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House of Commons

Treasury Committee

Macroprudential Tools

Oral evidence

Tuesday 16 October 2012 and Wednesday 13 February 2013 Ordered by the House of Commons to be printed 16 October 2012 and 13 February 2013

The Treasury Committee

The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.

Current membership

Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Mr Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Mr Brooks Newmark MP (Conservative, Braintree) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)

Powers

The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via www.parliament.uk.

Publication

The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/treascom. The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in printed volume(s). Additional written evidence may be published on the internet only.

Committee staff

The current staff of the Committee are Chris Stanton (Clerk), Anne-Marie Griffiths (Second Clerk), Jay Sheth and Adam Wales (Senior Economists), Hansen Lu, Gregory Stevens (on secondment from the Bank of England), and Callum Saunders (on secondment from the NAO) (Committee Specialists), Steven Price (Senior Committee Assistant), Lisa Stead and Paul Little (Committee Assistants) and James Abbott (Media Officer).

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All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5769; the Committee’s email address is [email protected]

List of witnesses

Tuesday 16 October 2012 Page

Anthony Browne, CEO, British Bankers Association, Adrian Coles OBE, Director General, Building Societies Association, and Paul Smee, Director General, Council of Mortgage Lenders Ev 1

Wednesday 13 February 2013

Rt Hon Greg Clark MP, Financial Secretary to the Treasury, and Lowri Khan, Director, Financial Stability, HM Treasury, gave evidence Ev 15

List of written evidence

Written evidence can be found on the Committee’s website www.parliament.uk/treascom

1 British Bankers Association 2 Council of Mortgage Lenders 3 Building Societies Association 4 Greg Clark MP, Financial Secretary to the Treasury

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Treasury Committee: Evidence Ev 1

Oral evidenceTaken before the Treasury Committee

on Tuesday 16 October 2012

Members present:

Mr Andrew Tyrie (Chair)

Mark GarnierStewart HosieAndrea LeadsomMr Andrew LoveJohn Mann

________________

Examination of Witnesses

Witnesses: Anthony Browne, CEO, British Bankers Association, Adrian Coles OBE, Director General,Building Societies Association, and Paul Smee, Director General, Council of Mortgage Lenders, gaveevidence.

Q1 Chair: Good morning. Thank you very much, allof you, for coming in. Can I begin with Paul Smee? Iwill just read you what the Government has said, “TheGovernment has noted that other countries’experiences of tightening mortgage terms andconditions, including setting LTV and LTI ratios,suggest that this has been a somewhat effective wayto limit financial instability”. I take it you disagree.Why?Paul Smee: I think the record in other countries isquite mixed and it has not had a uniformly stabilisingeffect. If you look at Hong Kong, for example, whichhas had LTV caps in place since the early 1990s, theyhave still seen a considerable fluctuation in propertyvalues as a consequence of the turbulence in the FarEast, for example, at the end of the 1990s. What didhappen there was that the number of mortgages thatwent into arrears as a consequence was probablylower than it otherwise would have been. I think whatwe would say is that there are other ways of gettingto the same result that may be more effective. Theother nation that has had LTV caps in place is Canadawhere there does at the moment appear to be a fairlyrocketing property boom, so I do not think an LTVcap can be seen as the sole answer.

Q2 Chair: Mr Browne, do you agree with that?Anthony Browne: I think it is very important whenlooking to all the macroprudential tools that you dolook at the evidence base for them because this isobviously quite an experimental area in many ways.That is why in our submissions we have been verypro having the countercyclical capital buffer becausethat is a very well-established area with internationalco-ordination. On the LTV side, the evidence isclearly very mixed, so we support going in with thosemeasures that we have a good evidence base on, agood knowledge base on, and then expand thedifferent measures. It may be in future that if there areparticular problems that are not being resolved by thetools that we have in the toolkit you want to move toother measures. In terms of LTV and LTI, there isobviously a greater signalling intention there, whichis that if you just change sectoral capital requirements

Mr Pat McFaddenMr George MudieJesse NormanMr David RuffleyJohn Thurso

for, say, the residential property or commercialproperty sector, then it will be an indirect signal to thegeneral public about the concern that the FPC has,whereas if it makes a statement that it wants to capLTV or LTI at a certain level, then that will be a verypublic statement that property buyers or commercialproperty companies would be well aware of and so itwould have a far greater signalling power. But you dohave to look at the evidence base in other countriesand it is mixed.

Q3 Chair: You are supporting the need for powerfulsignalling?Anthony Browne: Well, I am just pointing out thatthere is—

Q4 Chair: I am asking you what you think theyshould be doing.Anthony Browne: I think it is very important that theFPC’s actions and decisions are clear and accountableand transparent both to the industry and to the broaderpublic about the intentions. I was pointing out that isone of the upsides of LTVs and LTIs, but the downsideis that the real world impact is very mixed and youhave to take that into account.

Q5 Chair: If you were them, would you beintroducing an LTV/LTI?Anthony Browne: I think I would do exactly whatthey are doing and what the Treasury recommends.We have come out supporting that. It is just startingwith the two different measures, the countercyclicalcapital buffers and the sectoral capital requirements,because those are the measures that we, as I saidearlier, have clearest knowledge of, clearest evidencebase of, clearest international co-ordination aroundthrough CRD4. We start with those and then move itout. The whole area is obviously—experimental is notquite the right word, but the Government and theregulators are feeling their way on this. It is importantwe move slowly rather than jump straight in.

Q6 Chair: You think sectoral capital weights can bemade to work without gaming?

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Ev 2 Treasury Committee: Evidence

16 October 2012 Anthony Browne, Adrian Coles OBE and Paul Smee

Anthony Browne: There is clearly the risk of gaming.That is one of the downsides. With all these differenttools, there are upsides and downsides and you haveto do a cost/benefit analysis—and, indeed, the FPChas said they will do that—about what the upside isversus the downside. Often, until you actually usethese different tools, you will not know exactly howthey will work. As I said, you need to move slowly,build up the evidence base, see how it works. That isthe importance of the transparency, of accountability,of the FPC actually setting out the conditions underwhich it would use different tools, which weabsolutely welcome, and then once you use particulartools that it then sets out the reasoning behind why itused that tool, and reviews it later to see how thosetools worked. If you find out that sectoral capitalrequirements do lead to gaming, then clearly you haveto take that into account in any future action.

Q7 Chair: Mr Coles, were you surprised that theFPC used, “The need for a high level of publicacceptability” for any of this as one of its criteria fordeciding what to recommend?Adrian Coles: Not at all. I was very pleased to seeit. There clearly is a need for a high level of publicacceptability for housing market controls. They canhave big impacts on access to owner occupation orlevels of house building, on levels of buy-to-letlending with a growing private rented sector, forexample. These controls can go much wider thanfinancial stability. For example, if we do have LTV orLTI controls, that would favour those with access tothe “bank of mum and dad”, who are able to take upthe top 20% of the loan that you can no longer receivefrom a mortgage lender—if controls are effective—from other family members. If you do not have accessto that, clearly your access to owner occupation isdenied.

Q8 Chair: So if the public do not like something, itis more or less a veto on a macro tool in that area?Adrian Coles: I would not say it was a veto, but wehave to be aware of the downsides. As Anthony wassaying, each of these tools has an upside and adownside, and I am pleased to see the FPC is veryaware of the wider impacts that its tools could haveon other policy objectives.

Q9 Chair: Is that not enough evidence?Anthony Browne: I was just going to add a broaderpoint. If you go out to the street and ask people whothe FPC is, I guess the awareness would be fairlysmall because the evidence is there is very little publicinterest in the area today.

Q10 Chair: That would be quickly sorted out byputting in an LTV, don’t you think?Anthony Browne: Well, absolutely. The point I wasgoing to make is the actions of the FPC, although itmay seem arcane and technical, actually will havevery big, real world impact in terms of lending tobusinesses, in terms of people being able to getresidential mortgages, commercial propertymortgages. It is a very real-world social and economicimpact and so it is incredibly important to have a high

level of accountability and visibility for what theFPC does.

