1 Questions for Charlotte Hogg, from House of Commons Treasury Committee Personal/General 1. Do you have any business or financial connections or other commitments, which might give rise to a conflict of interest in carrying out your duties? My financial interests are recorded with the Bank’s secretary and I complete an annual wealth statement. As required by our code, personal financial transactions are approved by the Bank’s secretary. I have financial holdings in the US that are in discretionary funds, and I have no authority over the investments. I am in the process of disposing of some legacy Santander and Morgan Stanley shares. My husband is Chief Customer Officer at Burberry. As declared to the Bank’s secretary on my appointment in 2013, I do not advise my husband on his financial decisions with the exception of our mortgage which we hold jointly. My parents are both serving members of the House of Lords and their interests are recorded on the Lords’ register. My brother works for Barclays as a Director in Group Strategy. I currently serve on the Finance Committee of Oxford University Press, and have tendered my resignation. I currently serve as a trustee of First Story (an educational charity), and have tendered my resignation. I continue to support the development of NowTeach, an educational initiative. 2. Do you intend to serve for the full term for which you have been appointed? Yes 3. How has your experience to date equipped you to fulfil your responsibilities as a member of the MPC, FPC and PRC? In particular, in which areas do you feel especially capable of making a contribution, and in which will you have to undertake additional research? I come to this role with nearly two decades of experience in the private sector across retail and wholesale financial services, combined with the experience gained over the last three and a half years of serving as the Bank’s Chief Operating Officer. This combination will allow me to bring the following to the MPC, FPC and PRC: a. A detailed understanding of how households and businesses make financial decisions Financial decisions are amongst the most important decisions we all make and my experience running retail banking businesses and at Experian taught me a great deal about what matters most to households and businesses in making them. The margin between managing ok and financial distress is a narrow one. It varies by geography, and at Experian we worked to develop our analysis of the impact of economic changes in different parts of the country, down to the six digit postcode.
Transcript
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Questions for Charlotte Hogg, from House of Commons Treasury Committee
Personal/General
1. Do you have any business or financial connections or other commitments, which might
give rise to a conflict of interest in carrying out your duties?
My financial interests are recorded with the Bank’s secretary and I complete an annual
wealth statement. As required by our code, personal financial transactions are approved by
the Bank’s secretary. I have financial holdings in the US that are in discretionary funds, and I
have no authority over the investments. I am in the process of disposing of some legacy
Santander and Morgan Stanley shares.
My husband is Chief Customer Officer at Burberry. As declared to the Bank’s secretary on
my appointment in 2013, I do not advise my husband on his financial decisions with the
exception of our mortgage which we hold jointly.
My parents are both serving members of the House of Lords and their interests are recorded
on the Lords’ register.
My brother works for Barclays as a Director in Group Strategy.
I currently serve on the Finance Committee of Oxford University Press, and have tendered
my resignation. I currently serve as a trustee of First Story (an educational charity), and have
tendered my resignation. I continue to support the development of NowTeach, an
educational initiative.
2. Do you intend to serve for the full term for which you have been appointed?
Yes
3. How has your experience to date equipped you to fulfil your responsibilities as a member
of the MPC, FPC and PRC? In particular, in which areas do you feel especially capable of
making a contribution, and in which will you have to undertake additional research?
I come to this role with nearly two decades of experience in the private sector across retail
and wholesale financial services, combined with the experience gained over the last three
and a half years of serving as the Bank’s Chief Operating Officer.
This combination will allow me to bring the following to the MPC, FPC and PRC:
a. A detailed understanding of how households and businesses make financial decisions
Financial decisions are amongst the most important decisions we all make and my
experience running retail banking businesses and at Experian taught me a great deal
about what matters most to households and businesses in making them. The margin
between managing ok and financial distress is a narrow one. It varies by geography,
and at Experian we worked to develop our analysis of the impact of economic changes
in different parts of the country, down to the six digit postcode.
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This will be particularly useful at the current macroeconomic juncture, as households
decide how to respond to slowing real income growth, and businesses make investment
decisions in the face of uncertainty. We can’t fight shy of the necessary macroeconomic
decisions but we should always be aware of how they affect people in their daily lives,
and how that impact can differ around the country.
b. Experience in making pricing and rate decisions
The crucial first step in the impact of monetary and financial stability policies on
outcomes in the real economy is their transmission through the financial system. Retail
bankers are part of that transmission mechanism, and as head of Santander’s UK Retail
Distribution business I regularly participated in decisions on the interest rates on credit
cards, mortgages and savings products - sometimes as frequently as weekly. In making
pricing decisions we would rely on detailed analysis, including of the macroeconomic
outlook. Given the degree of uncertainty, we would have to use our judgement about
the ways that pricing would affect customers and our competitors, and how our funding
markets would react. There are clear parallels here with how the MPC and FPC set
monetary and financial stability policy.
c. Experience of wholesale financial markets
During my 8 years working as a consultant in North America for McKinsey & Company, I
increasingly specialised in wholesale financial markets, ending as the partner jointly
responsible for leading the wholesale banking practice there. My clients were mainly
stock exchanges and the trading arms of investment banks, and I left McKinsey to join
Morgan Stanley. There I headed their Strategic Planning Group for 4 years, based in
New York, working across their businesses and across the globe.
I was in New York on 9/11 and supported my boss, the Chief Administrative Officer as
we first worked to track down all our colleagues who had been in World Trade Centre 2,
and then to ensure our business could begin to function when many of our records and
systems had been physically destroyed. I gained invaluable lessons then not just about
how investment banks and financial markets operate, but the importance of resilience
and response which I will touch on more below.
I am greatly looking forward to spending time building a more detailed understanding
of all the Bank’s operations, and working with our colleagues who collate and analyse
market intelligence. Bringing this knowledge to all the committees, as my predecessor
has done so successfully, is vital to the role and is one of the bases on which the Deputy
Governor for Markets & Banking is a member of all three policy committees.
d. Leadership of FinTech and operational resilience work (including cyber) at the Bank
I am currently the lead at Deputy Governor level on both FinTech and operational
resilience for the Bank.
FinTech offers opportunities to democratise financial services, make them more
inclusive, and potentially to make the financial system more resilient, as the Governor
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outlined in his recent speech. However, over time new risks to financial stability might
evolve, for example as traditional bank funding and business models change, or as
FinTech-enabled sources of funding to the real economy are tested for the first time by
a downturn in the cycle.
We have worked to understand this fast changing landscape of new technologies and to
monitor its impact. I have been part of the decision making to open up the Real Time
Gross Settlement (RTGS) system to new payment services providers, and have led the
establishment of the Bank’s FinTech accelerator. In the accelerator we run rapid proofs
of concept with new technologies, working on issues that are important to us as an
institution. We seek to innovate in what we do, to gain real experience with new
technologies and to support emerging players by working with them on proofs of
concept and publishing our experience. Our approach is distinctive among central
banks and will support the Bank’s policy committees as, over time, they make choices
about the regulatory perimeter and any requirement for new macro prudential tools in
the future.
Operational resilience is a critical question for the Bank and for the financial sector. My
responsibilities as COO include technology and information security, and we have
invested substantially in both over the past three years. That includes investing in our
cyber defences, and those areas have gone on to provide support policymakers in the
development and implementation of CBEST. We consult and draw on advice from
GCHQ, the Centre for the Protection of National Infrastructure and the National Cyber
security centre. We also assess our own cyber capabilities and response management
using the CBEST testing framework – i.e. the same framework used by our supervised
firms. All of this will of course be valuable experience when it comes to assessing the
operational resilience of the financial system as a whole, as I set out in Question 20.
e. Experience in making difficult calls
Throughout my career, I have never shied away from making difficult calls, or ones that
go against the consensus. I hope I have never made these calls without considerable
thought and some heart searching, but I have made them.
