Treasury Committee
Oral evidence: Appointment of Randall Kroszner to the Financial Policy Committee, HC 1029
Tuesday 24 January 2023
Ordered by the House of Commons to be published on 24 January 2023.
Members present: Harriett Baldwin (Chair); Anthony Browne; Emma Hardy; Dame Andrea Leadsom; Anne Marie Morris.
Questions 1 - 66
Witness
I: Randall Kroszner
Witness: Randall Kroszner
Q1 Chair: Welcome to this morning’s Treasury Committee evidence session. We are here for your pre-appointment hearing, as you have been appointed to the Financial Policy Committee. Good morning. You have a very distinguished US career and a US background; what appealed to you about taking a position on the Financial Policy Committee?
Randall Kroszner: Thank you very much for having me. I am honoured to be appointed to this position to be able to work with you and other colleagues in the UK. I have enormous respect for the United Kingdom. I lived in the UK from the fall of 2019 until the end of 2021. I was deputy dean at that time and building out our campus here. The University of Chicago has a long history with the UK, as do I.
In particular, the Financial Policy Committee is an excellent structure as a macroprudential regulator. The structure of having the Bank of England, Monetary Policy Committee members, the regulators and then external members to come and think about the big picture, macroprudential issues is a very good structure. It is a particularly interesting time to be working on these issues.
I have been working on these kinds of macroprudential and microprudential issues throughout my 30-year academic career. Then I was in the eye of the storm, chairing the Supervision and Regulation Committee at the Fed from 2006 to 2009, so these issues are extremely interesting and important to me, and I have thought about them a lot. The structure that the Financial Policy Committee has here is an excellent way to try to deal with those issues, and to try to take past experiences and academic work and put it into practice.
Q2 Chair: Were you approached by a headhunter? Is that how it happened?
Randall Kroszner: Yes, an executive search firm reached out to me.
Q3 Chair: You mentioned that you lived in the UK from autumn 2019 until 2021. Were you permanently living here, setting up the University of Chicago or working on some of that campus work?
Randall Kroszner: Yes, I was here full time.
Q4 Chair: You were here for the pandemic, then.
Randall Kroszner: Yes; it was a little unusual time to be in the UK.
Q5 Chair: Other than that, tell us what your research work has done that particularly focuses on the UK. What is your knowledge of the UK economy, and the differences between the UK economy and the US economy?
Randall Kroszner: Certainly, there are very important differences between the US and UK. When I was in my official capacities—both when I was working in the White House as a member of the President’s Council of Economic Advisers, and at the Fed—I very much engaged on the international issues. I went to Bank for International Settlements conferences and conferences of the Bank of England, and I have also done that as an academic. I have had a lot of experience in thinking about and being exposed to issues in the UK. Certainly, during the two and a half years I was here, that was an excellent way for me to become more familiar with the UK, the different schemes that were used in responding to covid and how the economy was responding. I continue to be a very keen observer of that.
Q6 Chair: At the moment, you have your role as a professor, which you intend to carry on doing.
Randall Kroszner: Yes, I do.
Q7 Chair: You chair the advisory committee to the US Treasury, the Office of Financial Research, and you are a member of the Federal Reserve Bank of Chicago’s Academic Advisory Council. Might you need to cut back on any of these activities to devote the time required to being a member of the Financial Policy Committee?
Randall Kroszner: The key thing that has changed my time commitments is that I have finished my time as deputy dean. When I was here, my role was to build out our international operations, particularly here in the UK. That administrative role took an enormous amount of time for me. I finished my term over the summer, so that has given me more opportunity to be able to devote to things like the Financial Policy Committee.
Q8 Chair: In terms of your ongoing horizon scanning of the UK economy, how much of that will you do from here in the UK—or will you be looking at it from Chicago?
Randall Kroszner: I will try to do it from both. Certainly, I will come as frequently as I can to the Financial Policy Committee meetings. Also, the Bank has an agency network throughout the United Kingdom. When I was at the Federal Reserve, I found that we have a similar kind of thing with a structure of regional Federal Reserve banks, and it was valuable to visit the banks in the different parts of the country in order to find out what was going on, to understand things on the ground and to be able to explain what we were doing to a broader range of people directly. I hope, during some of my visits, to be able to take advantage of the Bank’s agency network and to travel throughout the UK.
Q9 Chair: I know that Andrea will have some questions on some of the detail, but you sent me a very thorough letter regarding your financial interests and you provided a lot more information to the Committee last week. Have your discussions with the Bank highlighted any circumstances regarding your future interests? I know it is hard to speculate on that, but do you have anything in the pipeline that might cause you to have to recuse yourself from any of the discussions?
Randall Kroszner: As you said, we have had very thorough discussions and tried to proactively think in a forward-looking way. As you said, it is never possible to have perfect foresight, but I do not see anything in my activities—and I do not think that the Bank’s Secretary sees anything—that would likely lead to recusal.
Chair: Thank you. I know, Andrea, that you wanted to ask some more questions on the UK attendance side of things.
Q10 Dame Andrea Leadsom: Thanks. Good morning, Professor Kroszner. First of all, how will you find time in your diary to meet the diary commitments of the FPC?
Randall Kroszner: Fortunately, as a professor, I have a great deal of flexibility in my schedule. I teach for a quarter a year—that is a nine-week quarter—and I have obligations that I must be in Chicago for the days that I am teaching. Fortunately, the way things work out is that I am teaching the spring quarter, so that would be end of March through to the end of May. There really aren’t any FPC meetings during that time period, so I am fortunate in that.
As I said, I have a lot of flexibility to be able to come over here for the meetings. That said, since the calendar was set up before I became a member, there will be a few conflicts. I will not be able to attend all the meetings—I will have to attend some via Zoom or Teams—but my intent is to participate as much as I can, because the reason for doing this is that I want to be engaged with it. It is an extremely interesting set of issues and I believe that I will be able to learn a lot from actually being here, talking with people, including the staff and my colleagues. I think that is the most effective way in which I can participate.
Q11 Dame Andrea Leadsom: As a rule of thumb, what would you expect your physical attendance rate at FPC meetings to look like? Then, would you expect to attend every FPC meeting either virtually or physically?
Randall Kroszner: Certainly, I expect to attend every meeting virtually or physically. I do not see any conflicts that would prevent me from, at the very least, attending every meeting virtually, but my intent is to come to as many meetings as possible.
Q12 Dame Andrea Leadsom: And how many will that be? You’ve said that already.
Randall Kroszner: I would say the vast majority. I have not actually counted it out, but I would say that I should be able to attend the vast majority in each cycle.
Q13 Dame Andrea Leadsom: Okay. In terms of travel costs, you will be aware that there has been some criticism of the enormous costs, which are partly paid by the taxpayer. How do you intend to manage that?
Randall Kroszner: As you said, obviously I could save the taxpayer money by not coming, but I think that that would not serve the taxpayer well regarding my participation in the FPC. I think it is valuable for me to come, so I will try to come.
