Time King had a modern court

28 November 2011 | By John Murray

I’m beginning to think the Monetary Policy Committee is not unlike a broken watch - the only difference being that a broken watch is right twice in every 24 hours.
That’s pretty good when compared with the MPC, as judging by its track record on inflation, it’s right about once in every 24 months.

What’s more, the position of the Bank of England is particularly ambiguous in all this given that quantitative easing has inflationary consequences as do eye-wateringly low interest rates, which have devalued the currency, cost savers dearly and made imports more expensive.

Then there’s the issue of uncertainty. In its most recent quarterly inflation report the Bank is uncertain about when our economy will recover and whether inflation will come down as quickly as it had hoped.

It’s even uncertain about past growth figures, so what hope have we for its forecasts?

I mention this because with the final report of the Independent Banking Commission imminent, I’m wondering if the problem with our banking system isn’t with the structure of the banks and building societies, or with liquidity levels and capital, but with the Old Lady herself and the issue of governance in Threadneedle Street.

Neither the track record of the Financial Services Authority nor the Bank have been that good - I’m thinking here of the demise of Northern Rock and the subsequent seismic problems at the Royal Bank of Scotland and HBOS - partly because of misunderstandings over who was responsible for what.

But for then chancellor Alistair Darling, what had been particularly frustrating was the reluctance of Bank governor Mervyn King to acknowledge that liquidity was the immediate issue, not capital.

So while the Financial Services Authority could be accused of not identifying the risks inherent in Northern Rock’s modus operandi - it had even granted it a waiver under Basel II - the Bank can be accused of not recognising or responding to the liquidity crisis that led to the bank’s collapse.

Liquidity continued to be a major problem in 2007 and according to Darling’s memoir, Back From The Brink: 1000 Days At Number 11, a conversation with Sir Freddy Goodwin, then chief executive of RBS, “was further evidence to me of just how poor the relationship between the Bank of England and Britain’s largest banks was”.

“The essential day-to-day contact, to feel the pulse and sense the ever-changing mood of these unwieldy corporate entities, was not just there,” Darling writes.
“It is an essential part of the governor’s role to understand what’s going on but it is not something that can be written into legislation, and I suspect that the Bank considered it to be the job of the FSA.”

Fortunately, by the time of the market turmoil precipitated by the problems at RBS and HBOS in October 2008, the different agencies had got their acts together and were able to respond with increased funding through the special liquidity scheme, the introduction of a £250bn government-backed credit guarantee scheme and a £50bn facility to help banks repair their balance sheets with additional capital.

Collectively they restored stability in our banking system, though the price was high and the availability of credit to this day is an issue.

That’s not to say all was harmony and light. The structure of the tripartite regulatory regime certainly seemed to trouble King. He used his Mansion House address in June 2009 to argue that the statutory duty bestowed on him for financial stability under the Banking Act of that year left him without the ability to do what he wanted and he called for greater powers for the Bank.

Darling, who obviously had his own agenda with King, describes this in his book as “a naked attempt to wrest power from the FSA”. Well, King has had his way with the incoming coalition government and a new regulatory structure will fall into place in 2013.

In addition there’s the Independent Banking Commission, which in its interim report has called for more capital and firewalls between retail and investment banking. But Darling argues that based on his experience, it won’t stop another crisis.

Given the interdependence of financial institutions, he believes that no regulator can discharge their duties as if each institution is free standing and self sufficient.

Then there’s the problem with the Bank. Citing the new regulatory regime, Darling asserts in his book that it is necessary to decide who calls the shots in a crisis.

“Even if the two principals charged with making the ultimate decision were the governor and the chancellor, what happens if they disagree, as was the case in 2007, over whether to inject liquidity into the economy?”

In his view, the ultimate authority must rest with the chancellor.

Finally, with responsibility for supervision of the financial system, as well as responsibility for monetary policy, and for smoothing the economic cycle all to lie with the Bank, it would be reassuring if it could improve on its track record with inflation, which it has viewed for so long as a temporary phenomenon.

A little less uncertainty too might improve one’s confidence in the incoming regime.

Darling, for his part, believes a more accountable regime in the Bank might help. Describing the court of the Bank as an anachronism, he calls for the creation of a proper board of directors who will help the governor form their views.

“He or she should be like the Prime Minister, first among equals,” he concludes.

Given the autocratic dispositions of both Tony Blair and Gordon Brown that’s a surprising stance, but as a matter of principle, I say amen to that.

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