As an example, one of the most difficult was the decision to sell Goldfish, the UK credit
card business of which I was CEO. We had worked hard in early 2007 to separate the
business from Morgan Stanley, and listed Discover Financial Services in the summer of
that year. However, in separating from Morgan Stanley we became more reliant on the
securitization market, which in the late summer of 2007 started to dry up. Deciding
that we had to now turn around and sell the business in order not to jeopardise
customers’ services was very hard, because I knew the potential impact on the people’s
jobs. It was even harder to execute, but I still believe it was the right call for the
company I served and the customers we had.
In choosing to return to the public sector in 2013, I was making a personal commitment
to the institution, its mission and the people of the United Kingdom. I value and respect
my colleagues enormously but that doesn’t prevent me from disagreeing with them
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when I believe the interests of the institution require it. There are occasions where I
have done so, and I imagine there will be again.
As well as being a member of the MPC, FPC and PRC, I will also have a broader role within
the Bank of England as Deputy Governor for Markets and Banking. For that, the following
additional experience will also be relevant.
f. Organisational leadership
For more than a decade I have had leadership responsibilities. At Santander, I was
responsible for more than 10,000 colleagues across our branches, call centres and
digital channels. At Experian, I was responsible for over 3,000 across multiple
offices. At Goldfish I was responsible for 1,000 colleagues, mainly based in
Cumbernauld. In these three roles we achieved a considerable transformation of the
cultures and business models. During my tenure at Santander for example, customer
service went from amongst the poorest in the industry up towards the best in some
areas. At Experian we reoriented to support new sectors such as the public sector and
insurance and developed our digital business, Credit Expert, while making the decision
to “replatform” the credit bureau – i.e. replace all of the infrastructure and
algorithms. At Goldfish we completed a number of transactions as well as spinning off
from Morgan Stanley, which involved rebranding ourselves, creating a separate bank
and our own terms and conditions.
As the Bank’s COO, I have led the work to develop and implement the Bank’s strategic
plan. The foundation of that plan was a single mission for One Bank to promote the
good of the people of the United Kingdom through maintaining monetary and financial
stability. We have now completed over 90% of the initiatives undertaken as part of that
plan: there is good evidence of more joint working across different areas of the Bank
(for example on the housing market and on contingency planning for the referendum);
there are more joint committee meetings; and staff mobility has increased. Our
research rank among central banks has moved from 21 to 11, and Bank Underground –
the blog for staff to showcase work that can support or challenge the prevailing policy
orthodoxies - has now had over 290,000 views.
Staff engagement and empowerment increased by a significant amount, although we
have further to go. We are on a path to achieve our diversity targets. For example we
now have close to 30% of our senior management roles filled by women from 21% in
2014. We have changed recruitment to increase social mobility by, for example,
widening the number of universities we recruit from and changing our grade
thresholds. We have strengthened our risk management and compliance frameworks,
introducing a new code of conduct which all colleagues now attest to annually. We have
increased disclosure in our annual report, and engaged in different communication and
outreach models, such as Open Forum and Future Forum. We have established the
Independent Evaluation Office (IEO), reporting to Court, which has published three
reports to which the Bank has changed in response.
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Cultural change takes time, and requires continual effort. We are currently working on
our 2017 strategic plan, which emphasises how we work and how we communicate. To
date we have engaged with nearly 1000 colleagues to garner their views, and met with
nearly 30 external institutions to learn from their experiences.
g. Knowledge of payments and operations
As the provider of central bank money and the operator of RTGS – which settles £500bn
of transactions every day - the Bank is at the heart of the UK payments system. My
experience in the payments industry at Goldfish, and the replacement of infrastructure
and algorithms of Experian’s credit bureau, will be very relevant for this role. Indeed,
reflecting my existing responsibility for the Technology area of the Bank, I have already
been closely involved in the maintenance and development of RTGS, including by sitting
on its Strategy Board. And it is one of the key synergies we will be able to take
advantage of by combining the roles of DGM&B and COO.
The renewal of RTGS over the coming three to four years will be a major project, the
completion of which will ensure that we are able to respond to the changing needs of
the financial system, while continuing to ensure high levels of resilience. The renewal
project – a blueprint for which will be delivered in the coming months – will be focused
on: strengthening resilience; the promotion of interoperability with other payment
systems; increased user functionality; and the provision of greater access to central
bank money.
Those changes will not come without risk. I plan to dedicate considerable time and
effort to this rebuild and draw on all of my experience to ensure we have the right level
and quality of talent with Banking and Technology working very closely together.
h. Experience of Risk Management
The Deputy Governor for Markets and Banking has responsibility for managing the
Bank’s balance sheet, and with it safeguarding the policy credibility of the institution as
a whole. The use of the Bank’s balance sheet to implement monetary policy or provide
liquidity insurance will always necessitate a degree of financial risk, but it is the role of
the Deputy Governor for Markets and Banking to ensure that policy choices are
implemented in a way that takes no more than the amount of risk needed given the
policy objective.
As the CEO of a consumer credit business, and then the Managing Director of Experian’s
business in the UK and Ireland, I developed my knowledge of risk management from
two different perspectives. At Goldfish, I had responsibility for setting credit and
underwriting standards within the broad guidelines set by our parent, while at Experian,
we focused on developing our modelling and credit scoring for our customers. We
made some important innovations during my tenure, including developing more
forward-looking credit scores for consumers, and introducing new scoring for small to
mid-sized businesses.
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Over the past 2 years, my predecessor and I have worked to further strengthen the
Bank’s approach to risk management, building on the investment in skills made over the
past decade. The Bank now has collateral pre-positioned with it that has a lendable
value of more than £250bn to support potential future operations and over £90bn of
lending through the FLS and now TFS. Much of that collateral is in the form of whole
loans, mostly mortgages. We have established clear first and second line risk
management, more detailed risk reporting, and an Executive Risk Committee which has
brought operational and financial risk under one risk framework and tolerance
statement. The Committee reports through governors to our Audit and Risk
Committee, ensuring a clear line of sight to the risks and risk management of the Bank
for our Court.
To complete the circle, this risk management experience and responsibility will also be
directly relevant for my roles on the policy committees by providing the link between
our monetary and financial stability goals and the provision of credit to the real
economy.
4. Have you published any research that is relevant to your role as Deputy Governor,
Markets and Banking?
Business decisions in the private sector require strong analysis of data on revenues and
costs, credit portfolios, valuations and investments. All the companies I have worked for
required an analytical approach, but much of that work used commercially sensitive
information and was not for publication. So unlike an academic economist, I have little by
way of published research.
However, I have looked to publish work where appropriate and relevant. For example I
jointly authored an article for the McKinsey Quarterly Bulletin in 2001 on electronic trading
and its implications for investment banking.1 Some of those views are arguably still relevant
to the current debate about the implications of FinTech.
At Experian, I established a quarterly “Insights Report” in 2009 that used Experian’s
consumer and business information to identify new trends emerging in the UK economy.2
We chose to launch at that time because we felt our granular data provided an insight on
the pressures across the UK economy. Small business data were especially interesting
because the impacts on growth and employment varied so much. Digging into the data we
developed models that supported the identification of business “champions”. These were
the small businesses that would generate employment growth. Some of this research was
published in an insight report in 2010.3 I spoke on these topics as a guest lecturer at
Nottingham Business School in 2010 and to the Liverpool Chamber of Commerce annual
dinner in 2011.
