Carney needs a tougher reform for all our sakes

BEFORE the financial crisis of 2008, the Bank of England’s main job was to move interest rates up and down to control inflation.

A great strength of the Bank’s Monetary Policy Committee, to which I belonged in its early days, was how we disagreed with each other: you end up with better policy decisions that way.

Those favouring higher interest rates were labelled as hawks, and those inclining downwards were called doves. since the crisis, as every saver knows, it has been doves all the way, with interest rates at the floor. The Bank now has another job too – keeping the financial system stable – and a Financial Policy Committee to decide how.

The FPC has a big decision coming up: how strong a buffer of shareholders’ capital (‘equity’ for short) should major High street banks have to maintain? This question is important for everyone because the strength of the equity buffer is our first and best line of defence when shocks next hit the banking system.

In 2008 the buffer was shown up as being woefully thin, which is why such big taxpayer bailouts were needed. The economy then limped along while the deficit and public debt soared.

Of course, in the Eurozone things have been worse still.

But until a week ago, when I questioned the Bank’s proposed equity buffer policy, this issue was under the radar. That’s largely because it’s discussed by banks and their regulators in very technical terms. But it matters a great deal to all of us. so what’s it all about?

Consider the example of a High street bank that has made loans of £ 300bn, equivalent to about two months’ output of the British economy. How big an equity buffer should it have?

Maybe £30bn? Then it would go bust only if it lost more than 10pc on its loans. Remarkably, however, international standards would allow it to have just £10bn of buffer – a ratio of 30:1.

International standards are far too lax. The Independent Commission on Banking ( ICB), which I chaired five years ago, recommended substantially stronger standards for Britain’s banks.

But there was a limit to how far above international standards we could go without risking unintended consequences.

We were also boxed in by the fragile state of the economy at the time, and the eroded equity buffers that the banks then had.

Nevertheless, the reform package recommended by the ICB – which included ring- fencing retail from investment banking – was as radical as any in the world. Government and Parliament largely accepted it, and on a cross-party basis.

Fast forward to a press conference at the Bank of England on December 1 last year. Governor Mark Carney declared ‘there is no new wave of capital regulation coming’ and set out a UK framework that was ‘a little above the basic international standards … for major global banks but… lower than some might have expected’.

Quite so. The banks are already ‘within touching distance’ of the Bank of England’s target, and three years ahead of schedule. They will be pleased if reform efforts end here.

WHY has Governor Carney gone dovish towards the banks?

He seems to trust that new (and untried) types of debt will work well when banks next get into trouble, and that the Bank’s ‘stress test’ exercises are reliable.

I am not so sure, and anyway shouldn’t central bankers be cautious?

so when the Bank published its detailed, and in my view disappointing, equity buffer proposals at the end of January, it seemed time to speak up. Public debate on such an important question is desirable, and the recent turmoil in bank share prices worldwide underlines the need for it.

How much debate, and openness to policy change, is there behind the closed doors of the FPC? I hope a good deal, and that by the time of its final policy announcement in May, the Bank of England will adopt a stronger policy to make our banks safe.