Bank to act as Prudential Regulation Authority

Bank of England and Financial Services Bill [Lords] – in a Public Bill Committee at 11:30 am on 11 February 2016.

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Question proposed, That the clause stand part of the Bill.

With this it will be convenient to discuss the following:

Clause 13 stand part.

That schedule 1 be the First schedule to the Bill.

Clauses 14 to 16 stand part.

That schedule 2 be the Second schedule to the Bill.

Clause 17 stand part.

That schedule 3 be the Third schedule to the Bill.

The Committee will see that I have not selected any amendments that would leave out clauses or schedules. That is because the more effective proceeding is simply to vote against the stand part question, but the amendments were a helpful and proper indicator. As clauses 13 to 17 and schedule 1 to 3 are all closely dependent on clause 12, no amendments to any of them were selectable. I propose that it is convenient to consider the clauses and schedules together in debating the question that clause 12 stand part of the Bill. Members will have the opportunity, should they wish, of dividing the Committee on individual clauses or schedules in turn.

Photo of Harriett Baldwin Harriett Baldwin The Economic Secretary to the Treasury

It is a pleasure to serve under your chairmanship, Mr Brady, on this sunny February morning. The clauses and schedules together end the subsidiary status of the Prudential Regulation Authority and integrate microprudential regulation more fully into the Bank of England. I hope I can make it clear that the changes increase the PRA’s effectiveness, but do not undermine its independence.

First, I will talk about increasing effectiveness. Placing the Prudential Regulation Committee on the same footing as the Monetary Policy Committee—and, with our changes, the Financial Policy Committee—will elevate the status of the microprudential responsibilities of the Bank to the same level as monetary policy and macroprudential policy. That reinforces not only to Bank staff but to the public to whom the Bank must be transparent and accountable that the Bank is not simply an organisation dedicated to setting interest rates, but one with equally important macro and microprudential responsibilities.

The Bank has told us that closer integration has increased the feeling among PRA staff that they are integral to the Bank’s mission and have broader opportunities for progression across the whole Bank. That can only assist recruitment of the best people to the supervisor. Another benefit is increased clarity of governance. As the Parliamentary Commission on Banking Standards noted in discussing the existing regime:

“The accountability arrangements of the new structures are more complex than those of the previous regulatory regime. The PRA is a subsidiary of the Bank, and the FPC is a sub-committee of the Court of the Bank.”

Ending the subsidiary status of the PRA and establishing the PRC, MPC and FPC on the same statutory basis simplifies and clarifies Bank governance.

A further benefit of ending the PRA’s subsidiary status is that it enables the members of the new committee to devote more time to microprudential policy and operations. As the Governor explained at the Treasury Committee, the change will

“liberate…a portion of the time of the members of the PRA Board that is spent duly exercising their responsibilities as directors of a company”,

while noting the important responsibility PRC members will continue to have for ensuring the prudential regulation functions are adequately resourced. The Governor concluded

“that time is freed up to do their core job—what they are there for—which is to provide guidance on judgment-led supervision.”

For example, the PRC will not have to spend so much time discussing IT provision since that will be a concern for the Bank at large, and ultimately for its governing body, the court. Equally, whereas the PRA board had to be involved in discussions on staff terms and conditions and recruitment, the new committee will be able to leave those important concerns to the wider organisation and focus more on supervision.

Secondly, in terms of protecting independence, the PRA is a wholly owned subsidiary of the Bank, staffed by Bank employees. The Bank appoints the non-executive directors of the PRA board, subject to the approval of the Treasury. The transfer of the PRA’s functions to the Bank does not therefore transform the PRA from a body that is independent of the Bank to one that is not.

It may be worth explaining what “independence of the PRA” actually means. The Basel core principles on banking supervision state that legal safeguards should ensure that a regulator has

“operational independence, transparent processes, sound governance, budgetary processes that do not undermine autonomy and adequate resources”.

