Environmental Audit CommitteeWritten evidence submitted by Sir Jon Cunliffe Deputy Governor, Financial Stability, Bank of England

Thank you for contacting the Bank regarding the Environmental Audit Committee’s inquiry into Green Finance.

You envisaged your inquiry covering what the Bank of England’s role might be in monitoring the risks of a bubble in carbon, and whether quantitative easing might be directed to renewable energy projects. The primary objective, set out in statute, of the Bank’s Financial Policy Committee (FPC) is to identify, monitor and take action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system. The Committee’s latest assessment of the risks to UK financial stability was recently published in the November 2013 Financial Stability Report.1 It drew attention to risks from over-indebted borrowers both domestically and overseas, including those that might be triggered by an abrupt rise in interest rates, and to operational vulnerabilities, including those from a cyber-attack. Risks could build were there to be substantial and rapid increases in house prices and a further build-up in household indebtedness, which is already elevated for some households.

The Committee did not identify risks to financial stability from a carbon bubble in its November Report. I understand that there is a concern that the possibility of binding future limits on the extraction of high-carbon assets may not be fully priced into market prices. The impact of any stress arising from any such mispricing on the stability of the financial system would depend on the size of financial institutions’ exposures. At present, the amount of lending by UK-resident banks to the UK extraction sector is relatively small, at less than 5% of their lending to UK non-financial companies. UK insurers will also have some exposure to carbon-intensive firms, through their holdings of equities and corporate bonds. Management of risks in banks and insurance company asset portfolios is of course looked at regularly in the process of prudential regulation of such firms.

You also raise the issue of asset purchases through the Bank’s Quantitative Easing programme. Such purchases are an instrument of the Monetary Policy Committee (MPC), responsible for maintaining price stability. The objective of that programme, therefore, is to support aggregate demand in the economy at a level that it is consistent with meeting the inflation target. The MPC recently set out, through its Forward Guidance Framework,2 its intention to maintain the currently exceptionally stimulative stance of monetary policy, through both the current stock of asset purchases and the historically low level of Bank Rate, at least until the level of unemployment has fallen below 7%, provided that remains consistent with price stability and does not endanger financial stability.

Beyond those statutory objectives for price and financial stability, the Bank has not been given a role to direct the flow of finance in the economy to, or away from, a particular sector. Such allocative decisions are rightly a matter for Her Majesty’s Government, directly accountable to the electorate. The Bank and HMT recently amended the Funding for Lending scheme to remove household lending from the extension to the scheme planned for 2014. That decision was made in the context of accelerating growth in housing activity and house prices and concerns, expressed by the FPC, about the consequences for household indebtedness. Any decision to amend the size or composition of MPC’s asset purchase programme would need to be grounded in the MPC’s objectives, having regard to the FPC’s judgement on risks to financial stability. Unless relevant to those objectives, it would not be appropriate for the MPC to take a decision to alter the composition of the asset purchase programme so as to direct the flow of finance to a specific use, including to renewable energy projects.

I hope that this letter has been helpful in clarifying the role and responsibilities of the Bank of England. Whilst we would be very happy to support the Environmental Audit Committee’s inquiry, in this instance, I am not sure we currently have much evidence of use to the Committee’s enquiries. Were circumstances to change and the FPC to identify a threat to financial stability from a carbon bubble, we would be at the Committee’s disposable should they wish to meet.

9 December 2013

1 The Report is available online at: http://www.bankofenqland.co.uk/publications/documents/fsr/2013/fsrfull1311.pdf

2 See “Monetary Policy Trade-Offs and Forward Guidance”, Bank of England, August 2013. Available online at: http://www.bankofengIand.co.uk/publications/documents/inflationreport/2013/ir13augforwardguidance.pdf.

Prepared 5th March 2014