Treasury Committee
Oral evidence: Bank of England July 2015 Financial Stability Report, HC 315
Tuesday 14 July 2015
Ordered by the House of Commons to be published on 14 July 2015
Members present: Mr Andrew Tyrie (Chair); Steve Baker, Bill Esterson, Mark Garnier, Helen Goodman, Stephen Hammond, George Kerevan, John Mann, Chris Philp, Jacob Rees-Mogg, Wes Streeting
Questions 1-82
Witnesses: Dr Mark Carney, Governor, Bank of England, Sir Jon Cunliffe, Deputy Governor, Financial Stability, Bank of England, Richard Sharp, External Member, Financial Policy Committee, Bank of England, and Dr Donald Kohn, External Member, Financial Policy Committee, Bank of England, gave evidence.
Q1 Chair: Thank you very much for coming to see us again at such short notice; well, so soon after your last visit anyway. We know that you have to get off to a very important meeting so will want to curtail this session in a couple of hours at the latest. Before I go any further with some introductory questions, Jacob Rees-Mogg wants to chip in.
Jacob Rees-Mogg: I just want to draw attention to my declaration of interests because we may touch on asset management and I have an interest in an asset management company; indeed, I am chairman of an asset management company.
Chair: I would like to take you to housing, which has become a big aspect of financial stability policy in the light of the great influence that the housing market has had over the decades on the business and financial cycle in the UK. Have you seen the OBR forecast for the rise in house prices over the next five years?
Dr Carney: I have seen it but I do not recall it, and that is an honest answer.
Q2 Chair: Does any of the rest of the team happen to know what it is? Yes, Jon does.
Sir Jon Cunliffe: No, sorry.
Chair: No, he does not know. Well, it is 34.1%, which is quite a large rise. Does the Bank have its own internal forecast of house prices and house price movements?
Dr Carney: Yes, the MPC has a forecast of house prices and just for clarity—I know you know this, Chairman—we obviously do not target house prices, either the MPC or the FPC.
Q3 Chair: What is your forecast?
Dr Carney: We do have a forecast that is consistent with house price growth being a bit higher than income growth, around 5% per annum, so it would obviously be less than the OBR’s.
Chair: A bit less cumulatively?
Dr Carney: Yes. The OBR is, off the top of my head, 6.5% probably and let us say we are 5%, 5.5%.
Q4 Chair: But you do not publish that, do you?
Dr Carney: We do not publish it, although we used it for our work on housing this time last year when the FPC took action and in the context of that we talked about it. We also talk about it quite often in general terms; whether or not house prices are growing, again from an MPC perspective, in the medium term at or above or below incomes is the general guidance.
Q5 Chair: Did the Chancellor discuss the introduction of these two policy areas that he has brought in on IHT and on housing association sales and the effects that they might have on the housing market with you prior to the Budget?
Dr Carney: We did not have a detailed discussion of those, no.
Chair: Or any discussion on it?
Dr Carney: Nothing of substance, no.
Chair: Nothing that you can recall?
Dr Carney: No.
Q6 Chair: Have you taken a look at those two measures?
Dr Carney: From an FPC perspective we have not—
Chair: From an FPC perspective; from a market stability perspective.
Dr Carney: Yes. I recognise there was a manifesto element to this, but given the timing of the Budget we had not looked at them. We have not yet looked at them from an FPC perspective. As you note, in the financial stability report we have been looking at obviously developments in the housing market as a whole and we still see it as one of the top issues for the FPC.
Q7 Chair: Okay. The OBR forecasts or suggests that the housing association sales will reduce supply of housing and, therefore, increase house prices. If that turns out to be right, even though it is on a relatively small scale, is that something that concerns you?
Dr Carney: Of concern is the longstanding challenges with supply of housing that has an impact on the volatility in the housing market and it is not clear that these measures would improve supply, shall we put it that way, net improve supply of housing. I would say ultimately, as you know, our concerns with the housing market are grounded in the direct exposure to the banks, the main banks and building societies, the main mortgage lenders, and importantly the overall level of indebtedness in the economy and the impact that could have on the scale of the cycle.
Q8 Chair: We are going to come on to some of these things and we are also going to look at buy to let. I expect other colleagues will want to chip in with questions on that. Before we do that, I want to ask you about the IHT change, the inheritance tax change. Have you had any advice at all in the Bank on that, on the net effect that has?
Dr Carney: No.
Q9 Chair: It looks like a tax cut so it is going to put demand into the housing market. The “Red Book” suggests a billion. Is that a matter of interest or concern to the Bank?
Dr Carney: There are a series of changes—including, as you are aware, changes to pensions and annuities—that were taken in previous Budgets, which we have examined in terms of their relative potential impact on the housing market. In the case of that aspect, in fact, some of the detail is provided in this report. We expect in that case a relatively modest impact on the housing market given, unfortunately, the relatively modest level of most people’s pension pots relative to the cost of buying a new property. We will look through IHT. We will look through the housing trust changes and other aspects. There have been a variety of factors—
Q10 Chair: The criticism being made is that building houses is difficult enough as it is and it looks as if it could have been made more difficult. That is the criticism. On the demand side, the IHT change is increasing demand at a time when reliefs to boost demand are probably not what is required in the market for stability reasons.
Dr Carney: Two comments. One, I think on the supply side we also have to take an assessment of the impact of any changes in planning, although one would expect that that will not have an immediate impact. I would say as a whole one does not see a prospect of immediate increase in supply of housing that would alleviate some financial stability concerns. The final point—and I know you are going to come to buy to let—some of those adjustments there are relevant.
Chair: Yes, we will. There are some other aspects of the fiscal regime for housing that arguably might offset the billion that is being put in, which are listed in the OBR report. I am hoping that the Bank will start taking a close look at these issues as they are extremely important given the history of the interrelationship of the business cycle and the housing cycle in the UK over the last 50 years.
Q11 Chris Philp: I would like to specifically ask about buy-to-let mortgages. I note that buy-to-let mortgages now account for 18% of new mortgage lending, a figure that has grown quite significantly in recent years. Clearly, those buy-to-let mortgages drive up house prices and potentially crowd out owner occupiers. Your financial stability report notes on page 26 that there are looser lending standards in the buy-to-let sector. For example, 70% of buy-to-let mortgages are interest only. Could you comment on whether you think, first, that 18% mix is potentially contributing to house price problems and, secondly, whether you think it is appropriate that, to use your report’s own words, looser lending standards are an appropriate thing to have in the buy-to-let sector?
Dr Carney: I guess there are two things. One, developments in the buy-to-let market is an area of active interest for the Financial Policy Committee. We have had a number of discussions about it. We have commissioned additional work on buy to let. We do draw attention to the fact that, as you note in your question, there has been an increased flow of buy-to-let mortgages. Buy to let now accounts for 15% of the stock of overall mortgages. On the other hand, we recognise that the purpose of buy to let is different than owner occupied. This is a commercial transaction as opposed to buying one’s own home. In that regard, being interest only is more understandable, particularly given the tax deductibility. Obviously, tax deductibility incentives have changed or are proposed to change. What is important as well is to look at the loan to value on buy to let and the assumptions around the interest cover, so both those aspects of underwriting standards, and, of course, the historic cap on average on buy to let has been around 75% loan to value, which provides an equity cushion for these transactions. That is all by way of context.
I stress two things. One is that this is an area of interest. We are doing further work. As we say as clearly as we can in our record, so the minutes, if you will, of the FPC’s last meeting, there is no presumption of action in that work, so it does not necessarily mean we are going to recommend that anybody adjusts policy, whether it is the PRA or the FCA[1] or others. I am sure you are aware of this, Mr Philp, but the Treasury is committed to consult towards the end of the year about providing the Bank with analogous powers in the buy-to-let market as it has in the owner-occupied market. Obviously, to be clear, it is the recommendation of the FPC that the FPC be given those powers so that if there were any action it could be both as effective as possible, as timely as possible, and also that we would have appropriate standards of accountability, which would include a stated policy on the use of such instruments.
Q12 Chris Philp: I would strongly support the FPC’s request to have those powers and I note that the Government did delay the consultation. I believe, as the FPC does, that that consultation should happen as quickly as possible. Personally, I would share your view that the FPC should be given those powers given it does cover, as you point out, 15% of the stock and 18% of new originations, and I think that should happen as soon as possible.
Just more generally on the question of the impact of buy-to-let mortgages, you have pointed out they are different in character in the sense that they are a commercial transaction rather than for the owner occupier’s own use. Wouldn’t you agree that the fact they are available on softer terms, so the fact that many of them are interest only, for example, and, in fact, things like personal income covenants tend not to apply, it is unhealthy that those buy‑to‑let mortgages are available on softer terms, easier terms, than somebody buying their own house? Wouldn’t you agree that that is a drag on home ownership and is adding fuel to the flames of house price inflation?
Dr Carney: Well, there are a few things that we are looking at. One is to ensure that underwriting standards do not drift from being responsible to becoming reckless, so there is not a marked softening in underwriting standards.
Chris Philp: I was asking about the relative difference.
Dr Carney: Yes, I will come to that. The second thing is that we have to recognise that there is a positive aspect, obviously, of buy to let, which is to provide housing for people who do not yet have a down payment or who cannot ultimately afford where they need to live, so there is a value in having a vibrant rental market in buy to let. It has played and can continue to play an important role there. Yes, in terms of the relative underwriting standards it is something we would look at. We would look at it in terms of the scale of this, the drift in underwriting standards if there is one, and I think a very basic point, which is that this is ultimately one housing market and if you have dynamics driven by certain sectors of the market that increase overall prices and, therefore, indebtedness in a way that is not ultimately going to be sustainable, it is possible that it could merit some action. That is a very conditional statement and it is those types of dynamics, both where the underwriting standards are today, how they are moving and the overall macroeconomic impact, that we have to consider.
