Treasury Committee

Oral evidence: Prudential Regulation Authority, HC 1080
Wednesday 4 March 2015

Ordered by the House of Commons to be published on 4 March 2015

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Members present: Mr Andrew Tyrie (Chair); Rushanara Ali, Steve Baker, Mike Kane, Mr Andrew Love, John Mann, Jesse Norman, Alok Sharma

Questions 1 – 104

Andrew Bailey, Deputy Governor for Prudential Regulation and Chief Executive Officer of the Prudential Regulation Authority, Sandra Boss, External member, PRA Board, and Charles Randell, External member, PRA Board, gave evidence.

Q1 Chair: Thank you very much, all three of you, for coming to give evidence to us this afternoon. You have given evidence before, Mr Randell. Ms Boss, I think it is your first time before the Committee.

              Sandra Boss: It is, yes.

Q2   Chair: Mr Bailey, you are a very familiar figure. You will no doubt have seen the hearing we had with HSBC. One has the feeling that it is still, to some degree, a federal institution. It is not clear that the right hand knows what the left hand is doing the whole time. Is HSBC too big to manage?

              Andrew Bailey: I think you are right in your description of it as a federal institution. If you go back in time, the history of HSBC is that it was a very federal institution. That goes well back into the period before it was a British bank—before the Midland acquisition. It had, I think, a very strong control culture at that point, but it was a very strong federal control culture. If you ever met Sir William Purves, you would know it was a strong control culture. That was the tradition of HSBC.

              It then grew by acquisition very rapidly, more precisely round about the late 1990s through to about 2002 or 2003. It grew by acquisition, which, in a sense, was quite contrary to the culture, both in terms of bringing things in and being at odds with the federal culture. Quite a lot of the seeds of the problems we have seen were sown then—that is obviously both the Swiss issues and, if you go back a couple of years ago, the Mexican issues, which have been the issue in the US. What you had then was a federal structure without the necessary controls in it to maintain the—

              Q3 Chair: What about now?

              Andrew Bailey: I will come to that. It is clear to me in the actions that we have taken as the prudential regulator that the question of being too complicated to manage has to be dealt with. We have been very clear with HSBC over a number of years about that. My view is that the current management has set about that task. I think Stuart Gulliver described to you in the hearing what he was doing, and we have strongly encouraged that.

              I can tell you that, as the prudential regulator, we are holding Stuart Gulliver and Douglas Flint responsible for delivering that process. They said, and I would agree with them, that it was not done. I think they said it was half-done; I would not want to be particularly precise about that. It does not seem to be a judgment that you can be precise about. There is no question but that, first, slimming down the complexity of the group and, secondly, transferring from a federal structure to one that has strong group controls and risk management are essential and are works in progress. That is not at odds with what they said.

              Q4 Chair: You have described what you feel is their personal responsibility. They were very reluctant to suggest there should be individual personal responsibility for these past actions of HSBC. Does that give you cause for concern about the frame of mind and culture at HSBC at the moment, in respect of the recommendation for much greater individual responsibility embodied in the recommendations of the Parliamentary Commission on Banking Standards, which is now legislation that you are implementing?

              Andrew Bailey: Like the Parliamentary Commission, I think the senior managers regime and the presumption of responsibility that goes with that is critical. I find it difficult and frankly inimical to live in a world where there is not an allocation of responsibility. I wrote a piece in the FT the other day and ended it by saying that I am a chief executive and, of course, we all delegate work—it would be crazy if we did not—but you can’t delegate responsibility. I believe that fundamentally. That is consistent with the purpose and goal of the senior managers regime. That is why I am so committed to introducing it and to making it successful. A lot of people say it is all about criminal prosecutions. It is not; it is about responsibility. That is at the heart of it.

              Q5 Chair: Okay. So, the question was: what about HSBC’s culture of personal and individual responsibility at the moment, in light of the evidence that we heard of the approach they took?

              Andrew Bailey: Are you asking a question about today or the past?

              Q6 Chair: I am asking about what we have learned about HSBC today from the approach they took to answering questions about the past. When we asked them who should take responsibility, they replied that it was all collective responsibility.

              Andrew Bailey: That is interesting.

              Q7 Chair: I am summarising and paraphrasing.

              Andrew Bailey: I read that part of the transcript carefully. I would say “Let there not be any doubt”, but I don’t think they are in any doubt. They as the senior management are responsible personally for delivering the change that has to happen; it is their responsibility. When you put to them the perfectly reasonably question, “Let’s apply the framework of the senior managers regime to the past. Who was responsible?", the answers became less clear, as you observed in the hearing. My answer would be, “You have got to apply the same framework. You have got to apply it consistently.” You have to understand that clearly, as they said, the local management in Switzerland has a responsibility, but I come back to the point I can’t emphasise enough: senior management can’t and couldn’t delegate responsibility.

              Q8 John Mann: You’re waffling, Mr Bailey, as badly as they were. Why shouldn’t they go to jail, as a potential sanction?

              Andrew Bailey: I don’t think I’m waffling. I wasn’t asked the question of who should go to jail. As I am sure you are aware, the criminal test in the senior managers regime relates to failed banks. I think this is about who is held responsible. In the case of the current management of HSBC, in respect of the current issues and objectives they face, it is a question of who is responsible for correcting the problems at the bank that have come to light. They are. I am not waffling about that; they are.

              Q9 John Mann: Let’s be clear then. I will correct myself: you are not waffling. What you said is that you have been clear over a number of years to them, yet irregularities continue. There was new court action in New York last week in relation to ISDA fixing, so it is carrying on—that is not past stuff, but pretty recent stuff. The Chairman read out the number of irregularities and areas. They made great play of saying, “Ah, but there wasn’t LIBOR—we didn’t fix LIBOR.” Well, everything else was fiddled and fixed in HSBC, yet you say that you have been clear over a number of years. Either your clarity hasn’t got through, or somebody is not listening and acting, so which is it?

              Andrew Bailey: My clarity is over who is responsible for fixing these problems, and it is very clear that they are—

              Q10 John Mann: No, let me stop you.

              Andrew Bailey: I hadn’t finished.

              Q11 John Mann: We had an hour of hearing how they are fixing the problems. Of course that is important—crucially important—but what about who is responsible for those things in the first place? It is a bit like us saying, “MPs—loads of fiddling of expenses, but what’s important is that we’ve improved the system.” Of course that is important, but what about accountability?

              Andrew Bailey: Look, I agree with you that the people who are responsible for all those issues have to be held to account for them. I am not disputing that with you at all. As a prudential regulator, I am very concerned that there is a senior management that is committed to fixing the problems. I believe, and I will tell you quite straightforwardly, that they are the senior management that is fixing the problems. They are responsible for it, and I am going to hold them responsible, whatever phrase you want to use—hold their feet to the fire, their noses to the grindstone, it doesn’t matter—because we have to have a management that sorts it out.

              Q12 John Mann: Yes, but they also have to be responsible for what they failed to do; otherwise nobody is responsible.

              Andrew Bailey: Yes, they have.

              Q13 John Mann: And they’re not, are they?

              Andrew Bailey: Well, they are, actually.

              Q14 John Mann: Well, they’re not accepting responsibility.

              Andrew Bailey: They do accept responsibility for things when they happen, because they have to. For instance, if you look at the remuneration policies, downward adjustments have been made to remuneration in respect of things that have come to light.

              Q15 John Mann: So what you are saying is that the sanctions on them are not heavy enough. If that’s accepting responsibility, and that’s the definition, the sanctions available are not strong enough.

              Andrew Bailey: I think that is a matter of debate. We could debate what the right level of sanctions is for any given piece of misconduct. What I am saying is that it is untrue to say that there aren’t sanctions and it is untrue to say that there isn’t allocation of responsibility, because I would strongly agree with you that that has to happen.