Q11 Mr McFadden: Do you think that the FPC wereworried—this is to Mr Browne first—that what theywould be setting themselves up for here would be asimilar situation to what has happened with SMElending in recent years, which is MPs from all aroundthe country having businesses coming to them saying,“We can’t get loans” and looking for appeals andredress mechanisms, and that we would have the samesituation with mortgage applicants if they had a rulelike this? Is that what they are worried about?Anthony Browne: You would have to ask them whatthey are worried about. I know the reasoning theygave in public and I do not know beyond that and Icertainly do not say that. I think it is absolutelyinevitable that if a public body like the FPC put out astatement saying, “We are going to cap LTV at, say,80%” then that would be the headlines in all thenewspapers. Everybody going for a mortgage wouldbe told, “You cannot have over 80%” and they wouldknow who the public would hold accountable for it.They would then write to you and other MPs and say,“This body has denied me the right to have housing”.There clearly would be real direct accountabilitythere. The downside is that if you go to sectoralcapital requirements you might end up having thesame sort of impact but actually the accountability forit would be far vaguer in that people would not knowwhether to write to their MPs about the FPC, whichthey probably would not know about, or to the bankor the mortgage companies. They would be probablyfar more likely to blame the mortgage companies orthe banks for it.

Q12 Mr McFadden: Mr Coles, you referred to the“bank of mum and dad”. This is already happening.What do you think the policy answer is to the feast orfamine problem with mortgages? No one wants toreturn to irresponsible lending decisions of 100% plusmortgages with no questions asked, which encouragedpeople to take out loans that they could not live with.On the other hand, it has severe consequences whenwe are in a situation like today where young peopleare being asked to come up with deposits of 20%,which is putting home ownership out of the reach ofa generation of young people who do not have accessto help from their parents.Adrian Coles: The policy answer partly is coming outof the Financial Conduct Authority’s MortgageMarket Review, which we will see published in itsfinal form over the next week or two, which willintroduce a wide range of indicators of responsiblelending so that we do not go to 100% or 100% plusas some lenders did pre-2007. Clearly, there are issuesnow relating to the advisability of taking out 95% and90% loans. Is that always a good thing? I think thereis a wider range of issues surrounding how the Britishhousing market will operate in the future in theabsence of any inflation. It becomes a riskier thing forpeople to buy houses at 90%, 95% loan-to-value ratiosif you do not have the house price inflation that wethought was a constant feature of the market in the 50to 60 years until 2007.

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Q13 Mr McFadden: But is there not a logicalproblem at play that has a wider economic impacthere? I visited a new housing development in myconstituency on Friday where they told me it isrunning at a loss because they have built the homesand they just cannot sell them because people cannotafford the down payments that are currently required.Now, most political parties around this table probablywant to see greater supply in the housing market andwant to see more houses built, but why would buildersbuild houses if they cannot sell them because theprospective buyers cannot get mortgages?Adrian Coles: There is a constant conflict, and thishas come out a lot from the Financial PolicyCommittee’s work, between risk and resilience. Itapplies to the banking sector and it also applies toconsumers. A consumer is sensible, in my view, tosave up at least 10% of the purchase price as a depositbefore they move into owner occupation so they havesome equity resilience to any decline in house prices.On occasion, it can be sensible to encourage people tobuy at 95%, but I am not sure it is frequently the case.

Q14 Mr McFadden: Do you think there arequestions that are more broadly social forpolicymakers in all of this? If people cannot buyhomes until their mid-30s, will that not have impactson their decisions to marry, to have children and tomake the other decisions that previous generationswould have accepted as part of the normal course oflife? Are we not storing up a series of unforeseenconsequences if current trends continue, which ishome ownership falling and the private rented sectorincreasing as a proportion of housing tenure?Adrian Coles: That is absolutely the case. When Ibought my first home 30 years ago, I had a 90% loan.Within four years the house price had gone up somuch it was 50%. It was extremely safe. Now, if wedo not have house price inflation, buying a house isrisky and that is going to have an impact on all sortsof the issues that you talked about. A loan at 90%now is likely to stay at 90% for the next five years,and that makes the housing market much moredifficult to operate because it makes it more difficultfor the people to move up the market and create thespace for the first-time buyer to come into the market.

Q15 Mr McFadden: Are we pulling up thedrawbridge on the younger generation in terms ofaccess to home ownership?Adrian Coles: Not pulling up the drawbridge, but Ithink the bridge is getting a little steeper. It is moredifficult to walk up towards the gate of the castle tolet you in.

Q16 Jesse Norman: Mr Browne, the interim FPCpublished its first recommendations in June of lastyear. How do you think it is doing?Anthony Browne: I should say, first of all, that wewarmly welcome the creation of the FPC. We havevery, very strongly supported it and you clearly needa body that is accountable for financial stability. Wewelcome it not least because actually everyonethought the Bank of England had that role to startwith, but anyway this absolutely clarifies it. In terms

of the interim FPC, we think broadly it has done prettywell. It has taken a very sensible approach. There aresome concerns in the industry about its actual statusin the sense that it is interim. It clearly is not in thelegislation yet. It has made recommendations that theFSA have implemented directly, so it is not clearwhether they are recommendations or directions,which obviously would not have legal status.

Q17 Jesse Norman: Maybe I should just tighten thequestion up a little bit. In the second quarter of thisyear, the FPC said, “In addition, the committeereiterates its recommendations to the FSA toencourage banks to improve the resilience of theirbalance sheets”. Its next recommendation was, “Thecommittee recommends that banks work to assess,manage and mitigate specific risks to their balancesheets from the euro area”. The question is, is thereanything other than the blindingly obvious that theFPC is able to say? Do you see any signs of noveltyor independence of thought?Anthony Browne: Well, clearly the FPC has beenadvocating tightening up or strengthening the balancesheets, which is what its role is at the moment, butthere is a trade-off between resilience and growth, asAdair Turner said last week. There has been morerecognition now, I think, of the fact that you need tohave some—and the FPC has recognised this—drawdown of liquidity allowing banks to do that inorder to operate things like the FLS scheme. Wecertainly welcome having more flexibility there.

Q18 Jesse Norman: Okay, thanks. Mr Coles, theBank of England said in March, “The committee didnot perceive the public debate necessary to achieveacceptability for instruments, LTV, et cetera, to besufficiently advanced and would welcome furtherdebate”. So here is the question. First, why are theyworried about the social impact of LTV ratios? Thatis a matter for Government. Their job is nothing to dowith the social impact. It is a political matter. Whyare they not just focused on the safety, security andwellbeing of the economy?Adrian Coles: I assume they are cognisant of the trendin the conversation we have had so far this morningthat they could have a very wide impact on societalobjectives. They are not elected. There is a debateabout the extent to which they are accountable. Thereis a debate about the extent to which they should beable to block access to owner occupation or to flowsof house building or to the construction of new privaterented dwellings, and they are very aware of that.

Q19 Jesse Norman: No, I understand that is theconventional wisdom. I am questioning it. Thequestion is why should anyone think they are goingto tighten? If they are worried about the politicalaspects of their decisions rather than the economic andfinancial aspects purely, why should anyone think theywill ever tighten?Adrian Coles: I think there is a concern about theextent to which they are saying, “We do not want LTVand LTI explicit controls, but we are in favour ofhaving the power to raise sectoral capital requirementson particular LTI and LTV ratios”. I am a little




discomfited by that because I think that might serveto confuse the debate somewhat.

Q20 Jesse Norman: Is it the point that they wouldlike the power without the accountability?Adrian Coles: I just wonder. I would not like toaccuse them of thinking that way directly, but it hascrossed my mind.

Q21 Jesse Norman: You are doing a good hint. Letme ask you a slightly more subversive questionquickly: why should there not be less accountabilityhere? Isn’t the point that when the economy isoverheating, someone has to take away thepunchbowl? We know the politicians cannot do it, sowe are choosing some people to do that on our behalf.We are pre-committing ourselves, as they say in thejargon. Why is that a mistake?Adrian Coles: I think there has to be a public debateon these issues. This body is not elected. It is notsubject to democratic control. You cannot throw themout after five years by exercising your right to vote. Ithink it is right that the FPC has the power—

Q22 Jesse Norman: They have all kinds of otherlegitimacy. They are very transparent. They arediverse. There is a lot of due process around it, lotsof other legitimacy around this. They are not elected,that is true, but there is plenty of other legitimacy. TheBritish constitution is perfectly happy with otherforms of legitimacy balanced with expertiseelsewhere. Why shouldn’t it do that here?Adrian Coles: Because of the wide-ranging impactthat this organisation can have. Don’t forget under thenew legislation the Bank of England is going to beone of the most powerful unelected entities probablyin the world, actually, in the democratic world. It isimportant that we have proper, as you say,transparency but also it is no good just being able tosee through. If you cannot influence it at all byappropriate accountability, then I do not think that isenough.