The Bill provides for all of those things. It provides that the Bank’s PRA functions may be exercised only through the new Prudential Regulation Committee. The Bank may not exercise its prudential regulation role in any other way.

The Prudential Regulation Committee will have a clear majority of external members. There will be at least seven external members, including at least six appointed by the Chancellor plus the CEO of the Financial Conduct Authority, and five internal members, comprising four Bank officers and one member appointed by the Governor. It is important to note that that is an increase in the weight of external members from the PRA board, on which a majority of only one is required.

Continuing with the protections for the PRA’s operational independence, the Basel core principles call for transparent processes and sound governance. The Bill sets out clear processes for the new committee’s decision making. The core principles also stress adequate resources. Every year, the committee will report directly to the Chancellor on the adequacy of its resources and the independence of its operations. The requirement for the Bank to separate resolution and supervisory functions will ensure that the UK complies with the European Union directives that insist on separation.

Finally, the Bill grants a strong statutory role to the PRA’s chief executive. He or she will be responsible for the day-to-day management and implementation of the prudential regulation strategy, and for determining how resources are allocated, managing policy development and overseeing supervisory decisions that do not reach the level of the committee. Our changes will increase the PRA’s effectiveness without undermining its independence. I commend the clauses to the Committee.

Photo of Richard Burgon Richard Burgon Shadow Minister (Treasury)

It is a great pleasure to serve under your chairmanship on this sunny day, Mr Brady, or indeed on any other day.

The effect of clause 12 will be to demote the PRA from being a separate authority to being a mere sub-committee within the Bank of England. We tabled an amendment to remove the clause and those that are consequential upon it. We think that the Treasury is dismantling another significant part of its regulatory reforms, which came into being through the Financial Services (Banking Reform) Act 2013. The clause would make the Bank of England as a corporate entity responsible for microprudential regulation. Our principal concern is with the manner in which microprudential regulation is to be conducted. We are concerned that the new PRC will be less independent than the PRA.

The risk is that the Government are demoting concerns about microprudential regulation by devolving the functions of the rule-making, free-standing regulatory authority, which is supposed to oversee that, to a sub-committee of the Bank. That is not a minor matter. The PRA is a separate corporate body and a distinct authority. It can be held separately liable and accountable for its actions and interactions. If it becomes merely a committee within a much larger corporate body, it will not be possible to hold it to account in the same way.

In the other place, my shadow Treasury colleague, Lord Tunnicliffe, said:

“The thing that keeps it clean is the fact that the PRA is a subsidiary—an independent company, as mentioned, governed by company law—and, therefore, there has to be an arm’s-length relationship between it and the FPC.”—[Official Report, House of Lords, 1 November 2015; Vol. 765, c. 2005.]

I do not believe that moving the PRA closer to the Bank and, by definition, closer to the FPC is a good thing. The present separation works and should continue.

The former Treasury Committee Chair, Lord McFall, said that the clause is

“downgrading the PRA to a mere committee”.—[Official Report, House of Lords, 26 October 2015; Vol. 765, c. 1059.]

The desubsidiarisation—a bit of a mouthful—of the PRA may simplify the Bank of England’s governance, as its current and outgoing chair, Andrew Bailey, said at the Treasury Committee. But will it make it more competent and more effective in carrying out its work? Our concern is that it will not, and there is no evidence that we are aware of to demonstrate that.

In Mr Bailey’s discussion at the Treasury Committee, the Chair of the Committee, Mr Tyrie, raised concerns that there will not be sufficient independence owing to the make-up of the committee’s membership. He highlighted:

“the Chairman of the FPC, who will also be the Chairman of the PRC, who will also be the Governor of the Bank.”

Mr Bailey said,

“We have to be very clear in our own roles and thinking which hat we are wearing at any given point in time”.

He also said that the body will be more integrated into the Bank, but that it also has certain functions that it needs to carry out independently. The Governor was also pushed on this, again by a Treasury Committee member, Mr Baker, who said:

“In addition to being Governor, you chair the Financial Stability Board, you are a member of Court, and you chair the FPC, the MPC and soon the PRC.”