My understanding is that two air fares are provided each quarter for the meetings. If possible, I will use only one, but I think that, in many cases, I will need to use both. There are limits imposed on the reimbursement for housing and for food, and obviously I would not be exceeding those limits, or, if I did exceed those limits, I would be responsible for those costs.
I would try to use the visits as effectively as possible either to engage with the Bank’s agency network in the UK to travel around and understand the different parts of the UK economy better, or to work with colleagues and staff at the FPC.
Q14 Dame Andrea Leadsom: For taxpayers listening to this, would you say that the overall cost should be taken into account when recruiting members of bodies such as the FPC? Undoubtedly, a UK national who already lives here would be considerably cheaper overall to hire, so what are the benefits to the taxpayer?
Randall Kroszner: One of the things that I think is quite special and excellent about the Monetary Policy Committee and the Financial Policy Committee in the UK is that there is an openness to have people participate in it who are not from the UK. There is, at least from my perspective, a great value in having diversity of thought coming in. Having an international perspective is quite valuable, particularly on something such as the Financial Policy Committee, where one of the key issues is looking at global interconnections and fragile global interconnections. Although there are costs associated with bringing someone in from the outside, they can be significantly outweighed by the benefits of having that global perspective and having different perspectives from around the globe.
Q15 Dame Andrea Leadsom: Okay, thank you. Can you confirm that you do not have any financial interests that might give rise to a perceived or an actual conflict—for example, investments in cryptocurrencies, Bank-held assets or anything that might cause taxpayers here in the UK to have concerns about your suitability?
Randall Kroszner: That is correct. I have worked very closely with the Bank’s Secretary to look at not only actual conflicts, but perceived conflicts, and I believe I have no such conflicts.
Q16 Dame Andrea Leadsom: Thank you. Let me turn to confidentiality conflicts. Is there any area in which you could imagine being given privileged information here in the UK as a result of your membership of the FPC, and finding yourself having to recuse yourself either here or from one of your many roles in the United States as a result of a potential conflict of interest?
Randall Kroszner: I don’t see that being the case.
Q17 Dame Andrea Leadsom: You are not concerned that you might be given information on the state of the UK economy that you could use to benefit one of your roles in the Unites States?
Randall Kroszner: I don’t see that being the case, but if such an issue did come up, I would not use the information in that way.
Q18 Dame Andrea Leadsom: Okay. Are there any circumstances in which the research you are doing may have to be curtailed due to your commitments to the Financial Policy Committee—for example, if you were looking into something that could be deemed as a criticism of UK policy or something that in some way implied inadequacy in the UK?
Randall Kroszner: I don’t see that coming up as a conflict.
Q19 Dame Andrea Leadsom: Okay, thank you. What about your current state of knowledge of the UK economy and macro policy? Is it adequate or are there certain areas on which you will need to update yourself?
Randall Kroszner: There are always opportunities to learn. Economies and financial systems are evolving. The change that occurs—whether that is technological or different kinds of shocks—is one of the important things the FPC needs to look into. There is always more for me to learn. I am a very curious person, so I am eager to learn more.
As I mentioned in my questionnaire, there are a few areas that it would be helpful for me to understand better. Given some of the macroeconomic challenges, better understanding the administration and bankruptcy regime is important, because that can have a very big impact on the availability of credit, and the ability of firms to continue on an ongoing basis and maintain employment. That is an example of one area that is worth me understanding in more detail.
Q20 Dame Andrea Leadsom: Thank you very much. Have you noticed any difference between how the US and the UK operate financial stability policy? Is there any area where you think, “I’m going to use my knowledge of US operation to benefit the UK”?
Randall Kroszner: I do think there are important differences. The structure here, with the Financial Policy Committee, is excellent. In the US, the equivalent has two pieces. There is the Financial Stability Oversight Council—the so-called FSOC—that brings together the regulators under the chairmanship of the Treasury, but that does not have the same role as the FPC. That is more a meeting for the robust discussion of issues, rather than having any decision-making power. The structure here is better—having the decision-making power and the power to make recommendations. It is a structure that gets more direct engagement of the different regulators.
One issue I saw when I was at the Fed during the global financial crisis is that we had a lot of siloes. The Fed was a banking regulator. The Securities and Exchange Commission was an investment banking regulator. When I was chairing the Supervision and Regulation Committee—I took over the chairmanship of that part way through my time as a governor—we were in the process of negotiating an information-sharing agreement between the SEC and the Fed, which struck me as rather odd. We are two federal regulators, and while we are focused on different parts of the financial system, they are obviously very interconnected. That shows one of the challenges when you do not have the information flow and there is not good communication between the different regulators. The FSOC is a step in that direction. Something like the Financial Policy Committee, which is a more formal body that puts out reports and that needs to make decisions, is a much better way of doing that.
One of the things I saw during the global financial crisis is the great importance of thinking about interconnections. I think that is one of the things that the FPC needs to think about. Those can be domestic, or they can be international. Obviously, for the global financial crisis, problems in the housing market in the US had global implications here in the UK. It had implications for Northern Rock, for example, which was one of the first banks in the world to get into severe distress. Even though it had no direct exposure to the US, it had a lot of indirect exposure; the business model was very much the same. That was very valuable to see; you need to step back and see that, while in the narrow you may be doing everything right, if you are in a dangerous neighbourhood, you have to think about what is going on around you.
That is one of the key lessons from my experiences at the Federal Reserve in the US. You have got to be looking for those sorts of things; you can never be complacent and say, “We got it right. Our banks are well capitalised.” Our banks may be well capitalised—your banks may be well capitalised—but there are a lot of other fragilities that can turn a well-capitalised institution into a challenged institution if the environment is problematic.
Q21 Dame Andrea Leadsom: I completely agree with you there. I have one last question. You will be aware that the UK economy is very highly exposed to the financial services sector. I wondered whether there are other major differences between the UK and US financial risks outlook, and, in coming to the UK, whether there were things you would want to keep a close eye on from your knowledge of the situation in the United States?
Randall Kroszner: One of the issues is the role of central counterparties—that is not a difference, but it shows the close interconnection. Obviously, that is extremely important in the UK, and really provides structures, such as the metal exchange, the clearing system at the stock exchange and others, that have a truly global role. That is also true for key institutions, such as the Chicago Mercantile Exchange, where I reside. Really thinking carefully about those global interconnections, and how such a small number of these institutions are important nodes throughout the entire system, is super-important. It is important to understand that it is a relatively small number of players who are the key counterparties on each of these exchanges. Individually, they may be very well structured and managed, so the microprudential part is extremely good, but the challenge is if there is an issue affecting these institutions across the globe. That would be something that would be valuable to look at.
I am delighted that the FPC has begun a preliminary process of doing some stress testing around these types of organisations. That is something that I have done a lot of work on with the Chicago Fed and is something that I am eager to work on with my colleagues at the FPC here.