              Q16 John Mann: Can I ask you something, Sandra Boss? You are relatively new, but you have a lot of experience. We are being told that HMRC managed to get in all the money, yet they only got in £135 million out of the very many billions that was banked. Do you see that as a rational investment decision? You pay a fee, and some of the fees I have seen are comparable with the amounts of money that it was claimed was got back in tax, is it a rational—

              Sandra Boss: Your question is did HMRC—

              John Mann: In your judgment, would you say that HMRC has got in all the money?

              Sandra Boss: I do not think that is a question that, sitting on the PRA, we are in a position to assess. First of all, clearly what HMRC is doing relating to individual tax matters is not something that is in our arrangement with them. We care very much about serious conduct issues, particularly if serious conduct issues then have prudential implications. This may be one; we will look at the evidence, but right now we do not have all the evidence in, in terms of what this particular situation means from a conduct perspective and what it means from a prudential perspective. We will go through that process, and we will then look at what it means in terms of the people who have been approved, but whether HMRC has or has not conducted its duties is really not a matter that I can comment on.

              Q17 John Mann: So what you are saying is that you are not yet sure whether HSBC is capable of being effectively supervised.

              Sandra Boss: That is not what I said. I won’t repeat what I said, but I would be consistent with Andrew, attentive to the issue of it being a very complex entity and very difficult to manage. The management team in place has a programme of transformation, and it is a very long programme—as we discussed before, it is a numerous years undertaking. I don’t think one can link what HMRC has or has not done yet on collection with a conclusion about HSBC’s manageability.

              Q18 John Mann: Mr Randell, are the PRA undertaking further work with HSBC on the activities of the Swiss private bank?

              Charles Randell: On the activities of the Swiss private bank in terms of tax compliance and conduct issues, the lead agencies are, respectively, HMRC and the FCA. We have close liaison with them. If they find misconduct that comes back to individuals whom we have to supervise from a fitness and properness point of view, we will look at the evidence and take all the necessary action. Obviously, we do not have an independent international tax compliance investigation capability. That is not what we do.

              Q19 John Mann: To confirm, the PRA is not currently undertaking any further work with HSBC.

              Charles Randell: We are undertaking a lot of work with HSBC.

              Q20 John Mann: About the activities of the Swiss private bank?

              Charles Randell: As Andrew explained, we have had a multi-year programme ever since the PRA came into existence to ensure that the symptoms of the “too complex to manage” problem you are referring to, nearly all of which predate the creation of the PRA but are now coming out, are addressed and remediated. That has been a multi-year programme; it is a big oil tanker and it takes a while to turn. On the specifics of the actions that other agencies are taking, we are in extremely close contact with them to ensure that these matters are expeditiously and vigorously brought to a conclusion.

              Andrew Bailey: To summarise, our objective here, in terms of conduct threatening our prudential objectives, is that they either shrink, reorganise or dispose of parts of the business that give rise to risks that threaten our objectives. Those threats to our objectives can come from conduct, clearly.

              Q21 John Mann: I have one other question, Mr Bailey. You and I have previously discussed leverage ratios and building societies. Are you certain that you have the right model and that you are not disproportionately affecting building societies with the system that is being introduced?

              Andrew Bailey: Let me say two things about the system that is being introduced in terms of that ratio. First, we have proposed to set a minimum of 3% and buffers for systemically important institutions on a countercyclical basis. That is very deliberately designed to have an effect that we think is proportional. We do not want to burden smaller institutions with the full weight of the leverage ratio—and, by the way, I think that is consistent with our competition objective.

              Secondly, to the extent that it bites, the leverage ratio bites more severely for those institutions that are using the so-called internal models approach. Those institutions that use the Basel or European standardised approach—the risk-weighted approach—tend naturally to have a higher leverage ratio as a result of the product of their business, the way their business is run and the way they calculate capital on the risk-based rate. The vast majority of building societies are on the standardised approach, not the models approach, therefore they are less directly affected by the introduction of the leverage ratio, so there is a mitigant there. I can assure you that, as we have discussed, it is something to which we are very alert, because we look across the piece at the effect of these policies on different sorts of institutions and, obviously, looking at the effect on mutuals is one of the things that we do.

              Q22 John Mann: Obviously, mutuals have additional issues in raising more capital. Ms Boss and Mr Randell, do you have any concerns that there may be a level of unfairness in terms of the competition objective by discriminating against certain building societies?

              Charles Randell: I would say we absolutely do not discriminate against building societies—quite the contrary: we have specific requirements to consider the impact of our policies on mutuals, and we also have a secondary competition objective, so we think very hard about these things. Nevertheless, where a building society is primarily exposed to one asset class in one geographical region and is also modelling its own capital requirements, I think it is proportionate to cover off some of that additional risk through leverage requirements. One thing I have been very heartened by since 2013 is just how easily the large building societies have been able to raise capital. It is a success story.

              John Mann: Any comments, Ms Boss?

              Sandra Boss: No, I think my view is consistent with Charles’ comment.

              Andrew Bailey: May I offer a couple of thoughts before we finish on this? As you know, there is a concern from a conduct perspective, which I understand, about selling alternate, what I might call non-equity capital instruments to retail investors. There is a good reason for that—there have been some difficult experiences. I do not think that Martin Wheatley would disagree with me on this. Over time, we need instruments that smaller societies in particular can sell; they will more naturally probably sell them to a retail investor base. We have to bear that issue in mind as we go forward.

              Secondly, and I am sorry that this is a long wave of history comment, we have designed a mutual system—in fact, we designed it probably in the 19th century—that cannot issue its own share capital. As you may know, that is not the case in some other countries. That is deeply enshrined in tradition and legislation and everything, but it is of course a restriction on the operation of the mutual sector in this country, because of the way the building society model was established.

              John Mann: Interesting.

              Q23 Chair: But, contrary to popular perception, it does not necessarily mean that those institutions carry less risk.

              Andrew Bailey: No.

              Q24 Mr Love: The building societies would argue that they are a less risky model, although the experience during the credit crunch was perhaps not as good as they would have hoped for. I want briefly to pursue this point about retail investors. As you will be aware, Nationwide has been very successful at raising new capital from the capital markets, but that does not apply to modestly sized building societies, which need access to a retail market. There seems to be some difficulty there, particularly with the conduct authority. Could the PRA use its good offices to assist in ensuring that small and medium-sized building societies can raise capital?

              Andrew Bailey: I agree. I am slightly in danger of repeating what I just said, but we should aim—I have discussed this with Martin Wheatley—to get back to a system in which it is possible to have simple instruments, so that the risk that people feel they have been mis-sold them is reduced. Of course, I should say that in the present world, where, if these institutions fail, the cost of resolution passes to the creditors rather than the taxpayer, it is important that people who buy these instruments understand where they are in the capital hierarchy and where the risk of triggering is—that they know what they own; that is important. That is Martin Wheatley’s concern, and I agree with him on that. To imagine that, forevermore, these instruments could not be sold to retail investors, for precisely the reason you give, would be quite difficult.

              Q25 Alok Sharma: May I go back to the point that made, Mr Bailey, when you said—I think this a quote—“You cannot delegate responsibility”? I could not agree with you more on that. You obviously saw the exchange between the Committee and HSBC. Many of us were pretty surprised that there was an attempt to delegate responsibility. It is an interesting point that when it comes to bonuses, they are not delegated—people take those on an individual basis—but when it comes to taking responsibility, that is delegated. I certainly was very disappointed by what we saw from HSBC. The Governor of the Bank has said that those who are unwilling to assume the responsibilities that they will acquire under the new senior managers regime should resign from their boards. Do you think there will be a large number of resignations? Have you had any discussions with board members of some of the banks to ask for their views on what they might do?

              Andrew Bailey: My experience is that this is more talked about in the media than in reality. There was an incident, as you may know, because the Chairman got involved in it, of two individuals—again, from HSBC—who said that that was it, they were off, because of the regime. Actually, the reality turned out to be slightly different: they were going anyway, I think.

              Chair: The original article in the FT was wrong.