He warned that,

“the institutions are set up in such a way that they strongly depend on the Governor’s capacity to act independently in different contexts.”

Also at the Treasury Committee, the hon. Member for East Lothian asked the Governor whether the overlap of personnel meant there were grounds for conflict

“if we have the PRC reporting on its independence from the rest of the Bank.”

I am sorry to quote the Treasury Committee at such length, but the discussion there threw up contradictions, and it is not clear to me that those contradictions have been sufficiently resolved. So can the Minister say whether the body can be both more integrated and remain independent? We welcome joined-up thinking and ensuring a broad overview. We also heard about the dangers of groupthink in Committee the other day, and the Governor of the Bank told the Treasury Committee that the Bill did not specifically address that. If we have too many key persons juggling too many tasks, is there not a risk of oversight being impaired or conflict of interest setting in?

An authority employs its own staff who are therefore dedicated to the pursuit of its particular goals, in this instance microprudential regulation. By creating a committee of senior figures, microprudential regulation becomes simply another series of talking points among senior executives, as opposed to an ongoing regulatory activity. There are many very important functions that must be performed by a microprudential regulator in the wake of the last financial crisis: first, the conduct of stress tests to ensure that individual financial institutions are putting to one side sufficient capital. That is a microprudential activity that relates to the solvency of the institutions. We are surely not arguing that it is no longer important.

With the creation of new starter banks, there is a greater need than ever for microprudential regulation as those institutions start up in business. If we continue to start new credit unions and new blockchain banks and so on, microprudential regulations remain fundamentally important. Also, there continue to be high street banks in financial difficulties, such as the Co-operative and Britannia. The danger of the Prudential Regulation Committee being appointed as is currently suggested makes it more likely that groupthink will develop.

The strength of having different agencies in existence simultaneously is that there is a useful tension between them as each of them considers the same question from a different angle in terms of the systemic risks, the risks to the solvency of individual banks, and in terms of activity on individual markets. So the political and economic context should be considered elsewhere beyond those regulatory bodies.

It is remarkable that we are witnessing what some commentators would call a downgrading of micro- prudential regulation UK at a time when financial institutions such as the Co-operative Bank and the Britannia, as I have just mentioned, face such serious solvency problems. The PRA was created for exactly that sort of situation. I therefore want to spend time on the arguments raised in relation to that change.

It has been stated that the PRA is being put on the same footing as other activities and that it is being taken back in-house. Taking the PRA back in-house is an odd idea. The PRA is currently a subsidiary of the Bank of England, so it is already in-house. A subsidiary is something that is owned by a parent company; the PRA was already a part of the Bank of England and in any event was answerable, through a statutory scheme, to the Governor.

There was a new post of deputy governor of the Bank of England, which was assigned to head up the PRA in the Financial Services Act 2012. So what is the problem with governance over it? What prompted this change from authority to committee in the first place? We wish to argue for the retention of the PRA as a distinct regulatory authority and believe that it ought to be given a shot in the arm, so that it comes out of the shadow of the FCA and begins to fight for microprudential regulation. We are of the view that the case to vest the powers of the PRA into the Bank, in a new committee called the PRC, is a good one and we will push our amendment to leave out clause 12 to the vote.

I now move on to the rest of our comments about clause 13. Once a Division has been held on clause 12, as you say, Mr Brady, that guides us on the following clauses, which are consequential upon it. However, I wish to take a moment here to say that the question is: why does it matter whether the PRA is an authority or a committee? We have discussed that in relation to clause 12. The Treasury is empowered to give a notice in writing to the new Prudential Regulation Committee, making recommendations about aspects of economic policy.

At one level, that is dangerous, because it allows economic policy to influence microprudential regulation. The importance of microprudential regulation is that it must continue to assess the solvency of individual banks without outside influence. If it allows itself to ask whether it would be better in economic terms for a bank to continue operating or not, that would distract it from deciding whether or not the bank actually has sufficient assets to stay solvent.

