Till Time's Last Sand

by David Kynaston

  Later that month, asked by the Treasury Committee about what he understood to be the government’s thinking, the governor answered carefully but firmly: ‘I think that there is agreement that, if the Bank is given powers, then it will require the resources and be held accountable for the exercise of those powers. What I think we cannot do is to accept a responsibility for something that we are in no position to deliver …’

  Of course, that year’s autumn traumas still lay ahead, and it is possible that by the early months of 2009 there was a greater appetite at the Bank for an enhanced role, especially in the context of that year’s Banking Act giving statutory form to its existing financial stability functions. NedCo in February continued to discuss its concern about ‘the Bank’s ability to meet its responsibilities for financial stability with limited powers and without direct access to information’, noting that ‘the inability to drill down to the level of an individual institution’s accounts and balance sheet in order to build up a picture of the system as a whole remained a large deficiency’; Tucker the following month gave a speech addressing in some detail various key issues in micro-prudential regulation, including the need to have supervisors with the bottle to face down bank management where necessary; and at NedCo in April, ‘it was stressed that the Bank was in a hazardous position at present’, given that ‘it had to progress the debate without putting itself in the position of either being or being perceived to be a shadow supervisor’. Then in June 2009 came King’s controversial Mansion House speech, rightly or wrongly interpreted by the press as a bid for greater supervisory powers. One passage received particular attention:

  To achieve financial stability the powers of the Bank are limited to those of voice and the new resolution powers. The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between. Like the church, we cannot promise that bad things won’t happen to our flock – the prevention of all financial crises is in neither our nor anyone else’s power, as a study of history or human nature would reveal. And experience suggests that attempts to encourage a better life through the power of voice is not enough. Warnings are unlikely to be effective when people are being asked to change behaviour which seems to them highly profitable. So it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials.

  Soon afterwards, the governor emphasised to the Treasury Committee that ‘what matters is that powers and responsibilities must be aligned’ and that ‘I am not forming any judgement about what powers the Bank of England should have at all.’ The Tory ‘White Paper’ démarche followed in July, and finally of course, eleven months later, the new chancellor’s Mansion House speech.

  King in his response welcomed the announcements; promised that the Bank would ‘bring its own central banking culture’ to the new dispensation, seeking ‘to avoid an overly legalistic culture with its associated compliance-driven style of regulation’; and observed that ‘just as the role of a central bank in monetary policy is to take the punch bowl away just as the party gets going, its role in financial stability should be to turn down the music when the dancing gets a little too wild’. Did he have any qualms? Next month, the Treasury Committee’s Chuka Umunna asked him ‘to set the record straight as to whether you did actually want to take on oversight of financial regulation’ – to which the governor replied that ‘I changed my mind after the crisis when I saw that, first of all, despite the fact that we have absolutely no responsibility for banking supervision, it seemed to make absolutely no difference to the degree of reputational contamination and that, more importantly, when big banks did get into trouble, as a lender of last resort, the central bank was inextricably drawn into the minutiae of dealing with the regulation of liquidity and capital of those banks’. He responded to another questioner: ‘We have quite deliberately not put consumer protection or market conduct in and the responsibilities are limited to prudential because that is what a central bank can do, so I think it is clarity of responsibility … it is asking the central bank to do what the central bank can do and not go beyond that.’29

  Although an interim Financial Policy Committee (a mixture, like the MPC, of internal and external members) started to meet in June 2011, it was not until April 2013 that the new set-up came fully into effect, with the Prudential Regulation Authority (headed by Andrew Bailey, private secretary to Eddie George back in those very different May 1997 days) open for business at 20 Moorgate, once belonging to Cazenove. Intimately involved at the Bank was Tucker as deputy governor for financial stability, and towards the end of May 2013 he spoke to the Institute for Government about the new system. The text released by the Bank made use of bullet points, around which he framed his remarks, first about the PRA:

  • Bank of England is once again the prudential supervisor of banks. And this time of building societies and insurance companies too.

  • Prominence given in public debate to the Bank absolutely not adopting a ‘tick box’ approach, but instead a ‘judgement-based’ approach. This has been widely applauded.

  • In fact, market practitioners tend to be schizophrenic about it. For a couple of decades at least, they have called for ‘certainty’ whenever any specific, isolated policy area is being reformed; i.e. clear and complete rules. But taking the resulting monstrous rule books as a whole, senior practitioners rightly condemn the ‘tick box’ regulation that almost inevitably results.

  • And leaders of firms have hardly stopped their staff from making a living finding ways around rules: endemic regulatory arbitrage was at the heart of so-called ‘shadow banking’ in the run up to the crisis.

  • Step back to consider the public policy purpose. Contrast prudential supervision with securities regulation as traditionally conceived. Latter works on basis of: write rules; check compliance with those rules; punish breaches. If the rules proved to be flawed, they should still be enforced, for credibility’s sake; but later changes should be made to the rules.