Q22 Chair: Thank you, Andrea. That prompted another question from me. It sounds like the majority of your time is going to be spent in the States. When you are there, how are you going to be following what is going on? What are going to be your sources of information, in terms of the media, while you are in the States?
Randall Kroszner: Since being in the UK I have followed the UK media quite closely. I have subscriptions to The Times and The Guardian, and I always look at the UK version of the Financial Times and the BBC, and so on, so I look at a whole variety of media like that. Then, as a member of the FPC, I will be getting a lot of briefings. They have some less formal briefings that are not specific to just the particular policies and issues that we are discussing that quarter, but are on bigger-picture issues—research reports on what is going on in the UK—so I will be getting a lot of information through that.
Also, my understanding is that the staff are quite generous and willing to answer questions. If I want to understand more about a particular aspect of the economy, I think they would be quite helpful. Certainly, they have been extraordinarily helpful so far, and I anticipate that to be the case going forward.
Q23 Chair: You are obviously someone who sits on a lot of panels, you go to a lot of different conferences and you are asked your opinion about things. What has the Bank said to you about expressing opinions on the UK from overseas—in the way that we discovered the IMF was very keen to do in September and October, but not on the record, to us?
Randall Kroszner: That is something that I have spoken about with the Bank Secretary, because I appear at conferences and I do media. I will not be commenting on the UK economy, UK monetary policy or the issues that the Financial Policy Committee is considering.
Q24 Chair: Or on any particular financial institution, presumably.
Randall Kroszner: Yes, in general I avoid doing that, and certainly I would not be commenting on any UK financial institution.
Chair: Did you have another question, Andrea?
Q25 Dame Andrea Leadsom: You will be aware that in the UK there is a new secondary objective of competitiveness for UK regulators. How do you see that interacting with the FPC? Will you be in favour of that? Against that? How does that impact on your judgments?
Randall Kroszner: I think it makes a lot of sense to have that. Obviously, the primary objective is thinking about the resiliency of the UK financial system. That is the primary objective that the FPC has, but I do not see any incompatibility between having a competitive system and having a system that is stable. In fact, I think they can be complementary to each other, because a strong competitive system is one that will be generating profits for the banking system and will help to build capital and confidence in the system, which is a very important part of it.
One of the things that is attractive about the Financial Policy Committee and being engaged in the UK is that the UK is a very important global financial centre, and maintaining its competitiveness is crucial in order to maintain its global position and strength.
Q26 Anthony Browne: You mentioned in an earlier answer your concern about central counterparties. What are the other main risks that you see to financial stability in the UK?
Randall Kroszner: There are issues of cyber-security, for example. Those are not unique to the UK, but they are very important issues. We need to be not only focused in a micro-way on each individual institution, but thinking about the interactions between them. Coming back to something like a central counterparty, if there is an issue at a central counterparty, there is a cyber-issue that makes it difficult for settlement to occur, for example. That has cascading consequences throughout the entire financial system, and not only for the biggest financial institutions, but also for households, if the financial institutions are uncertain about exactly what is in their accounts. That could lead to freezes throughout the system, so that is one very important area.
Again, this is not unique to the UK—but I do think it comes in with great force here—but there are also geopolitical shocks; obviously, Russia’s invasion of Ukraine has had an enormous impact on many markets, including commodity markets and energy markets. That can also lead to divestitures and sanctions that could cause financial issues for those lenders. Obviously, that is outside of the financial system and the UK’s control, but it is something that needs to be watched very carefully and that we need to be ready for. That does not mean that we can predict each individual shock that may come in the geopolitical sphere, but just because we cannot predict that, that does not mean we cannot be prepared for it—that we cannot do scenario planning and analyses that look at a class of risks. Those are a couple from off the top of my head that I would be worried about and be focusing on.
Q27 Anthony Browne: One of the shocks that we had recently was when there was the mini-Budget and gilt prices slumped, and then we had this issue about the liability-driven investments that threatened to undermine our pension funds and led to emergency intervention by the Bank in the gilt markets. The FPC had—you mentioned this in your evidence—identified that as a risk, but then, in your words, “there was arguably not sufficient follow through to avoid the stress occurring.” Having identified a problem like that, what is it that the FPC could or should have done to mitigate the risk?
Randall Kroszner: As you said, I noted that I think the FPC gets credit for finding the risk. One of the challenges of doing macroprudential policy is that—I use an iceberg analogy—it is not what is above the waterline that is most problematic, but what is below the waterline. I think the LDI was below the waterline, and I think it was valuable that they had identified that.
There are a lot of different risks out there and it is sometimes difficult to set the priorities. One of the things that could perhaps have got a bit more attention is trying to do more detailed stress testing around LDI. If there were large, rapid movements in interest rates, how might that filter through to their actions and the knock-on consequences for markets—not only here, there were global consequences of that? That could have been integrated into scenario analyses and stress testing.
In particular, the FPC is now undertaking some work in the non-bank financial area for doing stress testing. That is a particularly challenging area because that is almost all below the waterline. The data are not there. It is not as easy and not as transparent. But that is something that I have been working on with the Office of Financial Research in chairing its advisory committee: trying to look below the waterline. Where would you like to be getting data? What would you like to be looking at? Trying to do those kinds of things is something that I think would be valuable going forward. It is not going to be as detailed as a traditional bank stress test because we do not have the data, but I think it is worthwhile to take those steps in that direction and I think that will be helpful in trying to identify some of these risks and to try to look at the implications of something like LDI and other things like that.
Q28 Anthony Browne: You mentioned the potential of doing stress tests, but the FPC also has other powers—the powers of recommendation, for example, which they did not use for the LDIs. Do you think that the FPC has been too shy in deploying its different macroprudential tools? Should it be more interventionist or not?
Randall Kroszner: I would rather get away from “more” or “less” and focus on what is most effective and most important. In a number of areas, the FPC has been very important in making recommendations. Here may have been an area where it would have been helpful to do so, but certainly I, as a member of the FPC, will have no hesitation in pushing for that. There is a long history at the University of Chicago of people speaking up. It doesn’t matter whether you are a Nobel prize winner or the most junior faculty member, you speak up and you voice your opinion. I would certainly say that the FPC should be doing that and, if I see a risk, I will argue very strenuously with my colleagues that we need to make a recommendation.
Q29 Anthony Browne: On LDIs, do you think, with the benefit of hindsight, that the FPC should have done more—called for stress tests or made recommendations on it?
Randall Kroszner: I think doing further stress testing would have been valuable, but, as I said, it is tough because it is outside of the typical ambit of getting the data. My understanding is that the Pensions Regulator is not part of the FPC and so that makes it more difficult. That does not mean that it should not be done and doing more non-bank stress testing will be valuable, and that is something that I will promoting at the FPC.
Q30 Anthony Browne: The Governor told us last week that a lot of the pension funds that were most impacted by the LDI issue were domiciled outside the UK but in Europe. Do you think it is important for the FPC to co-ordinate or co-operate internationally with other regulators, and how difficult or easy do you think that would be?