1 Davidson, J, Grepin, L and Hogg, C, ‘Remaking Market Making,” McKinsey Quarterly 2001, Issue 3 pp 142-153.
2 For example see http://www.experian.co.uk/www/pages/downloads/reports/report.pdf
3 See http://www.experian.co.uk/assets/insight-reports/brochures/experian-insight-report-q4-2010.pdf
Two ongoing initiatives stand out as good examples of the form this kind of work
might take:
i. The first is the development of the FX global code to be published in May
2017. Developed under the auspices of the BIS Markets Committee in close
co-operation with a group of market participants, this code will provide a
comprehensive set of principles to guide trading practices, practical
examples for participants, and strong tools for promoting adherence.
ii. The second is the completion of the work to ensure the long-term viability
of the Sterling Overnight Interest Average (SONIA) benchmark. The Bank
has become the administrator of the rate and by the Spring of 2018 will
have completed a programme of reform which will significantly broaden the
range of transactions included in its calculation.
4. Market intelligence
Early on in her work, my predecessor recognised the importance of market
intelligence as an input to the work of the policy committees. She also recognised
the risks that come with that role and the need to put market intelligence on a clear
footing that the industry would understand as well. The market intelligence review
made a set of recommendations to reinforce transparency and safeguards around
the gathering of market intelligence, and to promote its effective use. Those
recommendations have now been completed, and we will continue to use the
successful Bank-wide executive level steering group to set the priorities for market
intelligence going forward and to continue to influence the Bank’s policy
committees.
5. Ensuring a sustainable income and capital model for the Bank
The Bank is very unusual amongst central banks in not having access to seigniorage
income. Our current income streams are changing. To deliver our policy remits
given to us by Parliament it is vital that we maintain a revenue and capital model
that is consistent with the forward-looking risk profile of the Bank’s balance sheet.
This is a priority that combines my role as COO with that of DGM&B.
7. What is your view on the size of the Bank of England’s balance sheet, and how do you
expect it to change in the future?
The Bank of England’s balance sheet expanded significantly as a result of stimulus measures
taken by the MPC in the years since the financial crisis. Having been £85bn at the end of
2006, the total assets on the Bank’s balance sheet are now worth £519bn. The largest item is
a £481bn loan to the Asset Purchase Facility - the vehicle through which gilt purchases,
corporate bond purchases and TFS lending have been executed on behalf of the MPC.[5]
[5]
Over the same period, the stock of open market operations (long-term and short-term repos) held before the APF was created has largely matured, balancing the difference between £519bn and the sum of £481 and £85bn.
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As the Governor has discussed in previous testimony to the Treasury Committee, the size of
the balance sheet is unlikely to diminish substantially until the MPC decides to reduce the
size of the APF. The MPC has previously stated that it is unlikely to reduce the stock of asset
purchases until Bank Rate has been raised to a level from which it can be cut materially –
judged to be around 2%. The current market curve suggests market participants don’t
expect such a level to be reached for some years to come.
When the APF does begin to be reduced, it is likely that the overall size of the balance sheet
will no longer be determined by the assets we hold, but instead by the stock of our liabilities.
In turn, that will be determined by (i) the stock of bank notes, which is relatively slow
moving and (ii) the quantity of central bank reserves that members of the Sterling Monetary
Framework (SMF) wish to hold. That is impossible to know in advance, though the increase
membership of the SMF from 70 to 186 since 2006, and each individual member’s
commendable desire to hold more liquid assets now than they did before the crisis, means it
could be considerably larger than the 2006 level of reserves.
For completeness I would like to mention some of the other components of the Bank’s
balance sheet, though they are unlikely to be the source of material changes. These include
the gilts held as the counterpoint to cash ratio deposits, and foreign currency assets held as
the counterpoint to deposits we hold from other central banks and the Bank’s own foreign
exchange reserves.
In short, even when the MPC reduces the size of the APF, the size of the Bank’s balance
sheet is unlikely to return to its pre-crisis level, though it is impossible to know in advance
exactly where it will settle.
Finally, I would note that over the same period the balance sheet has expanded, the Bank’s
broader response to the crisis means that the risk profile of the assets held has changed.
Consistent with the Bank’s approach of being “Open for Business”, we now lends against a
very wide range of collateral routinely and for longer maturities than in the past. In addition,
banks have pre-positioned collateral with a lendable value of more than £250bn,
representing prudent liquidity planning on their part. This means the Bank’s risk profile
could evolve further in the future in the event we were to provide liquidity on a large scale.
These changes have motivated the changes to financial risk management in recent years
that I have referred to at other points in this questionnaire. Operations – such as the APF -
undertaken with an indemnity from HMT also benefit from that strengthened risk
management framework.
8. How will you ensure the effective risk management of the Government’s foreign exchange
reserves, gold custody services and the operation of the real time gross settlement
system?
Having been a senior executive in consumer lending businesses, the Chief Operating Officer
of the Bank and a non-executive at institutions such as Oxford University Press and BBC
Worldwide, I am acutely aware of the importance of good risk management practices. In
my view, risk management activities should all stem from an understanding of the mission of
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an institution and what could cause that institution to cease to function. In commercial
organisations both finances and reputation are vital.
I see risks to the Bank as anything that would damage the Bank’s prospects of achieving its
mission by damaging its operational capability or financial soundness, and consequently its
credibility or reputation. The risk management of the Bank is an issue that I have been
closely involved with over the past few years, working side-by-side with my predecessor.
In 2015, as described in our 2016 annual report we revamped our risk tolerance statement,
our identification of principal risks, our risk governance structures and established a second
line of defence to provide independent, forward-looking assessment and challenge of overall
risks, reporting via the executive to our Audit and Risk Committee. An Executive Risk
Committee was established, and it meets quarterly to debate the key risks facing the Bank
and the actions that are being taken to mitigate them.
Government’s foreign exchange reserves
Risk management of the Government’s foreign exchange reserves relies on clearly
communicated thresholds and limits. A Service Level Agreement (SLA) between HMT and the
Bank specifies the parameters within which the reserves are managed. It covers:
benchmarks, limits for deviation from those benchmarks for the purposes of active
management, and the framework for controlling credit, market, liquidity and other risks. It is
reviewed and signed annually, but changes may be agreed at any time.
The foreign exchange reserves are typically exposed to two types of market risk: interest
rate risk and exchange rate risk. Around four fifths of the currency reserves are hedged to
reduce mark-to-market volatility, the remainder is unhedged which creates more mark-to-
market volatility but is seen by some as improving their policy credibility. The Bank monitors
and controls market risk primarily by using a Value at Risk (VaR) model, which estimates a
loss level that should not be exceeded at a specified confidence level, over a defined period
of time.
The Bank produces monthly reports for HMT on the size, composition and liquidity of the
reserves, their consistency with policy objectives, investment performance and risk
exposures. There is ongoing dialogue between the Bank and HMT, and officials meet
quarterly to review performance against parameters set out in the SLA and to consider wider
operational and policy issues. HMT’s Accounting Officer and the Bank’s Executive Director
for Markets also hold half-yearly meetings to discuss overall strategy and governance issues.
Additionally, the Bank provides HMT with a quarterly assurance report about how
operational risks to the foreign exchange reserves are being managed, including a forward-
looking risk profile and any operational incidents and breaches of the SLA. As part of this,
the Bank’s Executive Director for Markets attests to HMT’s Accounting Officer that risks have
been managed to an acceptable level and in line with the Risk Management Framework. The
annual report and accounts for the EEA is published and laid before Parliament.