The only strength of the 2013 regulatory reforms, which were introduced at the European level originally, is that they require different agencies to consider each problem from a different perspective, so that groupthink, which I mentioned earlier, is less likely to develop.

Given the discussion on clause 12 that we have already had, I will leave it there on clause 13.

We have nothing further to add to clause 14, on “Accounts relating to Bank’s functions as Prudential Regulation Authority” and evidently we will not push our amendment to a vote. The same is true of clause 15.

In relation to clause 16, Mr Brady, you will be aware that we have tabled an amendment to schedule 2, which is introduced by clause 16, to rename the Bank of England’s “Court” as a “Board”. We will now propose that amendment at a later stage, which I am sure the whole Committee is anticipating eagerly, in a new clause alongside the SNP’s discussion on the bank’s name. I do not know which one the Committee will consider the more radical proposal; I do not want to get into a competition with the hon. Member for East Lothian for radicalism or moderatism, if that is the phrase. However, our plan is one that would put the Bank on a similar footing to some of the major financial institutions in the City. On that basis, I have nothing further to add to clause 16 now and we will not push our amendment to a vote.

Finally, I can confirm that again we have nothing further to add to clause 17 and schedule 3, which has been grouped with these clauses, and will not push amendments to them to a vote.

Photo of George Kerevan George Kerevan Scottish National Party, East Lothian 11:45, 11 February 2016

Like other Members, I add my delight at serving under your chairmanship on this bright morning, Mr Brady.

There is no best way of constructing the Bank and its regulatory functions. In this instance, however, having set up a structure, I think we should let it work itself out and see what the issues are, rather than tear it up so quickly. From that perspective, I will support the line of argument followed by the hon. Member for Leeds East.

May I remind the Minister and the Committee that we have been here before? There was a long period when the Bank was effectively the prudential authority, and it did not do a good job. One can mention the Bank of Credit and Commerce International. One can mention Barings. The Bank failed at the very simple task of examining the imminent failure of major banking institutions and it did not ensure that that did not happen before it became a public catastrophe.

For that reason, in the Bank of England Act 1998, prudential conduct responsibility was taken away from the Bank and invested in the Financial Services Authority. That model, as we saw subsequently, did not work, in the sense that completely separating prudential conduct from the Bank led to a chasm between the two agencies in terms of who was letting whom know and who was responsible for tidying up.

In a sense, the halfway house that we now have, where we have put prudential conduct into the orbit of the Bank but kept it semi-discrete, is better than what we had before. Will it work in the long run? I doubt that any bureaucratic system ever works in all circumstances, but we have set it up; let us test it to destruction before we make another bureaucratic change. From that point of view, we have a model that seems to work.

The issues brought up in the Treasury Committee related particularly to the resources that were deployable to the PRA to conduct its activities and whether the main board of the Bank was providing sufficient financial and staff resources to the PRA to allow it to do its work. My worry is that the change proposed by the Government makes it too easy for the Bank’s main board to ration resources for the soon-to-be PRC. It would be better to leave a degree of independence within the PRC, so that if it comes to a debate over resources, the PRC has some muscle and can go public if it feels that it is not getting the physical and staffing support it needs from the main board.

We may need to come back to the structure of the Bank at some point; the Minister may want to reflect on that. As I said in the previous sitting, we are in danger of creating too many committees of the Bank. We may be in danger of reinforcing a silo mentality, even though the Governor serves on all the different committees. We may have to discuss at some point whether we need to separate the Monetary Policy Committee and the Financial Policy Committee, but we should certainly test the prudential part of the administration in its present form. Changing it now simply because we will get a better and prettier bureaucratic chart is not a sufficient reason.

Photo of Harriett Baldwin Harriett Baldwin The Economic Secretary to the Treasury

As I am sure you are aware, Mr Brady, desubsidiarisation of the PRA is not something they talk about very often down at the Dog and Duck, but it is incredibly important. Committee members have raised important issues, to which I would like to respond.

