Sir Mervyn King: A game of two halves

Robyn Hall

June 20, 2013

Sir Mervyn was speaking at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London at the Mansion House and cheekily he added: “Far from a boring goalless draw, it turned out to be a rather exciting and dramatic game, full of incident, with a red card or two and a passionate and at times justifiably angry crowd. We shall have to wait for the historians of tomorrow to file the full match report.”

Sir Mervyn first joined the Bank in March 1991 as chief economist and executive director, after being a non-executive director from 1990 to 1991. He was appointed Deputy Governor in 1997, taking up his post on 1 June 1998. He took over the position if governor in 2003.

King said that there were clear signs that a recovery in the UK is underway and that the housing market was picking up.

But he added: “Despite this encouraging picture, growth is not yet strong enough to reduce the considerable margin of spare capacity in the economy. Nor is recovery at an adequate rate fully assured. The weakness of the euro area and the problems of the UK banking system continue to act as a drag on growth. So the need to support the recovery remains.”

King was more concerned however that unemployment was “unnecessarily high”.

“We must not forget that one million more people are out of work than in the five years before the crisis. It is too soon to say the job of securing recovery is complete. There is a powerful case for more stimulus in the short run,” he said.

“The present extraordinary monetary policies cannot, however, continue indefinitely. Both nominal and real interest rates are at unsustainably low levels. There is an understandable yearning for a return to normality.”

Don’t push up rates

King said a rapid return to higher interest rates would do great damage to the balance sheets of highly indebted households, companies and, especially, financial institutions.

“The challenge in returning to normality is not so much managing market expectations when that eventually happens, important though that is, but in creating the economic conditions in which it is sensible to return to more normal levels of interest rates.”

And he added: “The real challenge – on a global scale – is to rebalance the world economy so that very low interest rates are not required to exhort deficit countries to spend in order to absorb the surpluses elsewhere.

“Monetary policy cannot provide the answer. It can only buy time to bring about the necessary structural changes in investment, trade and capital flows. Whether they involve changes in currency values or restructuring of debt is a political choice, but a failure to deal with global imbalances will not only retard the recovery in the world as a whole, but worsen the scale of the adjustment ultimately needed. It will inevitably be a bumpy ride.

“The other obstacle to a return to normality is our banking system where, despite the generous provision of liquidity and funding from the State, lending remains lacklustre, and risk premia high. Although the combined balance sheet of our largest banks has shrunk since the height of the crisis in 2008, it is still 400% of annual GDP. Leverage ratios have fallen, but all our major banks remain highly leveraged. And of course the two biggest lenders to the domestic economy remain largely in state ownership. It is difficult to imagine a banking sector like that making a real contribution to any economic recovery. It must be time for decisive action.”

Bringing Lloyds back

King said he welcomed chancellor George Osborne’s announcement that Lloyds Banking Group will be returned to private hands soon. And said he also supported his plans for a full review of the future structure of RBS.

But he warned: “In total, the eight largest banks have a capital shortfall of around £25bn relative to the standard recommended by the FPC. After this exercise, our major banks all now have plans for actions to fill that shortfall. The first evidence is the announcement on Monday by the Co-operative Bank. Others will follow. By taking firm pre-emptive action, we have shown what the new judgement-led approach to supervision means in practice. It substitutes substance for process and judgement for box-ticking. We need not more but better regulation and, just as with monetary policy, we have changed the way regulatory decisions are made.

“We must deal once and for all with the problem of financial institutions that are too big, or too important, to fail. Some progress has been made. When the crisis hit, we in the UK had neither an effective deposit insurance scheme nor a resolution framework to deal with failing banks. Now we have both. But there is unfinished business. Although the UK is leading the way in the development of agreements among regulators worldwide as to how the largest banks could be resolved, managing cross-border resolutions is still fraught with difficulty. We also need to implement the proposals of the Independent Commission on Banking as soon as possible, including the ‘ring-fence’ to separate commercial from investment banking, and the leverage ratio. A situation in which taxpayers again bear the burden when banks fail is unacceptable.

“That implicit guarantee is costly and distorts competition. The United Kingdom simply cannot afford to have an international banking centre if taxpayers have to underwrite a balance sheet that is many multiples of GDP. Too important to fail is too important to ignore.”

King said changing the ethics and culture of banking is a precondition of restoring trust and that the sheer size and complexity of global banks had led to failures of governance.

And he added: “Governments, regulators, prosecutors and non-executive directors have all struggled to come to terms with firms that pose a risk to taxpayers, cannot be prosecuted because of their systemic importance, and are difficult to manage because of their size and complexity. It is not in our national interest to have banks that are too big to fail, too big to jail, or simply too big.”

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