the FSA. I would not go as far as to say a mutual distrust, but there was an organisational scepticism that I did notice. I think that is quite common and I am sure it exists between Whitehall Departments, for example, in a different context. It is a reality. You cannot just strike it out through some sort of cultural regime. It just needs to be managed. I believe that the current Bill attempts to make that easier to manage.

Q22 Mr McFadden: It is, yes. To go back to your report, you had about five months between the time of appointment and reporting. Was that enough time? Were there any areas that you would have liked to have gone into further but you just did not have time to do it?

Bill Winters: It was enough time for what I produced. What I produced was a set of high level, I would say, thematic and conceptual observations, not all of which I possessed when I came into the review period-these were understandings that I developed myself through that period- and the next level down being reasonably high-level recommendations. Had I had substantially more time and a substantially bigger and broader staff, I might have taken those high-level recommendations and tried to answer some of the questions that in my review were couched in terms like "might consider" or-

Q23 Mr McFadden: Where would you have gone next if you had another five months, say?

Bill Winters: The big observations/recommendations that I made, which were also the most controversial, all related back to my observation that the nature of capital markets is changing fundamentally, and has changed and will continue to change fundamentally, and an approach that assumes that banks were the primary transmission mechanism from savings from corporations and individuals through to borrowers, individuals and companies-the banks would no longer be the overwhelming transmitter or intermediary in those savings flows and that non-banks would become more important. Part of that is reflecting the changing nature of regulation, which is making it more costly for banks to play that role in a safe and sound way, and some of it is quite natural. Why should one particular corporate forum have a monopoly on the connection between savers and borrowers? That is not a natural state at all. It never has been historically. It only became a natural state when banks were so heavily subsidised as a result of misproperly-priced deposit insurance and the too-big-to-fail subsidies and guarantees, which I think is broadly accepted.

Following from that, in terms of the role of the Bank, the Bank’s operations pre-2007 were entirely focused on providing short-term liquidity to the banking system in the event of a liquidity shock that was an insolvency shock, and for a long time that was adequate. Obviously it was inadequate in 2007 and the Bank quite correctly engaged in a number of programmes that deviated from that very narrow focus historically. They lent money for longer terms. They intervened in markets directly, buying corporate bonds and commercial paper, and they at least contemplated extending credit or liquidity to non-banks, so beyond the direct intervention of markets. My observation was that the banks should accept and be explicit that this change is fundamental and structural and take what had been extraordinary reactions to the crisis and make them a permanent part of the framework.

So why does it matter? Is it not just semantics to say, "We are going to do it anyway, why do we have to make it permanent"? The reason I think it should be explicit is that once it is explicit you have to explain, to you and other stakeholders, how you are going to discharge those responsibilities. You do that ex ante. You do that before the crisis hits, so that at the time that the crisis comes up-and, whatever the next crisis is, it will be something that we cannot perfectly forecast right now. That much we know. Well, we know two things: one, there will be another crisis at some point and we will not be able to prevent it; so the Bank will need to have an arsenal that it can deploy. It is very important that the Bank have an understanding of what you consider to be success. They cannot understand what you consider to be success if they have never talked about the types of facilities they might use or the types of approaches they might take to markets. This recommendation is almost philosophical, but I believe it very strongly and it is not without controversy.

Back to your question-you asked a very short question, I am sorry I gave a very long answer-what would I drill in on? I would take those conceptual observations with high level recommendations and test those recommendations in the real world. I do not mean by initiating a crisis and trying to solve it, but to talk to a broad group of people about a specific programme or a specific way to express the Bank’s modus operandi to see if it holds water in the real world.

Q24 Mr McFadden: You made 22 recommendations in total and I am trying to get a sense of what you think is the most important among them. Reflecting on what you have just said, would it be fair to say the most important thing is to take that which was an emergency response and normalise the structures around that and try and get some buy in from all these stakeholders that you talked about, plus the Treasury, the banks and so on? That is your key conclusion from all of this?

Bill Winters: That is right. Yes, as it relates to the liquidity insurance part of the review, that is the key conclusion. Through that process a number of the soft spots, in terms of accountability of different external stakeholders, would become clear as well: the role of the MPC versus the role of the FPC versus the role of the PRA board versus the role of Court. As those thorny issues are debated there will be different views on, for example, whether the Bank of England should have an exclusive responsibility to backstop the maturity transformation role that banks play in our capital markets or non-banks play in our capital markets. That is a controversial question.

I am not going to pretend that in five months I have answered one of the central questions that central bankers have wrestled with for centuries, but I have made it an insertion into the debate and other people will insert it into that debate. While debating that, it will become clear what the various stakeholders’ biases are on that question. That should embolden the Executive to take decisive action in a time of crisis, without feeling that they are going to have to look over their shoulder, "What is going to happen after I make this decision? Three months from now, when I show up in front of this Committee and have to answer, ‘Why did you do that’, it would be nice to know that I had some support going in".

Q25 Mr McFadden: There is a whole other report that could be written on the relationship between Select Committees and people’s appetite for risk, given the way that we conduct our business but that is perhaps not for today. Finally, given what you have just been saying about your key recommendations, what feedback have you had from the Bank about their response to this? We have concentrated a lot around these questions of the Governor as Sun King and all of that. To some extent let us leave that aside because the Governor is stepping down in a few months anyway, there will be a new Governor and so on. What is your impression of the Bank’s response to your report and how they intend to act on it?

Bill Winters: My impression is that the Bank has taken the report very seriously, that they will duly consider each of the recommendations, that they are concerned that the aggregate effect of all the recommendations is too radical and that if the Bank or Court went to the extreme in each of the recommendations that I made, cumulatively that could be too much. Of course, that is not what I recommended. In some ways there is a menu that we put out with a suggestion of not so much a pick-and-choose but a pick-and-choose in terms of getting the right balance. I think there is a concern that somehow they might be compelled to introduce too much change too quickly and have the aggregate package be imprudent. I am not concerned that that is what will happen, but I think that has been a little bit of the reaction that I have sensed.

Q26 Stewart Hosie: Mr Winters, your review says that when the crisis began to unfold in August 2007 the Bank’s published facilities proved insufficient. Paul Tucker at that point was the Executive Director of Markets. As part of your review, did you discuss with him why the Bank appeared to be so under-prepared at that time?

Bill Winters: We did. It was obviously before the period of my review, but I thought it was important to get an understanding of what had gone wrong during the crisis. I did not learn much beyond what I read in The run on the Rock report by this Committee. That was a very complete report of that period, I think. But, yes, I discussed with all the Executives the thought process that went into the evolution of the framework between 2007 and today. Of course, it continued to evolve up to and including the summer; so including Paul Tucker of course, yes.

Q27 Stewart Hosie: I am surprised by what you have just said there. This is a very good report indeed, The run on the Rock, but I would have thought, speaking to the people on the ground, you would have had some additional insight other than what this Committee managed to find and publish.

Bill Winters: Of course. No, perhaps I misspoke. I spent an enormous amount of time trying to understand, in particular, the thought process that went into the consultation document the Bank produced in 2008. That consultation document was a response to the crisis, but it was also obviously a response to the Select Committee’s report on Northern Rock. The consultation document in 2008 evolved into the framework that was published in 2010, which has continued to evolve, but it was all born out of the experiences that had been gathered primarily in that 2007-08 period.

Q28 Stewart Hosie: Let me go back to the experiences then, because a lot of the regime appeared to be developed on an ad hoc basis during the crisis. What did you identify as flaws that crept in because of the ad hoc nature of the decision-making at that point?

Bill Winters: Clearly there were flaws at inception. The framework itself was narrow in terms of the prescribed tools and almost infinite in terms of the potential tools. There are very few things that could not have been done for some legal reason and just about anything could have been done at the direction of the Treasury. There was every opportunity for the Treasurer at any point to say, "Do this", and the Bank, acting as an agent, was compelled to do that, but it was not specified in the framework and there were no tools that had become accepted tools or understood tools by the participants in the market. That was before the crisis began. As the crisis set in, my sense is that there was very, very active debate inside the Bank about the appropriate response. I did not review that interaction in any detail myself, but I have every reason to believe that there was a really full discussion of what an appropriate response would be.