Q23 Jesse Norman: Final question, if I may, toanyone. What happens when a Government ispursuing a deliberately short-term policy, a policy thatthe FPC actually disagrees, does not think is in theinterests of the economy? Could there not be a conflictof objectives because the FPC has been given theobjective of supporting Government policy? What ifthe Government policy is a bad idea?Adrian Coles: There are clearly balances to be takenin all of this. The MPC, the FPC, HM Treasury, theFinancial Conduct Authority could be pursuingpolicies that are not in line with the prudential healthof the banking system. There are conflicts built intopolicymaking generally irrespective of theinstitutional makeup of the regulators that we willhave to somehow resolve.

Q24 Jesse Norman: No, but I am putting pressureon the question as to why it should be an obligationon the FPC to support Government policy rather thanthe interests of the economy, the interests in long-term

stability of the financial system and these otherthings?Adrian Coles: Well, financial stability is an importantcomponent of a successful economy, but electedrepresentatives may feel that there are other ideas thatthey want to pursue, such as growth.Anthony Browne: You could substitute the word“growth” for Government policy, you are right, andclearly there could be occasions when there is conflictbetween the FPC and what is perceived asGovernment policy. Other examples of crises wehave had—

Q25 Jesse Norman: Six or seven years ago theGovernment was stoking up borrowing and demand.The FPC might have decided that was a bad idea, butif it has an objective to obey Government policy it isnot going to be able to do that, is it?Anthony Browne: The reason why we support theFPC overall is that we think, obviously, mitigatingfinancial crises is good for long-term growth. As anindustry, we support measures that enhance long-termgrowth rather than explicitly support Governmentpolicy. I just wanted to—Chair: Maybe come in on the next set of questions,which I suspect relate.

Q26 Mr Mudie: Mr Browne, in your evidence yourefer to too little attention being devoted tounderstanding how the market will react to aloosening of requirements. You suggest that the FPCwill need to undertake considerable market education.I thought your answer to my colleague was the proofof that, the validity of that, because you seem todownplay the significance of last week’sannouncements by the FSA and the FPC. With thestrengthening by the Chancellor on the Bill on thesecondary remit to make it much more positive andnot negative, do you not think that last week’sannouncements on capital easing and the financiallending scheme not being counted are significant interms of showing a different philosophy?Anthony Browne: I do, but in response—

Q27 Mr Mudie: No, but you seemed to throw thataway, a throwaway line.Anthony Browne: He was asking me a very specificpoint about raising capital standards and in responseto that I said we warmly welcome the flexibility thereis on liquidity and capital requirements.Mr Mudie: Very good.Anthony Browne: You absolutely need that and thesetools will only work if they are flexible. We support astable banking sector. We also want a banking sectorthat can lend widely. We absolutely strongly support,indeed we were strongly advocating before theChancellor introduced it, having another measure inthere to support economic growth.

Q28 Mr Mudie: Mr Browne, what I am getting at isthat in your own written evidence you say that themarket and signs to the market will have to beunderstood and it might take a bit of education. Is thelast week not an example of a clear sign that theexcuses for not lending by the banks have been




negated? Do your members understand thesignificance of it and do you think, as opposed to howthey behaved over Merlin, they will now startpositively lending to British businesses?Anthony Browne: Can I just come back to your pointabout our evidence? The point there was we want asymmetry in the growth and in the downside, as itwere, so that you do not—

Q29 Mr Mudie: You now have it, don’t you?Anthony Browne: Yes, absolutely, and—Mr Mudie: The FPC have demonstrated that theyunderstand it.Anthony Browne:—I support that and I absolutelywelcome that and my members—

Q30 Mr Mudie: Do you think your members haveunderstood it, have got the message from last week?Anthony Browne: Absolutely. The members, comingto the point about lending, the banks do actually wantto lend and they want to be able to lend. They havewhole departments that are based on it; their businessmodel is based on lending, so any measures that makeit easier for them to lend—

Q31 Mr Mudie: Mr Browne, I hear that, that theywant to lend. You would fail to convince anypolitician around this table or any businessman in myconstituency that they do. To be fair, when the FPCand the FSA were pushing them the other way interms of repaying the capital, et cetera, there was afair case for the banks to say, “You cannot ask us todo both things easily”. Now the FSA and the FPC aretaking this very important decision to say, “Look, weare clearing that excuse off the table”. Is it totallyunderstood by your organisation, by your members,that you have the green light and you have thefinancial ability now to lend without the FSAchasing you?Anthony Browne: That is why, as I said earlier, wewelcome it and our members welcome it, having thatflexibility there, but there are other factors in there. Interms of the FLS scheme, which this measurementwas about, obviously we do not know the actual dataabout it until I think December 3rd when the Bank ofEngland publishes the first three months. We canassess it then. But the other factors are there is also,as Vince Cable has said on a number of occasionsnow, demand factor. I know it is not a popular thingto say this, but the number of applications from SMEsfor loans has dropped by 20% so far this year, but thelevel of approval of loans has stayed steady. Thereason for the slight decline in lending so far this yearis because fewer SMEs are coming forward actuallyasking for loans. You have to ask yourself why.

Q32 Mr Mudie: Your past behaviour as banks hascontributed to that because many businesses feel thatto approach a bank is an indication of weakness,which makes the bank ready to look at their existingloan.Anthony Browne: The number of SMEs a year agothat were looking for new finance was 19%. It is nowdown to 14%. Fewer SMEs want to borrow. Far fewerSMEs are coming forward looking for loans. The

sector as a whole is now a massive net depositor.SMEs have more in savings than they have in loans.A year ago they had about £8 billion net deposits;they now have about £21 billion net deposits. In termsof the recession they are behaving as individualhouseholds do, which is actually battening down thehatches, not going out for loans.

Q33 Mr Mudie: This move, Mr Browne, does notalter the situation as far as the banks are concerned.Anthony Browne: No, I am just saying that—Mr Mudie: Let me finish the question. The banks arestill holding to their line that it is the lack of demandthat is causing business lending to be at such a lowlevel. If you agree that, then you cannot then say yousee last week as positive and it will lead to betterbehaviour.Anthony Browne: I am saying there is not only onefactor.Mr Mudie: I am not suggesting there is.Anthony Browne: Most things in life are fairlycomplex. Against the backdrop of lack of demand—clearly, it is more difficult for banks to lend—actuallymeasures like the FLS and so on are welcome.Through the BBA, the banks have also introduced awhole load of measures to make it easier for SMEs toaccess finance. We have a whole scheme on the BetterBusiness Finance programme to educate SMEs, makeit easier for them to find out where they can getdifferent finance, for them to go to banks. They canget appeals. If they are turned down on a loan theynow have a right to appeal. We are about to start areferral scheme so if they go to a bank looking for aparticular source of finance that is not appropriate, thebank will then automatically refer them to othersources of finance, whether it is CDFIs or angels. Thebanks are doing a huge amount about that as well ontop of mentoring SMEs. Thousands of SMEs are nowbeing mentored by people in banks. The banks areabsolutely on the front foot trying to help SMEs. It isin their own long-term interest. These are theircustomers and they want to build up their customerbase. It is good for the economy and good for them.

Q34 Chair: I am going to bring Mark Garnier in injust a moment, but Mr Smee has been very eager tospeak for some time, even if the subject has movedon a little. I am just giving him a moment to composehimself. What was the point you wanted to make?Paul Smee: I was very keen to make a point abouttransparency of the FPC, Chairman, if you want meto do that now.Chair: Why don’t you make that?Paul Smee: I was going to say with the FPC one ofthe things we hope will develop is the way in whichit shows its workings out and is transparent about itsreasoning, which I think will add to the accountabilitypoint that was raised by Mr Norman earlier.

Q35 Chair: By which you mean voting?Paul Smee: No, I think it is more about explainingwhy they are taking the punchbowl away and showingtheir working out to a greater extent than they havedone to date. I am sure this will happen when theybecome a fully-fledged statutory body.




Chair: Maybe we need something put into thepunchbowl just now and that might be the sort of areathat Mark Garnier might get into.

Q36 Mark Garnier: Can I just quickly follow up onSME lending? Isn’t the reality of it that we are notnecessarily talking about SMEs, we are more talkingabout micro businesses that are coming to ourconstituency surgeries and complaining about it? Letus not forget that an SME has a turnover of £25million a year and 250 members of staff, and they area reasonable size business. My question to you is this.In administrative terms what is the difference betweenthe cost of organising a £25,000 loan, a £250,000 loanand a £5 million loan in administrative cost within anorganisation like a bank?Anthony Browne: I do not know off the top of myhead, but I can certainly—

Q37 Mark Garnier: But it is likely to be roughlythe same?Anthony Browne: We can answer that question.