  • Animating spirit of ‘prudential supervision’ is completely different. Impossible to write down a complete (or even adequate) set of binding rules on the financial health of a bank (or on the substance of the professional competence of bankers). Instead, things like capital ratios or liquidity ratios are really indicators of financial health.

  • This is reminiscent of an old debate in monetary policy. Thirty-odd years ago, policy was meant more or less mechanically to follow targets for broad or narrow monetary aggregates. It didn’t work: the economic world was not sufficiently stable. Since we adopted inflation targeting, central banks have had an eclectic approach to indicators. We are constrained by a clear medium-term objective (2% CPI target), but do not use a set of supposedly fool-proof core intermediate indicators.

  • No more can we write down hard and fast rules on bank balance sheets.

  • Nor, consistent with Parliament’s wishes, is the Prudential Regulation Authority seeking to achieve a zero-failure regime. The failure of individual firms has to be an acceptable outcome so long as they can be wound down in an orderly way.

  • So the PRA’s approach to prudential supervision entails making judgements of the kind:

  – your bank isn’t as strong as you think it is

  – cut back on the risk in your book

  – I’m afraid you’re not fit to run the bank

  – your business could not be resolved in an orderly way if it fails.

  • This shift from rules to judgement changes the relationship between the regulator and business.

  • Challenge is how to make a judgement-based approach acceptable when we use it in earnest. Is our society really ready again for judgements from the Old Lady?

  Later in his talk, he turned to macro-prudential policy, in the form of the FPC (no longer interim):

  • … Can view the role of the FPC as being to ensure that the need for stability in the fi
nancial system is not overlooked. Looking ahead, this will mean keeping the regulatory regime up-to-date as the financial system evolves and, when the time comes, ‘taking away the punchbowl’ before the next party gets as dangerously out of control as the last one did.

  • The case for operational independence here is just as strong as for monetary policy. Taking Away The Punchbowl is something that requires a medium-term orientation. Parliament can tie us to the mast and rely on us not to seek to wriggle free.

  • But, as with monetary policy, this makes it vital that Parliament frames the objective and that we are sufficiently transparent to enable ex ante public accountability.

  • Objective: The legislation governing the FPC is clear that resilience of the system as a whole is the primary goal but that we must not aim for the stability of the graveyard. Resilience is not quantified, however.

  • Transparency: While respecting the confidentiality of data on individual firms, FPC is required by Parliament to be as transparent as possible – via the Published Record of our policy meetings and the twice-yearly Financial Stability Report.

  • This is the background to the FPC calling on the Bank to develop a regime for stress testing to be used for both micro and macro prudential supervision.

  • One possibility is for FPC to use stress tests to define the degree of resilience the system needs. Maybe that could become to financial stability what forecasting is to monetary policy. In the USA and elsewhere the results of such stress tests have been published.

  • That represents quite a change in regime for regulated firms. But neither the markets nor the public was comfortable with the degree of secrecy on these matters in the past.

  It all added up to a major moment. ‘Supervision and central banking grew apart in this country and they’re now being reconnected,’ Tucker told the Guardian earlier that spring. ‘Given where this country finds itself, that is a very good thing. It was always the historic mission of the Bank of England to look after stability.’ And in June, less than a fortnight before the end of King’s governorship, the impact was considerable when the PRA published its stress-test findings, revealing that five out of the eight major UK banks and building societies fell short of the PRA’s required standard for capital resources.30

  The first four post-crisis years – summer 2009 to summer 2013 – also saw a sustained focus on the Bank’s role in seeking to support and nourish the British economy as it only slowly and patchily recovered. Three areas were arguably key, with each provoking significant external criticism: lending; QE; and monetary policy more generally.

  ‘It is heartbreaking sometimes,’ was how King in July 2010 described to the Treasury Committee his experience of hearing from small to medium-sized companies across the country how hard they were finding it to obtain bank loans, even if they had built long-term relationships with those banks. ‘It is a lot harder to run a business out there’, he added, ‘than it is to stay in London and just trade away and make what appears to be millions one day and minus millions the next.’ King did not blame the banks alone. By October 2011 he was criticising the Treasury for failing to insist that the big lenders it owned – RBS and Lloyds Banking Group – increased their lending to SMEs (Small and Medium Enterprises); while in March 2013 he reiterated an earlier call (expressed soon after the bank’s collapse) that RBS should be broken up, in effect into a ‘good’ bank doing normal business and a ‘bad’ bank housing the troublesome loans (inevitably involving for government a big, up-front loss), so that the ‘good’ bank could become ‘a major lender to the UK economy’ and rapidly return to private ownership. Largely off its own bat (though in collaboration with the Treasury), the Bank’s key initiative came in June 2012 with the announcement of a scheme known as ‘funding for lending’ that would come into operation in August and in essence provide banks with cheap funding in exchange for a commitment from lenders to provide cheap loans to ordinary businesses and households. ‘The question is whether the cost of funding is the binding constraint on lending by banks,’ observed the Financial Times’s Martin Wolf. ‘Far more important, I suspect, are the risk aversion of banks and the state of potential borrowers: those who are credit worthy do not wish to borrow; those who want to borrow are not credit worthy, at least in the current enfeebled state of the economy.’ In the event, the majority of the £80 billion scheme went during its first year to homebuyers, not small businesses – which was not quite the original intention. The Bank was also becoming vulnerable to criticism on the score that its insistence (whether through the FPC or the PRA) on banks holding sufficient capital perhaps acted as a significant deterrent to their lending. ‘The idea that banks should be forced to raise new capital during a period of recession is an erroneous one,’ declared Vince Cable in March 2013; but King was adamant that ‘a weak banking system does not expand lending’ and that ‘the better-capitalised banks are the ones expanding lending’. Some months later the business secretary would be using and endorsing the phrase ‘capital Taliban’ to describe Bank officials, though by then a new governor was in post.31