Randall Kroszner: I do think it is very important because, as I mentioned earlier, a lot of the fragile interconnections are global; they are not just domestic. Also, you often do not have as much insight into what is happening outside the UK because you do not have the same access to data, so trying to build relationships with other regulators and supervisors to be able to perhaps do some joint stress exercises would be extremely valuable. I think that would be one concrete way to try to do this. There are fora like the Bank for International Settlements that bring regulators together through the Basel Committee and the financial stability committee. Those are good fora for discussion, but I think going beyond just a discussion and having, if possible, some sort of tabletop exercise to go through—to understand how a particular stress will manifest in a different country, how those supervisors will respond to that and then to try to take that into account in the UK—would be valuable. That is something that would be very important, and it is probably most important in the non-bank area.
Q31 Anthony Browne: The impact of the mini-Budget on the gilt markets meant that the Bank had to delay starting quantitative tightening. Do you think that the timetable and quantitative tightening itself has, or could have, any impact on financial stability in the UK?
Randall Kroszner: Obviously, the Bank of England has engaged in trying to withdraw some liquidity from the system through so-called quantitative tightening, and it did have a targeted intervention to deal with the disruptions that were associated with LDI. Much to the Bank’s credit, it clearly differentiated the financial stability action from the monetary policy action, and it had a limited duration. I think it was very important that the Bank clearly articulated that and differentiated it from the monetary policy action. It had a limited duration. It stuck to that, so I do not think that that then impaired its ability to continue down the quantitative tightening path.
Q32 Anthony Browne: You have mentioned several times in your answers your concern about the non-bank risks, the sort of shadow banking—I don’t know if you used that word or not. Do you think those risks in the unregulated, or less regulated, non-bank sector are the result of either capital requirements being too high or the banking sector being over-regulated? Or do you think the balance is right?
Randall Kroszner: That is a very important issue, and it is one that I have worked on, thinking about unintended consequences of regulation. In response to the global financial crisis, we significantly increased—not only in the UK but globally, through the Basel Committee—capital requirements and liquidity requirements, and those were necessary. There was no doubt about that. Exactly as you said, you need to get the balance right, because you could keep raising capital requirements and liquidity requirements, but that does not necessarily mean that you have reduced risks in the system—you can just have them migrate elsewhere. I think it is always very important to be conscious of the potential unintended consequences of that. I do not think that the broad range in which capital is for UK banks has been a significant factor in driving things outside of the banking system, but it is something that one needs to look at and take into account to get that balance right. Some people say, “Well, you shouldn’t be soft on the banks,” but it is not an issue of being soft on the banks, and you are not being soft on the banks; you want to think about the risks for the system as a whole. If you simply migrate risks out of the banking system, but there is still an interconnection back into the banking system, you have not made the system safer.
Q33 Anthony Browne: Do you think the balance now is right in terms of regulation? After a financial crisis, you obviously get more regulation as a result and there is a theory that the pendulum goes too far and ends up correcting backwards. Do you think that is what is happening at the moment or that should happen?
Randall Kroszner: We have had significant increases in capital requirements. I do not see a significant swing back to reduce those capital requirements, and that seems appropriate to me. We have had a good stress test for the increase in capital requirements with the health crisis—with covid. That easily could have turned into a financial crisis but didn’t—here in the UK as well as globally. That was, at least for me, a good stress test to suggest that we have a good amount of capital. I don’t think we have capital requirements so high that that is impairing the ability of the banking system to generate profits and to be able to expand. We have seen that many banks are still quite robust and have reasonable returns to their shareholders. So I think we are in a reasonable position.
That said, I think it is very important to always review regulations—that is true not only in financial services but elsewhere—not to rip them up but to review them to see whether they are still fit for purpose. The financial system is always evolving, and sometimes the financial system evolves specifically because certain regulations have come in and so you want to see whether there has been an unintended consequence. I think it’s important to do that kind of review and I know that the Financial Policy Committee does that sort of thing. I don’t see any glaring issues right now, but maybe as I look into things in more detail with my colleagues in the FPC I might.
Q34 Anthony Browne: That is what I was going to raise next. One of the reviews that the Government have looked at is the so-called Edinburgh reforms, which the Chancellor announced in Edinburgh. This is looking at the whole range of financial regulations post crisis. The two most high-profile reviews are on the ringfencing regime for UK banks, and the senior managers regime—I don’t think you have an equivalent in the US. And there is a whole series of recommendations for reforms of ringfencing and review of the senior managers regime. An example on ringfencing is raising the threshold for assets from £25 billion to £35 billion, which means a whole load of banks would be excluded that might otherwise come in. Do you have any concerns about those reforms to the ringfencing regime?
Randall Kroszner: My understanding is that they have not been fully fleshed out yet, so I would certainly need to see more detail on them before having a full view, but as you said and as I had said, it is valuable to have a periodic review of regulations. I think, on something like ringfencing, there is a little bit of a parallel to a review that we had in the US of the so-called Volcker rule.
Q35 Anthony Browne: That’s a lot more specific, though.
Randall Kroszner: Yes, ringfencing is more specific, but this was trying to address a similar kind of issue: if you have commercial banks that have a lot of retail deposits but are also involved in investment banking, could there be some risks if you are involved in both those activities? We took a different approach in the US, but actually a very similar review was done, because the Volcker rule had been applied pretty much to all banks—many banks that had basically no operations in investment banking—and it was seen as not fit for purpose for that; it was a large burden without really having much benefit. So I think undertaking that kind of review here is sensible also. We want regulations to be effective. It’s not useful to have regulations that have unintended consequences and just raise burdens without actually having a good impact on either microprudential or macroprudential outcomes. So I think a review of that nature makes sense. On exactly where the line should be, I would need to have more detailed analysis to understand where would be appropriate—whether we are dialling back too much on risk or whether we are making the right assessment that applying ringfencing to smaller institutions really is not providing much benefit and is just having a large cost.
Q36 Anthony Browne: Do you think that with these moves to deregulation, there is a risk that we collectively and the Government specifically have forgotten the lessons of the financial crisis?
Randall Kroszner: I think it is very important not to forget the lessons of the financial crisis. One thing that sometimes disturbs me a bit is that I teach MBA students, who are in their late 20s, and I talk a lot about the—
Q37 Anthony Browne: They were children when the financial crisis happened.
Randall Kroszner: Yes, now I’m talking about financial history when I talk about that in class, which sometimes makes me feel a little bit old. But that’s worrisome. I think that when people have experienced a crisis, that affects the way they approach things. I think it’s very important not to forget it. Certainly that is something that I will bring to the Financial Policy Committee: having lived through that experience, that is something that I will never forget. I think it’s important to keep it in mind. We will have to see how the whole package turns out, because it’s quite a few reforms; I think there are approximately 30 different reforms. We also have to look at how the reforms interact with each other. So I think it’s important not to forget that.