Q38 Mark Garnier: It would be useful because itstrikes me that half the problem of this—I wonder ifyou disagree or agree—is that actually the problem isthat it is much more interesting for a bank to lend a£5 million loan because you are getting the lendingside of your balance sheet out quickly for relativelyless work, whereas for a £50,000 loan you are goingto have to have 100 times as much work to get thesame amount of money out. Therefore, there is thecost of the funding to the micro business or the SMEwhere they simply cannot afford to pay the cost of theadministration to the bank and that is being reflectedin high interest rates or high set-up charges or highmanagement charges.Anthony Browne: We can come back to you withsome data about that, but there is also an element ofrisk there. The trouble for start-ups obviously is thatthey are very high risk. A lot of start-ups fail.

Q39 Mark Garnier: Yes, but they are not all start-ups.Anthony Browne: A lot of start-ups fail within a year,within two years, and so on. I just observe that thebanks are criticised for doing too much risky lending,whether it is in the boom times, whether it is onmortgages or, indeed, to companies, and then they arecriticised for not doing enough risky lending. Gettingthe balance right is very difficult and wherever thebanks try there will be people criticising them eitherside; maybe they should be doing more high LTVloans and five years ago they were being told off fordoing too much. Just on the SME side, clearly lendingto SMEs is a very risky business and that is reflectedin the high-risk premium. At the time when they arebeing pressured by the FPC and so on to reduce therisk and build up their balance sheets, clearly there isa trade-off there, which is what Adair Turner said.

Q40 Mark Garnier: Yet here is an absolutely classiccase of Government policy. I want to turn to thequestion of Government policy being part of themandate for the FPC. Here is a clear case of

Government policy. The Government absolutelycategorically wants more money to be got to the frontline in order to stimulate economic growth and a greatdeal of that can come through micro businesses morethan obviously medium-sized enterprises. Paul Smee,I will come back to you; you have been sitting on thereserve bench for quite a long time now. How do youthink that the Financial Policy Committee can actuallyact on that policy mandate? Do you think it is likepushing a bit of string; actually, if the banks do notwant to do it, there is nothing you can do to implementGovernment policy through the FPC?Paul Smee: I think there are several ways. I do notthink it should be the FPC’s main role to implementGovernment policy. They will have to produce a seriesof trade-offs between the various objectives that theyare given, and they have to look at the consequencesof their actions and the light that it will have onoverall Government policy.

Q41 Mark Garnier: Yes, but they could then tightenup lending to bigger enterprises in order to try topromote lending to smaller enterprises.Paul Smee: I think if you look at the housing market,which is obviously where I am coming from, I thinkwhat would be awkward is if the FPC tried to impose,for example, a loan-to-value cap that worked againstsome of the Government initiatives such as some ofits shared equity schemes or the New Buy scheme soit was actually pushing against a clearly statedGovernment objective within a particular policyframework.

Q42 Mark Garnier: It is worth coming back to MrNorman’s point. What happens if the FPC thinks theGovernment has the policy wrong?Paul Smee: I think that goes back to the question ofhow transparent the FPC is. I am sure that acommittee of that nature has a role in spelling outthe consequences for financial stability of a particularpolicy angle that the Government is pursuing. It hasto show its workings out and explain why it thinks itis right rather than the Government.Adrian Coles: Just one other point, if I could add tothat. The FPC can do the first thing when it is actingin a countercyclical way, it can relax the capitalbuffers and liquidity buffers, but there are two otherthings that have to happen after that. The banks andbuilding societies have to be able to change their ownculture and approach to the marketplace. For a longtime, for example, building societies have been told,“Don’t use your liquidity, don’t use the fact that youcan borrow from the Bank of England” and that haschanged this summer. Boards of directors have toabsorb that, have to change their own attitude to risk,have to change their own view of how much capitaland liquidity they need. Then you have to see whetherthere is demand in the marketplace as well. When theFPC relaxes policy there can be a pushing against apiece of string element. That is only the first of thethree things that need to happen.

Q43 Mark Garnier: I just want to turn finally to thequestion of symmetry. The FPC will absolutely becastigated if they allow too big a bubble to happen




and another crisis to emerge. Equally, they could befar too cautious. What are the sanctions against themof being overly cautious and how do we know thatthey are being overly cautious? How do we monitorthe symmetry between their objectives, Mr Smee?Paul Smee: I think you will see in the housing market,for example, lead indictors. If loan to values aredepressed and there is a perception that certain partsof the market cannot obtain mortgages that would be,I think, pretty good evidence. I am particularlythinking of first-time buyers. I think it will be anoverall impression that will go beyond any sectoralconsideration so the overall philosophy of the FPCwill stretch wider than a particular market.

Q44 Mark Garnier: It has to be more difficult thanthat, though. You talk about the housing market. Partof the reason why the housing market is finding itdifficult is because houses are so incredibly expensive.It takes such a long time to build up even a 10%deposit—on some estimates, 10 years for the averageperson. Isn’t that the real problem with the housingmarket: more to do with price and less to do withlending?Paul Smee: I think there are quite a few problems thatoverlap. There is a question of supply: are enoughnew houses being built to replace existing stock?Around 100,000 new homes a year is probablyinadequate to do that and probably the figure shouldbe much higher, possibly double what it is now. Thesecond issue concerns the attitude of people towardsbuying houses. There has been a move away fromvery high loan to value. People are expecting to jointhe housing ladder somewhat later than they did at thetime of the boom.Adrian Coles: If I could add to that, given that theFPC is going to have powers to influence LTV andLTI ratios offered by lenders through sectoral capitalrequirements, it is a little bit surprising, I think, thatin the table of financial stability indicators that wassent to you on 12 July there were no housing marketindicators. House price inflation is absent from thatand rate of growth of lending secured on housing isabsent. I just wonder if that is an omission that shouldbe corrected by the Bank.Anthony Browne: Fundamentally, I think the reasonfor the shortage of housing loans, dropping homeownership rates, is the long-term inability orreluctance in the UK to build enough houses that areneeded. As long as that carries on, you are alwaysgoing to have problems with housing until we actuallyincrease the supply of housing. The other issuesaround it follow on from that.Adrian Coles: Again, I would emphasise the otherissue that buying a house is a risk now. It was neverperceived as a risk in the past and that will changefundamentally the behaviour of British households.

Q45 Chair: A helpful point well made. This touchesvery much on what Mark has just been asking. Can Ijust ask each of you very quickly in turn, and more orless with a yes or no if you can manage it, do youthink—and why don’t I start with Mr Browne—thatthe FPC’s overall stance is currently procyclical?Anthony Browne: Is it procyclical?

Chair: Yes. That is, tightening at a time—Anthony Browne: There is a danger of that.

Q46 Chair: No, I am asking you whether you thinkit is. Of course, there is always a risk.Anthony Browne: But on the other hand they are thenhaving more flexibility around liquidity, which isobviously countercyclical. But there is a dangeralways of procyclical.

Q47 Chair: I am asking you whether you think it iscurrently procyclical.Anthony Browne: I am going to hedge my bets andjust say I think there is a danger of that.Adrian Coles: I think it is procyclical but moving inan anticyclical direction.Chair: Say that again. It is a clearer answer.Adrian Coles: I think it is procyclical but it isaddressing that concern by relaxing liquidity buffersand the capital buffers this summer, so it is moving inthe right direction away from being procyclical.

Q48 Chair: Okay, so there is a spectrum and we aremoving down the spectrum from procyclicality intocountercyclicality?Adrian Coles: Yes, that would be my assessment.

Q49 Chair: But we are still in the procyclical phase?Adrian Coles: Well, the minutes of the FPC inSeptember clearly—

Q50 Chair: Can you just give me a view whetheryou think we are still procyclical? The question is, isthe overall stance currently procyclical?Adrian Coles: Yes, but it is moving in the rightdirection.

Q51 Chair: Okay, that is a clear answer. Mr Smee?Paul Smee: I cannot top Mr Coles’ summary but Ithink that is the case. It is procyclical.Anthony Browne: You would not have started fromhere. Instead you should have built up the capitalbuffers previously rather than getting banks to buildthem up during the past year.Chair: Well, we have made a tiny bit of progress. MrBrowne has not rescued the ground that he failed totake at the beginning. I am going to go to AndreaLeadsom.

