Too big to nail

The bank’s three main divisions will each have its own boss with the rank of deputy governor, as well as a policy committee, or board, composed of a mixture of senior bank executives and outsiders. Managing the strains that will inevitably develop between them and keeping tabs on all the bank’s many goals will ask a lot of the governor. A successor to Sir Mervyn King, who stands down next June after serving two five-year terms in the top job, is likely to be decided before the end of the year. The job will soon be advertised. The joke is that only superheroes need apply.

Even the most gifted leader needs a staff with the right mix of skills. One concern is that the bank has lost too much of the tacit knowledge of the workings of the financial-services industry needed to be a good all-round regulator. When the bank took over interest-rate policy from the Treasury in 1997, it gave up its role as manager of public debt as well as its job supervising banks. That reduced the contact between bank staff and the City. And the primacy of the inflation mandate diminished the status of the bank’s financial-stability wing. Ambitious youngsters steered clear; some experienced staff left. When crisis struck, the bank was stuffed with smart economists but short of folk with a feel for finance. It will take time to restore the balance.

A bigger worry now is that the proliferation of committees will lead to internal strife. What if, to halt a credit boom, the bank’s new financial-policy committee (FPC) decided to increase the sum banks must set aside against unexpected losses on home loans? Such action, if effective, would also slow the economy and might cause inflation to undershoot its target. The monetary-policy committee (MPC) ought then to cut interest rates. But that would stoke the demand for credit that its sister committee was trying to curtail in the interests of financial stability.

It would be better to merge the two committees into one, say some economists, including Sushil Wadhwani, a hedge-fund manager who sat on the MPC until 2002. That way, when the two priorities come into conflict, the same group of people would be forced to decide the best trade-off between them. A single body might also find that an increase in interest rates is a more reliable way of preserving financial stability than the newfangled tools that will be at the FPC’s disposal. Academic estimates of the effect on GDP of varying capital requirements differ by a factor of ten, Mr Wadhwani pointed out to a parliamentary committee recently.

Others believe the FPC’s role is largely redundant, as long as banks are forced to hold lots of capital and the payments system is ring-fenced should they fail. But the big, indeed clinching, argument for a separate body overseeing financial stability is that the cause might otherwise slip. Dangerous imbalances can build slowly in a financial system, in ways that may not be obvious to a group of economists whose main focus each month is whether the monetary-policy setting is too hot or cold to hit an inflation target. And banks are not the only source of potential trouble: AIG, a big American insurer, had to be bailed out shortly after the collapse of Lehman Brothers in September 2008. There is merit in having a committee charged with worrying solely about financial stability.

Most of the time the FPC and MPC will be leaning in the same direction: credit booms that threaten financial stability will also tend to add to the pressure on inflation. But there is probably no institutional set-up which would make the goals of stable inflation and stable finance compatible at all times. Inflation is a well-understood goal and, with luck, today’s monetary-policy choices might hope to affect it within two years. By contrast, it is hard to know how much weight to give in such decisions to the remote chance of a financial meltdown. The two committees will have to slug it out. It may then be up to the bank’s governor to divine and explain the balance struck between the two. Better, though, to have such conflicts aired than for financial stability to be ignored altogether.

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