That is also very important for the UK as a competitive financial centre. You want it to be a well-regulated financial centre, one that is well respected and one where people have confidence that there is a good, effective regulatory regime in place. I think that goes hand in hand with a globally competitive financial centre.
Q38 Anthony Browne: Last question: we have just had figures this morning on Government borrowing and national debt for December. Borrowing was £27.4 billion, which is the highest on record, and of that, £17.3 billion was debt interest. This is several times higher than we have ever had to pay before. Do you think the level of national debt and debt interest payments pose any risks for financial stability, or is it a completely separate issue that we do not need to worry about?
Randall Kroszner: It is something that one needs to keep an eye on, for sure. There can be shocks that come in, such as what happened with LDI, that can raise issues. Not only the UK but many countries around the world are seeing significant increases in their debt payments as interest rates go up. That is an issue that the FPC should be monitoring, both in the UK and globally.
Q39 Anthony Browne: What impact could that high level of indebtedness and debt interest payments have on financial stability?
Randall Kroszner: One question would be: could that raise questions about ability to repay? If that raises questions about ability to repay, whether in the UK or in other countries, that can lead to changes in interest rates and changes in liquidity and in markets that people rely on to be liquid markets. So it would be through those, and then interconnections to other markets. As I mentioned, the challenges in the UK gilt market had an impact on the US treasury security market. It is not just that the big markets in the US can have an impact globally; it can be other significant markets around the world having these knock-on consequences. That is the sort of thing that I would be monitoring for, and hopefully we would be monitoring for, at the FPC. This is a global challenge.
Q40 Anthony Browne: Just to be explicit, you think that the FPC should pay particularly close attention to the level of Government borrowing and national debt.
Randall Kroszner: It should be looking at that for its implications for financial stability.
Q41 Chair: Thank you, Anthony. Anthony raises quantitative tightening. When we have had members of the FPC in front of us in the past, I have asked whether there has been any academic work on what quantitative tightening equates to in rule-of-thumb monetary tightening. I was told that there had not really been any work done on that. Is that your experience as well?
Randall Kroszner: There certainly has been work done; I am more familiar with it in the US context. We tried to come up with very rough rules of thumb, as you said: for every additional $100 billion-worth of securities purchased, what would that translate into in terms of changing, in the US, the federal funds rate—the short-term interest rate? I do not have those numbers off the top of my head. They are very much rules of thumb. I would say that most monetary policy makers would not feel comfortable in saying, “Aha! That $100 billion translates to 25 basis points, or 50 basis points.” I also think it can be different in different circumstances, such as at the beginning of quantitative easing or quantitative tightening versus the end. It seems that, for example, quantitative easing is more effective early on, after central banks have accumulated a lot of assets; to have the same sort of financial impact you have to buy more assets. So it is not a simple linear thing.
Q42 Chair: No, I can see that it would be state-dependent. I think probably there is some data now emerging on quantitative easing. As central banks around the world embark on this quantitative tightening journey, there seems to be a frighteningly low level of knowledge as to exactly how much tightening quantitative tightening involves.
Randall Kroszner: I think that is right. I think part of it is that we have not really experienced that, so it is hard to have a good set of data to analyse. Some people try to use analogues with quantitative easing, but as we were just describing, that may not be appropriate because, first, it is quantitative tightening and, secondly, it is a very different circumstance when central bank balance sheets are very large. We are also obviously in a period of a lot of global macroeconomic stresses.
Q43 Chair: Thank you. You would agree that the impact is not likely to be zero.
Randall Kroszner: Yes, certainly, I would agree that it is not likely to be zero. Central bankers would be surprised if it were zero.
Chair: Okay, great.
Q44 Anne Marie Morris: Professor Kroszner, I am absolutely fascinated by your iceberg. It seems to me that what we have been talking about, in terms of trying to manage stability and reduce instability, is applying a number of processes to try to ensure we get stability, but that process has been applied to data and facts. You yourself said that one of the challenges is a lack of transparency, particularly with regard to the facts below the waterline, if I can put it like that.
What is it that one could/should do to begin to do proper scenario planning to identify some of these issues before they arise? We have talked about what happened in the financial crash where we had the bundling of the sub-prime mortgages. Had we seen that coming, would we have done things differently? Now we have had LDI. Had we seen it coming, would we have done it differently? What is it that we could/should do? Is there anything that is being done in the US? Is there any academic thinking about what we need to do to try to do a better job of seeing these things coming, rather than having to react and then learn?
Randall Kroszner: That is an extraordinarily important point, and it is extraordinarily difficult. I chaired the advisory committee to the Office of Financial Research at the US Treasury, and its remit is basically to look between the cracks. It looks for the things that the individual regulators are not seeing, and at some of those deep interconnections that can be under the radar.
The advisory committee acts, in a very, very small way, like having external members of the Financial Policy Committee. It brings in experts from the markets and academia to talk about issues they are concerned about. They may be generated purely by academic theory, or they may come from people in the markets who are saying, “Do you realise that we have these sorts of issues? Have you been looking at this?” It is about trying to get that kind of input by looking for different players who have different points of view, from markets and academia, and saying, “What should we be looking at?”
One way I approach it, from my experiences in the global financial crisis, is by trying to look at categories of risk—markers. One is whether the sector is large and growing. Even if you don’t have the direct data on it, you can sometimes tell that some sectors are moving rapidly. You might then want to put a priority on that. Do you see a lot of leverage in that sector? Housing was a classic example of that. It is always an example with relatively high leverage, but if there is a new area that is borrowing very heavily, even if you don’t have full data on it, that may be something that you want to focus on.
Is an area relying a lot on a particularly liquid market that is easy to get in and out of? Markets are liquid until they are not. That is certainly something that I saw with great force during the global financial crisis. We had these deep liquid markets in mortgage-backed securities and other short-term securities, which suddenly dried up. Is there a reliance on those? Then, of course, there are the interconnections with the rest of the system.
One of the things that one can do is try to think creatively, drawing on these different academic and market thoughts, and do a deep dive—let’s use that analogy, because we are going below the waterline—to look at something in the non-bank financial sector. You are not necessarily going to get it right or have exactly the right focus, but asking those questions might lead to you saying, “Oh, we hadn’t really thought about that,” or, “Oh, we didn’t really understand this interconnection. Let’s pursue that further.” I can’t give you the framework that is used, but I can give you some markers and some approaches of how we have got inputs into the advisory committee to the Treasury Department, which I chair.
Q45 Anne Marie Morris: So, particularly in your new role on the FPC, will you be recommending and encouraging the UK to take what you just described more seriously? I can see it being left as a nice idea without it actually happening. It seems to me that change is happening faster and faster, and if we leave it, we are going to find ourselves unprepared for next crisis, as we were for the last two.
Randall Kroszner: Yes, it is super-important to do that. Will we always be able to find them? No, because there will always be something that is deep below the water level that we will not see, but focusing on that and realising that that is really what our focus needs to be can be helpful in trying to anticipate some of those issues.