Q13 Chris Philp: Yes, I think the fundamental question is: shouldn’t the playing field be level as between owner-occupier mortgages and buy-to-let mortgages?
Dr Carney: There are different characteristics of the creditworthiness, and the advantage that buy to let often has is the higher level of equity cushion and the ability obviously if the renter cannot continue to pay their rent that there is a cushion and a period of time in order to find a new tenant. There is a pretty long history in terms of the performance through various economic cycles, so it is not just a matter of conjecture. We can make a pretty informed decision.
Q14 Chair: You are relaxed about differential treatment between these two sectors?
Dr Carney: I would say that this is one of the aspects that we are analysing, so I would not choose “relaxed”. I am hesitating to make a direct judgment because I look at the—
Chair: Pick a word, Governor, because I think this is what Chris is on.
Dr Carney: I think what Mr Philp is on is one of the issues we are looking at and all I am doing is hesitating to prejudge the conclusions of that analysis. The question is very on point. I am just not in a position to give a conclusion on it.
Q15 Chris Philp: Finally, when you come to consider these issues, as hopefully you will if you are given these extra powers—and I would like it on record that I fully support the FPC having these powers at the earliest opportunity—will you consider not just the creditworthiness of the loan, which is important and you have referred to that, but will you also consider the wider impact on the housing market that these loans have as well as the creditworthiness of the counterparty for the loan?
Dr Carney: Absolutely. If I was not clear, I was trying to make that point, which is wider impact is as much if not more important than the specifics. We have to look, as the FPC, on the macroeconomic, macrofinancial impacts of these developments, yes.
Chris Philp: Yes, the sooner you have these powers the better.
Dr Carney: Yes. Chairman, may I be clear? I very much appreciate the support for the powers of direction, but to be clear, as you know, we are in a position where we could make a recommendation that something happens. That would not be a binding recommendation but we could make a recommendation to other parties. Some of the challenges with having recommendations are it is less accountable, there are longer time lags, there is less clarity, and so on.
Chair: Your recommendations tend to carry some force. You wanted a loan to income limit; you have one. You wanted an affordability test and you have one. People pay great attention when you make recommendations.
Q16 Chris Philp: Just very quickly, do you plan to make any recommendations prior to the formal powers—
Dr Carney: As I said earlier, there is no presumption that we will take action at this stage, but that is why we are analysing these issues.
Q17 Stephen Hammond: Can I ask a few questions about cyber risk? You obviously have the CBEST system in place. Can I ask how many firms you have identified as being at the core of the financial system and, therefore, how many tests you would like to see taken and how many so far have been undertaken?
Dr Carney: In terms of the number of firms that have fully undertaken the CBEST process, there are five major firms that have done so. I would add the Bank of England has also undergone this type of penetration testing. There is a broader universe of about 35 firms that we have identified that we would think should consider this. Eleven, which includes the five, I should say, have started this process. We have made a fairly clear recommendation that the PRA and the FCA should work with firms in order to establish cyber action plans, including CBEST testing, so there is that broader universe of, as I say, about 35 firms that we would encourage.
Q18 Stephen Hammond: Twenty-four firms have not as yet chosen to undertake it?
Dr Carney: Not as yet chosen, although I would—
Stephen Hammond: So to—
Dr Carney: If I may, Mr Hammond, put it in some context, we were rolling out CBEST, using it on ourselves first. There are some fast adopters, so it is not inappropriate these firms have not done it yet. But we do think now, having done it, that this is quite an effective tool. It is not the silver bullet, but it is quite an effective tool and it should be applied much more broadly.
Q19 Stephen Hammond: So 24 firms have yet to do it. Given that in your own survey what we see from there is the incidence of malicious intervention or malicious cybercrimes increasing, do you feel your recommendation is strong enough? Do you think that it should be mandatory for those at the core of certainly the financial system to undertake those tests?
Dr Carney: Maybe I will begin and Sir Jon supplement, if I may. I think at this stage it is the right approach. That was the judgment of the committee. I think we felt that there is real value to this process, that we did not want to be heavy handed about it. It partly is revealing of firm governance the extent to which they take up the recommendations, so we learn something through that process. We also recognise that setting a hard cap on implementation on a large number of firms we could have logjams in this. If I may speak for a moment as a member of the PRA board, which is one of the bodies that should implement this, the importance of cyber risk and operational risk is very high. It is as high as it has ever been in terms of the priorities for PRA-supervised firms, so we have quite high expectations that firms will take up this opportunity to use this penetration testing. I would underscore that on a cost-benefit basis the cost of these tests themselves is quite minimal. The direct cost is £150,000. We have the technology in use. Now, there are much bigger indirect costs in terms of organising yourself properly to get the most out of this. It is not just about technology, about governance; it is about preparedness, it is about recoverability. It is all those aspects, but this can be a catalyst for all of those elements.
Sir Jon Cunliffe: I would say on CBEST another reason why some of the firms have not yet done it is because they are international firms and they are in different jurisdictions. They may be doing something else in other jurisdictions, particularly true of the infrastructure firms in the US, so we need to work those things through. Generally, we have not seen opposition from firms to this process. It is more a point of rolling it out.
On whether we should have made it mandatory, we made a recommendation that the PRA, the FCA and the Bank—because the Bank supervises payment systems and CCPs—should establish arrangements for this to become regular. We think that is probably enough to ensure that it does become regular, but clearly if we found that even with those supervisory arrangements firms were not doing this on a regular cycle we would think again about whether to be mandatory.
The last point I would make is the CBEST test is important but it is part of defensive resilience, which involves more than penetration testing. The questionnaire we put out to firms on their resilience showed there were lots of other things they need to do, including some quite human things because some of the vulnerabilities are not in the hardware and software, they are in the people and the way the people treat their passwords. Then there is a new piece to go forward on recovery because we assume at some point there will be an incident and the recovery challenges around cyber are very different to the normal operational resilience pieces. Finally, there is something about governance. CBEST sits as one element in a more comprehensive framework but I have no reason to think this recommendation will not be effective.
Q20 Stephen Hammond: I certainly take your point about the international firms. Are you convinced that the similar sort of testing that CBEST implies in the UK is happening in other jurisdictions? I obviously take your point about the threats and what comes through. One of the threats, of course, is to data. Has the Bank done any estimate of the costs of the new GDPR, General Data Protection Regulation, which is quite a major change for the financial services system?
Sir Jon Cunliffe: I do not think we have done that in the context of cyber and cyber protection. We have established here the costs of doing the resilience and the penetration testing, but I do not think we have taken into account those costs in bringing forward the cyber recommendation.
Q21 Stephen Hammond: One last question: can I ask the external members of the committee have the test results been made available to you and can I ask for your impressions, whether you think that the system is more secure as a result of these tests or not?
Dr Kohn: We have been briefed on the results of the tests, yes, not on an institution by institution basis—that would not be appropriate—but on the overall basis and the progress. We will be monitoring the progress, as the Governor and Jon have noted, and make sure the progress continues. Is the system safer? It is very hard to say. This is a process. These threats change constantly. The resistance and resilience needs to change constantly. To emphasise something that Jon said, it is partly about the governance at the institutions. This has to be taken very, very seriously at the institutions at the highest level and I think that is one of the things we will be looking for as we monitor progress going forward.
Chair: Anything you want to add, Mr Sharp?
Richard Sharp: No. I would just reiterate that last point that Mr Kohn made. I think the boards of many institutions are structured and think about their composition looking back at the issues they faced in the past. They may need to think about the skills necessary not just at the executive but the non-executive level to also address the kinds of issues they have going forward, and cyber is clearly one of them.
Q22 Chair: Mr Kohn, are you plugged into what is going on in the United States in this field? Are we operating in a silo or very closely together?
Dr Kohn: I am not very plugged in, Mr Chairman. I know that there is co-operation between the UK and the US in a number of these areas, but I do not know any of the details on that.
Chair: I think this is an area to which the Committee will want to return. It is extremely difficult for us to do so, as you understand, because of the characteristics of the subject and the sources of much of the essential information to work out what is required to do. It is something where we are dependent on intermediaries for that scrutiny, not least of Court, and perhaps we should flag up now that we would expect Court, which does have access to all the confidential information, to be looking at this extremely thoroughly, not in a formal way but in terms of substance.
Q23 Mark Garnier: I have a couple of sets of questions. Governor, perhaps I can start with you to do with the risks presented by investment management organisations. The Financial Stability Board, of course, which you chair, is looking at proposals to try to designate certain asset managers as globally systemic important financial institutions. Fund managers tend not to have a very high level of gearing and if they all do move as a herd that is more of a market problem than necessarily a fund manager problem. Can you elaborate a little bit as to why at the FSB you feel you need to put these measures on them?
Dr Carney: Yes. Well, let me put this right up front in its proper context. The FSB is looking at a number of issues around asset management and then, more broadly, market functioning and, ultimately, the impact of each on overall financial stability. The focus on the FSB is and has been for some time on the activities of asset managers in the context of overall market functioning, and I can come to expand on that if you wish. It is also looking at this question of what non-bank, non-insurer entities are potentially systemic now. That would include central counterparties, other financial market infrastructure as falling into that category, and might include asset managers or other elements of the market-based finance system. It might. That process, though, of looking at entity designation, specific asset management complexes, if you will, is on a much slower track than the work on activities. The thinking that we have at the FSB, and I welcome the question to make this clear, is that we will address issues around activities first—I will come to that in a moment—and then take an assessment if there is any residual risk that merits any action because an asset management activity is part of a bigger asset management group. Ex-ante it is not clear that that would be the case. It is clear that there are areas of interest both to the FSB and to the Financial Policy Committee of the Bank of England that we should investigate. It starts with the relative importance of asset managers in financial markets has increased substantially over the course of the last decade. It has doubled in size, assets under management, that increasingly—
Q24 Mark Garnier: From what to what, just to give us—
Dr Carney: Well, you can get various measures of it, but on the order of magnitude of US$30 trillion of daily liquidity asset managers. That is an important point because what has happened is that the relative size—so more important relative to the size of the market offering daily liquidity but investing increasingly in more illiquid securities and at a time where a number of market participants may be overestimating the liquidity of those securities themselves. It is a double problem and I will give an example, an example expanded on in some length in the report, which is there has been a big increase in daily liquidity asset managers in emerging market corporate debt. That is a very illiquid market in the best of times and extremely illiquid when inevitably you have a turn in the interest rate cycle in the United States, as Mr Kohn knows, and you get a sudden stop of capital flows to emerging markets and all of a sudden it is very hard to get out of those positions.