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Gold custody services
The Bank is a gold custodian for HMT, other central banks, and other firms who facilitate
access to the liquidity of the London gold market for those central banks. As the Bank acts
only as custodian – i.e. we don’t trade gold on our or others’ behalf - the key risks to our
gold custody services are operational and reputational.
Gold is held on an allocated basis, such that every customer has an entitlement to a specific
bar. We have recently invested in upgrading our technology for managing and recording
gold bars, delivering increased automation and more straight through processing. All gold
accepted by the Bank is inspected to ensure it meets London Good Delivery (LGD) standard.
This is a market-wide set of standards that govern, for example, fineness and weight of bars.
These are maintained by the London Bullion Market Association (LBMA).
The Bank maintains a comprehensive register of potential risks to our gold custody services.
Each risk is assessed in terms of likelihood and potential impact. All three lines of defence
are active in managing operational risk for gold. Specific measures taken include regular
vault audits (by business area and risk functions) of customer and EEA gold, and checks on
security controls governing access to/from the vaults.
As for AML risk, and as is the case across our customer operations, all customers are subject
to a due diligence and monitoring framework maintained by an independent team that
reports to the Bank’s Money Laundering Reporting Officer.
RTGS
Responsibility for the management of RTGS risks is clearly defined within the RTGS
governance structure, with risk management and information security experts sitting on the
key governance committees. This structure was established as part of the work to meet the
recommendations of the Deloitte review into the 20 October 2014 RTGS outage. All the
actions from that report have now been completed.
The primary risks raised by the operation of the RTGS service are operational and we have a
range of contingencies in place. For example, in addition to regularly tested capability to run
in two different sites we can use a third stand-by RTGS system operating from a separate
location based on alternative technology (known as the Market Infrastructure Resiliency
Service).
One of the key benefits of RTGS is that, by providing real-time settlement for wholesale
systems and pre-funding facilities for net settlement for certain retail schemes, it reduces or
eliminates some financial risks that payment scheme participants would otherwise face.
However, the Bank itself is exposed to only very limited credit risk in the day to day
operation of RTGS through the provision of intraday loans, all of which are fully and
conservatively collateralised.
We remain very alert to the changing cyber threats and have taken a number of steps to
ensure our defences are strong and our responses tested. We have recently achieved ISO
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270001 certification to ensure we meet best practice guidelines for process and information
security risk management.
RTGS risk management is also subject to external scrutiny. We undertake an annual external
audit of controls (the ISAE3402) which is circulated to RTGS account holders. In 2016, we
published a self-assessment of RTGS against international standards for market
infrastructures. We have also recently engaged with external stakeholders via a simulation
exercise with market participants to test the collective response to a prolonged RTGS outage
(as recommended by the Deloitte review).
Finally, given the critical economic function fulfilled by RTGS, we consult and draw advice
from GCHQ, the Centre for the Protection of National Infrastructure and the National Cyber
Security Centre. Our security operations centre monitors alerts, proactively looks for
potential attacks, and continues to probe for weaknesses. We have looked to learn from
recent industry events and have adopted new approaches as a result. We can never be
complacent on this issue, and appreciate the risks have been very much in the minds of the
Treasury Committee too.
9. How do you intend to take forward the work of the RTGS Strategy Review and the Fair and
Effective Markets Review?
My answer to Question 6 covers how I intend to take forward the work of the RTGS Strategy
Review and the Fair and Effective Market Review
Prudential Regulation Authority (PRA)
10. How will you ensure that the PRA can operate independently from not only external
political pressure but also internal group think within the Bank?
I strongly believe that internal and external challenge is vital for any well-functioning
organisation. With respect to the PRA, or any of the Bank’s policy functions for that matter,
for that challenge to be effective there must be three things in place.
First, clear objectives. For the PRA, FSMA established three objectives: a general objective
to promote the safety, and soundness of the firms it regulates, an objective specific to
insurance firms to contribute to the securing of an appropriate degree of protection for
those who are or may become insurance policy holders; and a secondary objective to
facilitate effective competition. Such objectives strengthen the independence of
policymakers when they are inevitably come under pressure for the hard decisions they
take. This will be further strengthened by the provision for the Chancellor to provide a remit
letter to the PRC.
Second, to guard against group think, membership of the Committees must be diverse and
the environment inclusive. I am not a Bank of England insider. I left the Bank in 1994 after
two years on the graduate programme, and only returned in 2013. My career over that
intervening period included five different institutions and two different geographical
locations, and I have been willing to speak up and challenge the consensus throughout. So in
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joining the PRC, I believe I would add to what is already a diverse group with experience in
fields such as policymaking, insurance, banking, consulting and law.
As important in guarding against groupthink is ensuring the staff of the Bank is diverse. In
considering this issue, I have found the criteria established in James Surowiecki’s book ‘The
Wisdom of Crowds’ helpful. They include diversity of opinion, independence,
decentralisation and aggregation. Over the past few years at the Bank we have actively
pushed our diversity agenda. But diversity isn’t sufficient, an institution also has to choose
inclusion. Big decisions come to the PRC and all colleagues need to speak up and be
comfortable challenging each other. We have just held an inclusion fortnight in which over
1700 colleagues from around the Bank participated, and as part of which the Governor
affirmed our commitment to inclusion in his public speech on February 9th. Our engagement
survey questions on inclusion showed the highest increase year on year with 67% of
colleagues responding favourably, up 7pp from 2015. I am the Bank executive with the
leadership responsibility for our diversity and inclusion initiatives and am committed to
creating an environment where everyone can bring their whole self to work in the service of
our mission.
Third, policy committees and the PRA must be accountable to Parliament for the delivery of
their independent goals. And mechanisms such as regular appearances before or exchanges
of letters with the Treasury Select Committee are a vital part of how we are accountable to
the people of the United Kingdom.
11. What do you see as the key risks to the PRA’s objectives?.
Please my answer to Question 20 for my broad views on risks to financial stability. For the
purposes of this question, I would like to focus on the operational demands on the PRA that
may stretch its capacity to deliver ongoing supervision and respond to the changes that will
occur in the financial sector as a result of regulatory changes and the EU referendum.
The first is related to the implications of the EU withdrawal. As part of nationalising the
“acquis”, EU legislation that applies directly to the financial services sector will need to be
“onshored”. We estimate that this makes up almost 9000 pages of EU rules. The
Government’s aim is to bring the acquis into UK law with limited alterations to deal with
inoperable provisions (such as those which concern the role of an EU institution). The PRA
needs to rapidly identify what those provisions might be and to propose solutions to them,
such as inclusion in the rulebook.
EU withdrawal will, of course, also require supervisory decisions. The PRA will have to work
with firms to ensure that they take appropriate steps to accommodate the UK’s withdrawal
in a manner which promotes safety and soundness. Moreover, over the course of the
withdrawal from the EU it will be vital for the PRA and UK authorities more generally to
maintain committed to the implementation of robust prudential standards in the UK
financial system.
The second operational demand on the PRA is structural reform. Those firms in scope will
need to have established their Ring-Fenced Banks and Non-Ring-Fenced Banks by 1 January
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2019. Over the next 12 months the PRA will need to make a number of key decisions around
the requirements for and the authorisation of those new entities. Other areas of the bank
are also working to make sure they are ready to, for example, collect, store and analyse new
data sets, enable sterling market operations to function for the new entities and provide
access to RTGS.
As well as these big structural challenges, there is much in the day-to-day business of the
PRA that will keep it busy.
12. Are there any additional regulatory, supervisory or policy tools which you think it would
be useful for the PRA to have?