Q46 Anne Marie Morris: What about one of the underpinning pieces of this, which is transparency? Is there anything that we could/should do to increase that? That is always a huge commercial, political barrier, but clearly with transparency, a lot of these things will be spotted a lot earlier.
Randall Kroszner: Yes, for sure. It is very important to understand exactly what data you want; some people say, “Well, just give us more data”, but you can’t just say that. One, even if you do get all of it, you have to make sense of it: just because you have a lot of data does not mean that you can actually use it to identify something.
One of the things I would hope to work with my colleagues at the FPC on is to potentially make recommendations for gathering more data and having more disclosure in particular areas that are seen as fraught and fragile. I am not sure exactly what those areas would be, but I think that could be something that could be valuable for an FPC recommendation, trying to come up with more information in that area. It is certainly one of the things that the Office of Financial Research at the US Treasury also tries to do—monitor for these things, and then suggest, “It would be great if we could get more data in a particular area.”
Q47 Anne Marie Morris: Okay, thank you. We have an interesting toolkit of things that we can use—we talked about quantitative easing, and now we are into tightening. We have the Edinburgh reforms; they are different, but they all play a role in this whole smörgåsbord of process interventions. What do you think about the countercyclical buffer? Do you think that works as well as it could/should?
Randall Kroszner: It is an important piece that the FPC has worked on, and it has said, “We need to have a countercyclical capital buffer to be able to provide a cushion when there is a downturn.” I think that is a very important part of the toolkit. It is important to get the balance right in that, because you want to make sure that you have that cushion that can be drawn on if there are tough times, but you also want to make sure that you can draw on it and that you do not, as an unintended consequence, create a credit crunch. Historically in the US, when we did not have a countercyclical capital buffer, that was one of the challenges: we would have a downturn, and then credit conditions would tighten and that would actually make the downturn a bit worse.
By having the countercyclical capital buffer that you can draw on, the idea is that you have that cushion to be able to draw down, and it will not lead to a credit crunch. I think the countercyclical capital buffer can be very helpful in that, and I am glad that the FPC has recommended that we have one here in the UK. I guess the recommendation of the implementation of the first 1% was roughly a year ago, and then it was implemented at the end of last year. I think that is going to be helpful, because obviously there are a number of macroeconomic headwinds that are facing the UK.
Anne Marie Morris: That is very helpful. In answer to Mr Browne’s question right at the start, which is not quite “what keeps you awake at night?” but “what are the things out there?”, I guess right now, one of the things that is clearly an issue has been the cost of living crisis around the world. Interest rates have risen; that has had a huge impact on household finances and the level of debt, and it has also had impacts on corporate debt and the state of their finances. What are your thoughts in terms of the impact or risk—let’s take household debt to begin with. How do you think that is going to play out, and what impact, if any, do you think that might have on financial stability?
Randall Kroszner: That is a very important thing to look at, because obviously, this was a very important issue during the global financial crisis. Fortunately, banks are much better capitalised, and in general—certainly in the UK, as well as in the US—there are higher down payments, so the loan-to-value ratios are not as great as they once were. That helps to provide cushions there.
That said, in the UK, unlike in the US, there are far more mortgages where the interest rates will be reset over the next year or two. In the US, interest rates had come down quite a bit. Given the structure in the US that households are able to refinance into a 30-year fixed-rate mortgage—a unique product globally—a lot of people in the US who are in their houses have long-term, very low-interest rate mortgages, so even though interest rates are going up significantly, their mortgage payments are not being affected by that.
In the UK, that is different, as you have a much higher proportion of loans for which the interest rates will be reset in the next few years. That obviously puts more of a burden on households, which are facing a cost of living crisis, as costs of food and energy have gone up very significantly. That needs to be watched very carefully to ensure we do not get into a problematic cycle where people cannot afford to pay their mortgages and therefore have to move out of their homes, which puts downward pressure on prices in the housing market, which leads to more people potentially not being able to pay their mortgages or defaulting on their mortgages. It becomes a problematic cycle. It is the sort of thing we saw in the US and other countries during the global financial crisis. As I said, I think we are in a very different position because of lower loan-to-value ratios and much higher capital at banks, but that is something to be aware of.
On the corporate side, similarly, to the extent that corporates have done fixed-rate lending, they are insulated from short-term interest rates going up, but many corporate borrowings are floating rate and will be affected by that. Their interest costs are going up; their costs of goods are going up. They may not always be able to push through the price increases to cover their costs. Being aware of what that will mean for businesses—particularly small and medium-sized businesses—will be very important for the FPC to be monitoring.
Q48 Anne Marie Morris: I think what I am hearing is that it is important for us to cushion the impact by having flexibility, because if there is flexibility and you are not tied in, you are in a better position. Overall, the Bank view is that they will do their level best if there is a borrower in difficulty to address that and extend the term and so on, but that is the theory—then there is the practice. It is not just mortgages; there are also significant challenges, whether you are a domestic consumer or a corporate, with energy prices, more directly, and at the moment competition is pretty much dead in that area. You cannot move to a more flexible contract. With most energy companies, it is a kind of “take it or leave it”. When you enter into a new fixed-term contract, you do not really have much choice over how long it is for or what the rate is, and that may or may not match what actually happens in the market with wholesale rates. I appreciate that we are talking about energy, not mortgages, but in terms of the impact on the spending power and the financial position of the consumer, whether we are talking about an individual or a business, it is none the less the same. Do you think there is a role for the FPC to try to guide Government into looking at introducing greater flexibility and competition in these markets to enable us to get out of these difficult times? Too much of a solid-chunk solution, if you like, might not give you that flexibility when the global market changes.
Randall Kroszner: It is very important to be monitoring disposable income and the impact of the prices of energy and food and the costs of interest on that. That is extremely important. The key remit of the Financial Policy Committee is to focus on systemic risk issues. In that guise, the scenario that I described of how challenges for disposable income could make it more difficult for people to repay mortgages and have an impact on the markets would, I think, be the area that the FPC would focus on.
Q49 Anne Marie Morris: Okay, that makes a lot of sense. Do you think there is therefore a bit of a conflict between prudential financial stability and consumer welfare? That is clearly a role for Government to tackle, rather than the FPC, but it seems to me that the FPC will none the less have a role in providing policy advice. What sort of advice would you give in that challenging position where most Governments would wish to balance consumer welfare against financial stability?
Randall Kroszner: In some cases, they certainly go hand in hand. Many consumers were hurt quite a bit in the UK, as well as in the US and globally, when financial instability came about and there were challenges in financial institutions that could be harmful to individual households. Sometimes, they go directly hand in hand. Again, from the perspective—the remit—of the Financial Policy Committee, focused primarily on macroprudential policy and system-wide risks, we would be looking for those types of issue and seeing whether there were policy changes that could be helpful to try to mitigate stability issues. Obviously, many of your constituents are feeling a lot of pain. Obviously, that is an issue that should be taken into account.