  Elsewhere on the policy front, ‘new-fangled’ quantitative easing became during these years a semi-fixture. Having started in March 2009 with the Bank committing to the purchase of £75 billion in assets (mainly gilts) through the creation of electronic money, the programme continued later in 2009 with a further £50 billion in May, £50 billion in August and £25 billion in November – taking the QE total to a fairly staggering £200 billion, equivalent to 14 per cent of nominal GDP. Expert opinion was broadly, if far from unanimously, positive about this attempt to achieve higher asset prices, thereby reducing the cost of funding and increasing the wealth of asset holders, in turn boosting spending and increasing nominal demand. A typically measured assessment came in March 2010 from the City economist Roger Bootle, who concluded that the Bank had been right to launch QE (‘the only game in town’) and that it had helped significantly to strengthen asset prices and to counter the deflationary threat. In due course, the Bank itself offered some hard figures, claiming that its first full round of QE had boosted Britain’s GDP by up to 2 percentage points and inflation by up to 1.5 points.

  ‘Open the taps’ was the Economist’s cry at the start of October 2011, against the background of what it called ‘a sickly economy’. Within a week the MPC obliged, starting a new round of QE (soon known as QE2) with £75 billion of asset purchases, followed in February and July 2012 by two further tranches of £50 billion – taking the grand total, since March 2009, to £375 billion. A fresh round sparked fresh appraisals, prompting one economist, Richard Barwell, to devote an article in The Times in February 2012 to debunking five ‘QE myths’: namely, that ‘printing money inevitably leads to rampant inflation’; that QE was ‘a cunning plan concocted by the Bank and the Treasury to inflate away the Government’s debt on the sly’; that QE was ‘ineffective because asset purchases have no impact on the real economy’; that QE was ‘ineffective because the money that the MPC created is being hoarded in bank vaults’; and finally, that ‘asset purchases suffer from diminishing returns – that is, the more the Bank buys, the less impact each billion of purchases has’. Predictably enough, dissenting voices remained. Soon afterwards, Robert Skidelsky and Felix Martin argued that, although it had done good initial work to ‘stop the slide into another Great Depression’, QE’s fatal double flaw ‘as a recovery policy’ was that ‘its effect on aggregate demand is weak and uncertain’, with new money failing to be translated into increased spending, and that ‘QE does nothing to improve longer-term growth prospects’, given that it ‘simply freezes the existing [imbalanced] structure of the economy at a higher level of output’; while also that spring one of the most persistent attack dogs on QE, the Guardian columnist Simon Jenkins, was unequivocal that the policy had indeed done no more than fill bank vaults – ‘it has helped banks back to profitability but there is no sign the policy has had any impact on credit to businesses, let alone on domestic money supply
’ – and he called it ‘the costliest fiasco in regulatory history’.32

  In any case, there were before long increasing signs of a loss of confidence in QE at the Bank itself. QE had, Tucker publicly admitted in October 2012, ‘lost its bite’; and by June 2013 the MPC had voted against more QE for eleven consecutive months. Looking ahead that month to the policy options facing King’s successor, the prominent City economist George Magnus bluntly stated that ‘QE cannot address the dearth of investment, low productivity, weak trade or the handicapped financial system.’ What about King himself? Had QE, he was asked by Martin Wolf in a valedictory interview, worked as he had hoped? ‘I’ve always seen this as a way of increasing the broader money supply,’ replied the governor. ‘And the thing that’s so extraordinary is that, for the past few years, the banking system, which is normally responsible for creating 95 per cent of broad money, has been contracting its part of the money supply. And since we at the Bank only supply about 5 per cent of it, the proportional increase in our bid has to be massive to offset the contraction of the rest.’ Wolf then queried whether the Bank should have been more adventurous and purchased riskier assets. ‘No, right from the beginning I said that if other assets should be purchased, and I took no view as to whether they should or should not, then the government should decide on which assets are purchased, and we would finance it. I think that’s the right division of labour between central bank and the finance ministry.’