Q29 Stewart Hosie: I do not want to interrupt, but the first part of your answer was fascinating: very narrow in terms of the toolset, but extraordinarily wide in terms of potential. I don’t know if you felt it, but I suppose the frustration then was the inability to take an early decision over Northern Rock. Was that because the toolset was too narrow or because nobody understood the breadth of the potential?

Bill Winters: I am not best placed to answer the question, but I do not think it was either. I think it was a decision that was taken at the time that was wrong.

Q30 Stewart Hosie: To what extent then should we have expected the Bank to have been better prepared? In that sense, to what extent should we have expected the Bank to have put more thought and preparation into what might be done, given certain circumstances?

Bill Winters: I struggled a lot with this question in terms of the way that I propose in the recommendations that the Bank’s Executive interact with its various external stakeholders, because at one level I would have loved to have given a list of trade-offs that the Governors and the Executive of the Bank need to deliberate all the time, or most relevantly in a crisis, and have almost a checklist for the Chancellor or the Treasury or yourselves to say, "Well, this is what we would expect in a particular crisis". I was looking for an analogy to the inflation target that the Chancellor gives to the MPC. We knew at the outset that there would be nothing that straightforward, because we were dealing with financial stability and the liquidity of banks. It does not lend itself to a single metric like inflation or even a more complicated metric like inflation and growth, which would be a reasonable alternative to the pure inflation target.

I tried very hard, with the team, to come up with a number of levers that the external stakeholders might choose to pull to give the Executive guidance and we did not come up with a very good list, which is why you will not find a list in my 150 pages. What I concluded was that this was something that needed to be discussed between the external stakeholders and the Bank Executive. It needed to be discussed in terms of expected response and expected outcomes and how we are going to measure success, and that is a process that should be overseen by Court. Court is a group of esteemed individuals who have various types of experience-some financial, some industrial, some academic-but what they all have in common is that they have managed complexity and what we have here is a complex set of problems-

Q31 Stewart Hosie: When you did this work, did you identify if any other central banks had been better prepared; that they did perhaps have the checklists of things that might need to be done given certain circumstances?

Bill Winters: None of the central banks were well-prepared and different central banks responded differently, but in every case it was reactive. We had a financial crisis that arguably began in 2006, but let us call it 2007 when it was more visible, and every central bank was on the back foot in terms of responding to that, as was every Government, as was almost every bank. This was a real collective screw up. Central banks responded differently. The ECB responded earlier than the Bank of England with substantial amounts of liquidity, arguably misdirected, and, as we sit here in 2012 and look at ECB actions, no one is going to say that it was an unqualified success over that period. The Fed responded a bit later but it went around the banks much faster; so the Fed went direct to the real economy, as well as going to the banks. That also reflects the nature of the American capital markets, which are a much less bank-dependent market than either Continental Europe, the eurozone or the UK. Different central banks responded differently. I think the most important point is that in every case it was reactive.

Q32 Stewart Hosie: That is helpful. I suppose then the final question would be this. We were talking about liquidity. That was the nature of this report but when the special resolution regime was put in place, after a lot of thought, that deals with failing banks and allows them to fail or it does something else with them. Should we have looked at liquidity provision at the same time as we looked at the resolution regime for failing banks?

Bill Winters: I think the Bank did look at the liquidity regime and there was a whole series of programmes starting with long-term repo facilities and a broadening of the collateral the banks could use to access bank facilities. Of course, then there was the SLS, which dealt with the legacy problem on banks’ balance sheets. I think there was a substantial focus on providing liquidity and, in fact, had the Bank not been as proactive as it had, there would most certainly have been a cataclysmic collapse of the UK banking system. I think the Bank was reactive, yes, but appropriately reactive. One can debate, and we did debate quite substantially as I went through this review, the degree to which the Bank was very responsive or not so responsive. I think the Bank was pretty responsive.

Q33 Chair: Going back a moment to this question of the unpreparedness of the Bank in 2007, you say in your review, "When the crisis began to unfold in August 2007 the Bank’s published facilities proved insufficient". Did you discuss with the key players in charge of events at that time how that came to pass?

Bill Winters: I did.

Q34 Chair: Who did you discuss it with?

Bill Winters: I discussed it with all the Governors and all the Executive Directors with whom I spoke.

Q35 Chair: Who among them were the key people that were responsible for making sure that things were sufficient?

Bill Winters: First of all, the response that I received pretty uniformly across the Bank, as well as outside, was that, while the published framework was not very specific in terms of how the Bank would respond to different types of crises, the Bank was perfectly aware that they had a broad range of tools at their disposal. They just had not shared with the market exactly how they would deploy those tools, on what terms, at what time, under what conditions. That, of course, was not negligence. That was a decision that was taken by the Governor and predecessors.

Q36 Chair: But is now perceived to have been a weakness?

Bill Winters: I believe it was a weakness, yes, but the objective was to not be so precise in terms of how the Bank would help out the banking system, or individual banks, as to cause individual banks to take imprudent risk; a perfectly worthwhile objective. I think one of the central challenges, as you all know very well, in central banking is managing the trade-off between short-term financial stability and moral hazard, which leads to long-term financial instability. I certainly would not suggest that the Bank should be a structural intermediary of capital flows. The banking system should not rely on the Bank of England to conduct its day-to-day activities, and the banking system should not expect to be able to tolerate a higher level of risk because they know they have access to Bank of England liquidity on some preferential terms.

That management of moral hazard is the most complicated central feature of the Bank of England and, as this Committee articulated clearly in its report, the Bank of England-I would agree with that conclusion-placed a disproportionate focus on preventing moral hazard at the expense of allowing short term financial instability and that is, of course, exactly what we had with the run on Northern Rock. In discussing with the Executives, both those who are still around and were around at the time and those who were there and have subsequently left, they would all agree, to one degree or other, that the Bank’s response to the crisis was inadequate at the time.

Q37 Chair: I was asking you about immediately prior to the crisis-and just coming back to your comment in your review-that the published facilities were insufficient. I am asking you who was responsible for those being insufficient, and then I want to get on to the cause and whether it is connected to the points you have made about governance in the Bank and the lack of internal challenge.

Bill Winters: I am going to break your question into two. Who was responsible for what was published, versus what was not published? Ultimately, it is the Governor and the Governors, no doubt with advice from the Executive Director of Markets and others. I think the decision to have a narrow list of published facilities was a collective decision, but clearly reflected the views of the Governor in terms of managing moral hazard.

The second part of that question, which I think is perhaps more implicit, is: who is responsible for making sure that the Bank was ready to deploy an arsenal that was broader than that that was published? Of course, ultimately it all resides with the Governor. There is no escaping that. I think the Governor was very informed about those facilities, or potential facilities, as were the Deputy Governors, as was the Executive Director of Markets. I think it was a collective assessment in that case.

Q38 Chair: We began this discussion today looking at this filtering process, filtering out of challenge that you see still evident in the Bank, which was certainly there in 2007. Did the management style contribute to the fact that those facilities were not fit-for-purpose? Are those two problems connected? Was the way the Bank was run part of the cause of the fact that, in your view, the Bank was not as prepared as it should have been?

Bill Winters: Now I will break it into three parts. The decision not to be so specific in the framework itself, I think, was a direct reflection of the Governor’s views on managing moral hazard. That is an issue he understands extremely well, managed and made difficult calls. The second is the decision to deploy certain tools, either in the published or not in the published framework. I think that also reflected the management style coming from the top of the organisation. I have every reason to believe that those issues were debated. I have every reason to believe that there was not consensus on those issues and that ultimately there was complete respect for the Governor’s need to make a decision about a crisis response. I think all the Governors stood by that decision, but there was an active debate going into this.

Q39 Chair: I will have one more go at asking the question. You have referred to the management style. I am asking you whether the management style-and you have made some criticisms of the management style in your report, more generally, with respect to the Bank-contributed to the lack of preparedness of the Bank at the time of the onset of this crisis?

