It is fortunate that Mark Carney, who moves from the governorship of the Bank of Canada to that of the Bank of England in July 2013, is no stranger to political minefields.
Not only are expectations unrealistically high about what one man can do in a few years to remedy the problems ailing the UK economy (most of which are structural and of long standing), but the debate about the role of the central bank has already opened.
Vince Cable, the Liberal Democrat MP currently serving as Business Secretary, has become the first Cabinet minister to question the current mandate, which calls on the central bank to keep inflation at 2 per cent – the Governor has to write an open letter to the Chancellor if the target is missed by 1 per cent or more on either side.
“Every other quango in Britain is now required to have a growth objective,” he said in an interview with The Observer on 9 December.
“We have got to have a very expansionary monetary policy, which we have had until quite recently, but I sense the Bank of England is running out of steam, or perhaps motivation. A lot depends on this new governor.”
Mr Cable would like to see the Bank brought to heel, like other “quangos”. As the British prepare to endure yet another year of near-stagnation, the idea that it should have a formal mandate to boost growth is gathering increasing support among economic commentators.
To judge by his record in Canada, Carney will be ready to experiment. British economists have noted that in 2009 Carney pioneered an approach to monetary policy later adopted by the US Federal Reserve – committing itself in advance to holding interest rates down for an extended period.
My own guess is that if inflation and inflationary expectations remain subdued when he takes office, Carney will persuade his fellow members of the Bank’s monetary policy committee to adopt a highly expansionary policy. He took great risks in holding down Canadian interest rates at 1 per cent through the commodity and China booms of 2009-11 – as reflected in what many see as a property price bubble, now possibly about to implode. It appears that the jury is still out on whether that experiment will ultimately be judged successful.
Equally important challenges will be to tackle Britain’s now endemic banking weaknesses and restoring respect for the City of London. British banking has suffered a number of highly damaging body-blows – a succession of shameful scandals, collapse of public trust in finance, and perceived lack of support for the domestic economy. Equally important politically will be to safeguard the public finances from being burdened by further calls for support by the finance sector.
Those who know Carney’s thinking report that he will be keen to emphasise that responsibility for managing risks lies with the firms themselves. So he will be big on reforming governance of financial institutions. He will insist that bank boards live up to their duty to set the risk appetite of firms and monitor compliance.
More interestingly, he is likely to press for rapid adoption in the UK and internationally of three initiatives he has been working on at the Financial Stability Board (FSB):
- The report of the Enhanced Disclosure Task Force to improve comparability and readability of risk disclosures, and plug gaps in current information (the EDTF is a private sector initiative mandated by the FSB which reported in October, 2012).
- Banks to reduce reliance on credit rating agencies.
- A focus on better supervision, not just better regulation, of finance including shadow banking.
On the first, Mr Carney views the level of disclosures by banks as inadequate – bank accounts have been called a “black box” as far as investors are concerned. This causes massive uncertainty about the quality of a bank’s assets and adds to funding pressures.
Thus the EDTF report sets out principles relating to a bank’s business models, liquidity position, its sources of funding, the calculation of risk-weighted assets (RWAs), the drivers of changes in both RWAs and the bank’s regulatory capital, the relationship between a bank’s market risk measures and its balance sheet, a bank’s loan forbearance and modification practices and how they may affect the reported level of impaired or non-performing loans. The key is to tie accounting exposure more closely to true risk exposure.
On the second, Mr Carney wants firms to make their own credit assessments rather than rely on the agencies.
On the third leg, he is likely to insist on giving regulatory agencies clear mandates, operational independence and adequate resources. He is likely to confront the UK government with these demands with the full authority of the FSB and G20 heads of government behind him. He will remain head of the FSB.
He believes that supervisors should be involved with bank management, bank strategy, the appointments of CEOs and succession planning. The aim will be to make sure that bank management think deeply about their strategy and the risks involved.
Here one has one big doubt. What Carney does not seem to have yet faced up to, intellectually, is whether supervision – however good, and even when buttressed by other measures – can ever be a full answer to the risks run by big financial groups that include large investment banks, or indeed those of “too-big-to- fail” investment banks themselves. For the state to guarantee parts of a bank guaranteed and leave the rest of it free to do whatever it wants is not a sustainable or tolerable position.
George Osborne, the UK Chancellor of the Exchequer, has said that Carney supports the UK government’s plans to implement most of the recommendations of the Vickers Commission on ring-fencing the “retail” banks in the UK. But that is only one step towards the objective of separating the sovereign from banking risks – a challenge facing all G20 governments. One suspects he would shy away from forcibly breaking up big banks. But he also understands markets and power.
The markets seem to be saying that shareholders would do better if universal banks split into various component parts. The message from governments is that they can no longer afford to maintain a state subsidy for big banks.
Meanwhile, it would be natural if senior officials at the Bank of England were both excited and apprehensive. When Carney talks of “relaunching” the ‘old lady’, this is no mere figure of speech or rhetorical flourish. If the pattern observed at the Bank of Canada is followed, she should prepare for a housecleaning; virtually every member of the governing council either retired early or left to pursue “other opportunities”.
A tactic Carney reputedly likes to employ is to have many important discussions in a casual but challenging environment. He is an avid runner and if people seek him out for a discussion, he often invites them to discuss the matter during a brisk run.
Memo to members of the MPC and Bank employees: Be sure to have a pair of sturdy trainers ready!