Q25 Mark Garnier: An example of that is when the US stops its quantitative easing or tapers its quantitative easing and now these emerging markets get less liquidity coming into them as a result?
Dr Carney: Yes. One question is just the structure of daily liquidity asset management increasingly invested in more and more illiquid securities; what consequences does that have for market dynamics? As you say or you intimate, it is not a financial stability issue if you have short-term volatility. If you have sharp changes in prices that is not good news for the people who own those assets, but provided it does not impair the flow of capital going forward it should be manageable. We have to make a judgment about the overall impacts that these developments could make. We are very much going into this with our eyes wide open both in terms of the scale of the changes but that the channels of contagion into broader financial stability have to be clearly thought through.
Then we would need to think through, and I am speaking both for the FSB and the FPC—and I would say that as a whole I think the Bank of England is playing the leadership role, the people to my right are playing a leadership role on this internationally—what the potential policy steps are that could be taken. Will they happen naturally or will change happen naturally through market adjustment? These are very important but very complex questions that we are looking at at the FPC, at the FSB and, in fact, if I may just mention, more broadly at the Bank of England we are convening a so-called open forum to bring market participants, both users of capital and providers of capital, to discuss these very issues later this fall.
Q26 Mark Garnier: The interesting thing is that the FCA and IOSCO, the International Organisation of Securities Commissions, seem to be less enthusiastic about potential intervention in this area.
Chair: Can everybody turn off electronic devices? I did have a go at that this morning. Everyone has turned them on again over lunch.
Mark Garnier: There was a rather cheeky whistle coming from behind you, Governor. I am not too sure quite what that was. There is a disagreement with the regulators and that is the key point. What I am particularly interested in is from the FSB and the FPC point of view potentially you can have measures—you may not have got anywhere near that stage yet—that would intervene, particularly from the FPC point of view, to de-risk this industry, and yet the regulators, who will be the ones potentially having to implement that, may not necessarily be in agreement with you. It is quite helpful for us to know where you are going and how you are dealing with those conversations and, just as importantly, what measures potentially you could use or what levers you could use from the FPC.
Dr Carney: Let me say two things. I will dispense quickly with the FSB. IOSCO is a member of the FSB. The FCA is a member of the FSB. The Securities Exchange Commission is a member of the FSB. All these regulators are members of the FSB so they are fully participating in these discussions. In fact, on Friday we have a meeting of the steering committee of the FSB and all those members will be there as well.
Secondly, with respect to the FPC, as you know the chief executive of the FCA is a member of the FPC, so Martin Wheatley is a participant in these discussions. I will give you three points of context, if I may. The first thing is the liquidity arrangement rules that have been put in place for asset managers were put in place during a different time. They were put in place during a time when asset managers were not as important as a proportion of assets in financial markets. They were put in place in a time when liquidity in financial markets was ample; in fact, it was excessive, pre-crisis liquidity was excessive. They were put in place in a time when there was very little algorithmic trading, electronic trading, and when central bank policy was different. The second thing I will say is that this policy or any policies that we would develop at the Bank of England and the FPC, I should say, are going to be evidence based. We are out there. We have surveyed 135 asset managers[2]. We are working through that data. It is referenced in here. I would say that there is a wide range of quality—
Chair: I think Mark has one more question. We are going to run over time—
Dr Carney: I will finish on this point. There is a wide range in terms of the apparent quality of liquidity management of asset managers, but in aggregate the expectation of asset managers resident in the UK of their ability in the corporate bond market, for example, to sell securities if there is a stress event is a multiple, a significant multiple, of the underlying turnover in those markets. In other words, it is the classic crowded trade, whereas in the equity market it is a very small fraction. So there are issues that we need to get to the bottom of.
Mark Garnier: Thank you. That is really helpful. Sorry, just very quickly—
Chair: It will have to be very quick and it will have to be a very quick reply. We are over time.
Q27 Mark Garnier: Just getting teed up for the next set of questions, which is to do with the fact that we have had a huge amount of fines and there is a potential stability risk to banks of fines on banks. It is a general question because Helen Goodman is going to carry on with this. I think you mentioned or I have heard the number that there is something like $35 billion worth of fines have been levied and that has been at a cost of $750 billion worth of lending capacity, where also there is a key point that the fines are creating a potential balance sheet risk to the banks. Are we getting to the point where we are now getting too big to fine as opposed to too big to fail? Is an answer to this where you then levy fines on private individuals working within those banks who have perpetrated misdemeanours? Does that not result in the fact that you end up not being able to get anybody to run these banks that are now too big to fine? Are we not painting ourselves into a corner?
Chair: Let us have the answer to a difficult question.
Dr Carney: The quick answer is that the scale of fines is material—£30 billion matches the external equity that was raised in recent years since the crisis—and that we need a better balance between individual and institutional responsibility, which was one of the key focuses of the fair and effective markets recommendation.
Chair: We might come on to this again a little bit more.
Q28 Helen Goodman: I wondered whether the defence of the banks and the criticism of the high fines in terms of the impact on the stability and the capacity of the banks to lend is not just a little bit too clever by half and maybe this is one of the reasons why the general public feel such significant resentment against the sector. To take a really simple, practical example, if the police said, “We are not going to pursue this antisocial behaviour because the crime statistics locally will go up” I think people would be appalled. If we said, “We are not going to deal with domestic violence because it will reduce confidence in the institution of marriage” people would not be happy about that. Can you justify taking a different approach in the banking sector?
Dr Carney: No. Look, the justification is couple-fold and we are not taking a different approach. We are drawing attention to some consequences of this. The first is that the scale of these fines is material. They have a material impact on the capitalisation of the institutions. That on the margin has a financial stability impact. They have less capital than they otherwise would. It is part of our stress test. It will be part of our stress test. 2015 will not have an accounting version of how much people have to provision for fines but an expected version of how much the scale of fines is that they will have to pay. That is the first thing.
The second thing is that we absolutely understand that the integrity of the industry has been called into question. I like you go around the country; we all go around the country. We hear it constantly. It is an understandable reaction. The industry needs to rebuild trust, so there is also a stability issue that has been created by a diminished trust in the industry, which is particularly important—we talked earlier about productivity and competitiveness in the previous session—when you think about the scale of the financial industry here, the importance to the economy and its prospect to grow further as significant multiples of GDP. Well, that is only going to happen, to use a term that we have used, if it has social licence, if people respect that this is an industry being run with integrity.
What we have said in Fair and Effective Markets, which is not directly from the FPC, although FPC members were consulted on it—and that is a joint report, as you know, with the FCA, the institution that is levying these fines in the UK, and the Treasury—is we need to increase the level of personal responsibility of the individuals in the industry. Because what is happening and what I do get asked everywhere I go round the country is why have individuals not been put in jail? Why are individuals not paying the price? There are fines being paid by corporations and shareholders, but individuals are not bearing the consequences for their actions. We are trying to use some of the innovations of this Committee and others to rebalance that relative scale of responsibility towards the individual as well as the institution.
Q29 Chair: We are trying very hard to press for much greater individual responsibility on banking, as you know, and some of those measures are being pushed through. Have we done enough?
Dr Carney: My personal view is that the innovations with the Senior Managers Regime, the changes to compensation and the longer vesting periods, the clawbacks, the combination of those two particularly, puts tremendous responsibility on the individual. What needs to happen, if I may, Chairman, is that these changes take effect and people see them in action and over time there will be an understanding. This is not all about—not that this is a suggestion—putting bankers in jail, it is about having a responsibility. If you do not measure up to the standards, if your institution is consistently not meeting the codes and market practice, then you will not be authorised in a position of responsibility and that has implications. That is the purpose.
Chair: That was the purpose of certification.
Dr Carney: Certification, very much so, yes.
Q30 Chair: It was the purpose of the senior managers regime, neither of which were fully understood at the start by regulators, particularly the FCA. Mr Sharp, is there any aspect of this new structure that is being put in place that you think has gone too far or could be prejudicial to the industry?
Richard Sharp: No.
Chair: It has your full support?
Richard Sharp: Yes. I think we have a shared interest in having an effective banking system. Banks are given the right to create money. That gives them the opportunity to make money and obligations have to come with that and consequences have to come with that if they do not fulfil how they behave. I think what we have learnt is that individuals in positions of governance have to exercise that governance with the detail that means that they are accountable for the failings in the institutions, so I support the measures that have been taken. The shared interest, though, that we have is to ensure that the City also remains globally competitive and that we retain skilled people here. We have to have a balance only insofar as we have to make sure that we do not lose jobs, employment and economic welfare as a result of a successful City.
Q31 Bill Esterson: Governor, I think earlier you said that we should not be too concerned about the level of unsecured lending, yet at the same time it is going up. The household debt to income ratio is high by international standards and forecast to rise further, indeed above the pre-financial crisis peak, by 2020 by the OBR. At what stage should we start to be concerned about both unsecured lending and about household mortgage lending?