Bill Winters: Yes, I think it did. In terms of the question that you might not have asked, but maybe you asked, I think it also led to the decisions independent of the level of preparedness at the time. There were biases, as this Committee articulated in its report, about a focus on moral hazard versus shorter-term financial stability. I think that was a deeply-held conviction at the top of the Bank and that was translated through a management style, so that recommendations that were put up through the line were consistent with that bias.

Q40 Chair: Were the Executive Directors also part of this filter? When they put up proposals to the Governor, in your view, were they filtering out things they were not going to get anywhere, bearing in mind you have just said the Governor placed too much emphasis on moral hazard?

Bill Winters: There is a very unusual governance arrangement in the Bank that I have not seen anywhere else. The Governor is obviously appointed by the Chancellor. Court oversees the Governor, but does not have rights of removal except in an extreme situation. The Deputy Governors are also appointed by the Chancellor. They are accountable to the Governor, but the Governor does not have the ability to appoint or remove them. What you would think of as a normal chain of command in either the public or the private sector, does not apply to the Bank of England. Some of the management idiosyncrasies or the-

Chair: They are a bit more than idiosyncrasies, aren’t they? Your report is not limiting itself to pointing out a few idiosyncrasies.

Bill Winters: I am trying to be as explicit as I can about the unusual nature of the governance of the Bank of England. Inevitably, the Executive at the top of an organisation will embody a culture that gets transmitted through, but the governance management style, in terms of actual management, in many cases seems to have the effect of hopping over the Deputy Governors down to the Executive Directors, because the Deputy Governors are appointed by somebody else and can be removed by somebody else. It is very unusual.

In terms of how then a culture at the top transmits its way through, in this particular case there could be substantial dissent between the Deputy Governors themselves or between the Deputy Governors and the Governor, but the actual implementation of policy, and the recommendations and the way that they get filtered in often cases, it seems to me, just jump right over the Deputy Governors, which is why we had a very specific recommendation in the review to oblige the Governor to consult with the Deputy Governors. By the way there is every indication that this Governor did extensively through this crisis and there is every indication that the Deputy Governors gave their views, dissenting or consenting. There is not every indication that there was consensus on every point.

Q41 Chair: I am going to have one more go. When the Executive Directors, whether or not they were hopping over the Deputy Governors, offered their views to the Governor, did you find evidence or do you think it plausible that they were filtering their views to make sure that they would find a ready ear with the Governor?

Bill Winters: Yes, it is possible. Yes.

Chair: At this time?

Bill Winters: "This time" being during the period of my review or-

Chair: This crucial period when we discovered that these published facilities were insufficient.

Bill Winters: Unfortunately, I did not redo the work of this Committee on the Northern Rock run in that crisis. That was specifically outside of my remit. I did get a good understanding of what was going on during that period because it so informed the subsequent evolution.

Chair: Absolutely.

Bill Winters: The period I really looked at-and the decisions were, for better or for worse, far less impactful than the decisions that were taken in August 2007-yes, there was every indication that this filtering took place at the Executive Director level. Sure.

Chair: Okay. We have made some progress. Thank you very much for that.

Q42 Mr Mudie: Just staying on that, with the Governor’s fixation on moral hazard, had the Deputy Governors given up attempting to pursue other policy lines with the Governor?

Bill Winters: I am not sure I follow the question. Are you asking whether the Deputy Governors stopped trying to influence the Governor’s bias in favour of eliminating or reducing moral hazard?

Mr Mudie: Understanding that the Governor had this fixation with moral hazard, on the one hand he keeps telling us that he was well aware of the problems building up in the banking industry and in the economy, made speeches and so on, but the week before Northern Rock blew he had prepared a many-page document for this Committee on moral hazard. Faced with that mindset in the Bank, do you think the Deputy Governors gave up in terms of trying to pursue other policy lines?

Bill Winters: It is a good question and I do not have a clear answer. I am sure they did not give up. I am sure that, through the crisis period and during that whole consultation period around the thorough revamp of the sterling monetary framework, every indication was that the Deputy Governors that were in place in 2007 and then the Deputy Governors that came in subsequently have persistently challenged any bias that the Governor may have. As an aside, in fact no central banker I have spoken to anywhere disregards moral hazard entirely. It is at front of every central banker’s mind. It is extremely complicated and there is no right answer.

Q43 Mr Mudie: Yes, but it should not paralyse you to the extent if circumstances develop.

Bill Winters: That is right and I saw no indication that the Bank of England was paralysed or that the Deputy Governors had given up either their ability or willingness to influence policy, or influence the Governor for that matter. Biases are biases.

Q44 Mr Mudie: Why do you say you did not think they were paralysed? Didn’t the fixation with moral hazard paralyse them right to the last moment? We had the Governor here on Northern Rock and, when questioned why certain actions were undertaken, his defence was, "We don’t have the tools". You have said, apart from the published tools, there were other areas of activity that could have taken place.

Bill Winters: Yes. I would not use the word "paralysed" because every indication I saw was that the debate was active. Ultimately, the Governor makes the decision and, if there is dissent, he is empowered to make that decision. The Governor did make decisions and he may have made different decisions with the benefit of hindsight. He made many changes, or authorised many changes subsequently, that addressed many of the inadequacies, in fact most of the inadequacies, that were identified after the 2007 debacle. I would not say "paralysed". Clearly, there was a bias towards keeping moral hazard in check and it allowed the problem to run away a bit.

Q45 Mr Mudie: Yes. On some of your recommendations you seem stronger than others. You seem to indicate where you think something should happen. You put "should".

Bill Winters: Yes.

Q46 Mr Mudie: One of the ones I thought you were sympathetic to in your report was the question of capital, increased capital in the Bank.

Bill Winters: Yes

Mr Mudie: Yet your recommendation is that the Treasury "might consider examining the amount of capital"-do you regret being so fainthearted when it came to that recommendation?

Bill Winters: I think the semantics here, the "should" versus "might" and so on, reflected two things. You are quite correct, one was the strength of my view or the degree to which I am acknowledging that it is a complex issue that needs review by people who are more expert than me with more time.

Mr Mudie: That is very modest, Mr Winters.

Bill Winters: That one is not hard. The second was, and it applies in this case, a question in my mind whether this was in my remit at all. Just looking at the remit I was given, addressing the issue of capital of the Bank of England is pretty clearly not in my remit. I just said, "I have the pen and I have a strong view, so I will share it". The "might" reflects the fact that I was trespassing on somebody else’s remit, rather than a lack of conviction.

On the point, my observation is the Bank of England is, like other central banks, among the most leveraged financial institutions on this planet and represents very substantial risk in some scenarios to the public purse. That is observation. At the same time, I would note that the independence of the operations of the central bank is critically important, particularly in an environment where the financial markets every day are asking the question, "Should we believe in pounds sterling as a currency? Is it something that we believe is going to hold its value through time?" The only thing that protects the value of the currency is the credibility of the Bank of England. It is as simple as that. That credibility can only be sustained if it is independent.

I think the Government obviously made the right decisions in terms of establishing independence at the time that it did, but these two things are in some conflict at the same time. My observation is simply if the Bank is properly capitalised, or at least capitalised relative to the risks that the Bank is being asked or expected to undertake, it increases the likelihood that it can take its decisions independent-minded rather than assuming that it is relying on a Treasury backstop should it eventually incur some losses.

Q47 Mr Mudie: Just a question that you may wish to dodge or you may say is outside your report. Taking all the things together in terms of the weakness of the Court, the strength of the Governor, the recent action by an exchange of letters between the Governor and the Chancellor to take the surplus from the quantitative easing exercise to the Treasury, do you think the Court should have been consulted? Do you think they were consulted? Do you know whether they were consulted as it strays into the business of risk and independence?

Bill Winters: I do not know whether they were consulted. I have not thought much about the question either because, you are quite right, it is outside of the remit of my review and happened subsequently in any case. Tying it back to my observations on capital, obviously that was capital of the Bank of England that was moved, I think the decision on what the appropriate level of capital for the Bank should be should be a conscious decision. It should not be backed into via the profits that happen to be there at a point in time or the profits that happen to be removed at a point in time. At another point in time there will be losses. Thankfully, the Bank has not incurred losses, but obviously it could. It is engaged in risky activity.