Q52 Andrea Leadsom: Good morning. I want to askyou this. We have talked a lot about the absolute levelsof lending and how easy it is or should be for peopleto be able to borrow money for a house, but whatabout the type of lending that is going on andspecifically the interest-only mortgages versusrepayment mortgages? Is it your concern that there isa ticking time bomb where rather than foreclose andincrease their bad debts banks and building societiesare allowing people who should not be allowed to beon interest-only mortgages to transfer to them withvery little expectation that they will have thewherewithal to repay the capital at the end of theterm? I would be interested to know whether youthink that is a ticking time bomb, yes or no, and,secondly, whether this is something that the industry




in its normal risk-taking should be addressing orwhether this is something that requires regulation.Paul Smee: There are a large number of interest-onlymortgages; 3.9 million are outstanding. Two-thirds ofthem will mature after 2020. In the next few years,those that are maturing, those who hold thesemortgages will have an equity stake in their propertyof over 70%, in over half of those cases; a furtherthird, a stake of more than 45%. In the next few years,we feel that those who have interest-only mortgagesmay well have a means of repaying that mortgage—itmight be savings, it might be taking a lump sum frompension or something like that—and they also haveequity in their house.

Q53 Andrea Leadsom: Yes, but to push back onthat, they may have the means to repay it; are wechecking? Secondly, if they are already in a smallhouse and do not have somewhere else to move to, soin other words downsizing is not an option, are youlooking at that? Are these people going to be reachingretirement age at the point that they suddenly havethis enormous requirement to repay the capital andwill not be able to extend their mortgage terms?Paul Smee: I think that in those cases lenders will belooking very sympathetically at the question of howthey can extend repayment terms. They are already indialogue with borrowers. There is a regulatoryrequirement that the borrowers are contacted duringthe life of the loan. Many lenders are actually doingmore than that and trying to engage with borrowers atan early stage to understand their repayment options.

Q54 Andrea Leadsom: Mr Smee, you are sayingthat interest-only mortgages are not a ticking timebomb and they are not a problem?Paul Smee: I would not use that language for the nextfew years because of the structure of the market, therelatively low number of these mortgages that arecoming to their end and the fact that those who havethem have large equity stakes in their houses. Theycould, for example, look at vehicles such as equityrelease. There are various options and if they engagewith the lender they will be helped through them.Adrian Coles: Part of your question was related to asort of false forbearance: were we storing up problemsby enabling people to stay in their own homes bymoving to interest-only or even less than interest-only.One of the useful things that the Financial PolicyCommittee did back in July 2011 was ask the FSA toinvestigate that. Was forbearance a very good tool inhelping people out of their problems at a difficultperiod of the economic cycle or would it almost be,to use the American term, extend and pretend, extendthe mortgage and pretend there was not a difficulty?The FSA conclusion was the former, that it was veryhelpful; that we needed to help borrowers at a time ofdifficulty. Arrears are very stable and I do not thinkthere is an extend-and-pretend policy in the residentialmarket. I think it is a sensible thing to do at a timeof economic difficulty to help borrowers out of theirproblems. Very often, what borrowers need is time tosort that out, so I would defend what lenders havedone in that particular aspect of your question.

Q55 Andrea Leadsom: Okay. Mr Browne, is itsomething that requires regulation? Should regulatorsbe looking at it or is it the normal risk activity of thebanks and building societies?Anthony Browne: We do not do a lot of work onmortgages because the Council of Mortgage Lendersis the lead in that area. I cannot really add much towhat he says. I think it is in the normal risk activitybut actually it is something that various people haveraised to me since I started this job six weeks ago. Itis certainly something that I would want to get goodsatisfaction on whether there is a real significantproblem there or not and that the industry is doingeverything that it can because one of the things that Iam determined to do in this job is to make sure thereis no more alleged mis-selling or mis-selling; thatthere are no more scandals going forwards. I want tomake sure the industry—we are the trade association;I do not run any banks—are doing what we can tomake sure the industry is as customer focused aspossible.Andrea Leadsom: Good.Anthony Browne: So when there are concerns raisedlike that I take them seriously. The CML leads in thatarea, but I certainly want to be satisfied myself thateverything is being done that can be done.

Q56 Andrea Leadsom: Would you say thatregulators need to be closely looking at it as well?Anthony Browne: I think at the moment no, but it is,as I said, one thing I want to look at and variouspeople have raised it to me since I started this joblast month.

Q57 Andrea Leadsom: Okay. To change the subject,the Monetary Policy Committee and the FinancialPolicy Committee, should they be one committee?There is discussion and, in fact, one of the last MPCminutes effectively noted that the Financial PolicyCommittee was due to meet towards the end of themonth and would be discussing a range of issues. Itwas possible that the FPC would, therefore, be makingdecisions that the MPC did not want to pre-empt,effectively passing the buck. Is that a realistic problemwith having two organisations where the Governor hassaid that the boundaries between monetary policy,macroprudential policy and fiscal policy are blurred?Is this a problem in the offing?Anthony Browne: I think it would be a problem if itwere not the case that the two committees have thesame chairman and I think they have an overlap of sixmembers each. They are essentially served by thesame staff, so there is clearly good co-ordination thereamong the individual members. They are not going tosuddenly swap hats depending what committee theyare on and then choose policies that conflict withsomething when they were sitting in a differentcommittee.

Q58 Andrea Leadsom: Are you happy to hear thatthey are passing the buck, saying, “We won’t do itbecause they might”?Anthony Browne: Clearly, sometimes there might betensions between monetary policy and financial policyin that sense, but at least they have the mechanisms




there for resolving which was the right place to dealwith it. Sometimes it might not be right that it is theMPC and it should be the FPC; sometimes it mightnot be the FPC and it would be the MPC. Financialpolicy or financial stability is not a substitute formonetary stability and monetary policy. We clearlyneed stable monetary policy just as we need a stablefiscal policy. If we join the exchange rate mechanismagain, for example, or if we have a completelydestabilising fiscal regime then there is nothing theFPC can do about that.

Q59 Andrea Leadsom: Mr Coles, if the MonetaryPolicy Committee wanted to raise interest rates butthe FPC felt that the economy was not strong enough,how should that be resolved?Adrian Coles: It is going to be extremely difficult.As Anthony says, they have six cross-memberships ofthose two committees with the same chairman, so Ithink the saying “passing the buck” does not entirelyring true because that is Sir Mervyn passing the buckto himself.

Q60 Andrea Leadsom: You are saying that, in fact,they are one committee? You are both really implyingthat there is such a crossover that it might as well beone committee?Adrian Coles: There is a conceptual differencebetween financial stability and monetary stability.They have different tools and different objectives.Given the fuzziness of the lines between them, it issensible that those two committees are within thesame organisation with significant cross-membership,but still the approach that has been put in place I thinkis sensible. There are slightly different objectivesbetween the two bodies.Anthony Browne: They do have the power set out inlegislation to sit as one committee, so if there aresome irreconcilable differences they can all sittogether in one committee under the chairmanship ofthe Governor and resolve those issues.Paul Smee: I do think there is something about twobodies being more transparent. Problems betweenthem are visible rather than internalised and notvisible.

Q61 Andrea Leadsom: None of you have a realconcern that they are going to pass the buck betweenthem and that we end up with the same things fallingdown between two stools?Paul Smee: If the buck was passed, it would be veryvisibly passed and I think that is one reason that willstop issues being ducked.

Q62 John Mann: I have two lines of questioning,Chairman. The first is I just wanted to pick you up,Mr Browne, on your answer to Mark Garnier when hevery precisely clarified that when he talked aboutsmall business he was not talking about start-upbusiness. He was talking about other small business.You said in response that lending to small businessis—I quote you—inherently riskier. What is yourevidence base for suggesting that lending to smallbusiness is inherently riskier than lending to largerbusinesses?

Anthony Browne: I have not memorised the statisticsand we can certainly provide you with them, but start-ups do—

Q63 John Mann: No, we are not talking about start-ups. You said, and Mr Garnier clarified, lending tosmall business is inherently riskier. You are in chargeof the British Bankers Association. I am asking whatthe evidence base is to say that lending to smallbusinesses is inherently riskier than lending to largebusinesses.Anthony Browne: I can provide you with the data forthat offline. As I said, I have not memorised it.Clearly, businesses that are smaller with shorter trackrecords, with less security, with a less establishedcustomer base and so on, they do have higher failureand default rates than the big businesses—or biggerbusinesses, I should say.

Q64 John Mann: It would be interesting to get thatevidence base. I am not interested in start-upsbecause, of course, start-ups are by definition riskier.We are talking about established businesses because,picking up on your dialogue with Mr Mudie, I aminterested to see what the demand is from establishedsmall businesses for lending, which you say is low.You are saying it is inherently riskier.Anthony Browne: I am very happy to address thispoint. I came here to talk about macroprudential toolsso I do not have all the statistics here, but in terms ofthe lending approvals—

Q65 Chair: Why don’t you just come back to us onthat?Anthony Browne: I can come back.Chair: You have agreed that you are happy to do itand I think the Committee is very happy with that.