At the moment, and with the proviso that I haven’t yet joined the PRC, it seems to me that
the tools available to the PRA are broadly sufficient. The rule making process appears to be
working effectively and the range of supervisory actions available to supervisors is broad
including:
The ability to authorise a new firm and assess any firm relative to minimum
Threshold Conditions required to carry on regulated activities
The ability to set capital and liquidity requirements for individual banks
The power to sign off models used by supervised firms in determining capital
requirements
Enforcement powers, including the power to impose financial penalties in response
to a firm failing to meet the PRA’s regulatory requirements
The ability, via the Senior Managers Regime and the Senior Insurance Managers
Regime to approve individuals with a significant influence on a firm
13. Is there a case for greater transparency from the PRA, for instance through the publication
of PRC minutes, or the disclosure of supervisory information?
As outlined above, the PRA should be accountable to Parliament, the government and the
people of the united kingdom. What forms that accountability takes is a very important
question. In the case of micro prudential supervision it is perhaps even more complex – the
question of what should be disclosed publicly and when, given that much specific firm
information in is clearly commercially sensitive, is a difficult one. Indeed according to Section
348 of FSMA, the PRA must not publicly disclose firms’ confidential information that it has
received in the course of its functions.
My current position would be that given the minutes of PRC meetings would contain such
commercially sensitive data, they should not be published. My rationale at this stage would
be as follows:
The minutes would either have to be so heavily redacted so as to be of little use, or
the nature of the meetings would have to change thereby potentially damaging the
PRC’s ability to fulfil its role effectively.
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The PRA has already made significant steps forward in accountability, including by:
publishing Pillar 2A requirements; providing greater transparency into its
assessment of the financial position of firms via the stress tests; and by committing
to the CEO of the PRA sending an annual report to the Chancellor. These are in
addition to other channels through which the PRA is held to account, including
through attendance at Parliamentary Committee hearings, the publication of
consultations and the rulebook.
Supervised firms themselves have responsibilities under accounting standards and
good corporate governance to provide a fair, balanced and understandable
assessment of the company’s position and prospects, and to enable challenge from
their investors. Investors should not became reliant on regulators to be the
translators of corporate accounts.
This view is consistent with the findings of the Warsh Review into transparency on the MPC,
which also considered the implications of his findings for the PRA6. But it remains an
important question, and, as I am not yet privy to PRC discussions, one on which I plan to
keep an open mind.
14. What are the implications of the Bank of England and Financial Services Act 2016 for the
PRA, and in particular the requirement for the PRC to have regard to recommendations
made by the Treasury?
When I joined the Bank in 2013 and tried to get my head around the governance structure of
the Bank, it was hard to find consistency in the model. The policy committees were all
established on different footings, and that reinforced silos. Colleagues struggled to
understand how they should work with those in other areas and what their primary
objectives were. The most consistent feedback we received was that we were not able to
operate as one institution, bringing to bear all our capabilities against the range of our
objectives.
The restructuring that we did as part of the strategic plan helped to break down some of
these barriers, and the move to a single set of terms and conditions facilitated this, but the
different structures, and especially the subsidiary structure of the PRA remained an issue.
The Bank’s central services spent some time in administrative work to support a separate
legal entity. At the PRA board, the time that was required to be spent on the management
requirements of a separate subsidiary reduced the time available to be spent on the policy
objectives of the PRA.
Our goal, as the governor has said is to “conduct supervision as an integrated part of the
central bank and not as a standalone supervisory agency that happens to be in a central
bank.” With the 2016 Act, all three committees are now established on a consistent basis,
eliminating confusion and administrative burden, and freeing up more time for the PRC to
spend on policy matters. This will be a benefit to colleagues as well, and will reinforce the
ability to following broader career paths across the bank, encourage mobility and cognitive
diversity.
The Act also set out clearly the responsibilities of the PRA CEO. They have specific statutory
authority to prepare a prudential strategy and budget, and day to day management of
prudential regulation. The Act also requires that once a year the PRC must report to the
Chancellor on the adequacy of the PRA’s resources and the extent to which the exercise of
the Bank’s functions as the PRA is independent of the exercise of its other functions. These
were important provisions that we welcomed in the Act.
As discussed above, the Act also makes a provision for the Treasury to send a remit letter to
the PRC, as it does for the MPC and FPC. The remit letter to the PRC will make
recommendations about aspects of economic policy that the PRC should have regard to.
This again maintains consistency with the other policy committees, and the objectives of the
PRC remain paramount, preserving independency of action.
Monetary policy and the wider economy
15. Which do you think are the most significant risks to the outlook for the UK economy?
I believe that the most significant risks to the economy today stem from the uncertainties
that face us at home and abroad.
The outcome of the negotiations with Europe will affect many parts of the economy in
the medium and long term. Today we are still uncertain about the effects on people and
their opportunities to work, develop, innovate and invest. The nature of future trading
relationships and the transition to those arrangements will affect the productivity and
potential of the economy. These are things on which monetary policy can have no
bearing. But while they are still uncertain, and while the end effects could have both
upside and downside to our central forecasts for inflation and growth, they remain a risk
to the outlook.
More immediately, the degree to which households change their spending and how
quickly they make those changes could have a material impact on the economy.
Following several years in which real income growth averaged around 2%, households
are beginning to face a squeeze on their incomes as the effect of the 18% depreciation
of sterling since November 2015 feeds through. In January inflation rose to 1.8%,
significantly narrowing the gap between it and nominal wage growth of 2.6%. Indeed it
seems likely that real income growth will be stagnant over the coming quarters.
The MPC’s current forecast assumes steadily slowing growth in consumption, facilitated
by a continued fall in the savings rate. But I can envisage scenarios in which the reaction
of consumption could be more sudden. Consumer reaction to news and events today
can be rapid, facilitated by social media. Working in consumer businesses made me very
sensitive to how quickly information (right or wrong) can be shared and how quickly
customers could take action as a result.
19
The future path of business investment is still unclear. Investment growth has been weak –
falling by 1% over the course of 2016, But forward-looking investment intention surveys are
around their long run average..
Businesses are clearly still working through what the impact of the changes in their trading
arrangements will be and the degree to which they will be affected, positively or
negatively. The MPC’s current forecast suggests business investment will decline in the first
half of 2017, reflecting perhaps hesitation in the face of uncertainty, and grow only modestly
further out, implying very weak growth in the capital stock relative to past expansions. I can
see two sided risks to this forecast. While the drag from uncertainty may be more persistent
than currently assumed, in my experience businesses are very good adapting to change. So
there may also be upside risks to business investment as the new trading arrangements
become clearer, and businesses solidify their investment and expansion plans.
Finally, there are the risks to the outlook from events abroad. Recent data have suggested
there is some momentum in the world economy, particularly in advanced
economies. Markets reacted strongly to the election of President Trump as they anticipated
a fiscal stimulus that would support US and world economy growth. US equity markets rose
by around 10%, and the US 10 year yield reached a peak of 2.70%. However the momentum
behind those trades has fallen back in recent weeks as expectations of early clarity around
fiscal plans faded. In Europe, political uncertainty now appears to be affecting financial
markets – notably for France where the spread of 10 year French government bonds over
their German equivalents has risen by 21bps since the start of the month. And of course
discussions over the conclusion of Greece’s programme review and disbursement of funds is
ongoing. The MPC’s current forecast assumes a further pick up in global growth, albeit to
still modest rates, so a change from that would present a downside risk to the UK.
16. What do you regard as the main challenges facing the MPC during your term?
As set out in my previous answer, the most significant challenge facing the MPC today is how
to anticipate what the decision to leave the EU – an unprecedented event – will mean for
the economy, and how monetary policy should respond as a result. This is already posing a
significant challenge as the Committee considers the question of how to balance the trade-
off between the prospect of above target inflation and weaker output growth. I will cover
that issue in more detail in my answer to question 17.