Dr Carney: I referred in my earlier answer, which is that it depends what is driving that increase in household leverage. If house prices stay at their current level, I am not projecting a further increase in house prices, but just the natural turnover of the housing stock from houses that were bought much lower prices with much smaller mortgages to mortgages more commensurate with the current price of those houses, there will be an increase in the household debt to income ratio. The question is what does that mean for the debt service ratio of those individuals, given the level of interest rates and given where they are in their life cycle, in other words, whether they have prospects of improved income. It is not as simple—and I know you are not suggesting this—as just looking at one metric and making a determination off one metric, which then triggers action.
What action the committee has taken, and decided at its last meeting to keep in force, were measures to ensure that underwriting standards did not slip, so that we could expect both with potential increases in interest rates that individuals would be able to continue to service their debts through an interest rate test, but also that the number of households—the proportion, I should say—of households that have very high loan to income borrowings, that have borrowings above four and a half times income, that would be limited. Now, the reason we limit it, as opposed to eliminate it, is because borrowing at four and a half or four and three-quarters times income can be a very sensible thing to do for new families starting out, people at different stages of life. There are circumstances where this makes sense, so we limited it to 15%.
We have seen just directionally—if I may, and I will finish with this—that the direction of household balance sheets since we have put that in place a year ago has been to improve, so there are fewer households that are borrowing at these higher ratios, down around 9%, versus 11% prior. As you know, at least in the last few years there has continued to be a fall in debt to income thus far, so it is something we watch, we watch every meeting we convene, we discuss and we consider metrics, but we think we have, as evidenced by the decisions we took at the last meeting, the right set of policies in place at this time.
Q32 Bill Esterson: Yes. The FPC made this recommendation back in June last year that mortgage providers should test whether borrowers could still afford their repayments were the bank rates to rise by 3 percentage points over the first five years of the loan. I am interested how many people who took out mortgages in years gone by would be caught by this as much as by whether mortgage providers are implementing that recommendation.
Dr Carney: There is two things to say, that if you go far enough back—we have to go back to pre-2009, 2009 and earlier—people would have taken out mortgages with rates at those types of levels and so they have seen the adjustment in the last several years. As a whole, we think the better mortgage lenders have been doing this. We wanted to make sure the entirety of the market is doing it and these are the type of tests that tend to slip when the housing market starts to recover. What the committee wanted to ensure was that that behaviour did not repeat itself.
Q33 Bill Esterson: Sure. The flipside of that is people who have been borrowing for the last six years who are not used to higher interest rates, do you think they are ready and how do you think they will respond when interest rates eventually do go up?
Dr Carney: Yes. From a committee perspective, we have to look at the financial stability implications of that, and that is something we have looked through in our stress test last year. What we did last year is we had a scenario in which interest rates went up very sharply, in effect 5 or 6 percentage points, to 6%—yes, so much higher than the MPC would forecast, certainly on any reasonable horizon—unemployment doubled, a variety of other shocks, three-year recession and then looked at the ability of the bank balance sheets to withstand it. The banks were resilient to that as a whole. In that process, of course, we were assessing the full probabilities of various households, and we can provide the background on that information, which is in the public domain. There is no question that if interest rates were to move sharply, there will be some households who find it more difficult to adjust. As you would have heard in the previous testimony, that is not the central expectation of the Monetary Policy Committee, for a sharp move in interest rates, but equally, the Financial Policy Committee, our job is to look at what can go wrong as well as what is expected and so we do test for those types of possibilities.
Q34 Bill Esterson: A question then to Mr Kohn: what is your expectation about the possibility of interest rising in the next five years?
Dr Kohn: As part of the Financial Policy Committee, I am not here to comment on monetary policy in the United Kingdom, so I will let the Governor comment on that. I guess one thing I would say is I hope they rise, because their rising would imply that the economy had recovered and there was strength and the Monetary Policy Committee was comfortable raising rates and still hitting its 2% target.
I think one thing to underline about what the Governor said about the stress test and its effect on the banks and the households was that was an adverse scenario. That was a scenario in which interest rates rose in the context of a very weak economy and a rise in inflation because of sterling decline. I think the more ordinary expectation would be interest rates would rise in the context of a stronger economy, so I think people’s income would be higher. That would mute the effect of the rising interest rates to some extent on households.
Q35 Bill Esterson: Nothing to worry about when it comes to the affordability of mortgages?
Dr Kohn: I think there is always something to worry about, but you have to think about the context in which the interest rates would increase.
Q36 Helen Goodman: I just have one question. In answer to the questions on buy-to-let, you suggested that we live in one housing market. I am not convinced by that. It seems to me that, for example, in my constituency in Durham, house prices are literally a third of what they are in London. That is one housing market, and London is part of a big international housing market, which is why London land prices are shooting up. There may be all sorts of social justice issues around that, but from your point of view, if we have these big rigidities that mean that labour markets cannot work effectively, does it not also bring into question always using—either in this area of policy or in the monetary area of policy—national policy levers? They are too crude.
Dr Carney: There are certain macro policy measures that have to apply to the economy as a whole, to the UK as a whole. Monetary is the absolute classic example. We set monetary policy for the United Kingdom as a whole; we set macroprudential policy for the United Kingdom as a whole. There are distributional consequences of any macro policy, and the distributional consequences, the regional consequences of those and other factors are best addressed by other more targeted policies.
In terms of the housing market, I agree there is a distinction between a subset of the London property market, which is, as you say, an international cash-driven property market that is valued in relative terms to other international property markets, without question. In number of properties, it is relatively small relative to the scale. It is small. I will skip the “relative”, it is small relative to the scale of the UK housing stock and to the experience of the vast, vast majority of UK citizens. What is also the case is that across regions—and this is one of the things we looked at this time last year—is that it may be a lot cheaper in absolute terms to own a home. It is a lot cheaper to own a home in Durham than it is on the environs of Westminster, but it is a question also of the price relative to the incomes there. We watch closely where underwriting standards were going relative to incomes across the country and it was a similar move across the country to higher loan to income ratios that caused us enough concern, not that we were stopping activity in its tracks, we did not do that, but that we would take out insurance against a further loosening of those underwriting standards.
Q37 Helen Goodman: You would not consider having different ratios in different parts of the country, for example?
Dr Carney: We have not considered that, and one never says never—
Helen Goodman: Cautious.
Dr Carney: —but I would be very surprised if a circumstance arose that that were necessary.
Q38 Helen Goodman: Mr Kohn, do you want to say something?
Dr Kohn: I agree with the Governor’s answer. We have a hard enough job keeping our eyes on the financial stability of the United Kingdom as a whole, and the financial stability of particular regions, I think that would be more than we should be doing, beyond our remit.
Q39 Wes Streeting: The questions are along a similar theme from me. On one hand, the FPC has acted to restrict mortgage lending through loan to value restrictions and affordability checks, and then on the other hand, we have Government policy to reduce stamp duty and inheritance tax and help-to-buy schemes. Do you see a conflict in those two approaches?
Dr Carney: I would simply note that some of the Government schemes are quite targeted, so help-to-buy targeted the first-time buyers, and I think the statistics show that the vast preponderance of takers certainly of the home equity component of help-to-buy are first-time buyers. Obviously inheritance tax has an implication for the other end of the age cohort, so there is an element. We have to look at the market as a whole and we have taken steps in the market as a whole. I refer to my answer to Ms Goodman, which is that we look at that broader housing market and the broader risk that arises from that housing market, the one housing market, so both to the banks and to ultimately the debt cycle and the economy, the credit cycle and the economy, and that implication for sustainability of growth over the medium term. It is entirely understandable that a Government or Parliament will decide to have targeted housing policies within that broader market, and it is not for us to comment directly. They are serving different uses.
Let me just say this, I will just make a general comment, because we had been asked specifically to comment on the financial stability implications of help-to-buy and we did comment on that, but what I can assure you is that if the Financial Policy Committee came to a view that there were specific Government policies in the housing sector that were causing financial stability risk, we would make public our concerns about that policy. We would take it into account and we would make public our concerns. We would do that with robust analysis and as much clarity as possible.
Q40 Wes Streeting: How would you characterise the current risk associated with the London housing market and what steps do you think Government or public policy should be taking mitigate some of those risks?
Dr Carney: Again, we do not set policy for specific regions. There is a unique aspect to prime central London, as you are well aware. The financial stability risk, given the nature of the purchasers, there is limited exposure of UK financial institutions to the risk in prime central London. There can be some exposure to commercial real estate or commercial residential real estate, if you will, large housing developments through the banking sector. It is something the PRA looks at and we are looking at commercial real estate more broadly, the risks around it, so that is something we are monitoring, but we are not, again, flashing a red light around the issues there at present. Why do I not leave it there in terms of the direct impacts on financial stability? The situation in prime central London is they are not a material risk to financial stability, although they cause a number of other difficulties, of which we are all aware.
Q41 Wes Streeting: Can I ask, just on the mortgage affordability check, was that a response to UK public policy or was it a response to the EU Mortgage Credit Directive?
Dr Carney: The Mortgage Market Review was initially a response to some work that was done. I believe the ultimate genesis was worked on at the Financial Stability Board on mortgage underwriting standards, best practice mortgage underwriting standards, which had a series of recommendations. Sir Jon can help me whether that was then mapped into some EU—
Sir Jon Cunliffe: The MMR recommendation from the FCA was linked to the European legislation, but the FPC’s recommendation, which was on top of the MMR, which is 3 percentage points, the stress test, was not. That was what we thought was appropriate in the light of financial stability. I think before that, the test was to use the forward market curve, but at a time of exceptionally low interest rates, it clearly makes sense to test.
Q42 Wes Streeting: So they are aligned but not causal is how you see it?
Sir Jon Cunliffe: Our recommendation was to do with the UK.
Dr Carney: If I may, Mr Streeting, Sir Jon makes an important point, because that was the historic forward market curve, and what we have seen since we have put our recommendation in place is that the forward market curve has collapsed, but that 3% element has stayed, because we have made that recommendation. That has helped prevent the sort of pro-cyclicality that would have been built into the system.
