Clause 216
Banking Bill
1:00 pm
Mark Hoban (Shadow Minister, Treasury; Fareham, Conservative)
The hon. Gentleman makes a good point. I did not wish to regurgitate everything that was in the Treasury Committee report—just perhaps most of it. This dual aspect of financial stability is what is really important. It is about how the systems function and their resilience, but it is also about the allocation of risk. Narrowing the definition of financial stability could potentially lead to ignoring the risk aspect of that stability. It is important to reflect on that. As the Bank comes to terms with its new role and looks at its financial stability objective, I hope that it will consider actively the allocation of risk and the price that risk gets in the marketplace.
It is difficult to define financial stability. I expect that explains why the Government moved from their policy in July of wanting a definition in the Bill, to just saying that it is a high-level concept. Sir John Parker, in his memorandum on this to the Treasury Committee, suggested that there could be a “qualitative” objective for financial stability, rather than a quantitative objective, which might be developed to identify factors that could be used to define far better what financial stability would be. In his evidence, he suggested five factors that might be helpful in coming up with a qualitative objective:
“First, the Bank cannot and should not seek as its objective the elimination of all instabilities...within the...system. That could only be achieved by suppressing the financial intermediation...Second, the tools available to the...banks...are limited”,
which implies that the elimination of financial instability is unrealistic. That is important to recognise—I shall come on to tools later on, but there is a limited range of policy levers available to the Bank to tackle financial instability. I shall propose one additional lever that the Bank might be able to use. To continue:
“Third...the objective of the...authorities should be to ameliorate the effects”—
costs—of failure, which goes back to the definition that the hon. Member for South Derbyshire quoted. How can we build resilience into the system to ensure that, where there is a failure, the system continues to function effectively? Some of the clauses in the Bill tackle that—the reforms to the Financial Services Compensation Scheme will help the system perform better when there is a banking failure.
Sir John also suggested, fourthly, that the Bank’s role with regard to financial stability would be strengthened with its new responsibilities for oversight of payment systems, which we debated on Tuesday, and the operation of the special resolution regime, which we will come on to in part 1 of the Bill. His fifth comment was that, while financial stability might focus on the banking sector, there are non-banking activities that have an impact on financial stability. In our debate this morning on clause 214, the Minister explained the rationale for Government amendment No. 28 in the context that non-banking institutions can have a significant impact on financial stability, given the intermediation in the system and some of the business models that have been employed over the past few years.
If the Bank were to look at Sir John’s comments about the factors that could be used to set up a qualitative measure, that might help flesh out the definition of “financial stability” beyond that stated in the Bill. It would also help provide a framework for assessing how well the Bank met its objectives. Part of the challenge, in how the Bill is structured, is how to hold the Bank to account for deepening financial stability, when we only have a vague definition of financial stability and—we all accept this—it is difficult to measure.
I am sure that there will be a rash of research into the definition of “financial stability”. We may be able to reach a consensus in time, but the absence makes it harder to hold the Bank of England to account. As I said earlier, we shall know where there is a lack of financial stability, but the problem is in determining it. Sir Andrew Large, a former deputy governor of the Bank, said:
“There is neither a clear over-arching analytical framework nor a commonly agreed set of indicators of incipient financial instabilities...We are dealing with tail events—low probability scenarios—rather than central projections. It is about aberrant rather than normal behaviour and situations: less predictable and harder to model.”
That presents us with a challenge—how do we measure financial stability? The Governor alluded to this in the evidence that he gave to the Treasury Committee:
“I think therefore the danger is that financial stability looks like a period in which you are merely sowing the seeds of the next crisis and it appears to be a tranquil time but in fact beneath the surface those seeds are germinating and will produce the crisis down the road”—
very eloquent. I happily give way.