On a more technical note, it seems likely that the forces which have pushed down the
equilibrium rate of interest in recent years are structural rather than cyclical7. This means
they will continue to have an effect for some years to come. In light of this, given my
responsibilities for the Markets and Banking areas where monetary policy is implemented, I
will be particularly concerned with ensuring we are prepared to implement policy decisions
using the wide range of tools now at our disposal. I will endeavour to ensure that the expert
insights of the staff in the Markets and Banking areas are used to ensure those tools are well
designed and understood by the Committee. More generally, further work is being
7 As set out in Rachel, L and Smith, T (2015) ‘Secular Drivers of the Global Real Interest Rate,’ Bank of England
Staff Working Paper No. 571
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undertaken by staff across the Bank on the topic of low equilibrium interest rates and what
this means for our monetary and financial stability mission, and will be co-ordinated across
the MPC, FPC and PRC.
17. What would be the limits to your tolerance for above-target inflation, and what indicators
would you use to assess whether monetary policy needs to be tightened?
My tolerance for temporarily above-target inflation will depend on events. However, I
would have no tolerance for a less than credible path back to target – from either above
or below the target. The MPC’s remit clearly recognises the potential for actual inflation
to depart from its target temporarily as a result of shocks and disturbances. It makes clear
that in such circumstances “attempts to keep inflation at the inflation target. may cause
undesirable volatility in output due to the short-term trade-offs involved, and the
Monetary Policy Committee may therefore wish to allow inflation to deviate from the
target temporarily”.
In balancing this trade-off and assessing the credibility of the path back to target, It seems
to me therefore that the key judgements lie in
i. Using economic data to assess the degree of slack in the economy. For this I would
consider a wide range of indicators including the unemployment rate, wage
growth and short term indicators of economic activity.
ii. Analysing measures of inflation expectations to ensure that they remain
consistent with achieving the target over the medium term. At the moment,
household and market-based measures of near-term inflation expectations are
more elevated than usual, consistent with the likelihood that the depreciation will
push up on inflation over the coming years. But household and market-based
measures of medium term inflation expectations are around their long run
average.
The need to foster close co-ordination between monetary policy and macroprudential
policy is also recognised in the MPC’s remit. So while I will always set monetary policy in
order to achieve price stability, I fully intend to bring insights I gain from my membership
of the FPC and the PRC, and indeed through interaction with market participants.
18. Following the referendum, the economy has outperformed the Bank’s initial forecasts.
Why do you think this is?
First and foremost, the strength of the economy since the referendum is to be welcomed.
As I wasn't privy to the debates at the MPC at the time of the initial forecasts I will confine
myself to some general observations.
Decision making in a period of uncertainty always requires more judgement as you
are less able to rely on historic parallels and models. The referendum feels like a
once in a lifetime event. History has little to offer. Statistical relationships will break
down. Meaning the diversity of views on the MPC will be more valuable than ever.
21
Forecasts, like all analysis should be helpful in engendering a debate. Again, I wasn't
in those sessions but from what I can gather, those discussions and debates were
had. Forecasts are never perfectly right – indeed that’s why the MPC emphasises the
range of uncertainty in the form of fan charts. The IEO report established some
helpful criteria for forecasting: broad accuracy, unbiasedness and efficiency against
which the Bank is now regularly assessing itself. These tests suggested the Bank’s
forecasting framework performs relatively well, although some opportunities for
improvement were identified, and the Monetary Analysis area is responding by, for
example, broadening the suite of models used to forecast.
When you look at the judgements that the Bank made, they were reasonable and
used the data that was available at the time. GDP forecasts were in line with others,
indeed slightly higher. Survey data - for example the CIPS business survey which had
been a reliable indicator in the past - pointed south, falling very sharply indeed. A
mechanical steer from that survey would have suggested growth of -0.2% in the
third quarter - the MPC aimed above that when they forecast growth of + 0.1%. I
would add that the signal from these surveys was consistent with other indicators of
the outlook for the economy, such as the sharp decline in both sterling and gilt
yields.
19. What is your assessment of the effectiveness of the policy of quantitative easing in the
UK? What, in your view, have been the principal drawbacks of quantitative easing, and
what are the principal challenges of unwinding it in the future?
In March 2009, when Bank Rate reached 0.5% it was clear that the economy was in need of
further stimulus – GDP was contracting sharply, and unemployment looked set to rise
sharply. The broad package of macroeconomic policy measures introduced since then –
including monetary, fiscal and financial policy – have been successful in restoring economic
growth and bringing the unemployment rate to a level even lower than before the financial
crisis. Inflation over the period since QE was introduced has averaged close to 2%
confounding fears that had been expressed that QE would result in uncontrollable price
growth. In that light, I think QE can be viewed as a success.
Measuring the precise effectiveness of QE is difficult – we don’t know what would have
happened if it hadn’t been used. But there is an emerging body of literature which suggests
that QE has been effective in increasing activity, and most estimates suggest that the
impact of £100bn of Quantitative Easing boosts the level of GDP by between 0.3% and
1.5%8.
8 Bridges, J, Thomas, R, (2012). The impact of QE on the UK economy – some supportive monetarist arithmetic.
Bank of England, Staff Working Paper No. 442. Baumeister, C, Benati L, (2013). Unconventional monetary policy and the great recession: estimating the macroeconomic effects of a spread concession at the zero lower bound. International Journal of Central Banking 31, 165-212. Kapetanios, G, Mumtaz, H, Stevens, I, Theodoris K, (2012). Assessing the economy-wide effects of quantitative easing. The Economic Journal 122, 316-347.
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Although monetary policy is well placed to achieve certain goals – primarily price stability –
there are others that it cannot effect. The Treasury Committee has raised questions about
distributional impacts of QE in the terms of reference of its inquiry into the effectiveness of
monetary policy. I would note that over the period since the early 1990s the distributions
of income and wealth in the UK have been relatively stable, and have actually declined
since 2007. So even if quantitative easing does have distributional effects, it has not been
sufficiently strong to skew the overall distribution of wealth and income in the UK. That is
not to ignore or downplay the real inequality that does exist between income groups and
across regions. For example unemployment remains above its pre-crisis average in the
North East, West Midlands and Northern Ireland. However, monetary policy is not the tool
to address it. Monetary policy cannot act alone, nor is it intended to, hence the clarity of
the remit.
The Committee’s inquiry will also consider the impact of QE on pension funds. By pushing
down on long term bond yields, QE can increase the present value of liabilities in a defined
benefit pension fund, and this may not always be matched by an increase in its assets,
particularly if the fund is in deficit. Such moves could potentially have an impact on those
companies’ spending decisions. I know this is something the MPC and FPC have considered
in detail together, and the available evidence suggests that the effect on aggregate
investment growth is small, particularly relative to the overall benefits of stronger
economic growth and lower unemployment.
In purchasing gilts on behalf of the MPC, the Bank has been very mindful of its impact on
market liquidity. The process through which these purchases have been designed – regular
pre-announced auctions - are said by participants to create liquidity points in the market,
and since 2009 the Bank has made its holding of gilts available to the market via the DMO’s
normal repo market activity. Moreover, because of the increase in government borrowing
over the period, the outstanding stock of gilts available to the private sector has increased
by £217bn, even after taking account of the Bank’s purchases.
