For the second time recently, I got to hear the thoughts of
Andrew Bailey, CEO of the new Prudential Regulation Authority (PRA) and Deputy
Governor for Prudential Regulation at the Bank of England.
This time was at the annual dinner for the Chartered
Institute of Bankers in Edinburgh.
A fine evening and occasion, with lots of dignitaries and
luminaries of the industry in attendance.
Andrew’s speech talked in depth about the new approach to regulation
and, as he spoke, various phrases jumped out at me. I’ve picked these out in the text of Andrew’s
speech, as these words were the ones that hit home, but the key line of the
whole speech for me was this one:
The root of the
introduction of macro-prudential regulation sounds quite obvious, which is to
take into account the impact of financial regulation on the functioning of the
real economy. Obvious you might say – yes, but it wasn’t done in the past.
Andrew referred to the fact that the regulatory structure of
banking has fundamentally changed since he began working in the industry almost
thirty years ago, noting that “the UK is on its fourth system of financial
We had Big Bang, the consolidation of regulators from
product (the Investment Management Regulatory Authority) to industry (the Personal
Investments Authority) to market (the Financial Services Authority) to structural
(Prudential Regulation and Financial Conduct Authorities).
Each time something failed, and the system corrects itself
to deal with this. The first failure was
pensions mis-selling; we then moved on to bancassurance changed requriements
for regulation; then there was an integrated need across retail and wholesale
finance for regulation; and now there is a need to deal with financial failures
at the structural level of the system.
Other phrases stuck out:
“Banks are in the dog
house” which has “reminded us of the importance of banks to the functioning and
health of the economy”.
The role of banks is “intermediating
between savers and borrowers to enable credit creation”.
“The job of prudential
regulators is to maintain the safety and soundness of the banking system”.
This has failed, because
“the temptation to let the good times roll is deeply embedded in the political
economy of regulation.
“The Bank of England
is pursuing two important objectives: seeking to increase the resilience of the
UK banking system, and, supporting the creation of credit in the UK economy.”
“This is a reform of
the whole of financial regulation” including “the need to ensure that the
boards and management of firms appreciate and act consistent with the public
“I regard having the capacity
to resolve failed large banks – including the largest – as the holy grail of
“Having firms that are
either too big or too important to fail is bad for competition in the
industries that we regulate.”
“We define a stable financial system as one
that is resilient in providing the critical financial services that the economy
needs”, and “four services stand out here: the protection of savings; the
provision of payment services including access to funds; credit extension; and
I’ll let you read the speech in full, so that you can make
your own mind up about our new regulatory regime:
The new approach to
Speech given by Andrew
Bailey, Deputy Governor, Prudential Regulation and Chief Executive Officer, Prudential
Regulation Authority at the Chartered Banker Dinner 2013, Edinburgh, 1 May 2013
It is a great pleasure to be here this evening for the
Chartered Banker Dinner. President, in the description of tonight’s dinner you
made the important point that the Chartered Institute supports “ordinary”
bankers providing a vital service to their customers at a very difficult time.
I want to speak tonight about the importance of those vital services.
The fact of the matter is that banks are in the dog house,
and for reasons that are very well documented I am afraid. But, in saying that,
it would be wrong to believe that this makes banks irrelevant and unwanted.
On the contrary, the financial crisis has through adversity
reminded us of the importance of banks to the functioning and health of the
economy and their role as providers of critical financial services.
Going back in history, it was Walter Bagehot in the 1870s
who argued that the development of joint stock banks played an important part
in the growth of the mid-nineteenth century British economy with its very high
degree of openness to world trade.
Scotland played a very major part in that period of economic
development, and in the first official history of the Bank of England, Sir John
Clapham recorded that the Scots loved their banks.
Banks were then important institutions supporting the
industrialisation of the British economy and the trading system that fostered
There is no difference today as the purpose of banks remains
to support activity in the real economy, most obviously by intermediating
between savers and borrowers to enable credit creation.
Now an observer could easily intervene and say “yes, but, what
I observe is that they have developed funny ways of going about it” –
complicated products, likewise impenetrable slicing and dicing and re-packaging,
all with the end of supporting bankers’ remuneration on a vast scale.
There is some truth of course in that observation, but let’s
not forget that there is a permanent interest of public policy to ensure the continuous
provision of critical financial services to the real economy of this country,
that is protecting savings, enabling payments, credit creation etc.