Q43 Wes Streeting: Sure, and I think it is a good idea, but good ideas sometimes have unintended and detrimental consequences. Are you aware of the current issue that seems to be affecting people, no doubt in all of our constituencies, which is that because of these mortgage affordability tests, people who might want to move their mortgage to a competitive lender on more favourable terms and conditions are effectively unable to do so because of the mortgage affordability test, even though, ironically, the mortgage they are trying to move into is more affordable and better for them? There is effectively a consumer mortgage trap that is stifling competition, because it is possible within the existing lender, if I have my mortgage from bank X and I go in, then there is no requirement on them to do the mortgage affordability test, but neither is there an incentive for them to give me a more favourable mortgage, where if I go down the road to another lender, they may well be able to offer me a more favourable mortgage, but I am trapped because of the mortgage affordability test. Do you accept that is a problem and that it is something that we should look to act on?
Dr Carney: Two things: one recognises that people can find themselves—and some people are finding themselves—in that situation, particularly because two-year mortgage rates are at record lows in this country, but I would caution a bit on the overall analysis of whether it is a more affordable mortgage in the fullness of time, which is exactly what the mortgage affordability test is designed to address, because at current levels of historically low interest rates and a variety of other factors affecting forward interest rates in this economy, you can get two-year fixed-rate mortgage in some cases less than 2%. That is not a situation that is likely to persist, and certainly—let me put it this way—to be prudent in managing one’s own household finances, you do not want to be put in a position where you are at a very low interest that then moves up because the economy has continued to grow, the MPC of the Bank has gradually raised interest rates, and then that which looked more affordable becomes much lesser. That is what the affordability test is designed to address. Yes, it is unfortunate that some people cannot fully take advantage of historically low interest rates and market time that adjustment, but this is about stability over the medium term, and it is about stability across all mortgage borrowers.
Q44 Wes Streeting: You would not be sympathetic to a slightly more flexible approach and adjustment to some of the tests to take into account—
Dr Carney: I cannot speak for the committee, but I do not think it is an adjustment we would be likely to make but we will take that under advisement.
Q45 George Kerevan: Could I tap the wisdom of our external advisers here on the subject of ring-fencing of retail activities of the UK banks? David Walker has made himself infamous even by suggesting that this will damage the banks. I am interested in how you see the effectiveness of the ring-fenced regime as they have set it out in terms of meeting the criteria of resilience and resolution. Resilience and resolution are being handled in a multitude of other ways. Is David Walker right that perhaps you need to reconsider the form or even do away with the ring-fencing?
Dr Kohn: No, I do not believe he is right. I think in fact the ring-fencing is aimed exactly at resilience and resolution and will enhance both the resilience of the system and the ability of the authorities, if it should come to that, to resolve these institutions in an orderly way, imposing losses on not only equity-holders, but certain creditors of the institutions, and not on the taxpayers of the United Kingdom. I strongly support the ring-fencing. We have not—
Q46 George Kerevan: In its present form?
Dr Kohn: As it appears to be going forward, yes. I would note that in many respects it is very similar to what is true in the United States, that is in the United States they have a holding company. The investment bank is a separate corporation under the holding company from the commercial bank. I know in conversations with John Vickers, he has pointed to the US as an example, and our banks are able to live with that structure.
George Kerevan: Mr Sharp?
Richard Sharp: Yes. Look, I support the consensus of the FPC, which is precisely as articulated by Donald. This is a move for greater financial stability for this nation.
Q47 George Kerevan: Even though the Treasury says it cost the banks £4 billion a year?
Richard Sharp: It is a move for greater financial stability.
George Kerevan: I agree with the externals. I just wanted to make sure that we were all on the same page.
Q48 Jacob Rees-Mogg: I just wonder how compatible it is with the remit that the FPC gets from the Chancellor that requires competition and innovation and competitiveness for the UK market. The ring-fence and the capital levy combined seem to me to make it both extraordinarily difficult to be globally competitive, and innovative almost impossible. Which part of the Chancellor’s instruction is the FPC trying to follow or is the Chancellor giving you a contradictory instruction?
Dr Carney: Let me say two things. First, the Chancellor and the Government can pursue different objectives with different policy instruments, so the levy is entirely a decision of the Government, and the design of bank taxation, both with the tail-off of the levy and the adjustment in the bank surcharge, does have a potential impact on competition. It certainly has a differential impact, as you can appreciate, on bank models. I will say one thing on it though, that when the levy was originally conceived many years ago, it was conceived in part as a way to manage wholesale borrowing of institutions, a so-called Pigovian tax to reduce wholesale borrowing of management institutions. Subsequent to that, there had been a number of regulatory initiatives that have a similar impact, liquidity coverage ratio, the net stable funding ratio being two obvious ones. As those ramp up, the need for a Pigovian tax, if you will, a levy, goes down. Subsequent adjustments, increase in the bank surcharge, I will leave it to you to judge.
In terms of ring-fencing, one of the important elements of ring-fencing and the implementation of ring-fencing, and one of the focuses of the FPC in its implementation and the PRA, is to make it as compatible as possible for what banks have to do anyway in order to be resolvable, because if one believes in competition, it is important that the financial sector lives and dies by the rules of competition if banks are no longer too big to fail. Moving to models where you have separable businesses that either can be recovered, as one would want to do with a retail bank in the United Kingdom, or resolved, as one might want to do with a wholesaler investment bank, in the event that the overall institution gets into trouble, that is important. That is important whether we have ring-fencing legislation or not, so many of the adjustments are consistent with the two. We are trying to maximise the complementarity of those two objectives.
If I can go to a more general point and then hand back to you, which is with respect to our remit. There is a hierarchy, as you can appreciate, in our remit and whereby our first responsibility is to promote financial stability, words to that effect, and subject to that, support the Government’s economic policy, which includes these desires that you have indicated, ultimately one is linked together in terms of the economic desire. The Government is emphasising, as you well know, productivity of the UK economy. As Sir Jon referenced in the earlier session, financial stability in and of itself is a necessary condition for productivity. In fact, we can do tremendous damage to the productive potential of this economy by not sticking to our primary remit.
Sir Jon Cunliffe: I just want to make one other observation on the ring-fencing, which is the very large banks that were able to depend on a too big to fail guarantee from the Government effectively enjoyed a subsidy on their funding costs, which is observable. What you are seeing now, that in the UK and elsewhere they are being made resolvable, that is they can fail, you are seeing the credit rating agencies withdraw what is called the public support ratings, which is bringing the cost of their debt up, but it is bringing the cost of their debt up relative to small banks that never enjoyed that too big to fail subsidy, so in a way ring-fencing levels the playing field and should allow more competition.
Q49 Jacob Rees-Mogg: Is that not the point, because in the end, everybody was not allowed to fail under any circumstances? It started over somebody quite small and also with somebody doing routine mortgage lending, and that therefore the implicit guarantee from the Government still remains for ring-fenced banks that do rotten mortgage business, which we are trying to stop on the other side of it. But it seems to me it is a misunderstanding about the financial crisis.
Dr Carney: If I may, it is a quite a question, but a couple of things happened with the ring-fenced banks. One, as you know, is they have to carry higher capital because of their importance to the economy, but very much part and parcel of what we are doing as the FPC and as the resolution responsibilities of the Bank of England is to ensure that that ring-fenced bank can be resolved in the event it gets into trouble. Now, resolution can lead to the sale of components of it on to another institution, a replacement of management, a wipe-out of shareholders and a relaunching of the institution as well. There is a variety of things that we could do. We want to make sure—and it is our responsibility to make sure—that the critical economic functions of that ring-fenced bank continue, but there are very real consequences for the management and shareholders of those institutions if we implement it properly. The point I was trying to make is that what we are trying to do is to make the implementation of ring-fencing as complementary as the necessary implementation of ending too big to fail, by another name.
Jacob Rees-Mogg: Chairman, do you want me to come on to the liquidity questions now, because I think they follow?
Chair: Why do you not go straight on with those now?
Q50 Jacob Rees-Mogg: Thank you. Because one of the things we were discussing slightly earlier was the issues of liquidity and that business models and regulatory environment have reduced liquidity, and the ring-fencing almost certainly makes this worse, because it takes a very large portion of some banks’ capital out of activity within financial markets. I just wonder whether you think market participants are taking this liquidity risk properly into account, but also, perhaps more fundamentally, whether we are once again making pro-cyclical regulation and therefore you regulate for what was a major problem 10 years ago, and had it been done then and the reduction in liquidity come then, it would have been very helpful in avoiding the crisis, but that now the reduction in liquidity is simply making recovery from the crisis longer.
Dr Carney: I am going to speak to—which I think is the point of your question—liquidity in financial markets. I think first, in terms of the fact pattern, we observe and we spent some time on this report and we are spending a lot of time on the committee on exactly this issue. There are a few things that are happening. One is that there is an illusion of liquidity in markets, in other words, there are a series of metrics of market liquidity. I will pick one, on versus off-the-run US treasuries. That spread is very low relative to history. There is a variety of other indicators that would support this statement. There is a variety of indicators that suggest there is quite ample liquidity, bid offer spreads are quite narrow in many markets and so on, but when tested, that liquidity is ephemeral, and we are seeing in addition quite sharp jumps in intraday illiquidity. We saw it in the US Treasury market, we saw it in the bund market, we saw it in the foreign exchange after the Swiss franc moved. We would expect to see it other markets.
Then back to Mr Garnier’s question, there are assumptions of a number of market participants about their ability to realise market liquidity under stress, the ability to realise redemptions by selling, so there are real challenges here. The first is to analyse the scale of those, the causes of those, as much as possible have discussions such as these, so there is a learning process of market participants as well as ourselves so there can be adjustment.