              Andrew Bailey: And you commented on that. So I do not get that. It might sound a bit trite, but I do not think that good people should be put off by this regime, because, frankly, if you take this seriously and you take responsibility seriously, you ought to be pretty confident that you can operate in this regime and that it will be compatible. I feel that very strongly. So the straightforward answer to your question is no, I do not get people flooding into my building and saying, “If you introduce this regime, the world is going to end. We cannot stock boards.” I think there is a general tenor of commentary around that—mostly, as far as I can see, from people who are not directly involved in the boards of institutions. I saw a bit of that in response to the piece that I put in the FT. I should say that the banks that I have spoken to subsequently, particularly in the light of us issuing the consultation paper at the same time, have said no, they accept where this is all going.

              Q26 Alok Sharma: So in your opinion, there will not be a sudden shortage of qualified candidates for board memberships of banks.

              Andrew Bailey: No. What I would say, by way of observation, is that the mix of people on boards has changed a bit over time. The reason for that, I think, is that the demands of being on these boards are higher, the expectations of what boards do are higher, and I think that that does have a natural element of selection in it. To give you an example, we used to live in a world where it was possible typically to be, say, the chief executive of a fairly large non-financial company and to be on the board of a bank. You do not see that very much these days, and I am not surprised, because the time commitment required for being on the board of a bank has grown.

              It is something that we need to keep an eye on, and it is on our mind, because clearly there is also an issue about whether you spend too much time with the institution, so are you on the wrong side of the line in terms of the executive/non-executive thing? But I do not get the sense that there are huge numbers of people voting with their feet.

              Q27 Alok Sharma: So, given that there is more scrutiny of non-execs these days, particularly in the financial services sector, would you expect that, as a result of this, board pay will rise specifically in relation to all these extra responsibilities that are coming in under the senior managers regime?

              Andrew Bailey: I think it is possible, but—

              Q28 Alok Sharma: Do you think board members would be right to expect their fees to go up as a result of this?

              Andrew Bailey: I think it is possible, yes, but do not interpret that comment as meaning that we should have elements of variable performance-related remuneration. That is just wrong, and we have had one or two of those in the past, but what is the appropriate level of fixed fee for the work that is expected of people—yes, I think that is an appropriate question to ask.

              Q29 Alok Sharma: Okay. Let us say that you go on to a board.

              Andrew Bailey: I am not contemplating it.

              Alok Sharma: But let us say, for argument’s sake, that you were to go on to the board of a bank. What would you expect?

              Andrew Bailey: I can usually answer questions here, but I have never thought about that question, because I have a job that I enjoy.

              Alok Sharma: Ms Boss, would you like to answer?

              Sandra Boss: I also have a job that I enjoy. I have not been in the market, so I do not really know what the market is.

              Q30 Alok Sharma: I guess what I am trying to understand is what quantum, what percentage, we are talking about. Mr Bailey has made the point, I think—please correct me if I am wrong—that it would not be unreasonable for people on boards to expect the remuneration to go up to take into account the additional responsibilities. If the base is 100 today, what would you expect it would be reasonable to increase people’s fees by?

                            Sandra Boss: I don’t think there is a general quantification that you can give, but I would say that if you look at the senior managers regime, which will apply to some of the chair positions, one of the things that we are seeing is that the requirements, in terms of number of days, are explicitly going up. Typically, there is a concept in the discussion, as we have seen—this is anecdotal—that as days increase, the percentage is similar to the amount that your overall compensation would go.

              When it comes to the role of what we call a standard NED, and recognising that in the new consultation the requirements have changed in terms of whether they would be included in the senior managers regime as a senior manager, I would imagine that what would have been expected a year ago versus today versus a year from now would be quite similar.

              Q31 Alok Sharma: Okay. Mr Randell, perhaps I can ask you this one, then. Non-executive directors in banks, at least in recent times, have not had a brilliant record of challenging the executive and averting some of these risky practices—perhaps that is one way of putting it. Are you concerned that these failings will continue, given that most of these non-execs will be excluded from the senior managers regime?

              Charles Randell: No. I don’t think that the exclusion of non-executives from the senior managers regime is something that you can link to a reduction in challenge. To my mind, the problem with challenge has come from opacity of information, poor governance and firms that sometimes had business models that were too difficult for non-executives to really understand and challenge, and sometimes non-executives did not have the skills to challenge. There is a whole load of reasons why non-executives did not challenge. Those things are remedied not by threatening sanctions against non-executives; they are remedied by changing the business model of firms to make them more overseeable, by making the executive more accountable for what they do, and by chairs ensuring that boards spend time on the right things and in a simplified way.

              Q32 Alok Sharma: Mr Bailey, did the PRA have any role in persuading the Financial Conduct Authority to limit the scope of the senior managers regime, so that you had a much smaller number of NEDs who were effectively covered by it than was initially proposed?

              Andrew Bailey: We discussed it with the FCA at some length; it was a decision for the FCA board. Of course, I am a member of the FCA board, but it was a decision taken by the FCA board. My view is that, as Charles has said, there is a difference between being a standard NED and other responsibilities. The other thing that it is very important we do, because of the greater intensity—

              Q33 Alok Sharma: Just to be clear, in terms of your own position on this, first, as a member of the FCA board, you would share the view that you cannot have the net covering everyone who is a NED?

              Andrew Bailey: I did take that position. Obviously, it would be a bit odd if I argued one thing on the PRA board and another thing on the FCA board, but of course I am on the FCA board as the chief executive of the PRA, so the members of the FCA board are well aware of why I say the things I say, in that sense.

              There is another thing that is important. The senior managers regime is intentionally a more intensive process; it is intentionally designed like that. Over recent years, we have deliberately sought to take steps in that direction in the way that we operate the approved persons regime. To give you an example—the most obvious example, probably—the so-called significant influence function interview process that goes on for these people is now done at that level by senior people in my organisation and senior people in the FCA. Those of you who remember the hearings with, say, the Reverend Flowers, will remember that it was a very different story in the past. If you applied that to the whole of boards, that would be a very intensive regime to operate, and I don’t think it is appropriate. It is appropriate, as I think the senior managers regime appropriately sets out, to focus that on the people who really take responsibility. So that is all consistent, and it is an effective use of our resources as well.

              Q34 Alok Sharma: Turning briefly to Greece—perhaps you can start, Mr Bailey— obviously you do not have to name them, but have there been any institutions that have required particular attention from your organisation because of their exposure to the Greek economy?

                            Andrew Bailey: You can divide them into two, really. The exposures of the UK banking system to Greece are very small: I think the measurement at the end of 2014 was possibly about £2 billion. That is small—we watch it, but it is small. The second group of institutions are the Greek banks operating in London, of which there are four branches and one subsidiary. They are all actually quite small, but we were watching those carefully from the point of view of what might happen and we were doing contingency planning. The thing that encouraged me was that it was the first time since the creation of the single supervisory mechanism in the European Central Bank that the quality and depth of engagement we had with the ECB in the run-up to the outcome was wholly of a better order than we have had in the past. I am quite encouraged by that and I said to the ECB that that is good. That is how we wanted it, clearly, and that is good.

              Q35 Alok Sharma: Okay. My final question is on potential Brexit. It has been reported in the Evening Standard that apparently firms have been coming to your organisation for advice about the UK’s potential exit from the European Union. Is that correct?

              Andrew Bailey: No. Nobody has come to us and asked for advice on the UK leaving the European Union. That is not correct.

              Q36 Mr Love: May I go back one question? You mentioned the Greek banks, but there is also an issue with Cypriot banks who are retailers. Are they structured in a way that will protect them and the UK against what is happening back at headquarters?

              Andrew Bailey: Of course, Cyprus was the issue of two years ago, and now we have one Cypriot bank operating in this country: a subsidiary of the Bank of Cyprus. In fact, the former branch of the other bank that was closed down, Cyprus Popular Bank, was taken into the subsidiary. So there we have the advantage that is a UK-incorporated bank, with capital and liquidity buffers in the UK. But again, we are watching that one very closely as well, because we understand the potential linkage.