Q66 John Mann: My second question is onmacroprudential tools. In essence, the Bank ofEngland is shifting into an era where it becomes moreof an arm of Treasury than it has been in the lastdecade.Anthony Browne: In what sense?John Mann: In the sense that the identification ofmacroprudential tools and the shift away from simplyhaving the 2% inflation rate as a target by definitionlinks it directly into Government policy. I wonderedin that context how you felt the job specification forthe person at the top of the Bank of England shouldchange to reflect this new era that we are now in.Anthony Browne: The job advert that just went outin The Economist was quite clear about the enhancedrole of the Governor of the Bank of England and thefact that he or she—there is one female applicant Ithink, maybe more—will have far greater powers thanthe current incumbent, with the whole FPC committeeand toolkit as well. As I said earlier, it is absolutelyvital, if increased decision-making is basically beingdelegated to this body, that there is as muchaccountability as possible. That is why we stronglysupport having a super-affirmative procedure here forany new tools that the FPC are given because theGovernment, through Parliament, are giving powersto this body. It is essential there is as much debate and




openness and transparency about the powers you aregiving to it and that—

Q67 John Mann: Mr Smee, should competition beseen as a macroprudential tool that should be used?Paul Smee: I think competition has a very salutaryeffect on the market. I am not sure you can translateit into a macroprudential tool in the hands of the FPC,but I think that the FPC should be mindful that if itstifles competition, particularly in the mortgagemarket, it will have unintended consequences. It isback to the unintended consequences of the way inwhich these tools can be deployed.

Q68 John Mann: They could set a specific definitionof competition as a policy aid, couldn’t they, MrColes?Adrian Coles: Well, the Financial Conduct Authority,of course, has responsibility for ensuring that marketsare competitive, efficient, transparent, et cetera. Iwould not like to see too much muddying of thewaters between the various different regulatoryagencies that have been set up through this currentreform programme.

Q69 Mr Ruffley: Good morning. Mr Browne, inyour earlier remarks you talked about themeasurement of the effectiveness of themacroprudential tools. Could you just amplify howyou think that is going to be measured and by whom?Anthony Browne: The fundamental problemobviously with the FPC is that it is not as simple asthe MPC where there is a single measure that it istargeting, which is inflation. It has a single tool withwhich it targets it—well, normally has a single tool—which is interest rates. Inflation is very welldocumented, long track record history. We knowexactly how it works and so on. The problem for theFPC is there is no agreed definition of what financialstability is. I can give you a rhetorical definition thatit is an absence of financial crises, but in terms ofactually how you measure it, we are not going to havea precise single target with one indicator that it movesat. Because of the power that it will have, though, itis important that we have real clarity and transparencyabout how it is measuring what it does. What are thebases for its decision in implementing one tool oranother tool? Is it merely a matter of judgment andthey stick their finger in the air and think, “It feelsabout right” so change the capital buffers or whatever?We would clearly like to move to a far more evidence-based regime, which means they need to haveindicators. They need to monitor those indicators.They need to look at how those indicators respondwhen they do use tools or, indeed, recommendations.The indicators would include things like market riskand credit risk and liquidity risk. In terms of yourquestion about who should look after it, I think clearlythe FPC has a duty to provide that evidence base andmonitor how it is working in that way, but there are alot of other people doing work in this area.Internationally, the ESRB and the Financial StabilityBoard of the G20 are also looking at these areas, aswell as countless academics. It is a new area ofresearch and the evidence base is building up slowly.

Q70 Mr Ruffley: Because our specialist adviser,Professor Chadha, says that in the absence of a clearanalytical framework for considering the effectivenessof the tools his implication is that we might need todevelop that a bit better before we start using thetools. Your view is we have to start using them andsee what happens.Anthony Browne: No, at the beginning I said I thinkwe should dip our toe in the water here, which is whythe toolkit—a lot were discussed. The two that theTreasury are recommending, the countercyclicalcapital buffer and the sectoral capital requirements,are the two that are best known. Certainly, thecountercyclical capital buffer, there is a lot ofevidence base around that. That is one of the bestunderstood. It has the easiest transmission mechanism.It has the greatest transparency and so on. We shouldstart with that and as we develop the evidence base,we talked earlier about LTV ratios, for example, theevidence base is not there yet but actually if that didprove that that sort of thing did work in the end andthe evidence base built up, then certainly we shouldconsider that.Paul Smee: It will be quite important, I think, MrRuffley, to look at international studies as well. Forexample, on the LTV cap, the Hong Kong MonetaryAuthority has done some work on that, so that wouldbe another test that we could measure what is goingon.

Q71 Mr Ruffley: Could I just go back to Mr Browneon the costs? The impact assessment that the Treasuryhave come up with suggests costs of £7.4 billion,potential benefit of £76 billion, with a total net presentvalue benefit of over £68 billion. Do you agree withthose numbers or do you think there is any flaw inthem?Anthony Browne: We have not done an independentanalysis of those figures. We cannot comment onwhether we think they are exactly right or not, but wecertainly agree with the general principle that financialinstability comes at a massive long-term cost. Clearly,it is in the interests of the economy as well as mymembers to have long-term financial stability, whichis why we support any measures such as the FPC thatshould enhance financial stability in the long run. Thiscrisis that we had over the last five years is definitelynot in the banks’ interest.

Q72 Mr Ruffley: I understand that, but you have justsaid there is going to be a net benefit but you do nothave a view as to whether or not it is in the order of£68 billion?Anthony Browne: We have not done an independentanalysis of those Government figures.

Q73 Mr Ruffley: You are not in the realm of thinkingthere might be net disbenefits?Anthony Browne: Not in financial stability. We areconvinced that there will be definite net benefit overallto having financial stability. The short-term cost willbe outweighed by the long-term benefits in terms ofeconomic growth.




Q74 Mr Ruffley: Finally, Mr Chairman, a questionfor you, Mr Coles. The September document, theconsultation document, says that the distribution ofcosts is likely to differ between the tools and dependon how the tools are applied. They obviously talkabout the impact on household consumption equally,house prices; depending on the tools those thingscould be affected in different ways and at differenttimes. How easy do you think it is going to be tomeasure those benefits and costs to different parts ofthe economy in terms of the mechanics of measuringthis, something that the BSA will have an interest in,no doubt, particularly with household consumptionand house prices as well? How is that going to begone about?Adrian Coles: It is going to be extremely difficult tomeasure the impacts. You are going to have to workout what the counterfactual is: if the FPC had nottaken the action, how high would house prices havegone?Mr Ruffley: Exactly.Adrian Coles: How much additional wealth wouldhave been in the hands of existing home buyers? Howmuch additional expenditure would have beenincurred by first-time buyers? What the different pathof interest rates might be if house prices were allowedto go higher, looking at the clash between the FPCand the MPC. I really do not see with any confidencehow you work out what the precise figures are. Theonly thing I would say on the question that Anthonywas just answering, those sound very precise figuresto me, that £7.6 billion and £68 billion.Mr Ruffley: That is why I asked the question.Adrian Coles: We have not done any independentanalysis of it, but if you only look at the trend rate ofgrowth of GDP pre-2007 and see what output hasbeen lost post-2007, it is clear that there were hugecosts to financial disruption, but measuring theamount of them and the distribution of them betweendifferent parts of the economy is an extremely fruitfularea for academic research that will not come to anyfirm conclusions in the next 10 years, I am certain.Chair: What a vote of confidence in the academicprofession, Mr Coles.Anthony Browne: To answer your point and really asa former economics correspondent, economicforecasts are worse than weather forecasts. Havingprecise figures like that, clearly there is a largeelement of guesstimate around it inevitably. It is verydifficult to predict.