Q48 Mr Mudie: The last sentence in its statement when they announced this indicated they expected to have losses when they were rolling it back.

Bill Winters: Yes. I think any risk manager that takes risk and, even worse, generates profits on that risk who does not at the same time acknowledge that they could lose money is not a risk manager at all. Of course, these activities could lose money; funding for lending, very innovative and well-structured programme, exposes the Bank to real risk. It is on the Bank’s balance sheet. It is not indemnified by the Treasury and the Bank has not increased its capital on the back of a much more substantial increase in its riskiness.

Q49 Mr Mudie: The one part of my question that you have skilfully avoided is, should the Court have been consulted on that decision or was it a matter simply for the Governor and the Chancellor?

Bill Winters: I think the Court should be consulted as the Court has the ultimate responsibility for the risk management of the Bank.

Q50 Mr Ruffley: You talk in your report about the way in which the MPC and the FPC co-ordinate and you give us an example that it seemed to work okay with the extended collateral term repo facility over the last few months. I rather wonder if you could expand on your concerns about how these two committees will work together in the future. You say that the final authority over the design and implementation of the monetary framework, other than for those operations carried out with the express intention of affecting monetary conditions, which would be the MPC, should continue to rest with the Executive of the Bank and ultimately the Governor. You also say-and I am not sure if you think this is acceptable or whether you are challenging this-if the Governor chooses not to comply with the view of either the MPC or the FPC over the monetary framework, senior management should need to explain to the committee in question the reasons for that decision. What you are suggesting is it is okay for, de facto, the Governor of the Bank of England to disagree with both committees on decisions affecting the monetary framework provided he gives his reasons. Do you really think that is adequate?

Bill Winters: Yes. Ultimately, there needs to be a decision-maker on any matter, but certainly on the matters around the sterling monetary framework there needs to be a decision-maker. We contemplated a number of situations. One was one where the interests of the MPC, which of course has a very specific target around price stability, and the interests of the FPC, which has a macroeconomic oversight responsibility, macro prudential, could collide. For example, ECTR, the extended collateral term repo facility, which is an innovative approach to extending term liquidity to banks, was intended to and, in fact, I think has had the effect of reassuring markets that the Bank of England is, in certain circumstances-inclusion of the eurozone, for example-prepared to backstop UK banks with term funding. That is good. That is a macro prudential action.

It also has the effect of increasing the level of reserves in the banking system, which the MPC is deeply concerned about. They cannot make their decisions about the appropriate level of asset purchases via quantitative easing unless they know what is going on in the other. Perfectly appropriate for both groups to be consulted. They may have different answers. The MPC may say, "No, that is not what we want. We do not want those extra reserves. If we want extra reserves, we want to do more quantitative easing. Kill ECTR, too hard to manage, too uncertain". The FPC says, "No, we have to have that tool, otherwise we are not going to be able to assure the liquidity of the banking system". The Governor has to break that tie. The Governor has to break the tie. There has to be a final decision-maker.

If the Governor finds himself, or herself in some future world, in the position of disagreeing with one or the other of those two committees, he should have to explain. If he finds himself disagreeing with both, he should have to explain a lot and I would expect Court to take a pretty deep interest.

Q51 Mr Ruffley: I understand that. You have set out the issues and we understand how and why there might be a conflict, but, following the recommendations from this Committee, the Financial Services Bill now includes the provision for the FPC and the MPC to meet jointly, which is sensible. Of course, the Governor is chairman of both committees; so he will, in your phrase, be de facto a tiebreaker. Do you think there is any merit in Court requiring an extraordinary joint meeting between the FPC and the MPC in the event that there is disagreement on the monetary framework?

Bill Winters: I think it is a perfectly reasonable suggestion.

Q52 Mr Ruffley: I just want to move on to the Court, because this Committee has questioned the adequacy of the Court to oversee the work of the Executive and to hold them to account. Do you find it surprising that the Chancellor has not been more keen on our proposal from this Committee, also endorsed by the Joint Committee of the Lords and Commons on the Financial Services Bill, to have a supervisory board comprising more, let me put it politely, better technically-qualified individuals than currently sit on Court?

Bill Winters: I have read this Committee’s report on the accountability of the Bank of England, so I think I understand what you have in mind in terms of a supervisory board. Looking at the composition of Court today, it is a mixture of people with deep financial services experience, with broader industrial experience, and with what I call more academic experience. It strikes me that having some sort of a mix like that is appropriate. Obviously having the financial services experience, ideally in an unconflicted way-I obviously also recognise your observations about managing conflict and the difficulty of managing conflict, given the types of people that you would like to attract to this supervisory board, but having some financial services experience is very important.

Having people who are really experts at managing complex process is also important. From my experience in financial services, they were not always well-run. I do not mean from a risk perspective. I mean from a management perspective, person-management perspective. They are not always well run organisations. Sometimes they are, sometimes they are not. People that have run gas utilities or manufacturing or transportation companies are pretty good at managing complicated organisations and I think there is a role for that sort of skill on the board or the Court, whatever it is ultimately called. Exactly how those constituents are weighted is debatable, but just looking at Court today I see a diversity of backgrounds, which seems appropriate to me.

Q53 Mr Ruffley: Just going to this example that I started with where the Governor of the Bank of England will be the tiebreaker in the event that there is a difference of opinion on the monetary framework as between the FPC and the MPC, are you confident that the current composition of Court is likely to effectively hold the Governor to account for any tiebreaking decisions? They may be big judgment calls the Governor is making, in effect overruling one committee’s decision in favour of another. Does the current Court have the heft to call the Governor in to explain himself, maybe doing an ex post review into his decision to favour one committee rather than another in a tiebreak situation? Let me be blunt, quite a lot of external commentators of repute and even some members of this Committee would doubt very much whether the current Court composition is up to that kind of chore. What do you think?

Bill Winters: I think it is the right question, for starters. I think there is a chance with a combination of a new remit for the Bank, which of course is substantial and under way, with a new Executive of the Bank. There will be a new Governor in next year and perhaps changes in Deputy Governor, certainly an additional Deputy Governor if the Bill passes. There has been an evolution of Court itself and there will continue to be. It is a good time to lay out a fresh set of ground rules in terms of expectations. I think the same individuals on Court with a new mandate, obviously overseeing in some ways a new organisation, has a pretty good chance of serving exactly as you would expect.

I think there is a strategic question, as it were, around whether the Court should ever be in a position of arbitrating policy disputes. If you hold the Court to that standard of being able to effectively second guess the Governor in some way on policy matters, I do not recommend that. I do not think that is an appropriate role for Court. Should you decide that that is the appropriate role for Court, then it would need a thorough revamping. I think you would have a hard time getting eight qualified professionals, who are unconflicted, willing to put the time into a part-time role that could act adequately in the public interest to second-guess the Executive of the Bank.

Q54 Mr Ruffley: My final short question. Would you define "second-guessing" as Court, reformed or unreformed, commissioning ex post reviews into big decisions made by the Governor in, for instance, a tiebreak situation?

Bill Winters: Absolutely. I think that is absolutely appropriate and I think it is exactly what-

Mr Ruffley: That is not second guessing ex post reviews?

Bill Winters: No, I think ex post reviews are a critical part of the process of accountability. In my recommendations, while I did not specifically recommend ex post reviews, that is a part of the Governor’s process that I would foresee for Court. To the extent that ex post reviews are complemented by ex-ante discussions around what success might be viewed to be, it would create a much more robust process.

Q55 Chair: In a nutshell you are supporting the main thrust of the proposals that were made by this Committee for major reform of the governance of the Bank, are you not?

Bill Winters: You made many recommendations and I think most of them made perfect sense.

Q56 Chair: Just looking for one moment at this question of the diffusion of responsibility that you referred to a moment ago with respect to the FPC, MPC, PRA, other bodies, and you have now told us that there should be a tiebreaker and that that should be the Governor, are you confident it should be one man or do you think that he should be breaking the tie in some small committee, for example, a committee of the Deputy Governors? Have you thought about that issue?