              Q37 Mr Love: Sticking with you, Mr Bailey, the Parliamentary Commission recommended that a duty to whistleblow should be included in codes of conduct and employee contracts. In the consultation document, you rejected that rather emphatically. Why did you not allow the consultation to take place to get in views before you—

              Andrew Bailey: I am sorry; this was the consultation on the point about rewarding whistleblowers. I did not pick up the point. We have put out a consultation document on whistleblowing.

              Q38 Mr Love: Yes, and the Parliamentary Commission had recommended a duty. Your joint consultation document with the FCA rejected that rather emphatically, without seeking to consult over what firms believed should be a proper whistleblowing policy. Why did you reject that without listening to what the consultation said?

              Andrew Bailey: Rejected a duty on people to whistleblow?

              Mr Love: Yes.

              Andrew Bailey: Well, I think our starting point was that we do not want to create the idea that there is a penalty for people taking a decision one way or the other. We really want to enshrine whistleblowing in the practices of firms, so that it is just the thing you do, rather than the thing that, in a sense, you have a sanction if you do not do. That was our thought. We wanted it to become part of the way firms operate, rather than something that there is a threat around if you do not do it.

              Q39 Mr Love: I will come on to what difference the policy will make in real terms, but let me quote from the document in regard to the reasons given for not supporting a duty to whistleblow. It said that a duty “may place individuals in a position where they feel they face being penalised whatever course of action they take,” yet, surely, if you have a good-quality whistleblowing system that has trust and confidence, somebody should not feel under threat of disciplinary action.

              Andrew Bailey: I think your point is right, but I would add another leg to it. It is not only having a system, but people feeling confident in the way the system operates. The judgment we have made—I accept that it is open to challenge—is that we would like to have it embedded in a system where people think it is just a natural part of operating, rather than, as you quoted back from the paper, the slight sense of threat.

              Q40 Mr Love: The document uses words like “encouraged”. Employees should be encouraged: what does that mean? Instituting good practice: all of them are very nebulous concepts. What will change from the situation that exists at present?

              Andrew Bailey: I think that the overriding point there is that we want firms where management say to people who act as whistleblowers, “Thank you. You’ve done the right thing—and you have done the right thing in the course of duty, rather than out of some sort of imposed regulatory obligation.”

              Q41 Mr Love: I am starting from the position—no one can tell—that there are a lot of people out there that, if they had more trust and confidence in the system that applies to whistleblowing, would come forward. We need to encourage people to come forward.

              Andrew Bailey: I agree with you.

              Q42 Mr Love: The duty would have achieved that. Simply saying, “We encourage you to do so,” when clearly in a lot of cases that has led to disciplinary action being taken against employees who would have wanted to come forward, to whistleblow—

              Andrew Bailey: I think we must be very firm on any firms that frankly create a culture where there is a threat of disciplinary action on whistleblowing. That is exactly what we cannot have in the system, it seems to me. I suspect there is a slight danger—we agree on the objectives. You raise an interesting point, and I don’t think there is a single right answer to this about the question of duty versus the encouragement.

              Q43 Mr Love: Are there any further legal protections for whistleblowers contained within—

              Andrew Bailey: Look, I am quite happy, as we are in consultation, to think about this further. I am not dogmatic about it.

              Q44 Mr Love: So you will look again at—

              Andrew Bailey: I will look at it, yes.

              Q45 Mr Love: Because certainly I believe that just saying that people should be encouraged—that we should rely on good practice—won’t change the essential dynamic in whistleblowing, which is gaining the trust and confidence of employees that they can do so without harm to their careers or their prospects. A duty—maybe there is a halfway house.

              Andrew Bailey: Let’s think about it. I do not know, but let us think about it. I take the point.

              Q46 Jesse Norman: Thank you, Ms Boss and Messrs Bailey and Randall, for coming in. Mr Bailey, you are a man of cogent and crisp opinions and independent mind. You are also a member of the Oversight Committee of the Bank. Can I ask you whether you are entirely happy with how matters have proceeded on the Grabiner inquiry?

              Andrew Bailey: I am not a member of the Oversight Committee.

              Q47 Jesse Norman: Sorry, you are a member of the Court of the Bank.

              Andrew Bailey: I am a member of the Court.

              Q48 Jesse Norman: I take it back—that is a useful crisp clarification. Can you, from that perspective, just at least clarify whether you are happy with how matters have proceeded with the Grabiner inquiry?

              Andrew Bailey: I have only been involved in it as a governor, as a member of the Court—it is not, obviously, in my area of responsibility. I think the matters, as the Governor said yesterday, have come to a conclusion. I think the Governor gave you more of a sense, more of an account, of how that happened. I would share the sentiments that the Governor expressed, I think, about Lord Grabiner’s appearance before this Committee. I do not have anything to add to what the Governor said, but it was not one that I would have expected. I think the Grabiner inquiry itself and how that came to a conclusion has done, I think, what it was intended to do, in that sense. I think the Governor gave you more information on the particular circumstances, including circumstances around Mr Mallett’s departure.

              Q49 Jesse Norman: Was Mr Mallett dismissed for dishonesty in relation to any market activity?

              Andrew Bailey: I am sorry; I did not catch the last bit.

              Q50 Jesse Norman: Was Mr Mallett dismissed for dishonesty in relation to any market activity?

              Andrew Bailey: I think, as the Governor said, there were a number of issues and those led to a disciplinary action against him. It was not related directly to the point that Lord Grabiner was investigating.

              Q51 Jesse Norman: That does not quite answer the question. Among the charges for which he was dismissed, did any reflect dishonesty in relation to market activity?

              Andrew Bailey: I would not go any further than the Governor went yesterday on this, to be frank.

              Q52 Jesse Norman: I am sure that’s true, Mr Bailey. I am inviting you to do so by expressing an independent view.

              Andrew Bailey: Well, you are not going to succeed on that one. The Governor is closer to it than I am, because he has—as the Governor, rightly—taken direct responsibility for it. It is not in my area of the Bank, and I am not going to go beyond what he said.

              Q53 Jesse Norman: I understand that. Thank you. Mr Randell, if you had a case in the PRA that looked as if it was a matter of serious professional misconduct, would you expect to apply a subjective test as to whether the person was actually aware of malfeasance or had actually been involved in it, or would you expect, legally, to apply an objective test as to whether they ought to have been aware of that malfeasance—applying standard principles in relation to professional misconduct?

              Charles Randell: The context of your question is a little opaque to me, but there are two questions. One is, when you are disciplining somebody for bad behaviour—an example would be if we were taking enforcement action against an individual who was within our regime—would you expect to enforce against them only if they themselves had been involved in the bad behaviour? The answer is, historically, that is the way it has been. For the future, the senior managers regime will start from the position that if you were in charge of an area—if you were supposed to know what was going on in this area—you would need to satisfy us that you took reasonable steps to remain aware of what was going on in this area. So, coming back to the senior managers regime—if that is the context of your question—that is the great advantage of the new regime for us.  

              Q54 Jesse Norman: It applies what might, in law, be called the objective test—ought they to have been aware?

              Charles Randell: Yes. That is not how it is formulated exactly. It starts from a presumption that, if something is in your area of responsibility, it is up to you to demonstrate you took reasonable steps.

              Q55 Jesse Norman: And that would bring it into line with other professional bodies relating to doctors and others, where someone ought to have been aware of the standards in play at a particular moment.

              Charles Randell: Yes. Certainly, I practised for most of my professional life as a lawyer, and the standard that applied to me was one of negligence, and negligence is not just messing things up yourself; it is failing to supervise people and failing to have systems and controls in place to find out if other people are messing up.

              Q56 Jesse Norman: I understand. Thank you. Mr Bailey, do you think that standard ought to have been applied in the Grabiner inquiry, rather than the lower standard of just actual awareness of malfeasance or potential misconduct?

              Andrew Bailey: I think the Grabiner inquiry, frankly, got to the bottom of the actions that needed to be got to the bottom of. Now, the fact of the matter is, of course, that Mr Mallett departed for other reasons, as the Governor said. But I think the Grabiner report, in a sense, got to the bottom of what we needed to get to the bottom of.