The second is to look at what are the potential structural or policy causes of this and you rightly, I think, point to some of the measures we have taken to make the core of the system more resilient are leverage ratio, higher capital requirements, higher capital requirements for the trading, perhaps ring-fencing, which should add to the quantum of capital, but as you are suggesting, might shift capital initially to the ring-fenced bank away from a standalone investment bank. All those factors could contribute to less liquidity. We have to take a judgment in the round. My personal view is that we are net in a better place—in fact, unequivocally, in my view—to have the core of the system much more resilient and able to withstand shocks.
I would note that in all of the cases, whether it was the taper tantrum, October 15, the bund tantrum, the Swiss franc move, the core of the system, into which we have direct line of sight, as the regulator of the world’s largest financial sector, sailed straight through, did not amplify the shock. It was a bad day at the office if you were managing positions as an asset manager, I appreciate that, but it did not get amplified out more broadly in the financial sector or more broadly into the real economy. Now, none of that suggests a complacency, but it does suggest that directionally we certainly think we have it right. There are questions centring increasingly around the structure of markets, some of these changes to electronic trading, around the liquidity assumptions of various participants, including asset managers, and what, if anything, can or should be done about that, or is this just a learning process to get it right?
Q51 Jacob Rees-Mogg: The risks, in your view, the highest areas of risk are currently the more peripheral areas. You are quite comfortable about the risk in the core of the financial system?
Dr Carney: Yes.
Q52 Jacob Rees-Mogg: To what extent do you think market participants have come to reprice the risk of liquidity or do you think they are not there yet?
Dr Carney: I would suggest they are not there yet, and part of the reason they are not there yet is there has not been a real shock, in other words, there has not been a big change to fundamentals in the last few years. Forecasts are off a bit and here and there is always news, but there has not been a big change in fundamentals, so it has not been tested. Then on top of that, the stance of central bank policy has provided a lot of comfort to many market participants, so this will be tested more as policy starts to normalise, particularly in the United States.
One point we would want to stress is that we think liquidity premium and volatility in the markets are too low, so as policy begins to adjust, we think there is a natural increase in both of those. That is a good thing. The question is whether there is overshooting or structural reasons why it persists or maintains at a much higher level than we would expect. That is what we are trying to examine.
Q53 Jacob Rees-Mogg: Do I take it that you think that the normalisation of monetary policy will lead to a better pricing of liquidity automatically, rather than there being a need for the regulator to try to do something, and it is part of the normalisation process rather than something that either leads or follows the normalisation process?
Dr Carney: My personal view is that is correct, and just to link it back to this morning’s session, on the margin I would expect that in the new normal there would be a higher liquidity premium just as a matter of course in markets, whereas prior to the crisis, there was no liquidity premium in the markets, and that on the margin is one reason why the risk-free rate is likely to be somewhat lower than it had been in the past.
Q54 Chair: Can I take you back to your earlier set of answers to Jacob Rees-Mogg? Also, it relates to what George Kerevan asked you. Are you confident that we can resolve our biggest banks, Governor?
Dr Carney: If we were resolving someone today, we are not yet in a position to resolve our largest institutions today. We have made considerable progress in terms of developing the resolution plan, but the capital structure is not yet there, there needs to be changes in capital structure and there needs to be changes to a number of the aspects of the way they are organised, including critical economic functions. That is part of why the ring-fence work is important, but the broader agenda, ending too big to fail, which is one of our priorities at the FPC.
Q55 Chair: So the subsidy is still there?
Dr Carney: The implicit subsidy, I entirely agree, in both ratings and in markets, that subsidy has gone down. It has gone down quite materially, but it has not been eliminated. If you own a—
Q56 Chair: But it will not be if you cannot get to resolution?
Dr Carney: That is correct, and it will not be until we have the capital structure fully in place, so bail-in-able debt, but this is important, so there is still work to be done. We are already in a position where we have many more options in terms of what would happen if an institution would fail, but I cannot sit here today and tell you that the largest banks are resolvable today.
Q57 Chair: This is going to be heart-pounding: the bank levy was of course introduced as a rough quid pro quo for the fact that, “Banks should make” and I am quoting, “a fair contribution to the risks they pose”. Those were the Chancellor’s words when he introduced it in 2011. It is now being withdrawn. Is that premature?
Dr Carney: I do not think necessarily it is. I think that the timeline the Chancellor has put in place is consistent with what our ambitions should be for putting in place that capital structure, the organisational structure and ring-fencing all four of the major banks so that we can answer positively to your question.
Q58 Chair: So when the bank levy goes, you are before us, I can say to you, “We were right to remove the bank levy at this time, because we have now come to resolution”?
Dr Carney: Yes. That is entirely—
Chair: That is the sunny uplands?
Dr Carney: It is a reasonable expectation. Look, Sir Jon and I at the FSB are pushing for an agreement on so-called TLAC, which is bail-in-able debt, which should be struck this year, and the objective is to phase that in by 2019, 2020. That is a horizon consistent with the Chancellor.
Q59 Chair: Were you consulted about the withdrawal of the bank levy by the Chancellor?
Dr Carney: Consulted is a big word.
Chair: Okay. I have offered you an opportunity to put your own word in in another context, so let us—
Dr Carney: I was aware, yes.
Chair: But you were not consulted about it?
Dr Carney: Look, the Budget is the responsibility of the Chancellor and the Government.
Chair: Were you asked for your view?
Dr Carney: If I had ever had been asked for a view in public, I would have said that I thought that—
Chair: No, on a private view.
Dr Carney: I do not think is entirely appropriate that I replay my conversations with the Chancellor, quite frankly.
Chair: I am not asking what your view was. I am just saying were you asked for a view? Were you consulted is the question I am asking.
Dr Carney: The Chancellor has long been aware of my views on the bank levy.
Q60 Chair: Have you made them public?
Dr Carney: You forgot to ask me in the past.
Chair: Let us have a go now. Off you go, Governor, you can have a go now.
Dr Carney: I refer back to my comments to Mr Rees-Mogg earlier, which is around the original intent. Other mechanisms are being brought in place to address those issues, including liquidity regulation and resolvability, as you point out, so that—
Q61 Chair: Were you consulted about the profit surcharge? Same answer, okay. Just silence. Do you think that the profit surcharge might have behavioural effects on the shape of UK bank balance sheets?
Dr Carney: I think it is fair to say the UK domestic financial industry is quite diverse and so any tax is going to have differential impacts on different business models, so—
Q62 Chair: Have you taken a look at what those were?
Dr Carney: We did not perform analysis, just as we rarely perform analysis for Government fiscal policy, unless explicitly asked.
Chair: That is very helpful. There are a whole bevy of colleagues wanting to chip in now. Steve Baker is next and then Chris Philp.
Q63 Steve Baker: I would like to turn to resilience and the stress tests, but page 35, chart B2 gives the Bank’s leverage ratios. In the footnote it says, “Note discontinuity due to introduction of IFRS accounting standards in 2005 which tends to reduce leverage ratios thereafter”. Presumably that is because IFRS tends to encourage banks to overstate their assets. Have you grasped the implications of IFRS yet?
Dr Carney: I believe the issue, Mr Baker, is that yes, IFRS ... to overstate their assets? No. IFRS, the issue is onboarding of so-called off-balance sheet assets, which the direction of travel in accounting and in regulation has been that formerly arm’s-length assets are increasingly on-balance sheet, which, as you say, reduces the leverage ratio, but gives a more fair representation of the leverage ratio, of the actual leverage of the entity. If I may, just quickly, as you know, one of the key things in the start of the crisis was the sudden discovery that a bunch of supposedly off-balance sheet vehicles—the structured investment vehicles is one example—were the responsibility of the institution and their leverage was considerably higher.
Q64 Steve Baker: I had in mind loan loss provisioning and mark to market, but I do not want to get too far drawn off down this path. It is just that I note that the Bank has now acknowledged a specific discontinuity in the leverage ratio of the banks. I wonder if, Sir Jon, do you want to come in?
Sir Jon Cunliffe: The only point I would make is the leverage ratio we have set is based on the Basel definition of the leverage ratio. What we are doing here is for illustration using the simple leverage ratio, which just takes the accounting results for the Bank and leverage, which is what the market participants use. But our leverage ratio is based on a Basel definition, which takes on board these off-balance sheet—
Q65 Steve Baker: To park this and move on, I remember Andy Haldane made a very interesting speech about the pro-cyclicality of IFRS. Are you satisfied that IFRS is developing in such a way that it is not a material threat to financial stability?
Sir Jon Cunliffe: I think that is the objective of expected loss provisioning.
Q66 Steve Baker: Let us park that one there. Professor Kevin Dowd has given evidence to this Committee in the past, and he has recently published a paper with the Adam Smith Institute in which he is highly critical of the Bank’s stress tests. He made seven areas of criticism, but the one where he made the most strident criticism, he said the tests were fatally flawed, was on this point about having just a single stress scenario. Governor, in the past you have made the point that a single scenario will have multiple stresses in it and it will be a coherent macroeconomic package.
Dr Carney: Yes.
Steve Baker: Even so, is the question not then why not have several coherent macroeconomic packages and several scenarios?
Dr Carney: First off, let me say I welcome the work of Professor Dowd and a broader discussion of stress testing. It can only help improve stress testing, and part of the utility of these exercises is discussing the results and their advantages and limitations. That is the first thing.
Secondly, in terms of the scenario, just so we are on the same page, the scenario last year had this housing scenario that we have been discussing, so it was balance of prices that flowed through to a housing shock, long-term recession and unemployment associated with that and a very high increase in defaults, but that was layered on top of a European stress, an EBA stress test that had a sharp increase in peripheral spreads, a slowdown in our largest trading partner and the knock-on effects from that drag. You had two major stresses, and also had a steepening in the yield curve as a whole as one of the motivators. You had multiple scenarios embedded in one stress, which were then put against UK institutions.