Bill Winters: Yes. First, I think the Governor is more than a tiebreaker. I think he is the ultimate decision-maker in terms of matters that have been delegated to the Governor by Court. My tiebreaker reference was in that situation where the MPC and the FPC have recommended different courses of action and the Governor must decide. He is more than a tiebreaker. I am sorry, your question?

Chair: The question is, should the Governor be doing that tiebreaking alone or should he be doing it as part of some kind of third group, which might be the Deputy Governors?

Bill Winters: I think that is a very relevant question. What I recommended was that there be an observable and documented process of discussion where dissent would be by the Deputy Governors, or the Executive Directors to the extent that the Court deems a particular issue should include an equally well-documented debate involving the Executive Director for the relevant area or areas. That process should be demonstrably undertaken and Court should ensure that it is undertaken and it is undertaken in an efficacious way.

The next step would be to say, "Okay, we are going to have a vote", and the Governor can be overruled by the Deputy Governors if they get together and muster enough votes or whatever the voting mechanism is that is put in place. I do not think that is a practical recommendation for the operation of the Bank of England where the most difficult decisions will be taken in a time of crisis, when a timely response and a consistent response is necessary. Having a single decision-maker at the end of the day on the issues that have been delegated to the Governor-of course, powers can be inserted or taken away from the Governor, but once we are in the crisis it is a bad time to start second-guessing the authority of the chain of command, as long as the process is properly undertaken.

Q57 Chair: An alternative approach that was put to us extensively in evidence by people with direct experience of crises from the Bank of England-in fact, a number of people made this point to us-was that there should not be two committees, that the FPC and the MPC should be one and the same body. Have you any thoughts to add on that?

Bill Winters: Yes. It is not a question that I either was asked to or did specifically address but, of course, I was around that issue. I am very sympathetic, but do not accept ultimately, the argument that the two committees should be merged or, for that matter, the third committee, being the PRA board, should be integrated in. Having looked at this problem through the lens of the sterling monetary framework, I see that the skill set that is required to have independent outside members of the FPC and the skill set required for those independent outside members of the MPC, while overlapping in some cases, is very different. That has to do with the narrowness of the remit of the MPC for one thing-it is an extremely narrow remit, both absolutely but also relative to other central banks-and the remit of the FPC, which is far away from monetary policy. I think the-

Q58 Chair: That is in theory, but in practice they have ended up much more close together, haven’t they? We have just been watching the MPC getting involved in what some might call quasi fiscal policy.

Bill Winters: That is right. As I say, I am sympathetic to the view and I think either approach could be made to work. But, on balance-and it is just my opinion and it is not something that I have researched in the context of this review-I think the Bank and the nation is best served by having these respective skill sets and then undertaking the substantial amount of work required to keep them in sync.

Q59 Chair: You are absolutely clear that we have to think this through carefully now before we have the crisis, otherwise we are going to hit this diffusion of responsibility that you alluded to earlier?

Bill Winters: That is right. For the purposes of my review, I took the MPC, FPC, PRA structure as given and then we asked the question: how can it be made to work?

Chair: We have concentrated on governance a lot this morning and we have already overrun, but there is another big aspect to your report, which is, of course, liquidity itself. We are now going to take a look at that, last but not least.

Q60 Mr Newmark: I am glad you saved the best until last, Mr Chairman. Liquidity is clearly key for banks but, as you have identified, the risk of stigma has meant that banks are not tapping into the liquidity facilities that are available and so are hoarding cash. You suggest a way around this is that you favour reduced disclosure in order to prevent this stigma. How do you square the circle in an era when everybody is crying out for greater transparency as to what is going on with trying to remove the sense of stigma that banks at least perceive that they have by drawing on those liquidity requirements?

Bill Winters: That is a very good question. It was an uncomfortable question for us exactly as you framed it, which is on the one hand recognising that central banking precedents are always around the disclosure of effectively some form of emergency lending but after the emergency has passed. If you disclose the emergency lending, as was the case in Northern Rock, for example-it became known that Northern Rock had access to emergency facilities and that was what caused the run on the Rock. It does no good to have emergency facilities available that just prompt a crisis or accelerate a crisis.

On the other hand, the idea that you are intentionally trying to prevent information from getting into the public market that could be of public interest sits uncomfortably, I think, with all of us that have a respect for information and free-flowing of markets. I made a number of recommendations in the review around ways that we could increase the likelihood that a bank would rely on bank facilities-so the discount window and others-in their ordinary planning; therefore, allowing them to hoard less cash. One was that they needed to be more confident that their access to bank facilities was not going to be made public.

In the US, one of the precedents I have looked at closely under the Dodd-Frank Act, the Federal Reserve is obliged to disclose in an extraordinary level of detail all access to the discount window facility exactly two years after drawing. The first of those disclosures came out during the course of our review: a 25-page Excel spreadsheet with every borrowing, the amount, the nature of the borrowing, the risk rating of the borrower. I was not asked to do a review of the Dodd-Frank Act, but had I been asked I would have said that is a bad idea because banks will have, at the bottom of their list of things to do, accessing the US Federal Reserve’s liquidity facilities. They will do almost anything before they go to the Fed, including running their bank right on to the rocks.

Q61 Mr Newmark: The reason for that is because there is no smoke without fire; there is the perception that there is a problem?

Bill Winters: Yes, exactly. If you just look at the risk and return for credit market participants, if you lend money to somebody you will get a small interest on top of your principal back unless you lose, in which case you lose it all. It is completely asymmetrical and if there is any whiff of doubt they just disappear. Disclosure was one element, but more broadly what we recommended was that the Bank take a series of steps to regularise the usage of these facilities in a way that the usage that is prompted by some sort of liquidity shock does not look so out of the ordinary. Now, is that hiding the truth from the market? Yes, to an extent it is, but it is also saying-

Mr Newmark: It is?

Bill Winters: It is.

Mr Newmark: But you suggest, just taking that on, that perhaps there should be some sense of compulsory regular drawings whether they need it or not?

Bill Winters: That is right.

Q62 Mr Newmark: I can understand why that gets around the problem, but what is the point of drawing, effectively, when you do not need the liquidity?

Bill Winters: First of all, all the same concerns that you are citing did sit uncomfortably with me as I was going through the review. I have explored the issue from both sides and, on balance, I obviously came out where I came out, which was recommending this regularisation of usage.

Take one step back. The first observation is that the banking model as it exists in the western world today would not exist but for the existence of central banks providing liquidity backstops. Even with much lower levels of leverage that banks are enjoying today, it still would be unsustainable without a Bank of England backstop or other central bank backstop. The state is providing a very valuable form of insurance to the banking sector today, ongoing. It is not inappropriate for the banks to pay for that and it is not inappropriate to take what is an implicit relationship, which is, "We are not going to sign anything, but you know if you get in trouble we are going to bail you out". Wrong choice of words, "We know if you get in trouble we are going to give you liquidity as long as you are still solvent". The banks are enjoying the benefits of that insurance without paying for it.

You still may argue that they are paying for it in other ways, with balance sheet taxes or whatever, but that is for you to decide. In terms of explicit payment for access to central bank liquidity, the banks are not paying for it. One of our recommendations is pay for it; make it contractual; make it perfectly clear on what terms the bank can draw down that liquidity. In fact, structure it so that the bank regularly draws down liquidity for which it has paid. You are adding money to the public purse. You are recognising a value transfer from the state to the bank. The bank is paying for that. We can all say, "Great, there is no more subsidy of the banking industry", and at the same time get the benefit of regularising these facilities so that when there is a run because there has been a fraud or there has been a eurozone collapse or whatever, the bank can go and access the Bank of England facility.

Q63 Mr Newmark: How do you differentiate between, I guess, the regular drawings with the need for at least the public to understand there is some risk going on with the bank? You are effectively disguising the fact that there may be a problem with the bank with the solution that you are proposing.

Bill Winters: You are disguising it in one way. In terms of visible access to a particular point of stress for an individual bank, you are disguising that. It is not disguised to the Bank of England. The Bank of England, both through its market operations and also through its micro prudential responsibilities, the PRA, should understand exactly what is going on. Again, this is a process that Court should be responsible for overseeing in terms of making sure that the proper level of accountability of the bank to the Bank of England and the Bank of England to its stakeholders is made clear, but there is a trade-off here, for sure, and we are preventing the market from having access to some information because it is in the public interest.

