Recently Nationwide has complained to the Treasury that its ability to lend is being threatened by the Prudential Regulatory Authority’s insistence on it raising more equity capital. Vince Cable took the unfathomable step of coining the phrase ‘capital Taliban’ to refer to the regulators, something more out of the student union bar than minsterial office, making it clear that he was on the side of the banks. The FT today took the side of the regulator, arguing that it needs to be left alone to get on with its job. I think the FT is spot on here, but I think some of the arguments as to why need teasing out further.
We are in the early phases of a new regulatory regime, and Vince Cable makes a gross procedural error by complaining in public about the PRA’s efforts to force Nationwide to raise capital. This is an error because it will encourage further lobbying, setting the implied precedent that the ultimate regulatory arbitor will be the Treasury press briefing, not the discussions on the Financial Policy Committee. This will make it harder for the FPC to achieve what it wants to, because banks will hold out thinking that they can pressurise the FPC into a change of heart, and perhaps will make the PRA less effective in applying directives of the FPC, since it may be inclined (or, simply to get results, forced) to split the difference with the banks.
The FPC mandate is new and fragile. The Government had ample time to frame it as it wishes, and now it should leave well alone until a decent interval has passed. If there is discontent with how that remit is being interpreted, it’s too late, frankly, to rewrite it now, and discontent should be pursued entirely in private, but preferably not at all. The regulators will rightly find such private pressure intolerable; they will be held to account by Parliament through the Treasury Committee for their actions in pursuit of the FPC remit, and if they give in to private pressure they risk being seen not to do their jobs, without any verifiable evidence as to why they chose a different course.
Government interference of this sort creates regulatory uncertainty, since it will undoubtedly raise in financial participants’ minds the possibility that the FPC remit will be changed, or that there will be private pressure to force the FPC to interpret the remit differently, and this, just as with all kinds of uncertainty, is bad. Observers will wonder whether the FPC remit should be gleaned from the remit, or from what Vince Cable has said lately. [Recalling how the MPC remit review was spun, with the text saying ‘no change’ and the interviews saying ‘go for growth’].
The interference with the operational independence of the FPC is damaging. The parallel with monetary policy is close. Political interference [eg compelling the MPC to evaluate forward guidance, a tool for monetary loosening, not much removed from compelling them to evaluate looser policy itself] raises in observers minds the possibility that the monetary policy that results will in part be a function of what the government wants from day to day. The BoE’s MPC was made independent of the government precisely to avoid this, because what the government wants from day to day (usually looser policy) was not in the long run interests of the populace, since this would leave us with high inflation (and no lower unemployment). So interference defeats the point of the regime in the first place. So with the FPC. The fact that the FPC exists is (in part) testament to the view that the government thinks itself incapable, day to day, of correctly balancing the short and long term costs and benefits of tight financial policy. As many have opined before me, tight financial policy brings long term benefits, fewer crises down the road, lower tax burdens from bailouts, but those benefits are felt mostly by someone else (some future government). Loose financial policy brings benefits now (powerful friends who might offer you a non-exec when you get kicked out of the Treasury, higher tax revenues, etc) but costs down the road (which some other poor government, kicked out in electoral retaliation, has to pay).
The Government collaborated in a laudible, and relatively open effort to make a technical judgement about the right balance to strike here, in drawing up the FPC remit. One can argue about whether the right balance was struck, or enough clarity was achieved. But to interfere in this way Vince Cable puts at risk the gains hoped for in drawing up the legislation in the first place – that financial policy would be governed by long-termism, not what would run well in the newspapers on the day. That’s why the FT is right to argue that they should let the FPC get on with doing what they were told.