              Q57 Jesse Norman: Thank you very much. It has been reported in the Evening Standard that firms have been coming to the PRA for advice about the UK’s potential exit from the EU. Is that right?

              Andrew Bailey: I thought I had just answered that. 

              Q58 Jesse Norman: Can we just revisit that for a second?

              Andrew Bailey: Sorry. I am not going to give you a different answer: no, they haven’t—I think that’s the answer I gave before. We have not been approached by firms.

              Q59 Jesse Norman: And, therefore, there has been no guidance given by you?

              Andrew Bailey: No.

              Q60 Jesse Norman: And no discussions, possibly, with banks interested in the implications of departure?

              Andrew Bailey: No. As you know, there is a lot of general chatter about the subject, but it is not something on which we would give guidance.

              Q61 Jesse Norman: Finally, can you just give us a quick update as to where you are on the stress tests?

              Andrew Bailey: We obviously finished last year’s stress test right at the end of last year. We published the results. I think that was a good outcome in terms of the publication. I was pleased at the level of transparency and the level of account of the situation of institutions that we were given. I can tell you that it has been very useful to us already in terms of the dialogues we have with firms—a very helpful tool. We are now—it is a bit like the Forth bridge, in that you finish painting one end and start the other end—beginning the work for the 2015 stress test. I expect that we will publish the scenario for the 2015 stress test towards the end of this month. That will set out, as we did roughly at this time last year, what the test is this year. The work is now under way at a very detailed level, particularly on the data side of it, on what we need, and so the whole thing is grinding into action again.

              Q62 Jesse Norman: What will change this time around?

              Andrew Bailey: What we have said so far is that we will steer the scenario—last year’s scenario had a fairly substantial domestic UK shock in it, in terms of the macro-economic shock. We came up with a scenario where there was an inflation shock, an exchange rate shock and, in essence, the Monetary Policy Committee had to raise interest rates into a recession to get the shock. That is, I know, a rather alien concept, but it was designed to capture this where inflation came away from the target in an unsustainable fashion in a recession to get the shock. What we have said so far about this year’s test, which is still work in progress, is that it is going to have more of a global aspect to it, so I expect that the basic underlying shock will be international rather than particularly UK, and then it will be the pass-through into the UK.

              Q63 Jesse Norman: Has the Co-op satisfied you with regard to stress tests in the way it has now been recapitalised?

              Andrew Bailey: The Co-op was interesting. Obviously, we published that the Co-op did not meet the stress test, and I do not think that that was surprising. I think that the Co-op has achieved a lot in terms of recapitalising itself in today’s going concern, what you might call baseline, environment. We therefore agreed with them, in the light of the stress test results, the actions that they will need to take, and are taking, in terms of meeting the stressed capital requirement, and they are under way in terms of putting those actions together and structuring them.

              Q64 Mike Kane: To the external members first, we have been doing a little bit of work on trying to understand and raise the profile of the small but, I think, fundamentally important issue of credit unions. The PRA regulates 600 of them across the country. How does it ensure that they receive the resources and scrutiny that they need?

              Charles Randell: You are right to raise it, because it is a challenge, given the number of credit unions. What we have done is to implement a very supportive supervision regime for them, where we, to some extent, go out and help them with their own bookkeeping and reporting, because that seems to be the area where consistently credit unions first get into difficulty. They find our reporting requirements challenging, particularly if individuals change at the credit union and there is a hiatus. We have tried to give them a nudge rather than a whack, if I can put it that way, in helping them come back into line.

              Ultimately, on the compliance rate within credit unions—given their nature, given the staff that they have and given the fact that people come and go, and sometimes they go and are not replaced—there is an issue that sometimes we have to take action to close them. I think that will always be the case with the sector, but it is a sector where the deposits, pretty much invariably, are within insured limits, and so members of the public can have confidence that they will get their money back.

              Sandra Boss: The regime that we have is forward looking. One of the things that we try to do, because there are a lot of credit unions, is actually the group looks across the credit unions at some of the data that we receive from them to be able to anticipate which ones might be potentially in danger. That allows us to focus our interventions a little bit more.

              I would emphasise what Charles has said about the fact that this is a regime in which institutions can fail. Having a reasonable mechanism for resolving them enables ease of entry and ease of exit. Particularly since they are all FSCS protected, it is a focus of ours not to penalise them when we think about competition issues.

              Q65 Mike Kane: It is important in terms of financial inclusion and access to working credit for generally poorer-income households. As credit unions are covered by the Financial Services Compensation Scheme, is there a danger that the work on them is sidelined by the PRA?

              Charles Randell: We must take an approach to our resources that is proportionate to the risks and benefits of each part of the financial sector. That is very much what we do. You should not take out of that a sense that we ignore credit unions; we absolutely do not. Indeed, we have reached out to them. One of the independent directors has been to Northern Ireland to spend time with the credit unions there. We know and care about credit unions. We cannot really give each of them an individual supervisor. That is not really possible, given the number of credit unions and the number of supervisors that we have.

              Andrew Bailey: I might add that there is a fine line between not sidelining them and not overburdening them. If we did give them an individual supervisor, they probably would not thank us because the amount of time taken up with regulation would be larger.

              Q66 Mike Kane: I worry, Mr Bailey, that when I asked Mr Gulliver, the chief executive of HSBC, “I have got hordes of people at the back there.” Power lies with the big banks in terms of the banking system and some of the powerful players. Have you met with staff from the PRA’s credit union team?

              Andrew Bailey: I have.

              Q67 Mike Kane: Is it something that crosses your agenda and is important to you?

              Andrew Bailey: Yes, it is. I have met with credit union associations. I have been to Northern Ireland as well and met with them there. The reason that we keep mentioning Northern Ireland is that it has a bigger concentration of credit unions than the rest of the country. I agree—I think that as much as the question about credential supervision, the competition issue is relevant. They have the advantage, going back to my point about overburdening, that the full burden of prudential regulation does not apply to them. The senior managers regime does not apply to them, for instance. I think that is appropriate.

              Q68 Mike Kane: In addition to overburdening them, what are the other risks that they face?

              Andrew Bailey: I think, in the current environment, all smaller institutions tend to face a bigger squeeze on their net interest margins. The reason for that is the low inflation environment. All banks, but possibly the smaller ones to a greater degree, rely on the fact that there is the endowment effect—that you are always holding a certain proportion of deposits without paying interest on them because they are transactional balances. Obviously, in a low interest rate environment, that gets squeezed in all institutions, but it is probably more serious for the smaller ones, which are feeling that squeeze as we operate in a near zero interest rate environment.

              Q69 Rushanara Ali: Ms Boss, Mr Randell, the Bank has been implementing its One Bank strategy. How has that changed how the PRA and its board have operated and has it all been to the good?

              Sandra Boss: I can certainly comment on how it is working now. I think that, for the change, you probably need to speak with Charles. I could give an example of what I have observed in the context of operating in a one-bank manner in, for example, stress testing. The FPC and the PRA board are both inherently interested in the stress-testing work—one from a macro-prudential perspective and one from a micro-prudential perspective.

              In designing the parameters for the test, thinking about the best way to execute it so that it is practical, informative, replicable, and thinking about the right way to take actions at a micro-prudential and a macro-prudential level, we have been able, over the course of the autumn, to have a series of joint discussions with the PRA board and the FPC, to look at where the PRA board is coming out in terms of individual institutional decisions and have the FPC make their analyses and recommendations. By being sighted on what each other was doing, it got to an outcome where we learned more about the system collectively and were able to take right actions informed by each other. I see that working well going into the next year. There are other examples, but I cannot talk about before, so over to Charles.

              Charles Randell: It has been a big change since 1 April 2013, and it has been a big improvement in the liaison and functioning of the institution. It is difficult for me to say how much of that comes from the One Bank strategy that was launched under the aegis of Mark Carney and how much was the result of the continued integration of the PRA into the Bank, post 1 April 2013. But essentially, they are the same thing. What is clear to me is that it is essential. You cannot have a situation where, effectively, the same institution has information from which it is drawing different conclusions in different parts of the Bank or which, worse still, is not being passed across the Bank and used and where the culture is not one of good communication and co-operation.