Q64 Mr Newmark: Right, and it prevents, effectively, a run and you are hoping that the bank can discreetly manage its way through the crisis?

Bill Winters: That is right.

Q65 Mr Newmark: What happens when it suddenly does not? Where does the buck stop? The bank has tried to deal with the problem. The magnitude, as we have seen in 2007 and 2008, is much bigger than the bank can handle and suddenly the public becomes aware some time later that there is a big problem out there. Does the buck stop at the top with the Bank of England or where does it stop?

Bill Winters: It is the Bank and the Court. The bank is clearly responsible for managing its capital; so the risk of loss, which ultimately in extremis becomes a loss to the taxpayer, is a risk that the Bank’s Executive is responsible for managing and I think they take that risk extremely seriously and they discharge that responsibility fully. Court is responsible for overseeing the process of risk management within the Bank and I think they also take that risk seriously and take that oversight responsibility seriously. The buck stops with the Executive of the Bank.

Q66 Chair: I just want to be clear on one point on liquidity. Do you think there is still a lot of stigma left in the system despite the decisions that have been taken to try to ameliorate it?

Bill Winters: Yes, I do. It is interesting to see how stigma plays out. You can see it most demonstrably in Europe where the European Central Bank introduced facilities that were clearly extremely attractive economically to banks-LTRO, for example, very subsidised financing-and at the beginning they were not taken up. You could say, "How could they not be taken up? It is a direct contribution to your bottom line". The answer was, "Because we are concerned that if we tap into the Bank using these facilities it will be viewed as weak or we will be viewed as having been bailed out or there will be some political repercussion". Then it became so attractive that the investors in those banks started to say, "Are you an idiot? How could you not take that? It is money for nothing. How could you not take it?" Then they started taking it and then they took a lot. That is an extreme version of what it took to overcome stigma, a real hard economic incentive.

I think the Bank of England has been much more nuanced in terms of getting that balance right, which is appropriate because the situation is nowhere near as acute in the UK. But there is clearly still stigma. We heard it from every bank with whom we spoke and we heard it from investors in banks, who identified the concern that they would attach to one of their potential or actual investees should they seek some sort of Bank of England liquidity support.

Q67 Chair: When it comes to stigma, either you have stigma or you have not. If you have stigma, you will take measures to protect yourself and they will mean, ultimately, less lending to the real economy, won’t they?

Bill Winters: I think there are gradations of stigma. There are some facilities that are very stigmatised, access to them would be the kiss of death, but I think your point is right.

Q68 Chair: We have not cured that problem and there is more work to be done?

Bill Winters: There is more work to be done.

Q69 Chair: We have to get it right because it is causing problems in the real economy.

Bill Winters: That is right.

Q70 Chair: It is retarding the return to normalisation of bank activity in the UK. Is that correct?

Bill Winters: That is correct. Every indication is some of that cash that is being hoarded by banks above what is required by their regulator could be used to promote growth in the real economy.

Q71 Chair: This should reasonably be described as an urgent, pressing and important policy question that needs more work?

Bill Winters: I agree.

Q72 Chair: Okay. Thank you very much indeed for giving evidence this morning, which is now very nearly this afternoon. We are extremely grateful.

Bill Winters: Thank you.

Chair: We will now take a five-minute break.

Examination of Witness

Witness: Ian Plenderleith CBE, Chairman, BH Macro, and Non-Executive Director, Morgan Stanley & Co International, BMCE Bank International (London) and of Sanlam (South Africa), gave evidence.

Q73 Chair: Perhaps we should recommence where we left off, more or less, before we get on to the liquidity issue. Just asking you about your response to what you heard on governance and the responsibilities and the relationship between the MPC, the FPC and the PRA and whether you think they are sufficiently clear. Is your answer the same as we have just heard from Bill Winters or is it different and, if so, why?

Ian Plenderleith: Broadly the same, Chairman. I think the responsibilities and functioning of the MPC are very clear. That is well established. The FPC is a new venture and will need to feel its way. Like Bill, I would come down on the side of it being sensible to start at least with the two separate parallel committees. They have different areas of policy focus. They are going to have to have different kinds of debate and those two processes seem to me to be sensible to assign to separate committees. There clearly will be areas where they overlap and need to interact and that seems to be where the processes need to be established, but I see absolutely no reason why they cannot be in a sensible way.

Q74 Chair: In a way that is robust enough to cope with a crisis?

Ian Plenderleith: Yes.

Q75 Chair: After all, in peacetime these things work. It is only when there is a crisis on and everything has to be done in 48 hours that we find out if these structures work. Isn’t that correct?

Ian Plenderleith: Yes, but I think in a crisis, assuming it is a financial instability crisis, it will be more a matter of focus for the FPC. As I say in my review, it would be sensible that consideration is given to what kind of role they would play. The distinction seems to me to be rather straightforward. The FPC is concerned with macro prudential policy issues and some of those issues will be relevant to managing a crisis. The Bank’s Executive is responsible for operational actions and has to be responsible and have powers to carry those out. It seems to me it is perfectly possible to establish a structure in which the policy framework is clear and the Bank’s Executive then executes in line with the policy.

Q76 Chair: You picked up in your review a number of cases where there was not adequate exchange of information in the Bank during the crisis. For example, you say, "It is not clear that the lack of information on the specific decision to extend ELA to two individual banks had a material impact on the MPC’s decisions. Given the extreme sensitivity of the ELA’s operations and their short-lived term, it is understandable that the full MPC was not briefed on them." Did you ask them?

Ian Plenderleith: Yes, I did. I spoke to two members of the MPC at the time who had expressed concerns in this area. The period in which emergency liquidity was provided to those two banks, secretly as you know, started on 1 October 2008 and the next MPC meeting was on 8 October 2008. On that day, the Government provided the large-scale recapitalisation for those two banks and the MPC was fully briefed on that recapitalisation at the beginning of its meeting. The only concern in relation to the emergency liquidity can be whether the MPC feels that it should have been told that, within that larger capitalisation, there had been eight days of emergency liquidity provided to those two banks. In order to maintain secrecy they were not informed. That seems to be a reasonable judgment in terms because they got the news of the much larger operation and were fully briefed on that.

The more general question then is whether, during the course of 2008, running up to the intensification of the crisis in October, the MPC had sufficient appreciation of how far the financial situation was deteriorating, which might have been a relevant factor on their monetary decisions. That is a difficult judgment to make. If you read the minutes, the committee clearly was briefed on the situation. If you talk to the individual members, I think they feel that they did not sufficiently appreciate how badly the situation was deteriorating and, if they had, it might have affected some of their monetary decisions along the way. I think that is a case you cannot resolve.

Q77 Chair: You never can. You have to form a judgment and that is why we have you to help us make that judgment.

Ian Plenderleith: I think my judgment would be it is very important that both the MPC and the FPC are fully briefed on the situation as it currently stands, but the civic question of whether they should have been informed about emergency liquidity for those two banks was not germane.

Q78 Chair: Who should be in overall charge of liquidity decisions at the Bank?

Ian Plenderleith: It has to be an Executive operation, led by the Governor and the Deputy Governors, operating under policies established by the FPC in agreement with Treasury and approved by Court. That seems to be a perfectly normal structure in any policy area.

Q79 Chair: But not the MPC? You left them out completely from this long list of actors.

Ian Plenderleith: It depends on the nature of the liquidity facility. If it is a facility designed to help financial stability, then the lead policy interests would be the FPC. If it is the Bank’s much narrower open market operations providing standard liquidity, that is a monetary operation and that is for the MPC, but most of the interest recently has been on the wider range of liquidity insurance facilities, which are financial stability focused.

Q80 Chair: The more we listen to you we are getting an appreciation of the diffusion of these lines of responsibility that we heard about an hour ago.

Ian Plenderleith: I think the responsibility is very clear. It is with the Bank’s Executive led by the Governor, but there are committees that have policy responsibility that bear on this. That seems to be a perfectly natural interaction that you would have.

Q81 Chair: What about the decision not to inform full Court of the extension of emergency liquidity assistance for a whole year, another point that you allude to?