What goes with this is a very sharp public policy interest
in the state of the banking system.
This will not change and nor should it – banks are too
important to lose sight of them in ways that happened in the past.
The job of prudential regulators is to maintain the safety
and soundness of the banking system to ensure the continuity of those critical
services to the economy and to the public.
The crisis has been a searing experience for banks and
regulators, precisely because at times they have both failed to fulfil this
central objective of maintaining safety and soundness and hence the continuous
supply of critical services to the public.
For what is now not far short of three years we have been
working to change the approach to financial regulation in the UK.
We are still working to do that of course, but the difference
is that for the last four and half weeks we have been doing so within the new
regulatory framework of regulation – we are doing it now as the Prudential
Regulation Authority and the Financial Conduct Authority.
The prompt for this change of approach has been the severity
of the financial crisis, a crisis that has been through a searing phase of prudential
problems – failing banks – and more recently a conduct phase as the misdeeds
and unacceptable behaviours of the past have been revealed.
On a personal note, recently when my appointment was
announced, I was described a number of times as a veteran of the Bank of
England. It was for me a moment of home truth; 28 years is quite a long time in
one place, even if the term veteran sits uncomfortably. But it reminded me that
the UK is on its fourth system of financial regulation during that time. The
serious message from this is that institutional structures do matter for the
success of public policy goals and objectives.
The last major reform of the institutional structure in this
field was in 1997, when the then government reformed monetary policymaking and
The results of these changes were very different.
The Monetary Policy Committee (MPC) has in my view been a
good example of a successful institutional structure.
You can argue with what the MPC decides month-by month, you
can debate how the framework of policymaking should put into effect the mandate
in statute, but the test of a successful institutional structure of
policymaking is that these debates can be had without undermining the
credibility of that institutional framework.
As a close observer, I would say that the MPC has passed
this test very well.
I make this point because the same cannot be said over the
last fifteen years or so for the institutional structure around financial
stability and supervision.
In the 1990s in the UK there was a very determined effort to
build a lasting structure of monetary policy in the wake of the difficult
experiences before that.
That institution building effort was about enabling good
policy-making, supported by strong accountability to Parliament and the public,
a determination to be transparent in making policy, and as part of that a commitment
to engage with all the regions of the country.
Today, we face the same challenge with financial stability
One thing I should emphasise is that this is a reform of the
whole of financial regulation.
I say that because it is easy to conclude from observation
of the issues we face as regulators, and the public debate, that we are just
dealing with reforming the regulation of banks.
That is not the case, and what we are doing is not about dragging
the rest of the financial services industry into reform to solve a problem that
is in essence only about the banks.
We have to design a system that works effectively for all
sectors of the industry.
The 1997 reforms created the FSA as an integrated regulator
– by which I mean regulation which combined Prudential and Conduct of Business
in one regulatory body covering the broad sweep of the financial services
The record now shows that this approach did not work as effectively
as it needed to do.
I think there are a number of closely related reasons for
First, on a rather practical point, I think it is hard for a
single organisation to balance, particularly during a period of crisis, a wide
range of very demanding issues which are individually rightly of great concern
to the public and can come from anywhere in a landscape of around 25,000
Second, I think the evidence suggests that over the last 15
years there have been periods when either conduct or prudential supervision has
been more in the ascendancy to the detriment of the other.
In the years leading up to the start of the crisis there was
a dearth of prudential supervision, but I am quite prepared to acknowledge that
there have been periods where the opposite has been true.
My point here is that I don’t think the system of integrated
regulation demonstrated the ability to deliver a stable equilibrium of conduct
and prudential supervision.
Third, there was something of an inbuilt tendency within
integrated regulation to play down the active debate of issues where conduct
and prudential regulators found themselves with potentially conflicting
There are several important reasons why reform of financial
regulation will in my view be an important step forward.
It starts with establishing very clear public policy
objectives for financial regulation to which we, as the regulators, are fully
For both banks and insurance companies, the PRA will have
the objective of promoting the safety and soundness of firms.
Consistent with this objective, it will focus on the potential
harm that firms can cause to the stability of the financial system in the UK.
We define a stable financial system as one that is resilient
in providing the critical financial services that the economy needs.
And this supply of services is a necessary condition for a
healthy and successful economy, as demonstrated by the costs imposed by the
financial crisis on the public and society at large.
