APPENDIX 5: NOTE OF VISIT TO THE BANK
OF ENGLAND ON 21 NOVEMBER 2011
Bank of England, London, 21 November 2001 at 2.30pm.
Attendance
From the Committee
Lord McFall of Alcluith Mr Nicholas
Brown MP
Lord Newby Mr Peter Lilley MP
Lord Skidelsky David Mowat MP
Baroness Wheatcroft David Ruffley MP
From the Bank of England
Sir Mervyn King, Governor
Paul Tucker, Deputy Governor for Financial Stability
Andrew Bailey, Deputy Chief Executive designate of
the PRA
Note of discussion
The Bank of England's lender of last resort function
The Committee and the Bank representatives discussed
the Bank's function as lender of last resort. In the course of
the discussion the Bank made the following points:
· It was important for central banks to
provide liquidity insurance to help institutions overcome short-term
liquidity constraints. The provision of short-term liquidity was
different to the long-term funding of banks. The problems banks
were encountering in raising funds reflected the market's concern
about the capital held by banks, relative to the risks they faced.
· Liquidity assistance was provided against
collateral in the form of assets held by institutions. Central
banks would assess the value and risk of the collateral and lend
accordingly. The percentage reduction in the liquidity provided
relative to the value of the collateral was known as a 'haircut'.
Properly graduated haircuts provided an incentive for institutions
to hold good collateral, as well as protecting the central bank.
· The Bank of England had arrangements with
financial institutions whereby collateral was assessed and haircuts
calculated in advance through 'prepositioning' the collateral
with the Bank. In a crisis this would allow for quicker action
and more considered haircuts.
· In this way, a central bank could provide
a lender of last resort function while helping to incentivise
proper management of liquidity in institutions and the holding
of good collateral.
· The lender of last resort function was
originally intended to support the market as a whole, rather than
simply allowing existing banks to remain in business. This was
still the key guiding principal. The Bank of England had traditionally
been willing to assist individual banks on the basis that their
failure could have consequences for the rest of the market. It
was preferable that banks should be able to fail without endangering
the stability of the financial system, via employment of effective
resolution regimes.
· If a bank was failing, it would eventually
get to the point where it did not hold the collateral that would
allow the Bank of England to provide liquidity assistance. At
this point the Government might choose to step in and provide
taxpayers' money. The use of taxpayers' money would always be
a decision for the Government, not for the Bank. The Bank may,
however, carry out a 'support operation' outside its normal remit,
on the decision of the Chancellor. The draft Bill would formalise
this procedure. Such operations would be carried out with an indemnity
from the Government if the Bank determined that the risk involved
exceeded the capacity of the balance sheet.
· 'Normal' liquidity insurance arrangements
were carried out with a high degree of transparency. In certain
cases the provision of liquidity to a certain institution as part
of a 'support operation' would need to be done covertly. In these
cases the Chancellor and the Governor would give a private briefing
to the Chairs of the Treasury Select Committee and the Public
Accounts Committee. The broad substance of the liquidity arrangements
would always be revealed at a later date.
· The FPC's role in the liquidity insurance
regime would be, for instance, to advise on whether the financial
environment required the Bank of England to adjust its arrangements
for lender of last resort to the market. The FPC would not have
a role in support for individual banks—that would be handled
by the Bank executive and Court, PRA Board (on regulatory decisions),
and the Government.
· Sound liquidity insurance arrangements
and a good resolution regime within the Bank of England should
greatly reduce the need for the Chancellor to intervene.
· Any deposit-taking institution would be
potentially eligible for liquidity support, whether incorporated
in the United Kingdom or abroad, provided it had a banking operation
in the UK (whether a branch or subsidiary). A solvency and viability
test would be applied to the firms as a whole, in the case of
a branch operation. In cases concerning international institutions
of this kind the Bank of England would work closely with the 'home'
authority and other concerned central banks.
Judgement-led regulation
The Committee was told that FSMA had been designed
to be a rules and compliance based regime and that it would be
a challenge to amend it to become a piece of legislation promoting
judgement-led supervision. The Bank suggested that, in order to
empower the regulator to make judgement-based decisions, paragraph
17(1) of new Schedule 1ZB (inserted by Schedule 3 of the draft
Bill), should be amended from a duty on the PRA to maintain arrangements
designed to enable it to determine whether persons it regulates
are complying with relevant requirements, to a duty on the PRA
to maintain arrangements that allow it to supervise firms.
The Bank also proposed that threshold conditions
for regulation should be amended in line with Paul Tucker and
Hector Sants' letter to Mr Lilley of 18 November. This would
allow supervision to be focused primarily on judgement-based regulation,
rather than on compliance with a rule book. The Bank also suggested
that the language of the threshold conditions should be made clearer.
The FPC ought to play a useful role in "backing-up"
PRA supervisors, especially in situations where supervisors were
using their judgement to impose additional requirements on institutions.
The FPC would also have a role in ensuring supervisors pursued
potentially systemic issues that might not be apparent to supervisors
of a single institution. But the FPC is not a substitute for,
and should not become involved in, the discussion of supervisors
on institutions. The FPC could also provide support to supervisors
tackling highly complex or obscure practices.
The EU single market regime has created a problem
for so called "host authorities" where firms branch
across borders. This was a particular issue in the UK, where some
very large EU banks operate on a brand basis and the regime provides
the FSA with very few formal prudential powers. Moreover, the
FSA was not always invited to be on the international supervisory
colleges for certain "big players" with branches inside
the UK. The Bank would expect to pursue that in due course.
Macro-prudential powers
It would be necessary to have an expedited procedure
for adjusting the macro-prudential tools established under secondary
legislation, with a high threshold and appropriate checks and
balances.
Information-gathering powers
For firms within the regulatory perimeter, the Bank
agreed that the FPC should gather information indirectly, via
the PRA and FCA. However, the Bank felt that the FPC should have
the power to gather information directly from firms outside
the regulatory perimeter. This would make clear that the information
gathering was not linked to any supervisory role: if the PRA had
the power to gather information from outside its regulatory perimeter,
this could create confusion and give the impression that the PRA
was somehow supervising those individual firms.
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