Ian Plenderleith: I think that is part and parcel of conducting a covert operation. If it was right that that emergency-

Chair: The Court cannot be trusted with this sort of stuff?

Ian Plenderleith: No, I think Court has an unusual role in relation to emergency liquidity. It is not Court’s decision to do it. It is not its responsibility. It is a decision for the Chancellor. Court’s responsibility is oversight, particularly with regard to the risk that the Bank is exposed to. That oversight, it seems to me, is going to be more effective if it is assigned to a committee of Court that can focus on the task. If it is going to do that then, necessarily, if it is covert it has to remain secret to that committee and not disclosed more widely. That seems to be the decision Court took actually before the 2008 crisis in setting up the Transactions Committee and charging it with that responsibility.

Q82 Chair: Even though they are responsible for risk management, you do not feel that non-subcommittee Court members have a case for wanting to know?

Ian Plenderleith: I think in any organisation you have to handle these things in a practical way. If you need to keep the thing covert-and in many cases it is going to be more effective if you can-I can see the sense of delegating to a subcommittee that can then focus on it more closely. That follows that the knowledge would be confined to them. I agree there is a trade-off there and you can argue equally that the whole Court, now that the Court is smaller, should be involved in the oversight, but, in the circumstances of 2008 that I looked at, I thought the decision to have a smaller committee of a much larger Court was sensible.

Q83 Chair: You will understand that, when a number of us pressed the Government vigorously at the time of the Financial Services and Markets Bill going through Commons that this new tripartite arrangement and memorandum might not survive its first test in a crisis, we were told, "Don’t worry, this is the sort of thing that could be sorted out in a practical way". Indeed, I think that is the phrase I remember, "Don’t worry, people who are working together can solve these problems". The problem is that, of course, when the pressure comes on people tend to rush off to defend their bailiwicks or their perceived interests, often based in statute. What you are saying is we will not have this problem, notwithstanding what many would see as a complex and diffuse line of command and accountability.

Ian Plenderleith: I was talking about the decision-making and operational structure in the Bank, Chairman. The MOU obviously extends to the relationship with the Treasury. I entirely agree with you. I think it is extremely important to be clear about precisely who is responsible for what well ahead of a crisis. The new MOU endeavours to do that and certainly you can pick your way through it and say, "This is what the Bank will be able to do and this is where the Bank needs to go and get authority from the Chancellor". That seems to me coherent on paper. Whether it will work in practice, we can only see.

Chair: Whether it will work in practice, we can only see. Okay, we will take that as a vote of confidence in the new system.

Q84 Mr Ruffley: You note that the Bank is now receiving better quality data on banks’ liquidity positions, but you also note that systemic shocks could emanate from non-bank financial institutions, shadow banks. How confident are you that the Bank is getting the data it needs from shadow-banking organisations?

Ian Plenderleith: I think you have to distinguish three areas. There is the banking sector where the point I am making is that the Bank’s preparedness to be able to offer liquidity in an emergency is very much focused on banks.

Mr Ruffley: Sure. I am talking about the non-bank institutions.

Ian Plenderleith: Then in the non-banking area there are those regulated entities where the Bank is well aware of what they are doing, it gets data on them, they are regulated and, therefore, they report to the FSA-and it will be the PRA-and all that data is available on them. There is a third leg, which is the so-called shadow banking, unregulated entities that are doing banking-like activities, where there is much less data on. In the middle one, non-banks that are regulated, there is perfectly adequate data. Beyond that, I think it is much weaker.

Q85 Mr Ruffley: What do we do about that weakness in the data flow from the non-regulated financial institutions?

Ian Plenderleith: Well, that is very much a live issue and you have seen the Financial Stability Report.

Mr Ruffley: That is why I ask about it. What is your view about how this deficiency is to be remedied or can be remedied?

Ian Plenderleith: I think you have to extend your monitoring and data gathering to these unregulated entities; not necessarily regulating or setting standards or capital requirements, but getting information on what they are doing so you are aware what kind of risks may be mounting up there outside the City walls as well as in the regulated sector.

Q86 Mr Ruffley: Indeed, it is an important point. In your judgment, does the Bank have the capability and the resources to do that?

Ian Plenderleith: Not on its own. It has to be an international effort, but I think the Bank is focused on that, as I understand it, and I very much welcome the report from the International Financial Stability Board that has just focused on this area and pointed out the need to step up monitoring.

Q87 Mr Ruffley: Because it is important on judging what liquidity there is in the system, that goes to the financial stability objective, and I just wonder is there a specific unit, to your knowledge, in the Bank looking at this, looking at what international co-operation is taking place. How seriously is this being taken?

Ian Plenderleith: Well, within the regulated sector there is regular data.

Mr Ruffley: No, I am talking about the non-regulated sector.

Ian Plenderleith: Outside, yes, my impression is that the Bank is stepping up its intelligence-gathering and monitoring, data-gathering, activity there. I think that is very important. The point I make in my report is that it is not just a matter of gathering data and monitoring, it is actually having the capacity to deal with a liquidity problem there if you thought it carried a systemic threat.

Q88 Mr Ruffley: No, sure. You point out the danger of the Bank being overwhelmed by the data it is getting in, but my point is, if it might have difficulties just dealing with the data it is already getting, what capability does it have to get other important data that goes to the very heart of the banks’ and non-financial institutions’ liquidity positions?

Ian Plenderleith: That is a very important point, if I may say so. I think the Bank and the regulatory authority have to be prepared to step up their monitoring exercise to ensure they do get appropriate data and can interpret it and understand what it means for the system.

Q89 Mr Ruffley: Do you think the Financial Services Authority, to your knowledge, is devoting time and energy in this direction?

Ian Plenderleith: My impression would be that principally they are focused on the regulated firms and less on the unregulated.

Q90 Mr Ruffley: It is for the Bank to look at the non-regulated?

Ian Plenderleith: Yes, and looking at the broad financial stability picture. That is right.

Q91 Mr Ruffley: Do you think they have the resources and the capability to do this work?

Ian Plenderleith: I think they are building up their efforts in that direction, yes.

Chair: We will take that as another sort of vote of confidence- building up their efforts in that direction.

Q92 Stewart Hosie: You recommended, Mr Plenderleith, that the Bank consider pre-emptive intervention if it becomes aware of a bank experiencing liquidity strains. You know that contingency plans considered providing gilts to HBOS via collateral swaps at the time of their crisis. Did you find any evidence that, once a contingency plan had been drawn up, the Bank considered pre-emptive action in relation to HBOS?

Ian Plenderleith: Yes, I think the case of HBOS is a very good case in point. The bank and the FSA were perfectly well aware that HBOS was under extreme and growing liquidity pressure through the course of 2008 and I think in the early months of 2008 there was serious consideration as to whether pre-emptive action should not be taken to bolster their liquid resources to avert a real crisis. Then the special liquidity scheme was launched in April 2008, which provided market-wide liquidity, and HBOS, among a number of other banks, took advantage of that. That took quite a lot of pressure off HBOS, so through the rest of the summer I think there was a feeling that things were not good but not critical, and then with the collapse of Lehman Brothers in September, that tipped HBOS over the edge. I can understand why it was not done during the course of the summer, but it seemed to me one lesson from that is that before you get to the brink where a bank literally runs out of liquidity it would be worth considering taking pre-emptive action to avoid having to do it at the last minute.

Q93 Stewart Hosie: Would that indicate that the Bank knew the special liquidity scheme was coming and, therefore, they decided to hold fire, or was there a weakness in decision-making that stopped them taking this pre-emptive action?

Ian Plenderleith: No, I think it was that they knew they were planning the special liquidity scheme, and when that was promulgated HBOS were able to take care of it and that helped relieve their situation. I do not think there was a weakness in decision-making, just a sequence of events.

Q94 Stewart Hosie: That is helpful just to understand that. In terms of pre-emptive action more generally, where should the decision-making lie within the Bank if it were determined that a pre-emptive act was necessary? Who should decide that?