              I do not want to say that on 1 April 2013 that was bad, but what we have seen is a continuous improvement—particularly the joint meetings with the FPC have, to us, been hugely helpful. In addition to stress testing, we had those meetings in the discussions on the loan-to-income speed limit for mortgages. That was invaluable, not to ensure—this is important—that we and the FPC board come to the same conclusions, because we are independent bodies and must come to our own conclusions, but at least to make sure that we are working off the same base of information and that we do not have misunderstandings. That has been a very good and constructive process.

              Q70 Rushanara Ali: In the Bank’s response to the Warsh review, it stated its approach to the PRA board being a full part of the Bank of England and not a subsidiary and the PRA board having a similar status to the MPC and FPC. Do you think those are sensible reforms? Are there any risks to them?

              Charles Randell: I am not at all wedded to the idea of the PRA having a separate legal entity status. It is a slight side issue to the main question, which is, what does the PRA board do and is it the same as the MPC and the FPC? The answer is that it is not quite the same, because the majority of what the PRA board does is the oversight of operations. In Whitehall, in particular, people sometimes draw a distinction between policy and delivery. For us, that is a completely false distinction. You cannot treat what we do as, “Today, it’s policy; tomorrow, it’s delivery.” We have to have policies that are joined up with delivery and that are properly delivered.

              In order to ensure that our policies are properly delivered, the PRA board has to have a line of sight into resourcing issues, into the teams we have on individual firms and their tenure, the number of people, what they are spending their day doing—we have to have that line of sight. Provided that that line of sight is maintained in the new structure, I am sure that everything will work very well. It will be important to work through, at a practical level, what the differences would be.

              Q71 Rushanara Ali: Can you anticipate any risks to those reforms?

              Charles Randell: The risk, to my mind, would be if somehow or other policy making in the prudential space were taken away from and treated as something separate from the actual execution of supervision. I see them as one and the same thing. There is no point having a policy that you cannot execute and there is no point executing the wrong policy. But that is a risk, and it is a very obvious risk. The Court, I am sure, being intelligent people, will be very alive to that risk.

              Another risk that I know the Court and the Governors generally will be alive to is the risk that this structure effectively results in a greater centralisation of executive power in the Bank. I am sure that this Committee will ensure that the Court keeps its eye on that ball. Indeed, from your recent hearings, it sounds as if that is in your mind.

              Q72 Rushanara Ali: I was coming on to that. Do you think that there is a risk, with this greater integration, that something going wrong in one part of the Bank will affect the reputation of another part of it?

              Charles Randell: I think that risk is there today. It is inconceivable, with a PRA board that is chaired by the Governor of the Bank of England and has three Deputy Governors on it today, that a major issue in the PRA would not be seen as a reputational hit for the Bank as a whole. That risk is with us today. The question is, how do you best manage that risk? That risk is, I think, best managed by good integration, good information sharing, good co-ordination across the Bank and a culture that ensures that each of the three committees gets all the information they need, including all the alternative views they need.

              Q73 Rushanara Ali: My final question on this issue, for you and Mr Bailey, is: do you think that there is a risk of groupthink with greater integration, or do you feel that there is enough separation and distinction to avoid that?

              Charles Randell: I think in any institution there is always a risk of groupthink. There is a risk of groupthink today. This is a risk that, in any institution, you need to spend a lot of time worrying about. I know that the institution does worry about that, and that is one of the reasons why one of the four pillars in the One Bank manifesto—so to speak—is that we will be open and transparent, and that will include airing alternative views. That risk is one to which we need to be alive, almost regardless of legal structure.

              Andrew Bailey: I completely agree. Two things: first, of course, that is a reason why we have independent members on each of the committees, and why it is important. The second thing for me is that it is another reason why it is important that we are transparent—more transparent—in all that we do. I think this is particularly important with supervision.

              Up until a few years ago, supervision was essentially an opaque activity. If you go back to hearings before this Committee, very little was said about supervision, and in particular little was said about individual firms’ supervision. Of course, the reason for that was that it was always regarded as commercially confidential, which of course it is, in an important sense, but the problem with that is that you do not get the transparency                                                                                                                  and accountability.

              I will just go back to the stress test for a moment. For me, the stress test at the end of last year was quite an important moment, because it was the first time that we as a supervisory authority—or indeed any supervisory authority in the UK, including predecessors, some of which were in the Bank of England—had published our view on individual institutions under a particular scenario, our view of the capital actions that those institutions would take and our view of the acceptability or otherwise of particular management actions. We wrote down our view of each institution on a page for each of them. By the way, I think we went further than other supervisory authorities who had done this in other countries. I was pleased about that, because it is exactly relevant to your point about groupthink. We have to be alert about this. One way we can be challenged on this, of course, is by being more transparent about what we are thinking.

              Q74 Rushanara Ali: Thank you.

              I have one final question about the switching—the revolving doors—between the regulator and industry. There have been a number of cases: Howard Davies was a former FSO chairman and was then appointed to chair RBS; Margaret Cole went on from the FCA to PwC; there was also Sally Dewar; and then Dave Hartnett.

              Andrew Bailey: No, he never worked for us. That was HMRC.

              Rushanara Ali: Sorry. The point is that those people move from one sector to another. Do you feel that there is sufficient distance between the two, given the regulator role? Is there sufficient space between moving from regulator to the industry? What are the risks of that? There are issues at the moment particularly around distrust—I am not casting any aspersions on any individual—of the establishment. Here we have the establishment of regulator and industry moving between sectors. You can imagine the inevitable distrust, given what has happened, for example, in the HSBC case—and there are many others.

              Andrew Bailey: I am not sure that being a regulator has ever qualified you to be in the establishment, but I don’t know.

              Rushanara Ali: I’m afraid it does.

              Andrew Bailey: Okay. Look, there are two things. First, we have procedures essentially for the time that people have to spend on gardening leave—the air gap, or whatever you call it—between leaving our organisation and starting in an organisation that we are directly involved with—one we regulate—but it gets broader than that. The challenge, frankly, is this: the other charge that we get is that if you only have people who have essentially been lifetime regulators or central bankers, call them what you like, then you have a very limited—many people would say too limited—base of understanding of the industry that you are regulating. That is the opposite of the charge that you are making; it is a fair one.

              It seems to me that we have to find a way to strike a balance. We try to do that, recognising the constraints that we operate under. We are in no sense trying to rival the remuneration paid by many of the firms that we regulate; that is never going to happen and it is not our desire. I would not want that at all. We have to strike a balance. There are people who come to the end of their career in the official sector, and then go off and do other things.

              To return to the earlier question about the pool of non-executive strengths—that is obviously relevant to Howard Davies—it is reasonably part of the pool of non-executives. On a good day, we do know something. I do not think that that is unreasonable, but it is a balance that we constantly have to watch. You are right that if you get it wrong, you can have unreasonable access and unreasonable use of information, and we are very careful to protect against those things.

              Q75 Steve Baker: At the risk of boring you, when Mr Norman very helpfully followed up Mr Sharma’s question about Brexit, you said you would not give guidance. Why?

              Andrew Bailey: Because that is, at root, a question for Parliament.

              Q76 Steve Baker: I can completely understand not wanting to be involved in the political debate, but presumably it is conceivable now, and if it is conceivable, presumably it is a prudential risk.

              Andrew Bailey: You are correct, in the sense that it is rather like the Scottish referendum. Of course we focused on the prudential risks that could have arisen from either outcome—particularly the other outcome, if you like—but we did that at a point when we knew what we were dealing with, in terms of the proposition on the table, the timing and what have you. We did that work privately. We didn’t go knocking on people’s doors asking what they were worried about, and we didn’t offer a view on it. That is appropriate. My own view is that it is far too early. I don’t know what is going to happen; I rely on you to help me. 

              Q77 Steve Baker: I can tell you confidently that we are going to leave.