Q50 Anne Marie Morris: Thank you. I am going to go international now and look at a more geopolitical position. If we look at what has happened in China and Hong Kong, we have had a significant economic deterioration. Looking at the impact of that and what we in the UK should be doing to think through the impact on our financial stability of what is going on in China and Hong Kong, what would your thoughts or advice be to the FPC? What do you think the FPC should be looking at to make sure that we have taken proper account of the risks from what is happening in China to our own domestic financial stability?
Randall Kroszner: That is a very important issue. There are both direct and indirect impacts, so certainly one thing would be to look at the exposure of UK financial institutions and UK corporates to activities in China and trying to assess whether there is a financial problem or a significant slowdown in China. What impact does that have on UK firm profitability? What impact does it have on the potential losses for financial services firms or investors in the UK? That would be one direct effect.
There is also an indirect effect because much of the rest of the world is also very integrated with and dependent upon China, so you would want to look not only at the direct exposures of the UK, but the indirect exposures. If there are others who are funders of UK activities or involved in UK markets that might be in other countries, but have a lot of exposure to China, that is something you would want to take into account also. You want the direct and indirect exposures.
Then you would also want to look at economic activity in the country. Obviously, there has been significant change in covid policy, which has led, in the short run, to a significant slowdown in economic activity. Many people are optimistic that that might lead to a significant rebound in economic activity. I think the jury is still out on how economic activity will go, or will rebound going forward, but that is another important thing, particularly for corporates, because many corporates have a lot of direct exposure to the Chinese domestic market.
Third is the supply chain issue. A lot of companies have an enormous dependency upon China in the supply chain, so disruptions in the Chinese economy or geopolitical disruptions could have a big impact. Carefully looking through what those interconnections are would be very important in thinking about the impact of China and Hong Kong on the UK.
Q51 Anne Marie Morris: That is very helpful. A number of issues could impact which have a global dimension. I have identified and asked you specifically about China, but clearly many other things might impact. Let me give you a few thoughts; I would be interested in your view.
There seems to be a move towards deglobalisation if I could put it like that and to take your point about supply chains. That begins fundamentally to change how trade works. What should we be doing to think about the impact of that on our own financial stability?
Secondly, across the world we are seeing very different approaches to climate change, which clearly will impact what happens in other countries and what they choose to do. The impact on their economies will have an impact on us—never mind how migration flows will change in the fullness of time. Covid has given us the wake-up call that we are always going to be under threat of attack, whether viral or bacterial, and we will not always be able to see it coming.
There is lots of potential, and those are just some examples. How can the FPC begin to try to scenario-assess, to enable us to build in the resilience that we might need for those sorts of changes?
Randall Kroszner: Those are extremely important and of course extremely challenging questions. It is possible that, now that we have a lot of—unfortunate—experience with covid, we will be able to do some scenario planning around other health crises. Will they operate in the same way as covid? Of course not, but we certainly may be able to learn something from it.
We now see very different approaches taken globally to covid policy and the economic and financial consequences of those. To go through scenario planning of something like that would be important. There is also understanding the consequences of lockdowns—it is not just the health consequences; other Government policies that come in can have devastating effects on different sectors. Obviously, the transportation sector was enormously affected. Looking at the exposures that financial firms have to those particular sectors is important.
Climate is an important issue to think about globally. Many firms as well as financial institutions thought, “Oh well, if I lend globally, I have global diversification.” But one of the consequences of climate change appears to be increasing correlation of weather patterns around the world, so that there are droughts or floods in a number of places simultaneously.
One of the things that would be valuable for the FPC to look at is the changes in the underlying correlation. People may have thought, “We have this great diversification by lending to the agricultural sectors in Europe, Latin America and Asia. We are well diversified because there will not be a drought or flood at the same time in all those places.” That may not be the case anymore, so we must try to understand that. That said, we also have to be humble that we do not understand the full implications of climate change for some of these things; we have to go through some different scenarios with different diverse tolerances in them.
Yesterday, I was speaking with a job candidate—we are looking for a new faculty at Booth—who was doing some extremely interesting work on the auto industry, looking at the locations of plants and the threat of flooding for both the firm’s risk management and in cases of co-location. In the United States, a lot of plants are in Detroit, so a weather event there could have an effect on not just one car manufacturer but the entire industry. That is true globally; we see a lot of these kinds of hubs. He was looking at the consequences of the potential for flooding affecting both individual firms as well as the auto industry. Looking through those and seeing the financial stability consequences for lenders and market-based finance would be valuable.
Those are some examples of trying to think through these things. Obviously, that is still at a fairly high level, but I think we can make some progress at least in saying, “This is a potential consequence of climate. Let’s try to work that through.”
Q52 Chair: Thank you, Anne Marie. I have a few mop-up questions, if I may. Last week, we heard evidence from Sam Woods on the decisions that had been taken around Solvency II, the capital for the insurance sector, which I am sure you have been following. It was clear from the evidence that the Financial Policy Committee was not terribly happy about where things ended up in terms of the decisions taken around Solvency II. Do you have a view on those?
Randall Kroszner: I think I have a high-level understanding but not a detailed understanding of some of the changes that are part of Solvency II. There has been a discussion about whether there could potentially be trade-offs between trying to promote growth and perhaps having a little bit more risk. I don’t yet have a fully formed opinion on that. I would have to look more carefully to see what the trade-offs are.
Q53 Chair: Okay. You answered Anne Marie’s questions on the counter-cyclical buffer. It is currently the FPC’s policy to raise that buffer to 2%. Given where we are in the economic cycle, does it feel like the appropriate time to be doing that?
Randall Kroszner: Certainly, the FPC is wisely focused on that financial stability mandate. As I mentioned in my previous answer, having a cushion for when things do not go so well is extremely important.
It will obviously be important to look at how the economy is evolving and whether it is appropriate to continue to implement the 2% by July, but fortunately it seems that financial institutions are quite well capitalised and would have sufficient capital to get to that 2% countercyclical capital buffer. We have not yet seen signs of the credit crunch, but that is something that I would certainly want to look carefully at, because you would not want the unintended consequence of trying to build a buffer to be making it more difficult to borrow. It does not seem as though we have seen evidence of that yet, but that is something I would want to look at very carefully and take into account.
Q54 Chair: Where are we in the cycle in the UK at the moment?
Randall Kroszner: People have different views on the macroeconomic cycle.
Q55 Chair: Your view.
Randall Kroszner: Fortunately, the labour market has held up reasonably well so far. I am not sure that the labour market will continue to be as strong in the year ahead. There are lots of headwinds that the UK economy will face. Fortunately, some of the energy headwinds have not been nearly as bad as was expected, so that it is an enormous plus, but we cannot necessarily assume that will be the case for the next year.
A recession is the most likely outcome; I think the Bank has also said that. The question is how deep that recession will be. The depth will come not from particular choices or actions taken in the UK, but from actions taken by Mr Putin or others outside the UK that can have a very big effect on energy or food prices. That will affect inflation and what the Monetary Policy Committee needs to do to fight it, so a recession is likely to be on the cards.