Ian Plenderleith: The Executive decision has to be taken by the Governor and the senior Executives, as they were during the crisis that I have written my review about. As we said before, the Financial Policy Committee may have an interest because of its mandate for macro prudential stability, so there will need to be a clear understanding of the basis on which it is involved. Clearly, if the actions pose risks to the Bank’s balance sheet then Court would need to be informed and consulted, and probably would be in any case, and if it involves the provision of liquidity, as in 2008, then it requires prior agreement by the Chancellor.

Q95 Stewart Hosie: Indeed. Clearly, in some of those instances one would imagine that the decision would remain covert in order to avoid precipitating a further crisis within the Bank. I want to talk about the stigma attached to assistance more generally, particularly de-stigmatising the use of the discount window facility because that would clearly mitigate risk. How do you think the Bank should try to de-stigmatise the use of that facility or facilities like that?

Ian Plenderleith: I think that is pretty difficult and the ideas that have come up in Mr Winter’s report are well worth trying. I am not honestly sure whether they will work fully effectively because I have a kind of instinctive lack of confidence in artificial measures like that that force banks to use facilities they would not otherwise use. It goes against the grain, but it is worth trying and seeing and the Bank will consider that.

My own view is the way you deal with stigma over the medium term is by changing the culture by which the banks manage their liquidity. You have to establish a sense that taking liquidity from the central bank from time to time is the norm and natural and not a sign of crisis. You can’t change that overnight. You just have to work away at it through communication and perception. That is why I said it would be a good idea for the Bank, when the dust has settled, to set out a general statement of how it approaches lender-of-last-resort generally in the light of that crisis to help condition what people’s views should be.

Q96 Stewart Hosie: The normalisation of using bank liquidity as opposed to the regularisation of it where they are obliged to take it whether they need it or not would be your approach?

Ian Plenderleith: Yes. I think that is what I would probably want to try, but it would take time. There is an underlying question there, which has changed a lot in recent years. In principle, it seems to me right that banks should manage their own liquidity. It is part of the cost of banking. When the new liquidity rules came in, banks grumbled that that was unfair and the answer is, "No, liquidity is your stock in trade. If you do not want to manage your own liquidity and incur that cost, then don’t be a bank". Banks now accept that they need a liquid reserve as part of their business.

The question is, how much do they have to have? Of course, we have the worry now that banks have accumulated quite a lot of excess liquidity. You can help reduce that excess by giving them access to Central Bank facilities. We have built up a lot of facilities in the last few years, far more than in peacetime we would think appropriate. Why should the Bank be providing all these facilities when banks can get them in the market normally? Answer: because the markets have become dysfunctional and the central banks had to step into that role. That is fine in this kind of critical situation. If we go back to normal sometime, then it seems to me that there is probably less need for central bank facilities. More emphasis could be put on banks finding liquidity in the market. The kind of area I think I would draw the line would be to say for 95% of the times when you are going to need liquidity, normal liquidity need, you should have it on your own balance sheet and find it in the market. For the tail risk, the 5% when something blows you aside and you do not have enough liquidity, it would probably not be sensible to say, "Well, you must have even more liquidity to cover that", so have a central bank facility that would cover that 5% chance. That would be a different balance and then the question of stigmatisation would be much less.

Q97 Stewart Hosie: Clearly, there is an urgency to do this precisely because of the hoarding of cash now by the banks and the constant complaints we hear in the real world about an inability to lend or at least an inability to borrow at the correct price. How much of this is hoarding cash out of fear and how much of it is hoarding cash because of concerns about Basel III and Vickers and the new financial legislation going through the Commons? How much of this is driven by what the FPC might do in terms of capital ratios and leveraging rules? How much of this is real and how much of it is a fear on the part of the banks? Where does the balance lie?

Ian Plenderleith: I think a lot of it is driven by new regulation. I do not think that is fear. That is responding to regulations that have been put on banks to require them to hold more liquidity. It may be that that can run too far too fast. I think the FPC was saying that in the current situation there may be ways in which one can moderate the pace at which that is built up so as not to have this costly holding of excess liquidity that may be impeding the banks’ lending on the scale that we would like. I think it is an important issue and a live issue for debate at the moment.

Q98 Stewart Hosie: It is indeed. Just one final question in terms of the covert operations and the non-stigmatising. The non-reporting of transactions, I think the report said two of the big loans were reported in 2008 and 2009. One I remember clearly was a full year after it had been repaid. In terms of not spooking the market in troubled times, that has some merit. Do you think that a year after a loan or facility has been repaid or taken out is reasonable, or should the reporting be sooner than that, or should it simply depend on the circumstance in each case?

Ian Plenderleith: I do not think there is a set time. It has to depend on circumstances, but I would absolutely feel in that situation that I would not want to disclose it until I was pretty sure that it was not itself going to re-precipitate stress and strain in the market. Firstly, you need the two institutions that you have supported to be seen to be stabilised so that you are not going to undermine them; and secondly, you need the general market nervousness to have subsided to the degree that you can announce it.

I do not feel hangdog or apologetic about that. It seems to me if you are doing an operation like that in the wider interest of financial stability, then there can legitimately be some trade-off with disclosure in order not to undermine the financial stability purpose. What is important is that you should have a process for reviewing regularly whether you should be disclosing. I do not think that was there in 2009. It is there now and that needs to be observed, that at regular stages you have a process that makes you stop and assess whether you can disclose or not.

Q99 Mr Newmark: The nature of collateral on bank balance sheets are forever evolving and the risk management skills need to keep pace with that. You noted that the internal audit made suggestions for how the due diligence process for collateral could be improved. What were those suggestions and what gives you assurance that the Bank will implement them?

Ian Plenderleith: Well, the need, once you decide to do an operation, is to satisfy yourself, verify if you like, the collateral that the banks are offering you. You then have to value it and decide on the haircut, but first of all you need to make sure that what they are telling you is on the disc, is on the balance sheet, is there. What you do, essentially, is get a kind of CD that contains the record of all these mortgages, so you then have to have an audit team that goes through them and establishes that they appear to be what they say they are and that it actually matches against documents at the banks.

What the audit team that we put in found was that the records were pretty good on the whole, but there were inevitably gaps and that it would be sensible to try to make sure that those kind of hitches do not arrive in future. They were not critical, but the process was not as smooth as it could have been; hardly surprising since it was done at considerable speed at the last moment. My impression is that they have very much taken that on board and an important improvement in it is that, against the discount window facility, which is probably the first instance the way that emergency liquidity would be provided, collateral is being prepositioned. It comes to the Bank, is vetted, verified by the audit team, and then can be valued and is established that that is what the Bank will be prepared to lend against that collateral.

Q100 Mr Newmark: Do you think that the skill sets internally in the Bank are keeping pace with I guess the collateral that is being used nowadays?

Ian Plenderleith: They are within the banking sector. They have built up a considerable capability now and I think are able to value most forms of assets that appear on normal bank balance sheets. If you go beyond the banking sector, you get into a very different kind of business; broker dealers, for example, where they will have derivatives and securities, often themselves already pledged in order to provide financing, a different structure of balance sheet. One of the recommendations in my review is that the Bank perhaps needs to look next at that area to satisfy itself that it could handle collateral from non-banking financial institutions like that.

Q101 Mr Newmark: Do you believe, though, that the Bank today itself has the capacity for managing and realising assets held not in the short term but over very long periods?

Ian Plenderleith: Managing in the sense of taking a charge over or an interest in, realising in the sense that if the counterparty, the bank that is being supported, collapsed it would then have to keep the collateral and realise it, sell it or dispose of it, to raise value, I think is a work in progress. It would be a huge task if you suddenly find you are holding 10% of the mortgages in the United Kingdom. That is a live asset that has to be managed day by day. You would have to subcontract a huge administrative apparatus to handle it for you. While there is outline contingency planning on that, I have encouraged the Bank to do further work on working out exactly how to manage that process.

Chair: Thank you very much for coming to give evidence what is now this afternoon, and I am sorry you had such a long wait before getting on to the platform.

Ian Plenderleith: Not at all, Chairman. It is a very interesting debate.

Chair: A very interesting morning altogether for the Committee and I appreciate that you were waiting.

Ian Plenderleith: Not at all.

Prepared 23rd November 2012