Q75 Mr Ruffley: Just my final remark; the reason Iask these questions is that, as I think you said, MrColes, huge amounts of economic and political powerare being invested in the FPC, huge powers. Whendocuments are published indicating X, Y and Z willbe done and the distributional effects have beenlooked at, it gives I think false comfort unless we canactually say now that these are going to be reliableindicators and measurable benefits and disbenefits.What I am hearing from you, the witnesses, today isthat, as with any forecast, of course it is finger-in-the-air time. I just wondered if you thought, reading thedocumentation over the last year that has been put outby the bank and that has been put out by the Treasury,

they are to an extent flying blind because a lot of thethings they say will be measured, we have not seenhard evidence as to how that is going to be measuredproperly. Would you agree with that generalproposition?Adrian Coles: Yes, I do. As I have said, it is going tobe very difficult to measure the impacts, but given theseverity of the financial crisis that we have just beenthrough it is very important to be seen to address theissues that have come up. The key point is not goingto be measuring precisely. As various regulators havesaid over the last three or four years, a main featureof the next five years of regulation is going to be theexercise and use of judgment. Regulators are goingto judge what is a well-run and poorly-run financialinstitution among the microprudential regulators andthere is going to be a significant use of judgment, withwhich some of us will agree and some will disagree,in the use of the macroprudential tools. I think it isuseful to have that list of financial stability indicatorsin the letter that was sent to you on 12 July by theBank, although I would add one or two indicators tothe list, as I said.Chair: Thank you. A couple more colleagues want tocome in.

Q76 Mr Love: Can I come on to sectoral capitalrequirements, which has been in some senses toutedas an alternative to restrictions on loan to value orloan to income? How effective will that particularinfluence be when the market is somewhat in over-exuberance, Mr Coles?Adrian Coles: I think one of the problems with usingsectoral capital requirements to control or influencehigh LTV and high LTI lending is that they could welldistort the market. For example, you can apply suchrules to deposit-taking institutions such as banks andbuilding societies, but would such tools giveadditional credibility to create and distribute, tooriginate and securitise mortgage-type models? If youare originating mortgages and selling them to overseassovereign funds, for example, which was happeningduring the period up until 2007, business may well bediverted to that sort of model if you impose high LTVratios on banks and building societies in the UK. Tobe fair, the Financial Policy Committee is looking atinternational leakage issues.

Q77 Mr Love: My question was intended to elicit aresponse to the question whether sectoral capitalrequirements will address the problems that peoplethink that loan-to-value restrictions might do. It is ina sense a comparison. How will sectoral capitalrequirements address those problems, Mr Smee?Paul Smee: I think they are a more sophisticated toolthan the fairly blunt instrument of loan to value. Ifyou look at the present situation, a bank or a buildingsociety has to have seven times more capital tosupport a 95% mortgage than it does an 80%mortgage. We have seen banks moving back fromthose high loan-to-value mortgages as a consequence.

Q78 Mr Love: I am looking particularly at a time ofover-exuberance when all sorts of mechanisms areused to get around the restrictions. I understand




sectoral capital requirements will introduce thoserestrictions. What will happen at a time of over-exuberance?Paul Smee: I think because these instruments can befine-tuned, for example, to particular areas of thehousing market and geographic areas of the housingmarket when there is over-heating, they will have aneffect. It will not be a perfect effect and there may beleakages as my colleague referred to, but I think theywill have an impact. It will not be necessarily a bluntimpact, which was behind some of our concerns overthe loan to value tool.

Q79 Mr Love: Can I ask you about whether or not itis possible to game the system? We have hadsubmissions that suggest clearly that banks andbuilding societies can get round some of the sectoralcapital requirements through what they call gamingthe system. Is that a possibility?Paul Smee: I do not think there is any system thatcannot be gamed in some way. I am not sure that it ishappening at the moment and I think, given the levelof supervision and the declared intention of the newregulatory bodies, it will become increasingly difficultfor the mainstream lenders to play those games shouldthey even have an appetite to do so. I have no reasonto believe that they have.

Q80 Mr Love: Can I ask you, Mr Browne, if it ispossible to game the system as has been suggested bysome? Is it difficult in times of animal spirits to resistthe need for greater mortgages and greater loan-to-value ratios? Will sectoral capital requirements rise tothe challenge in those particularly stressedcircumstances?Anthony Browne: We certainly believe they will havean impact, but exactly the impact we do not reallyknow. That is the point I was making earlier. A lot ofthese things we do not actually have the evidence basefor at the moment. With sectoral capital requirementsit can be fine-tuned, as they said. You can targetparticular LTV mortgages, you can target particulargeographic areas, but there is a risk of leakage.Clearly, the more you fine-tune them the less impactthey will have overall macro-economically, that youare trying to target one particular thing. One dangeroverall about the FPC is we do not want too muchfine-tuning all the time. We do not want peoplepressing the switches every day here and there andturning taps on and off because it would be verydetrimental for the workings of the markets and forstability overall. This is a point that has not come outso far today. We have not really talked about thepower of recommendations for directions. We think itis incredibly important that the FPC uses directions asmuch as possible. So far we have seen that when theyhave done it in terms of ETFs, for example, and thebanks’ dependence on ETFs, the recommendationshave had quite a lot of impact. When they come todirections that is in a way the absolute backstop, as itwere, when all their recommendations have not hadan impact. If there are particular areas where thereis irrational exuberance in, say, some aspects of theproperty market, the FPC should signal a loud clearwarning sign that they think things are going over the

top first and see whether our members and the marketsand the homebuyers and so on respond to that. Thecapital sectoral requirements should only be a last stopbeyond that. Ultimately, as I say, a lot of these areaswe have not operated in this space before, which iswhy we need as much consultation and transparencyand accountability as possible.

Q81 Mr Love: I am sure the FPC will have heardyour plea for recommendation rather than directions,at least in the first instance. I think what you weresaying was that they may find themselves inherentlyin a position where they would want to recommendrestrictions to loan-to-value ratios. Is there not a casethat that will be the only measure that would restrainanimal spirits and irrational exuberance in themortgage market? Do we not we have to have thatdebate now in order that if in the future irrationalexuberance occurs we will be in a position to dosomething about it?Adrian Coles: We certainly should be having thedebate now, but it depends how irrational the animalspirits are. The evidence from Sweden, for example,that has not been mentioned so far is that theintroduction of LTV controls on mortgage lending wasaccompanied by a growth of unsecured lending. Thatcould possibly lead to greater risk in the system withmore expense of unsecured borrowing at a higher rateof interest, making it more difficult for borrowers whodecide to go down that route to support their overallsecured plus unsecured mortgage payments. There isno failsafe system. The unexpected side effects; theextent of regulatory change, the range of new powersthat are being introduced, the FCA, the PRA, the FPC,is so massive that to expect there to be no unexpectedside effects of everything that is happening at themoment is wrong.Chair: John Thurso, just before I bring you in, I justwant to say I note that there has not been quite aneven amount of airtime for all witnesses. What I amgoing to do is at the end I am just going to give eachof you an opportunity for 60 seconds to say anythingyou feel you would have liked to have said when youwere preparing to come. You need not feel obliged totake that up, but it does at least give everyone achance to make additional points.

Q82 John Thurso: Mr Coles, can I come to youfirst? In an earlier response, you talked briefly aboutthe financial stability indicators. It seems fairlyobvious that the first thing the FPC is going to haveto do is work out a way of measuring whether we haveinstability arising. How content are you with what theGovernor has suggested in his letters to us and whatmight be an improvement or do you think these areadequate?Adrian Coles: Well, I made the point earlier that therewas a list of five indicators in the letter of 12 July,and given that there are proposed to be controls onthe housing market through sectoral capitalrequirements or direct LTV/LTI requirements, I amsurprised that one of the financial stability indicatorsis not a housing market indicator. It certainly wouldbe sensible for the bank to examine whether or not ahousing market indicator should be included.




Q83 John Thurso: What sort of indicator do youthink would be appropriate?Adrian Coles: The obvious ones are house prices andvarious house-price ratios; house prices to earnings,house prices to disposable income, variation of house-price trends, current house-price rates of increaseagainst long-term trends, all those sort of indicators.For each of these indicators there is a family ofindicators surrounding them. The other one is theamount of overall mortgage debt outstanding. One ofthe indicators is household debt to income ratio. Youmight want to look at mortgage debt to householdratio, even though mortgage debt actually is about80% of total household debt. If you are looking atinfluence in the housing market, you might want somehousing market indicators. That is all I would say.

Q84 John Thurso: Very quickly, does anybody elsehave a comment on the indicators? No. Then can Icome to you, Mr Browne, because of course the keypoint, having worked out what the indicators are, is tolink them to the tools and what you do. There hasbeen a general call for guidance from the FPC on howthey are going to use their tools, both how they willuse them and the policy leading up to their use.Should those relate back to the indicators? How wouldyou expect the FPC to communicate the relationshipto the indicators and the use of the tools?Anthony Browne: The FPC has obviously said theywill set out guidance how they would use the toolsand also once they use the tools set out a justificationfor the use of them. We expect this will evolve overtime, but certainly the ideal would be that they areclosely linked to the indicators so that if certainindicators are moving in a certain direction, such aswhether it is household debt or the lending aggregateleverage ratio of major banks, et cetera, if they aremoving in a certain direction then the markets willknow, the industry will know, households will knowthat it is ringing alarm bells there and they are likelyto respond to it. Having that transparency of themechanism would be incredibly beneficial ultimately.They are developing their evidence base as well anddeveloping their thinking around all this, so it willprobably be steps to that. But it would definitely begood that we end up in a situation like the MPC wherethere is really great clarity. You have an indicator, weknow whether it is in the wrong place or not, weunderstand their thinking behind it, and so it is quiteeasy to predict and pre-empt how they are going tomove. That leads to far greater stability because ifpeople pre-empt the moves then the moves may notbe necessary in the long run.