If one were in the pub discussing the Bank of England, the extent of people’s knowledge of what it does probably would stop with the changing of interest rates; the hon. Member for Leeds East made that point clearly. He said that the change represented a downgrade of the incredibly important microprudential responsibilities of the PRA, but I would argue that it is an upgrade, in the sense that it gives the PRA the status of a committee—the Prudential Regulation Committee—that has the same status as the Monetary Policy Committee. That reinforces to not only Bank staff but drinkers in the Dog and Duck and the public at large that it is an incredibly important function. I completely agree with hon. Members who raised that point.

The microprudential responsibilities of the prudential regulator are extremely important. The hon. Member for East Lothian made the important point that, in the 300 years of history of the Bank of England, until its independence under the Bank of England Act 1998, there were obvious failures. Firms did fail, and no one should be under the illusion that we are in a zero-failure regime for banks.

However, it is clear that the decision to separate that microprudential function and move it to the FSA created a system that was tested to destruction. That separation under the failed regulatory regime of tripartite arrangements meant there was insufficient communication between the microprudential regulation at the FSA and the day-to-day liquidity challenges that banks were experiencing in the markets in the run-up to the crash. That seems to me the strongest possible argument for having moved the microprudential function back to the Bank of England. I am glad that Committee Members have supported that important change. By following the logic of that argument, one is compelled to see that it makes sense to go one step one further, and change the PRA from being a subsidiary into being at the heart of the Bank with the same status as the Monetary Policy Committee.

By making the points he did, the hon. Member for East Lothian has made my argument for me—for having that much closer feeling of all staff being part of one Bank, which is the agenda that the Governor has set out. That not only gives a much higher status within the organisation to the incredibly important function of microprudential regulation but it reinforces the ability of the organisation to communicate with the important other parts of the organisation, and gives them more time to do it. They will not have to worry about all of the responsibilities of being a separate company.

Photo of Harriett Baldwin Harriett Baldwin The Economic Secretary to the Treasury

I am glad to see that the hon. Gentleman, a thoughtful and intelligent man, is nodding vigorously as I make my argument.

The hon. Member for Leeds East asked what prompted the decision. It was very much the one-Bank agenda that the Governor has followed. He argues that it makes sense to have different points of view and not be captured by groupthink. Although I agree with the importance of having a range of views on these committees, I would counter that argument by saying that the tripartite arrangements were so clearly inadequate that that difference meant that no one spoke to each other about what they were seeing.

I hope that the Treasury Committee returns to evaluate how the transition has worked. I want to reassure hon. Members on resources, because they are incredibly important. We want to ensure that the microprudential function does not have to compete for resources or find itself starved of them. It is important to note that the levy will continue to provide those resources. No changes are being made under this legislation to the available resources for microprudential regulation.

The hon. Member for Leeds East mentioned the importance of the role of the Governor. Of course, the Governor is an incredibly important person who sits on all the committees. That is an important function of having a one-Bank organisation. He is obviously a very responsible person. With those responsibilities comes accountability, not only through the Chancellor but to Parliament through the Treasury Committee. I emphasise that that arrangement does not change as a result of these clauses.

Having reviewed all the questions raised against making the changes, I insist that the changes will improve the Bank of England’s governance.

Question put, That the clause stand part of the Bill.

The Committee divided:

Ayes 10, Noes 7.

Division number 2 Christmas Tree Industry — Bank to act as Prudential Regulation Authority

Aye: 10 MPs

No: 7 MPs

Aye: A-Z by last name

No: A-Z by last name

Question accordingly agreed to.

Clause 12 ordered to stand part of the Bill.

Clause 13 ordered to stand part of the Bill.

Schedule 1 agreed to.

Clauses 14 to 16 ordered to stand part of the Bill.

Schedule 2 agreed to.

Clause 17 ordered to stand part of the Bill.

Schedule 3 agreed to.

Clause 18