As I have already alluded to, we have less history on which to base our estimates of the
effect of quantitative easing, and for that reason most central banks would like to be able
to return to a world in which Bank Rate – a more simple and better understood tool – is the
only monetary policy lever. When the time does come to unwind QE (even if that is likely
some way off, as I set out in Question 6), we will do so in a way that is mindful of the need
to maintain orderly markets. It will take much thought, clear communications and very
careful execution – the Taper Tantrum of 2013 showed how sensitive financial markets can
be in response to central bank communications. The MPC will need to be clear about its
intentions, in order to avoid an unintended move in gilt yields. Moreover, in any reduction
of the stock of gilts – be it through natural run off or a programme of sales – the Bank
would co-ordinate closely with the Debt Management Office.
Churm, R, Joyce, M, Kapetanios, G, Theodoridis, K, (2015). Unconventional monetary policies and the macroeconomy: the impact of the United Kingdom’s QE2 and Funding for Lending Scheme. Bank of England, Staff Working Paper No. 542. Weale M, Wieladek, T, (2016). What are the macroeconomic effects of asset purchases? Journal of Monetary Economics 79, 81-93.
23
QE is a monetary policy tool and decisions on it remain solely a matter for the MPC. It is
implemented through a facility (the APF) which is indemnified by the government. Under
the arrangements for this indemnity, the Bank has transferred £70bn of net cashflows to
HMT, representing the difference between the coupons received on gilt holdings and Bank
Rate (which is the rate paid on the Bank’s own liabilities). As has been made clear from the
outset of QE,9 in the event that Bank Rate were to rise above the coupon yield of the gilt
portfolio these cashflows would change direction and flow from HMT to the Bank.
As such it is appropriate there are robust risk management arrangements in place between
the Bank and HMT. HMT receive regular updates on the risk profile of the APF at a
quarterly Risk Oversight Meeting. And HMT is able to provide views to the MPC on the
design of the Term Funding Scheme and on private sector asset purchases.
The clarity of these arrangements has allowed the MPC to use QE to focus solely on
monetary policy and demonstrate its independence in doing so.
Financial stability
20. What do you view as the main threats to UK financial stability at present? What other risks
would you wish to monitor closely in the future?
In 2007 I was managing a consumer credit business that had just been spun off from Morgan
Stanley and was funded through securitisations. By the autumn of that year events playing
out around the world felt very personal. The business was no longer sustainable. 1000 jobs
were at risk. To protect our customers and try and manage the redundancy risks we had to
sell the business. We were just a microcosm of what so many were experiencing. When the
financial sector, individual firms, payment systems or infrastructure doesn’t have the
resilience to absorb stresses on it, then the pain can be felt across the economy.
There is a great number of risks that colleagues about the Bank monitor. Today, they do so
in the context of much stronger financial resilience. By any measure firms have more
capital, liquidity, and higher quality assets than they did in 2007. Stress testing has thrown a
range of scenarios at the banking system (including a synchronised UK and global recession,
a sharp fall in house prices, and a congruent financial markets shock) and it appears to be
able not just to withstand the stress but also to continue providing credit to businesses and
households throughout.
For this answer therefore, I would like to focus on those risks where our resilience tests and
mitigation are relatively less developed, where the landscape is changing fast, or where
some short term disruption may occur.
Towards the top of my list is operational resilience, including to cyber threats. Operational
failures in critical economic functions such as payments, custody, clearing and settlement
9And as demonstrated by in a scenario analysis tool on the Bank’s website
have the potential to feed through into the real economy quickly. We have known about
issues of technology obsolescence for some years; what has changed more recently is the
scale and nature of the cyber threat. The FPC recommendations in 2013 initiated the CBEST
exercise. These penetration tests were designed to include specific threat intelligence and
use accredited ‘red teams’ to identify vulnerabilities. 30 financial institutions have now run
them.
The Treasury Committee has rightly continued to raise these issues and the Deputy
Governor for Prudential Regulation recently responded jointly with the Chief Executive of
the FCA to a letter from the Chair. That reply described the work we are doing around
developing specific micro prudential tools, establishing risk tolerance metrics, initiating work
on sector mapping, and engaging with international bodies. All of these will strengthen our
ability to respond and to absorb future threats but we are at an earlier stage of the journey
in a world that is changing fast. I have been personally engaging with the firms as we work
to try and understand where we have concentration risks or single points of failure across
the sector in our systems, processes, suppliers or premises.
Of course operational resilience is as important an issue for the Bank of England as it is for
the firms we supervise. The RTGS service is clearly systemically important. My answers to
Questions 3 and 6 have set out our approach to our own operational resilience, which
include assessing our own cyber capabilities using the CBEST framework. In my role as COO
for the Bank, I have led our information security work and the continual upgrading of our
capabilities, with the chief information security officer reporting directly to me on our
progress.
The second risk I would highlight is that of market disruption. The FPC has for some time
drawn attention to the potential for ‘fragile’ financial market liquidity to lead to a disruption
of the flow of credit to the real economy, and this would seem to be exacerbated by the
prospect of withdrawal from the EU. We don’t yet know what will be the future
arrangements in the financial sector across Europe. Firms will change their business models,
structures, and locations. We do not yet know what regulatory path the US administration
will take, and what the impact will be on our policy objectives. Given the complex nature of
collateral and capital arrangements in today’s globally interconnected cash and derivative
markets, any large-scale changes to existing arrangements have the potential to cause
fragmentation and or interrupt the supply of credit. It is a risk that we need to continue to
monitor.
Lastly, unresolved conduct risk is a concern. The Bank’s stress tests did include stressed
projections for known past misconduct issues but there is a high degree of uncertainty when
trying to quantify the scale or impact of this risk. As well as the consumer impact, which is
the purview of the FCA, when conduct costs are large they can become a prudential issue.
Those costs can come through not just in financial costs, which can be very large, but also in
operational costs if firms have to close particular businesses or locations.
There are three other developments that I would like to highlight as areas to monitor.
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FinTech offers opportunities to the financial system as well as risks. Customers could get
better pricing, or more tailored products, lend directly to business, and delegate financial
decisions to robo advisors. Operations could be streamlined and global payments made
more quickly. New competitors are emerging and the PRA has authorised a number of them
recently. There are however risks. New concentrations or single points of failure could
emerge, deposits could become more volatile, or we might see more herding activities in
financial markets. As digital banking becomes ever more prevalent, and connectivity
increases cyber risks will come ever more to the fore. These technologies are still at an early
stage of maturity, but we continue to monitor them as they grow.
At 10.6%, the growth rate of unsecured consumer credit in the year to December 2016 was
close to the fastest since 2005. The initial pick up in consumer credit growth was driven by
auto finance which arguably has more in common with secured lending. More recently,
however, the growth has become more broad based. And we are also starting to see some
of the product developments that were associated problems in the past such as long term
balance transfers and lower rates on personal loans. Product design is the remit of the FCA,
but from a macroprudential perspective these activities reinforce the importance of
monitoring consumer payments, the performance of lending vintages and any
concentrations of weakening credit. While unsecured lending is a small percentage of
consumer spending at 1.5%, it is the more volatile part. The FPC is already monitoring this
and is very alert to risks around consumer credit. The 2016 stress test included a sharp rise
in defaults in unsecured lending. It is also an ongoing part of the PRA’s continuous
assessment of its firms.
The final risk I would like to highlight as worth monitoring is banking profitability. The
returns banks reported before the crisis reflected inadequate levels of capital, and hence
shouldn’t be seen as a realistic targets for the future. However, some level of profit is
required in order to build capital, and some major UK banks continue to be challenged by
weak profitability. For the long term resilience of the sector, banks need to have sustainable
business models, generating sufficient returns to maintain capital at levels that keep the
system resilient. As they work through the one off impacts of conduct costs, we will need to
keep a watchful eye on underlying earnings and the sustainability of their business models.