              Andrew Bailey: Well, that’s good. I might go around the table. The point is that we are not there yet.

              Q78 Steve Baker: That’s fine. Since we are not there yet, can we talk about the European Banking Authority and the European Insurance and Occupational Pensions Authority? I believe that the PRA—

              Andrew Bailey: You certainly can.

              Steve Baker: Can you tell us what the main UK priorities are in those organisations?

              Andrew Bailey: They are different institutions. They look similar from a high level, but they are rather different. Let me start with the EBA. They both have a rule and guidance-making function; they also have a role in mediating between countries. I think the real challenge for the EBA is that the European single supervisory mechanism, the ECB, has come into existence, and the euro-area countries have gone into a supervision union, you might say, free of the SSM. A single resolution mechanism is also coming into existence as well.

              The EBA is translating into a world where it has a different configuration of members. It has the same members, but they are in a different configuration of organisations. The priority, for me, is that the EBA can function effectively within that world. As I said earlier—let me go back to Greece for a moment—I was very encouraged two or three weeks ago that the ECB, the EBA, we and the other countries involved in the Greek issue showed a much higher standard of co-operation than we had seen in the past, so that is good.

              EIOPA, the insurance authority, has one objective at the moment, which is to implement Solvency II. Solvency II is a vast project that has been going on almost longer than anybody can remember, but it really is coming to a conclusion this year. This year is the year to implement Solvency II. It is a very big issue—in many ways, it is the single biggest thing we are doing this year—and EIOPA is obviously very important in that respect, given its rule-making and guidance-making functions. That is the biggest issue in the EIOPA landscape.

              Q79 Steve Baker: A couple of things have come up at a European level; I wonder whether you have pursued them at all with these organisations. One is IFRS accounting and its potential impact. I think the Banking Commission touched on it. I know Andy Haldane made some speeches about how IFRS can be pro-cyclical. Is that something that you have pursued at a European level, and if not, why not?

              Andrew Bailey: We do, but we also pursue it at a broader international level, because of the scope of IFRS. We have been involved in the broader international efforts and at Basel level, where there is engagement with the accounting bodies. It operates at both levels.

              Q80 Steve Baker: Where is there room for improvement in the PRA’s engagement with these various bodies?

              Andrew Bailey: I can tell you, we are all deeply frustrated that the world has two accounting standards bodies that cannot seem to get it together. There is one in North America called FASB. This is not the first time it has been said, but it is deeply frustrating that we cannot get more connection. Many of us have spent many hours in rooms where there have been commitments to do that that have produced nothing, but we live in hope.

              Q81 Steve Baker: Can I ask the externals whether you are satisfied with how the PRA board supervises its international work?

              Sandra Boss: In terms of how we conduct our policy making?

              Q82 Steve Baker: In terms of whether the board feels that it is adequately engaged in supervising how the PRA works internationally.

              Sandra Boss: I certainly feel comfortable with what we have been seeing. Essentially, we are sighted on the development of most policy development and implementation issues. In the life of the policy, we receive updates on the issues that are being pursued by the PRA. Where we have jurisdiction, we take quite a heavy involvement in the policy area. Where we are dependent on the European negotiations on banking or insurance, we know the status of the project and know how the group is engaged. One benefit of One Bank—my observation is that the PRA and the FPC are working closely together and, I think, well—is that we are in a situation where we sing with one voice externally, and that can be of benefit as we think about the international agenda.

              Charles Randell: In banking and insurance, you have to remember that having the chair of the PRA and the Governor of the Bank as the chair of the Financial Stability Board has enabled us to punch well above our weight. I do not think we are laggards in international policy engagement on the banking side. On the insurance side, we have led a lot of the work at the IAIS on the development of international capital standards, and a lot of effort goes into that. There is a good story to tell about the level of engagement.

              Q83 Steve Baker: You have both raised some interesting questions. Are we, for example, too dependent on one brilliant individual who happens to be in the United Kingdom at the moment?

              Andrew Bailey: We are very conscious that Mark will have the chair of the FSB. He is into a second term now. If I could offer a broader reflection on that, it is not so much about Mark, gifted though he is, but the institutional structure and ensuring that the role of the FSB as the international body brings together the right mix of countries and has the right mix of central bank and finance ministry involvement, and that that is cemented. It got a big impetus as a result of the crisis, which was natural. We needed an international body to fix it, and the FSB was the one. As we go forward, new issues emerge, such as the implications of conduct risk for the prudential world and for the access of parts of the world to banking. Those are issues that bear on the international banking system and they are of relevance to us, and it is important that we have an institutional structure that can deal with them. My view is that the FSB is the best one we have got, so we should ensure that it is institutionally embedded.

              Q84 Steve Baker: Ms Boss, you mentioned One Bank. Have you discussed at the PRA board how the PRA should feed into the new One Bank research agenda, which I think is very encouraging?

              Sandra Boss: In the past, over the summer of 2014, there was a series of meetings—Charles can talk about the specific meetings—at which the PRA actually fed its ideas into the One Bank research agenda. Now that research agenda has been published and is being discussed and contemplated. We have not yet seen the output, because obviously they are just kicking off, but in the input portion there are several items on the list—Charles, you might even have identified them.

              Charles Randell: I do not want to take the credit for any part of the research agenda, but we were lucky enough to be offered meetings with Andy Haldane when he was developing the project and we came up with a number of things that we thought it would be useful to include. The Bank has historically had a very strong monetary policy research function, but research in prudential areas is a new thing to an extent, so it was very heartening to read the document that was published a day or two ago and to see that there is a heavy micro-prudential piece in there and some themes that we could relate back to things we had suggested.

              Q85 Steve Baker: I believe it has been said that the research agenda should challenge the orthodoxy as often as it supports it. What have you fed in that will challenge the orthodoxy? I have a list.

              Andrew Bailey: You should send it in.

              Charles Randell: The thing I raised with Andy in particular was the idea of applying some behavioural analysis to the way that regulators regulate—biases and so forth: how do we identify them, how do we guard against them, to what extent are regulators fooled, or are they guilty of confirmation biases, anchoring biases and all those sorts of things—and it is in the agenda and I am really looking forward to seeing the output.

              Q86 Steve Baker: I think we can almost certainly say yes, they are. Probably you have heard enough from me to know some of the things that I am concerned about. One of them in particular is big players setting people’s expectations and causing herding and therefore instability.

              Charles Randell: Yes.

              Steve Baker: It is brilliant that we are agreed on that. You mentioned the FSB and being a global body; we also talked a moment ago about the two different standard-setting bodies on accounting. One of my concerns would be, if we really did have a single global accounting standard that happened to be procyclical, the disadvantages for financial stability would be obvious, wouldn’t they?

              Andrew Bailey: That is true, yes. One would like to think that there was an outcome that brings them together more and that does not involve that risk. To go back to insurance for a moment, Charles mentioned the IAIS and the desire to have some form of capital benchmarking. The way things stand at the moment—this comes back to insurance accounting—it is pretty difficult, if not impossible, to compare the position of, say, a north American insurance company with that of a European insurance company. It is real apples and oranges stuff. It is quite difficult actually.

              Steve Baker: Thank you very much.

              Q87 Chair: Earlier, Mr Randell, in answer to Rushanara Ali, I think you said that the PRA wanted a line of sight into resourcing. As I’m sure you know, when the original legislation was put on the statute book, it was left unclear whether the PRA set its own budget, or the Court set the budget, and who was ultimately responsible. The Court has now got responsibility. Does that mean that you feel that you do not have enough control over the resources you need to do the job?

              Charles Randell: No, and when I said that it is important that we have a line of sight into our resources, what I think I said was that it is important that we keep the line of sight into our resources, because we have that line of sight today. We are involved in the discussions about the budget, but ultimately—

              Q88 Chair: What does “line of sight” mean? Can you be more precise?