Q56 Chair: But that sounds to me as if the countercyclical buffer is not acting countercyclically at the moment.
Randall Kroszner: It is certainly something that could be drawn down on. Right now, the banks seem to be quite robust in having enough capital. There are no signs of credit crunch. If the recession is deeper than anyone would hope, it would be easier to draw down on that. It will be important to monitor the situation closely, because we do not want the unintended consequence of a credit crunch, but it would be useful to ensure that there is a buffer to draw down if things turn out to be worse than we hope.
Q57 Chair: We are doing an inquiry on crypto. From your public comments, it is fair to say that you do not sound like a huge enthusiast. We have had evidence from the Financial Policy Committee, which assesses the risk to UK financial stability from crypto currencies as being low. Is that your assessment, and could you see a scenario where they did become a threat to UK financial stability?
Randall Kroszner: I would agree with that assessment. We have had quite a stress test, given what has gone on—the incredible turbulence in the market over the last year, stable coins not being so stable, failures of lenders, failures of exchanges, and significant changes in the price of the underlying coins. Fortunately, although that has created incredible tumult within the sphere and created tragic losses for many households who invested in crypto, it does not seem to have had an impact on broader financial stability. I think that is because the interconnections have been relatively small. Even though it was leveraged within the crypto sphere, there was not much leverage that was out to the traditional financial sector. That is why that sector has not had as much of an impact.
Also, the sector has shrunk dramatically. It had been roughly $3 trillion, and now it is less than a trillion. That is an enormous change in a fairly short time. Now, relative to the UK financial system and the global financial system, it is relatively small.
Q58 Chair: I know that you think that blockchain technology has a lot of potential. What potential do you see it having in the UK financial system?
Randall Kroszner: There are possible use cases for it for efficient payments. So far, these products that have been called cryptocurrencies are not really currencies. We typically think of a currency as a unit of account, medium of exchange, and store of value. These products—I prefer to call them crypto assets—have stored value and are very volatile, but they are not really used as a medium of exchange or unit of account. However, there may be value in being able to have property registries through something like this, through property records. There are discussions about so-called self-executing contracts. It may be very efficient to have things done in an automated way, which could reduce costs. It is important to allow for innovation, but in a way that does not lead to a threat to financial stability. So far, that has been the case.
Q59 Chair: Do you think the Bank of England should issue a central bank digital currency?
Randall Kroszner: I think it is very valuable for the Bank of England to look carefully into new technologies. It is very important that central banks are aware of those technologies and look into them. The question would really be what kind of central bank digital currency the Bank of England chose to have. Some of them could have very big financial stability impacts. For example, if it decided that the central bank digital currency would be one where every individual has an account directly with the central bank—
Q60 Chair: It disintermediates the whole banking system.
Randall Kroszner: Exactly. That could have the unintended consequence of disintermediating the banking system, reducing liquidity in the rest of the system, and raising questions about how banks would raise funds to finance their operations.
Q61 Chair: So you are not in favour of that approach?
Randall Kroszner: That would be a very problematic approach. However, there are others that would not necessarily be like that; there could be a way of having a digital central bank currency that is a complement to activities going on now, potentially increasing the efficiency of the payment system. We will have to see. I do not think it is obvious that it is solving a problem. It is important for the Bank of England to be investigating that, because it is very important for central banks not to be stodgy or say, “Anything that is new is bad, and what we have been doing since 1694 is right; we will always do that”. That is a recipe for mistakes. That said, you don’t just adopt something new because it is new. The deliberate approach that the Bank of England is taking, as I understand it, is quite reasonable.
Q62 Chair: Do you still think that digital renminbi could be a rival to the dollar, over time?
Randall Kroszner: That is certainly one of the motivations for the People’s Bank of China in creating that. In principle, it could be. It is very difficult to be a challenge to an international reserve currency if you do not have a lot of transparency about how decisions are made. There is a dramatic difference, even with something that is on a blockchain, because it is a blockchain that is centrally controlled by the People’s Bank. I am not sure how much of an appetite global players would have for making a lot of transactions with that. It may help the renminbi to internationalise, but unless you have a trusted, stable and transparent regime, it is extraordinarily difficult for a currency to rival the US dollar or another international reserve.
Q63 Chair: So not in the near future, it sounds like.
Randall Kroszner: I think that is right.
Q64 Chair: Finally, the UK financial sector is under cyber-attack all the time. The risks are increasing and, clearly, Russia’s evil invasion of Ukraine has exacerbated that. How big a risk is this for the financial sector? Is the risk of a quantum apocalypse, whereby quantum computing manages to get through some of the banks’ encryption systems, is increasing? Do you think that is a near-term risk to the financial sector, and what can we do to mitigate against it?
Randall Kroszner: Cyber-risk is extremely important. It is a real risk and, fortunately, one on which there has been a lot of spending, both by Governments and by individual financial institutions, in order to try to become more robust. Fortunately, we have not seen a major successful cyber-attack on a financial institution, but that should not make us complacent. It is very important for the Financial Policy Committee to be attentive to those risks. It is very important too for the financial regulators to co-ordinate closely and talk with the security agencies, not only domestically but internationally, because obviously these are international threats.
Also, a cyber-attack on, let’s say, a US central counterparty clearing house could have a very big impact on the UK. Understanding the cyber-risks, for UK infrastructure and institutions, including financial institutions, and globally, is extraordinarily important. That is a high priority for me and, I think, for colleagues on the Financial Policy Committee.
Q65 Chair: And quantum apocalypse, specifically?
Randall Kroszner: I have a close colleague who works very much on quantum, and I have a high-level understanding of quantum and quantum computing. I do not yet understand enough about it to be able to give an assessment. It bears watching, because my understanding is that the power of computing will go up in a way that is virtually unimaginable, so cryptography that has been very successful will not be.
The positive part is that quantum can be used on both sides to try to prevent an attack. If we were to just sit by and say, “Oh well, we don’t have to worry about it”, then I would say that that is a very real issue. If we work on both sides—if the financial institutions try to use cutting-edge quantum to protect themselves, just as the bad actors try to use quantum to get in—that hopefully will be a way to avoid that. However, as I said, it is a very technical issue that I have a high-level understanding of, but I cannot say that I am an expert on quantum.
Q66 Chair: But it does sound as though these are some of the issues where your transatlantic perspective could bring quite a lot of insight to the Financial Policy Committee discussions.
Randall Kroszner: Yes. In fact, while I was at our Booth campus here in London, the university worked out a memorandum of understanding with Imperial College London on certain issues related to quantum and other cyber and security issues. It is super valuable to have that kind of transatlantic discussion, and I am glad that we have been able to at least take the first steps with a memorandum of understanding.
Chair: Great. Unless my colleagues have any further questions, we come to the end of your grilling here this morning, Professor.