Steve Baker: Sorry, multiple stresses in one scenario?
Dr Carney: Multiple stresses in one scenario. Thank you. This year, we are looking at a different set of stresses that emanate out of Asia, a broader global slowdown and associated financial market impacts through direct and indirect channels back to the UK. One of the differences, as well, is that instead of last year’s scenario where you had a potential inflation shock and interest rates going up, you have a scenario where you have weakness, you have a yield curve not steepening but flattening, and you have disinflation and the flow-through from that. You get a very different set of impacts layered across and different impacts on institutions. What we will do as a committee is not just discuss this scenario and these stresses but also look at the previous one, and an update of the previous one, and think about them in the round, in terms of the appropriateness of the capitalisation.
Q67 Steve Baker: It feels like you have given a very robust defence of using one scenario with multiple stresses and then doing your wider work around it, but is it simply too expensive, complex and time-consuming to operate multiple coherent scenarios which test the banks in different foreseeable circumstances? I like Andy Haldane a lot and I do not want to drop him in it, but he did say previously that he had deliberately inflated the biggest bond market bubble in history. I do not see it being tested; it is deflation being tested.
Dr Carney: How many years ago did Andy make that comment?
Steve Baker: I do not see QE on it.
Dr Carney: I do not think it really came to pass, did it?
Steve Baker: As I say, I do not see QE unwound yet and I still see interest rates on the floor. I am still worried about these various asset bubbles that have been burst and that, by the way, prior to the last crisis, people have now admitted were not adequately considered by banks. What I am concerned about is a set of things that we have seen go wrong in the past going wrong again in the future, and they are not in your stress tests.
Dr Carney: Let us take the bond market issue. The scenario last year, which had a sharp steepening of the yield curve, is exactly the kind of scenario which starts to lead to large capital losses, obviously, in fixed-income positions and beyond. That is something that was actually in the stress test and was worked through. Again, if I may, part of the exercise here is to give a coherent macro scenario a series of things that happen to institutions to see how they expect that they would react to it and the impact it would have on their asset quality and appropriate capitalisation; however, it is also for us to cross-check it and to iterate it. You have multiple views and then what the committee does is to take those inputs and make judgments about the adequacy of the overall resilience of those institutions to these types of stresses. It is an iterative process.
Q68 Steve Baker: Testing the interconnectedness of these institutions was previously described as an “aspiration” but in the report, on page 38, the stress test is described as “concurrent”. Does that mean that individual institutions are being tested separately but at the same time, or does it mean the model is going to test their interconnectedness and the systemic risk as well?
Dr Carney: Historically, what the Bank of England or the Prudential Regulation Authority did was to run stress tests on individual institutions sequentially, one institution at a time. By the time you got to the eighth-largest financial institution it could be two years since you did the stress test on the first, so it was very difficult to compare. Certainly what you could not do, as the Financial Policy Committee, is look across the financial sector as a whole and make a judgment about the resilience of the system as a whole. You could not make the type of judgment we needed to make last time and will probably need to make this time, which is: what is the add-up in terms of reduction of lending, for example, of all these institutions? How does that feed-back to underlying growth assumptions? How much additional capital or other resilience do these institutions need in order to ensure that we do not have the shock amplified through the system? That type of analysis.
Your question is around interconnections and counterparty exposures, and we do look at those counterparty exposures. I will just take this opportunity to add something that is a non sequitur, slightly: we will be looking at and being clearer about the conduct exposures of these institutions, so not just the fines that they provision for but that they are likely to pay in the future.
Steve Baker: It does sound like you are testing all of the institutions at once, but you are not necessarily testing the systemic consequences of one or several of them suffering badly in the course of the scenario.
Dr Carney: As the creditworthiness of the underlying loan portfolios deteriorate, the asset portfolios deteriorate, the health of the institution can deteriorate and the CDR, what you have to provision as a counterparty, also increases. There is a capital call on institutions because the system as a whole has become more risky. You can say that is procyclical or you can say that is prudent, but that is part of the way the system works and what we look at.
Sir Jon Cunliffe: I think I will make just a few points. The first is that “concurrent” means doing all the banks together and also trying to see if their actions, when put together, are consistent. Last year, for example, we discovered that for a number of them, their way of dealing with the stress was to reduce lending. Of course, if they all reduce lending then the economy goes further down and the stress gets worse, so we put a floor in to prevent them doing that. There were also some joint effects around the modelling.
We have not got to the point yet where we can map all of the interconnections between all of the banks—that is an aspiration still—but this year, when we set the stress and the liquidity conditions that will be there in particular markets, those stress and liquidity conditions will take account of what happens to those markets, because of the interconnections, when they dry up. We are trying to bring it in there.
Steve Baker: Thank you. Can I just stop you there? I have been asked to wrap up.
Q69 Chris Philp: On the question of looking at these various regulatory initiatives to improve financial stability, and ring-fencing is one we have discussed, do you consider the regulatory regime in other, competing jurisdictions and the impact on London’s relative competitiveness in the international landscape? I am asking that question particularly in light of the review HSBC is currently conducting into where to locate itself.
Dr Carney: Is that to me or to—
Chris Philp: It is to whichever member of the panel is best qualified to answer it.
Sir Jon Cunliffe: Our objective is to do what the Chancellor just put in his remit: to ensure that the United Kingdom has the best-regulated financial sector in the world. Much of our regulation and legislation comes from the European Union so it is consistent across European Union countries. We are interested in how other countries in different jurisdictions do things. Much, again, of the regulation comes from international standards. We try to ensure that we at least get equivalent outcomes.
I think I would say, on the HSBC point—and I think it is a point that has been made before—that if you want to be a globally systemic bank, if you want to have operations in different jurisdictions and to be interconnected in that way, then the international standards wherever you go will be aimed at ensuring that you have the highest possible standards because jurisdictions need to be confident that they have somebody there who is robust to the sorts of problems we saw. I do not see this as an issue of being able to find a lighter-touch regulation elsewhere and still being able to continue, nowadays, as a globally systemic bank. I do not think that is what HSBC are doing, by the way: I think they will make their choice on their own business model. The days are gone in which, if you want to be a bank like HSBC, a globally systemic bank, you will be able to forum-shop in that way.
Q70 John Mann: Dr Kohn, Mr Sharp, good afternoon. It is an absolute delight having you both here and you are very welcome. Is there any point you being here any more?
Dr Kohn: That depends on whether you ask us some questions.
John Mann: The Chancellor has altered the terms and conditions on which you are operating so that any dissent that you may have is no longer going to be minuted.
Dr Carney: I am not sure I recognise that. The—
John Mann: Let me quote for Mr Kohn and Mr Sharp, if I may, “All decisions have to be co-ordinated and consistent and reached by consensus”.
Dr Carney: If I may, Mr Mann, to advance things: as you are no doubt aware, under the legislation for the Bank of the England and for the FPC, unlike the MPC, is required to reach consensus wherever possible. However, it envisages circumstances, and there will be circumstances, where consensus is not possible. In those cases, decisions would be taken on the basis of a vote. What we have endeavoured to do—and we will continue to endeavour to do this—is to ensure that even though we go through a process of developing a consensus, that the arguments and the full flavour of the discussion is reflected in the record. In the end, the experience has been that members have joined to that consensus, as required by legislation.
John Mann: The Chancellor, in the Budget, has said that you do not need to reflect the balance of arguments any more, unless there is a vote.
Dr Carney: As chair of the committee, we all work through and sign off on the record, which is our minutes, and we endeavour and we will continue to endeavour to capture the issues around any decision that we take. There are always pros and cons around various courses of action. That is what we look to do because that is the nature of the discussions that we are having.
Q71 John Mann: So even where a consensus is reached, defined as there being no vote, any balance of arguments will be captured fully in the minutes?
Dr Carney: The relevant issues to a decision will be captured in the record, yes, because that is the nature of the policy development process.
Q72 Chair: There will be a court observer at these meetings?
Dr Carney: There is always a court observer.
Chair: We will be holding the court to that, to ensure that—
Dr Carney: I invite colleagues to opine. I do not think there is a challenge with having robust debate at the FPC in terms of developing policy on a series of extremely complicated but important issues.
Dr Kohn: I can confirm that I have never felt constrained or restrained from stating my views and entering into the discussion with my own views. I feel like I have been able to contribute to reaching the consensus, which we have been able to do so far. There is no guarantee that we will always reach a consensus in the future.
Q73 John Mann: No, but it is whether that is reported out and, if you have a variance on views, that the world can be aware of that. You feel no change whatsoever in constraint?
Dr Kohn: I think the record has taken account of the logic and the reasoning leading up to the consensus that we have reached. I do not feel that the record has constrained me or that it is not an accurate representation. It does accurately represent the discussion of the committee.
John Mann: That would be your view as well, Mr Sharp?
Richard Sharp: Yes. I think we have robust discussions in the FPC and it is extraordinarily valuable for stability that the consensus exists. I take enormous comfort, structurally, that the court independently scrutinises to ensure, as the FPC performs in its intimate discussions before the record is produced, that the independent members’ voices are heard, are taken seriously and have the opportunity to shape the discussion and the conclusions.
Q74 John Mann: No. Under the Chair’s astute chairmanship this Committee always reaches consensus, but the members of the Committee do not feel in any way restrained from expressing their views, during or after. I just want to be clear: there is no view, from what the Chancellor said in the Budget, that in any way the feeling of the external members in expressing their view and that being recorded would change?
Dr Carney: May I make a point of process? The FPC has not met since the Budget and the new remit letter. We will be responding as a Committee, as we always do, to the remit letter in the next few weeks.
Q75 John Mann: We will leave that there. Two other quick questions. One is, Mr Sharp, that in relation to the capital requirements on building societies there is still a view that seems to have been expressed that this could, in some way, undermine competitiveness; even, potentially, destabilise some of the existing building societies so they become less competitive in the future. Is that a concern that you would at all recognise?