Indeed, this is an issue that I understand will be explored in the upcoming ‘exploratory
scenario’ stress that will this year be run alongside the usual cyclical scenario.
21. What do you regard as the strengths and weaknesses of the work undertaken by the
Financial Policy Committee?
Today there is an understanding of what financial stability is, what to watch for, and how to
build resilience. There is recognition that micro supervision alone doesn’t cut it, you need to
look at the system wide effects and the feedback loops across institutions. We have a
financial policy committee with statutory objectives, an annual remit letter, and an
established set of policy tools. It conducts an annual assessment of financial stability risk and
regulation beyond the core banking sector, and can recommend changes to the regulatory
26
perimeter to HMT. The FPC is accountable to the Treasury Committee and, through its
minutes and decisions, to the public.
Financial stability tools are a complement to monetary policy tools and supervisory tools.
The FPC has joint meetings with the Bank’s other policy committees, and works closely with
them on topics such as the housing market and the implications of EU withdrawal.
Most importantly perhaps, the financial system has been stable despite periods of market
volatility, and the level of capital is three times that in 2008.
We cannot ever be complacent. The risks to the system are ever changing and I have
highlighted some of those. Widespread understanding of the FPC’s work is still developing.
We can always be clearer. The topics in which the FPC deals are arcane and the language is
studded with acronyms. To be fully accountable, not just to Parliament, but to the people of
the United Kingdom, what we do and why has to be easily understood, and it has to be clear
why it matters.
22. What is your view of the macroprudential tools that are available to the Financial Policy
Committee?
Broadly speaking it would seem to me that the FPC has sufficient tools today and has used
them effectively. The committee is still relatively youthful, and it seems to make sense to
bed down the existing tools and assess their impact before looking for others. I welcomed
the action the FPC took on housing, both the affordability test and the LTI flow limit, because
they support strong underwriting standards as well as minimise risks to the system. I have
read too many customer letters concerned about unsustainable debt levels and the hardship
that causes.
In the FinTech area I don’t think we currently need any additional tools. Those FinTech
companies that conduct banking activities will be regulated as banks. The FPC conducts an
annual assessment of financial stability risk and regulation beyond the core banking sector,
and can recommend changes to the regulatory perimeter to HMT.
If I had to imagine where tools might be required in the future, I would look to the
commercial real estate market and question whether, in addition to the existing power of
direction over sectoral capital requirements on commercial property, parallel lending tools
might be appropriate. I also welcome international initiatives, underway to develop a
framework for supervisory stress tests for CCPs, to which the Bank is contributing.
23. What indicators would you use to assess whether to increase the countercyclical capital
buffer?
Banks need to understand from regulators which tools they will use and under which
circumstances. Having worked for an investment bank many years ago, I have first-hand
experience of how banks can desire to hold “buffers on buffers” to ensure their regulatory
requirements are never breached. While in many cases this is prudent, taken to excess it will
impact lending and banking activities.
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So it is entirely desirable for policymakers to set out how they would intend to use the
macro-prudential tools at their disposal, as the FPC are statutorily required to do for their
powers of Direction, and have done for their approach to setting the Countercyclical Capital
Buffer (CCyB). The Committee monitors a wide range of core indicators of indebtedness10
and financial market conditions, all of which feed into the design of the Annual Cyclical
Stress test scenario, itself an important input to calibrating the CCyB.
I wasn’t on the committee at the time but I understand that the FPC has said that it expects
the CCYB to be around 1% when we are in a standard risk environment and that the
Committee reduced the CCYB from 0.5% to 0% following the referendum to guard against
any pressure on firms to restrict lending, and so promote a financial system that dampened,
rather than amplified, the impact of uncertainty and adjustment on the real economy. The
Committee has said it will review the setting of the CCYB in June. Alongside a more general
assessment of the resilience of banks, households and businesses’ balance sheets, and of the
terms on which credit is being supplied, I will be looking to see if risks of defensive actions by
banks had started to crystallise or are still in prospect.
Accountability
24. How important do you think it is for MPC, FPC and PRC members to be subject to
parliamentary accountability? What do you think are the strongest and weakest parts of
MPC accountability?
Committee members should be subject to parliamentary accountability. It is their
responsibility to be independent in their views and to be challenged on them. I know that all
of my colleagues recognise the vital importance of this.
I have spent most of my working life in private sector institutions. We had shareholders,
customers and colleagues to whom we are accountable. Customers vote with their feet;
shareholders can sell. You get real time feedback. Accounting standards and corporate
governance establish industry wide standards of accountability. Loss of trust and reputation
costs dear.
As a public sector institution, the Bank doesn’t have the same forms of accountability, and I
am very aware of our responsibility to use all the alternative channels we do have.
Openness and accountability make up one of the pillars of the Bank’s strategic plan and have
underpinned a number of the changes we have made in recent years. For example, the
changes to our governance through the 2016 Act strengthened our board, a key component
of good corporate governance. We have expanded the disclosures in our annual reports.
And our employee engagement survey and 360 assessments are ways of holding each other
to account against the values we set.
10
This includes the Basel “buffer guide” of the gap between the ratio of credit to GDP and a statistical estimate of its long-term trend. The FPC is required by legislation to review this metric, though the long run trend on which it is based gives undue weight to the period before the crisis and therefore may not be reliable.
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Our accountability to Parliament is one of the most important channels we have. But even
that is not sufficient. The Treasury Committee and Parliament are comprised of individuals
who regularly engage with the details of what we do. For the general public, who quite
rightly want to get on with their lives rather than bury themselves in the detail of the Bank’s
work, we need to be able to communicate clearly and succinctly.
This is not something central bankers have historically been good at. Alan Greenspan’s
famous quip “if I turn out to be particularly clear, you’ve probably misunderstood what I’ve
said” springs to mind. We now recognise the need to get our message across to a variety of
audiences. What we do matters and because it matters we need to be clear and open to
challenge and debate. A major element of the next strategic plan, which we are currently
working on, is to change how we communicate, and through that to be more accountable.
25. What activities do you intend to undertake in order to add to the public’s understanding
of the role and decisions of the MPC, FPC and PRC?
As set out in my answer to the previous question, one of the pillars of our strategic plan has
been openness and accountability. A clear understanding of policy strengthens the
effectiveness of that policy. Over the past three years we have changed the ways in which
we communicate. In my role as COO, I have played a role in that. For example, we have
changed the Annual Report to: increase our accounting disclosures; describe our strategy
and implementation; introduce best practice diversity reporting; and introduce a section on
community and social responsibility.
As mentioned elsewhere, I have made speeches on diversity, the cultural change at the
bank, cyber and FinTech. As one of the governors I have supported Open Forum and Future
Forum, and I have conducted a FinTech based visit to Cambridge and an agency visit in
Scotland. At Santander, I was a great supporter of branch visits and “back to the floor”
days. Talking to customers and to colleagues gave me a much better grip on the issues that
we needed to address and how they varied around the country.
In this role, my responsibility will be greater as it will encompass policy as well as
operations. The world of markets and banking is full of jargon and hard to access but the
impact on the public is great. The onus is therefore on us to continue to work to build the
understanding of what we do and why. Our new strategic plan will have a series of
initiatives to change our communications to tailor our approaches to different audiences
and needs. I will embrace the opportunity of this role to visit the different regions with our
agents. I will look forward to meeting with businesses, schools, universities and consumer
groups. Beyond the face to face, I am keen to explore new technologies and approaches,
making sure that everything I do is grounded in the mission and remit of the bank.