              Charles Randell: There is a series of things that we have. Obviously we have granular information about how many supervisors we have. We have a target operating model, which enables us to conclude how many supervisors we would ideally have, and we can judge where we are in relation to our target. But it is not just a quantitative function; it is also a function about the tenure and experience of those supervisors and what they spend their time doing. That is the line of sight that we have into our resources. There is then the question of our budget and do we get given the budget to have the number of supervisors that we think we need to meet the risk appetite we have for supervisory outcomes? That, under the statute, is a budget that is set by Court, but the key thing is the way that the dialogue between the PRA and Court works on that, because it is critical that the PRA’s views on resourcing are fed into that budget and risked appropriately.

              Q89 Chair: If you don’t have the money you need, what are you going to do about it?

              Charles Randell: The short answer is that if we don’t have the money we need, we can’t do the job.

              Chair: No, but what are you going to do about it, then?

              Charles Randell: In that case, we have to—

              Chair: I just want to follow through the sequence to try to get some clarity. What is going to happen then? You decide that you haven’t got the regulators you need—

              Charles Randell: We would have to go through a series of stages. We would have to look at the budget we have and look for other ways we can adopt a different model that will make it work and keep our risk within our risk appetite as an organisation.

              Q90 Chair: If you conclude that you haven’t got the money, what happens?

              Charles Randell: If the answer to that is no, we would need to very clearly escalate our concerns to Court.

              Q91 Chair: Now we’ve arrived at that, and Court has said, “No, get lost.” What is happening then?

              Charles Randell: It’s very difficult in the abstract to say how and why, but ultimately, as a member of the PRA board, if you felt that you couldn’t do your job, I think you would have to say that you couldn’t carry on doing your job, and it may be that in the process of departure you would want to tell people why.

              Q92 Chair: So you’ve got to explain publicly—probably in front of this Committee—that you haven’t got the resources that you need.

              Charles Randell: Yes.

              Chair: Good. That is the clarity I want.

              Charles Randell: That is our job.

              Q93 Chair: The Parliamentary Commission on Banking Standards recommended that there be a cap for existing functions and new functions that you would need new money for. Are you going to be able to stick to that cap on the levy, Mr Bailey?

              Andrew Bailey: I think over time, yes. I will tell you why. We have a huge amount of implementation to do in this year and coming years. There is Solvency II, the senior managers regime, the ring-fencing regime—we have to do all those things.

              Q94 Chair: The short answer is that it might rise past that, but you’d get it back.

              Andrew Bailey: The short answer is that it might, but for reasons that I believe are consistent with the framework that I remember outlining to you in a hearing a couple of years ago. It is my objective that we should not go outside that framework, because I fundamentally do not think that is justified.

              Q95 Chair: And there is always a risk of mission creep. It is in the nature of quangos to expand. Perhaps it might be helpful if you put on a piece of paper for this Committee how you intend to get back to that commitment, and to what extent and how much is being added in on the side.

              Andrew Bailey: Yes, we can do that.

              Q96 Chair: Mr Randell was referring to other ways in which your commitments might be met. Great concern has been expressed, in respect of 166 orders, the FCA. I would be interested to know whether there is any other back-door route to obtaining regulatory finance?

              Andrew Bailey: Let me say a couple of things about that. I can tell you that the PRA’s section 166 report cost for the year that literally ended a week ago—

              Q97 Chair: It was relatively low. I have already looked into it.

              Andrew Bailey: It was a little bit lower than the previous year. It was about £11 million or so the previous year, and it was £10 million-odd last year. Going back to my point about the burden of implementation and the effects that the implementation will have on us once it is all steady state, as Charles said earlier, we are looking at our operating model in the light of that, particularly with this financial issue in mind. We are all conscious that if you put in something like the ring-fencing regime and say, “Well, I need some more supervisors, thank you,” and you get some more supervisors, that is more cost, so we are about to kick off a quite large piece of work to go back to our operating model with that in mind. Obviously, I am very happy to keep the Committee apprised of that.

              Q98 Chair: I want to end with a discussion about what might happen in terms of advice to the Government in the event of a crisis. I think it is agreed that while we have made considerable progress with respect to the resolution of banks, we have not arrived at feeling comfortable in all respects that we will be able to resolve everything.

              Andrew Bailey: It is not finished. It is never finished.

              Chair: Therefore, there is always the possibility of the need for a bail-out, or at least a contingent call-out on taxpayer funds. The legislation makes clear provision for the moment at which the Chancellor may seek or obtain direction over the Bank on those occasions. A memorandum of understanding associated with the legislation makes clear that it is the Governor’s job to go to the Chancellor to explain what has gone wrong and what now needs to be done.

              A great concern of this Committee over many years—certainly the past five—has been that the accumulation of more responsibility in the Bank of England creates a single point of systemic risk. There is therefore merit in any Chancellor having access to other advice in the event of a micro-prudential risk materialising of the type I have described, with contagion risk associated with it. You are the person most likely to be able to offer that challenge and advice. Do you think there is merit in returning to that memorandum of understanding to provide you with an independent line of access to the Chancellor in the event of a call being made on those resources?

              Andrew Bailey: First, I think it is important because both the current Chancellor and the previous Chancellor—I have worked closely with both of them—have always made clear to the Bank of England that they need to have an early line of sight into anything that is coming up. I absolutely agree with them, because if I were them I would want that.

              Coming back to your question and the groupthink point, it is important that the Bank does not succumb to groupthink if we find ourselves in that situation. It is also important that whatever happens on the subsidiary status, which will be for Parliament, that is a secondary issue, as Charles said. The PRA is an authority and will have to remain an authority in my view, and I am the chief executive of it; and if there were a divergence of views, it would be important—critical, as you say—that the Chancellor understands that there is a divergence of views. I personally don’t think you necessarily have to legislate for that.

              Q99 Chair: A memorandum of understanding is not legislation.

              Andrew Bailey: Okay. It has to be clear in the system that the Chancellor is aware of that, should it get to that situation. The Bank of England should be underlining that.

              Q100 Chair: So, you do see some merit in getting this point into a memorandum of understanding.

              Andrew Bailey: Yes, I think the Bank of England should operate under the understanding that, if that were to happen, the Chancellor has an absolute right to say, “I want to know what you guys think.”

              Q101 Chair: I am asking whether you have got a right to say, “I want to go and see the Chancellor and tell him what I think.”

              Andrew Bailey: I always have a right of access to the Treasury.

              Q102 Chair: You don’t have it laid down in a memorandum of understanding, which leaves responsibility for the expression of the Bank’s view exclusively with the Governor in that case. That is also supported by statute. That is why I am raising this issue today.

              Andrew Bailey: Yes, but look, I can tell you that, speaking from a personal position, I would always say to the Governor, “Look, you have to understand that we don’t agree on this, and I do feel that the Treasury needs to understand my point of view.”

              Q103 Chair: That may be you and you may be a reasonably strong-minded head of the PRA. I will ask you for third time: do you think there is merit in ensuring that it is written down that there is access for the head of the PRA to the Chancellor in those circumstances?

              Andrew Bailey: In my experience, I have not found that necessary, but I would not wish to oppose it were that to be decided as the way. The underlying point is to ensure that it is understood that if there is a difference of view then that is transparent to the Treasury.

              Q104 Chair: There is a second circumstance that is closely related. Prior to the point at which a Chancellor might find himself with a group of people in his office telling him he has minutes or hours to choose between writing a cheque and financial armageddon, he may well want to exercise a discretionary power of direction. We had considerable difficulty getting that on to the statute book. It was a recommendation of this Committee in 2011 that such a discretionary power of direction should be given to the Chancellor. It now has been. However, he may also need to hear advice about whether he should be exercising it in good time. Do you think that the MOU should also apply to that, with respect to your role?

              Andrew Bailey: I think that would be okay as well. Again, in my experience of how the system is operated, there has not been suppression of the opportunity to do that, but as I said earlier I would personally have no objection to that featuring in it.

              Chair: Thank you for coming to give evidence to us this afternoon. It has been very interesting, as usual. We have had some clear and direct answers, and we appreciate that.

              Andrew Bailey: You’re welcome. Thank you.

              Oral evidence: Prudential Regulation Authority, HC 1080                            21