Richard Sharp: We are aware that different business mixes give arise to different outcomes as a result of some of the capital constraints we have put on businesses that have different strategies. On the other hand, we are also aware that building societies, having had certain privileges and leveraging opportunities in the past, have taken advantage of that to take bigger risks in the commercial and real estate sector than is represented by what they classically presented their business model to be. I think this goes hand in hand with making sure there is a broad provision of mortgage from the industry as a whole and it is a competitive one. I have no qualms with building societies having to operate, in that sense, under the same constraints.
Q76 John Mann: My final question is entirely different, Governor. It is in relation to what is going on in China. Is this something that we should regard as an internal issue, a rebalancing or similar, that we should keep a keen eye on but not worry too much about, or is it something that is potentially more serious and that might become a big issue beyond China and for us here?
Dr Carney: Let me take a slightly longer lens. If we look over the course of the last few years, the Chinese economy has been slowing notably from very fast rates of growth. Since it is the second-largest economy in the world and has been one of the engines of global growth, that is having a material impact on global growth. It is one of the reasons why the global expansion continues to be quite tepid. There is a possibility that as they rebalance that economy towards more domestic consumption that it will take a further period of time and it will be further slowed. That is material and we should keep an eye on it.
In terms of what is happening in the financial sector, there are some considerable financial stability risks playing out in China and they are important for the short-term prospects of that economy, without question. The authorities have a number of tools and can take a number of steps to address them, but as Mr Kohn knows and we know from painful experience, it sometimes takes some time for those measures to have effect.
In terms of the exposure, the UK is exposed just in terms of global economic conditions, less than many other economies at the moment. That is both good and bad, given China’s ultimate prospects. In terms of financial exposure, most of the Chinese financial system is quite well-contained within China so there are not big financial links, direct financial links, out of China as there were in the case of the United States, for example, several years ago where it had more immediate ramifications.
Our institutions, a few of our institutions, have considerable exposure to greater China in terms of lending and other assets. That is one of the things we are looking at in the stress test. I would underscore that, while the Chinese economy has slowed, it is still growing at rapid pace and that asset quality remains quite high. However, this is something we are looking at not just in terms of the base case, the current level, but a stressed version of the base case, and we will be able to report on that later this year. It is something we are watching quite closely, yes.
Q77 Chair: I would like to take you back to the questions that John Mann was asking earlier, which are extremely important to this Committee and also to wider public accountability. We are trying in inculcate a sense of individual responsibility in banking and we are just wondering whether we ought to have a bit of it in the FPC as well. After all, we manage it in the MPC: people said the roof would fall in if people could offer differing views on what rates should be at any one time, and things seem to work perfectly well. It does seem that, as every year goes by with the FPC, there is another attempt to tighten the rules. We have been given a summary assurance that, in fact, these rules and guidelines have not been tightened as a consequence of the remit. Time will tell.
Can I ask Mr Sharp and Mr Kohn whether what is described as a “co-ordinated and consistent” way of communication would not inhibit you publically from offering a view that may—how shall I put it?—differ, nuance considerably or qualify substantially the view of the FPC?
Richard Sharp: As this Committee knows, the FPC is a young institution. I think these are material issues to look at very carefully because what we set now has to persist for some time. Particularly given the last interchange that I had with you, Chairman, I have given a lot of thought to this particular issue; you made the same point in terms of wanting to hear how the external members act, and actually—
Chair: And the thinking about it.
Richard Sharp: The thinking about it—
Chair: The thought processes are as important as the decisions.
Richard Sharp: —and, importantly, the accountability, because we have real powers and obviously you represent the people. We have to respect that accountability. We have not had the opportunity to discuss, as a committee, the new remit. I make that point.
Chair: We will come back to it.
Richard Sharp: We will have that later. However, as far as I am concerned, as I said, the discussions themselves are very objective in that the externals have to have the opportunity to speak; but in addition we do have the opportunity, on matters of materiality, to have our positions noted and, if necessary, have a vote. I think the prospect of that is real. That is a real authority that we have, potentially. In addition I take, as we mentioned earlier, extraordinary comfort from the importance of the scrutiny of how the FPC operates. I think that is the key element that ensures that there is not just the opportunity for us to speak up, which I believe we have—and I would do so myself—but also scrutiny of how the FPC itself is conducted. I am quite satisfied that the FPC is conducted in a way that allows free, open and rigorous debate.
Q78 Chair: This Committee has not yet had an opportunity to discuss these issues. However, the last Committee did and came to the view that, where financial stability would not be put at risk, there was merit in having these arguments and discussions, in a considered and balanced way, presented to a wider public for scrutiny, challenge and probably improvement, so that the decisions could be better informed. Is there anything you want to add to these exchanges on this issue, Mr Kohn?
Dr Kohn: No, Chair, but I make two points. One is I am very aware, as an external member of the committee, that it is my job to bring an independent view and my own personal experience to this. The reason for having external members on the committee was to guard against groupthink, as well as to bring our more varied experience to bear.
Chair: Now you are answering John Mann’s first question, which, curious though it may have sounded, was really saying, “What is the point of externals if they are going to come and say exactly what the full-time executives would tell us anyway?”
Dr Kohn: Right. We have also had discussions about the policy record and we are aware that, in reaching the consensus, it is helpful to present the full richness of the discussion as much as possible leading to the consensus. It may not be perfect yet but the committee is very focused on the communication with the public, and what would support the consensus and build the confidence of the public in our consensus is spelling out how we got there.
Chair: Many committees find it perfectly possible, including this one, to form a consensus while also having a range of views among its individual members.
Dr Kohn: Right.
Chair: It is that that we want to see more of. I would be grateful if the FPC could think carefully about that point when they consider the remit letter and look at the issue, perhaps, afresh at the beginning of this Parliament, and take this opportunity to help develop what you have described as a young institution, Mr Sharp.
Q79 Chair: Governor, I would like to raise one further point with you that you have not had an opportunity to see, no more than I—it has just been put in front me—which is that an IMF report that went round to the eurozone countries last night has concluded, and I quote, “The dramatic deterioration in the debt sustainability of Greece points to the need for debt relief on a scale that would need to go well beyond what has been under consideration to date and what has been proposed”. You described this as a Herculean task, Governor. Has the IMF already confirmed your view that even Hercules might not be up to it?
Dr Carney: Obviously, as you say, I have not seen what the Fund has said. In the statement of the euro group leaders, there was an observation that—I do not have the precise statement in front of me—subject to progress of Greece on various actions, they would explore the possibility of smoothing the debt profile in order to provide additional relief, and so on. They were words to that effect; no haircuts but changing the profile. That is the extent to which debt relief has been contemplated, as far as I am aware, by euro group.
The point I was making—which sounds to be consistent with what the IMF is saying and, I would think, consistent with members of the euro group of which I am aware—is that this is a considerable need and it is one that should be assessed as objectively as possible.
Q80 Chair: Has the Bank been giving thought to whether the IMF should have got itself so close to this whole issue, rather than offering independent advice to its quota members?
Dr Carney: I would say the following: the UK representative at the IMF is appointed by the Treasury, not the Bank. We have worked in recent days, weeks and months with the IMF to offer an independent perspective on some of these issues and potential solutions to these issues, in an effort to be helpful. The Fund is dealing with an extremely fluid situation, obviously, in Greece, and I would just reiterate that there is no simple solution, as you and the members of the Committee can appreciate. There will need to be debt relief, in our view—I think I am speaking for colleagues; certainly for myself—but debt relief, in and of itself, will not be sufficient. The other elements of structural reform and fiscal adjustment are going to be required, as will a measure of privatisation, ultimately.
Maybe if I can finish with this and associate myself with parts of an answer in the earlier session, I think it does underscore again that the institutions of the European Monetary Union are unfinished and need to be reinforced. This process, the scale of the issue, the response and some of the things that were contemplated on the weekend for Greece by the euro group underscore the need for considerable reinforcement and extension of those institutions for those countries that are part of the euro area.
Q81 Chair: Yes. Arguably, it is the IMF that also needs some reinforcement. The IMF has got itself into a bit of a pickle, has it not? It is very heavily exposed. Is it going to get its money back? Are you looking at that issue and at the vulnerability of the IMF itself? Is that being discussed?
Dr Carney: I think it is important to recognise the preferred creditor status of the IMF and that any contemplated extension adjustment to the debt of Greece should respect that. I agree that, as a personal view, it is important the IMF, in any situation, is an independent institution providing objective advice and making appropriate lending decisions in that context, that it is not—
Q82 Chair: Are you confident that it has been doing that?
Dr Carney: What I would say is that, even with the benefit of hindsight, given the stakes in 2010 and the contagion that was possible then because of the very grave imperfections in Europe, there was merit in not having a disorderly restructuring at that time. A much clearer-eyed assessment of the scale of the restructuring that was necessary was apparent to some at the time; it clearly would have been welcome, in hindsight. However, that is water under the bridge and what it important now is that the IMF is as objective, transparent and public as possible in its assessment of the debt sustainability of Greece. I would say that, with the release of the debt sustainability analysis last week and perhaps subsequent comments, this appears to be what they are trying to do.
Chair: The depth and complexity of that reply tells its own story with respect to the question, which was a simple one about the quality and independence of the IMF’s advice. That itself speaks volumes and we are very grateful for that reply, as we are for all the replies we have heard today. We are going to finish bang on time, as you requested, for your next meeting.
Dr Carney: Thank you very much.
Chair: Thank you very much for coming to see us, Governor. Thank you.
Oral evidence: Bank of England July 2015 Financial Stability Report, HC 315 11
[1] Correction by witness: Replaced ‘FPC’ with ‘FCA’.
[2] Note by witness: should say “135 investment funds”