For insurance companies, the PRA will have the second
objective of contributing to securing an appropriate degree of protection for
Why do we need a second objective for insurance?
One reason is that in taking out some forms of insurance
policies, the public can become locked into very long-term contracts, much
longer often than is the case in banking with deposit contracts.
Bearing this in mind, the public interest I think justifies
a second objective for insurance, which is more directly targeted at the
situation of individual policyholders.
There are a number of important points in this description
of the PRA’s objectives.
First, the emphasis on economic well-being as an ultimate
goal aligns the supervision of banks and insurers more closely to the field of
This is in line with the definition of financial stability
in terms of the continuity of supply of critical financial services which are
important to the functioning of the economy.
Four services stand out here: the protection of savings; the
provision of payment services including access to funds; credit extension; and
This definition is critical to clarifying the public
interest-objective in a stable financial system, and that this public interest
can diverge from the private interest of a firm in profit maximisation without
reference to the public interest.
One of the biggest lessons I take from the financial crisis
is the need to ensure that the boards and management of firms appreciate and
act consistent with the public interest.
To achieve this end, we need a much better definition of the
public interest, which I believe we now have in the new legislation.
The second important point in terms of the meaning of the
PRA’s objectives is that it will not be the PRA’s role to ensure that no firm
Rather, the PRA will seek to ensure that any firm it
regulates that does fail should do so in a way that avoids significant
disruption to the supply of critical financial services.
Nevertheless, failure is not costless and there is inherent
uncertainty about whether a firm can fail without damaging the financial system
and the supply of critical services.
Consequently, the PRA will expect a given level of
resilience to failure from all firms.
There is another major public interest in the banking
system, namely that by becoming too big to fail, the largest banks have
developed an implicit, and in some cases explicit, dependence on public money.
This is unwelcome, for the public, and for the banks, the
former because of the unwanted cost, and the latter because of the intense
scrutiny and oversight of the banks, which must be more intense as long as this
state of affairs lasts.
Now, I recognise that we have a lot to do still on
resolution planning to be comfortable about our objective of avoiding a no
failure regime and thus solving the Too Big To Fail problem.
For large banks, we are making progress on resolution
planning, and this world is different to five years ago, but we are not there
yet by any means.
I have a background in resolving banks, and I regard having
the capacity to resolve failed large banks – including the largest – as the
holy grail of resolution.
Unlike the legendary Holy Grail, I think there is a good
reason to believe that the objective of being able to resolve large banks that
fail can be within our grasp.
I am very clear that when firms mess up, they should be
allowed to fail, and by doing so they are putting at risk the money of their
shareholders and if necessary after that those who provide debt funding
according to levels of seniority.
But I am also very clear that really achieving the objective
of avoiding a no failure regime requires a fundamental change of mindset both
inside firms, the authorities and in society more broadly.
Fear of failure is an important conditioner of behaviour in
a financial regulator, and achieving a change on this front depends on
establishing a wide acceptance of our approach that orderly failure which does
not compromise our public policy objectives is an acceptable outcome.
To be clear, we should be criticised where failure
compromises those objectives and we could have taken steps to avoid it. But if
failure is orderly, and does not compromise our public policy objectives, the responsibility
should rest with the board and management for failing to serve the private
interest of their shareholders and creditors.
Last on the theme of failure, having firms that are either
too big or too important to fail is bad for competition in the industries that
An industry where exit is too difficult is one where entry
is likewise inhibited. This is what we see in the banking industry.
Embedding resolution into the public policy objectives of
financial regulation matters for two reasons relevant to competition: first, because,
to repeat, exit enables entry; and, second, because if, as we will, we require
new entrants to satisfy us on their resolvability in order to be authorised, we
will lower the barriers and costs of opening for business.
Put simply, if we don’t know how to deal with a failed firm,
we will inevitably set a higher barrier to entry.
We have already started to put this new approach into
Resolution of failed firms consistent with the public policy
objectives is one key plank of the new approach to financial regulation.
Another key plank concerns the macro prudential approach to regulation.
The legislation has formally established the Financial
Policy Committee (FPC) charged with the primary objective of identifying,
monitoring and taking action to remove or reduce systemic risks with a view to
protecting and enhancing the resilience of the UK financial system.