Q85 John Thurso: How important do you think it isfor the FPC to set out—this comes back probably toMr Smee’s point about the workings—in advance thatthis is how we expect it to work; this is what weexpect it to do to a particular indicator; this is why wewill use it and when we will use it?Paul Smee: It is very important because I think themarket should be looking at them and should bereacting to what they are saying as well, which willsave some of the issues over whether they makerecommendations or decisions.

Q86 John Thurso: Do you think that there wouldcome a point when if there is sufficient clarity the FPCbecomes important for the fact that it does not haveto act because the market has already anticipated it?Is that the ideal?Paul Smee: A sort of Governor’s eyebrows for the21st century. I think that would be possible but itwould take some time.Anthony Browne: The ideal would be that they neverhave to use the directions because through theunderstanding of their mechanisms and the indicators,through the power of recommendation, actually, thatleads to the stability and deflates any bubbles beforethey arise. You could see that the use of directions asa last resort, as I said earlier, will in a way be a simplefailure of all the earlier steps in the process.

Q87 John Thurso: Final question if I may, and canI ask all three of you this? I will start with Mr Smeeas you are at that end so, Chairman, if you would startat the other end with the 60 seconds. To what extentare the regulatory advances and legislative changes inEurope going to overtake what we are doing? Are wespending enough time being aware of what they aredoing and relating what we are doing to what theyare doing?Paul Smee: In the mortgage area, quite a lot of whatis happening in Europe is following some of the trendsthat have already been set by the Mortgage MarketReview and by the discussions that have been hadabout the loan-to-value caps and the sort of macromeasures we have been talking about this morning.Our problem is that at times the European initiativesfollow us for perhaps 80% of the way but that stillleaves 20% where there has to be fairly detailedchange, possibly with very little visible effect to theconsumer but which is costly. I do not think that theEuropean trends in regulation are counter to what weare doing and have done. The devil comes in the detailwhether there at times has to be minor amendment.Adrian Coles: We are certainly spending a great dealof time in monitoring what is going on in Europe. Wewere pleased with the outcome of what is currentlythe capital requirement regulation and CRD4 directivetext, which is not adopted yet but giving mutualsadditional forms of capital, which clearly comes to thecore of what we have been talking about today withcapital buffers and sectoral capital requirements.There is clearly a risk of conflict and I am pleased tosee that the FPC is constantly recommending to theTreasury that the powers that Europe takes do notconflict with the ability of the FPC to take action thatbrings financial stability to the UK, even if that isinconsistent with the European approach to 27different economies.Anthony Browne: I think that at official level there isenough recognition taken of it in the sense they onlyrecommend the tools that we have some nationaldiscretion over. There is continuous referencethroughout this to what we have national powers over,and part of the reason for the countercyclical capitalbuffer is that that is one of the tools in CDR4 as itcurrently stands—it has not been finalised yet—thatthere will be national discretion to use it up to 3.5%.




As a more general point, and I say this partly as aformer Brussels correspondent, I think as a countrywe really do not pay enough attention to Europeanregulations and the scope of them and the way theyimpact the UK. In financial services, as an estimatearound 80% or 90% of the legislation that is affectingmy members comes from Brussels and they have tocomply. Obviously, they comply with it and so on, butthere is actually very little awareness in Westminsterof all the different rules and regulations coming outof Brussels and sometimes they do conflict withmoves here. I would urge all, and I say this toMinisters and so on, to see things in the round—whatyou are doing here with the FPC, with the wholechange of regulatory regime here, with the Vickersreport that is coming out, starting to be applied to nextyear or legislation next year—of the whole Europeanlegislative agenda that has either been finalised or iscoming down the line, because industry is affected byall of them. You may not be in the driving seat of allof it, but the British Government is agreeing to all thisstuff in the Council of Ministers in Brussels.

Q88 John Thurso: Of course, we do have the chairof the relevant committee who is from this country,Sharon Bowles.Anthony Browne: Absolutely, yes. She is doing afantastic job and she has huge respect in the industry.You talk to her, she has 10 dossiers going throughTRIALOG at the moment; she has about 40 differentdossiers in total. You compare the amount of financialservices regulation going through her and hercommittee compared to the amount of legislationgoing through here: one is huge, one is not so huge.When you consider the financial services and financialstability in the UK and the banking industry and soon, the way is to see it in the whole. I have said thisto Ministers at various times that obviously in thespeeches they make and so on, they talk about theVickers reforms, the ICB reforms, the regulatorychanges; they should also mention all the stuff comingfrom Europe because they are agreeing to it.

Q89 Chair: I think you have burnt up your 60seconds.Anthony Browne: I have.

Q90 Chair: Well done, free hit there, Mr Browne.You said that the Government did not pay enoughattention to what is going on. I would be grateful if inwriting you could send us some examples of areaswhere the Government has been demonstrablyinattentive. Not now.Anthony Browne: At official level there is a tension.It is just at the higher public political level there isnot attention.

Chair: Not now; and suggest ways in whichprocedurally we can improve on our representation.Anthony Browne: I will definitely do that.

Q91 Chair: Not now, later. Goodness me, for a newwitness it is hard work. Mr Smee, what else wouldyou like to add?Paul Smee: Very briefly say that bodies such as theFPC should also have regard to the cumulative effectof what is happening within the market. I think themacroprudential tools should not be seen in isolation.They have to be seen alongside changes in other partsof regulation such as conduct regulation and the waythat that is enforced. I am sure they have that in mind,but I would like to put that on record.

Q92 Chair: Helpful thought. Anything you want toadd, Mr Coles?Adrian Coles: Yes, please—a sectoral plea on behalfof mutuals. The Government has a policy of fosteringdiversity and promoting mutuals to create competitionin the financial services market. The FPC has to bearin mind the greater difficulties that mutuals have inraising capital, because most of it comes from retainedearnings rather than external capital. Bear in mind thatlegislatively building societies have to put 75% oftheir lending into the housing market so they do nothave alternative markets they can move into if LTVand LTI controls are introduced in whatever way. ThePRA and the FCA by statute have to pay particularattention to the effects of regulation on mutuals whenproposing new forms of regulation. I think it wouldbe helpful if the FPC did that as well, but we didparticularly welcome Sir Mervyn’s point when heappeared in front of you on 26 June that some of thecontrols that might be appropriate for banks might notbe appropriate for building societies. We hope he andhis successor continue to recognise that possibility aswe move forward into the operation of the newregime. It would be very helpful to us. Buildingsocieties are different. They do have certainadvantages and disadvantages, but the advantagesmust not be lost as a result of the action of the FPC.

Q93 Chair: Okay. I am going to call the session to aclose. I am very grateful to you all for coming to seeus today. It is possible we may want to contact youfor more evidence in written form. We have alreadyrequested one particular piece. It has been very helpfuland thank you again for coming in.Anthony Browne: Thank you.Adrian Coles: Thank you.Paul Smee: Thank you.Chair: We will adjourn for five minutes and go intoprivate session.

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Wednesday 13 February 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark GarnierStewart HosieAndrea Leadsom

________________

Examination of Witnesses

Witnesses: Rt Hon Greg Clark MP, Financial Secretary to the Treasury, and Lowri Khan, Director, FinancialStability, HM Treasury, gave evidence.

Chair: Thank you both very much for coming to giveevidence this afternoon, which will probably be thefirst of a number of sessions we will have withMinisters over the years on macroprudential tools. Iwill begin by asking Andrea Leadsom to ask a fewquestions.

Q94 Andrea Leadsom: Thank you, Chair. Goodafternoon. The Institute of Chartered Accountants inEngland and Wales believes that the tools you haveprovided so far would not necessarily contribute tofinancial stability if conditions similar to the lead-upto the 2008 financial crisis were encountered again.Do you agree with their assessment, or how wouldyou counter that?Greg Clark: Well, firs

macroprudential tools · 2014. 1. 16. · director general, building societies association, and...

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