The FPC also has a secondary objective, to support the
economic policy of the Government, including its objectives for growth and
The root of the introduction of macro-prudential regulation
sounds quite obvious, which is to take into account the impact of financial
regulation on the functioning of the real economy. Obvious you might say – yes,
but it wasn’t done in the past.
Macro-prudential regulation is focused on protecting the
financial system as a whole.
It is quite simply about ensuring that financial regulation
is conducted with an eye on the state of the economy. In a very big picture sense,
there is nothing new about this activity.
The problems of the last five years have emphasised the close
links between the health and behaviour of banks and the condition of the
This is a lesson of history, and one that should not have
been forgotten. But, forgotten it was.
A clear objective of macro-prudential policy is to act in a
countercyclical fashion – to restrain booms by acting to tighten regulation,
and to seek to dampen the impact of busts. Unfortunately, the record of the
past shows that the behaviour of regulators has not been consistent with these
The crisis illustrates the dangers of not applying restraint
in what appeared to be good times. But it requires a very strong culture to
allow this type of restraining to happen.
The record of the past indicates that the temptation to “let
the good times roll” is deeply embedded in the political economy of regulation.
Macro-prudential regulation can also lean against the
tendency otherwise of micro-prudential regulators to toughen up their regime in
the teeth of the storm.
At the heart of this new approach to making policy is a very
simple observation, namely that changes in regulatory intensity in this area
can have an impact on credit availability and thus the performance of the
There are two legs to this argument, and it is important to
The first leg involves the simple proposition that a well
capitalised banking system is more likely to support credit creation in the
economy. We see evidence today of better capitalised banks tending to see more
rapid growth in lending.
It is with this objective in mind that the Bank of England’s
Financial Policy Committee has recommended that the major UK banks as a group
should increase their equity capital resources.
The whole point of this action is to enable forward-looking
judgemental regulation to take effect in a system where balance sheet strength is
a necessary pre-condition of stronger lending to the economy as a whole.
In the same vein, last summer the Bank of England and the
FSA took steps to implement a clearly counter cyclical response to a situation which
was a problem to for the economy as a whole.
It was an occasion on which responsibilities were
well-defined and thus the accountability for the actions was clear; for the
Bank, to introduce the Funding for Lending Scheme (FLS) to support lending by
bank and likewise to introduce the extended repo operations for the FSA, to
loosen liquidity requirements and adjust capital buffers to incentivise net new
The key message here is that if the banking system is
sufficiently capitalised against future losses, it can play a full role in
counter-cyclical policy which seeks to respond to and lean against the
conditions of the day.
That is the essential use of forward-looking judgement, done
with the explicit objective in mind of using financial regulation as a
At present the Bank of England is pursuing two important
objectives: seeking to increase the resilience of the UK banking system, and,
supporting the creation of credit in the UK economy.
Let me say a few words therefore about the announcement last
week to extend the Funding for Lending Scheme and modify its terms.
It is almost a year since we designed and began the
implementation of the current FLS.
That was done against the backdrop of a much more febrile
environment in the euro area in terms of sentiment and a real concern that the
risks arising from the euro area situation were affecting the costs of funding
for UK banks and therefore their lending and the economy more broadly.
Alongside that evidence, we could see that the sum of the
projections for lending in the two years ahead for the UK banks was
The case for acting was therefore strong, but the challenge
was also that in its first year, success for the FLS was in some ways to prevent
the most negative outcome for lending, which in an absolute sense would not
What we have seen over the last year is quite a substantial
change in the funding costs of banks which has fed through into lower lending
costs, but more so in terms of the amount of lending in the mortgage market than
for small firms.
Funding for the major banks have also become less disposed,
which has probably increased the willingness of banks to compete on lending.
But the uneven pattern of lending meant that we thought it was sensible to
increase the incentives for banks to lend to small firms.
We cannot say that this will conclusively deal with the
question of whether the problem is a lack of loan supply or demand, but we can
say that we have used our toolkit to create a big incentive for banks to lend
to small firms.
In summary, there is a strong public interest in the banks,
which has been sharpened by the crisis.
One element of that public interest is permanent – the role
of banks in supporting the real economy.
Another is permanent, and like the first should be in the
category of a given – namely, good conduct by banks.
But the third – the dependence on public money – should not
survive, hence the strong focus on developing bank resolution and ending too
big to fail.
Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...