Mark Carney: The UK at the heart of a renewed globalisation
Speech by Mr Mark Carney, Governor of the Bank of England and Chairman of the Financial
Stability Board, at an event to celebrate the 125th anniversary of the Financial Times,
London, 24 October 2013.
* * *
1. Introduction
Financial Times
When the opened for business in 1888 London was the world's preeminent
financial centre. It had the most international banks, the largest capital markets, and the
deepest money and gold markets. It backed projects all over the world, and most of world
trade was financed by bills drawn on London. Supporting the critical mass of banks, insurers
and investors was an army of solicitors, accountants and clerks.1
What London had lacked, at least until the FT's great rival Financial News was founded in
1884, was a ready provider of financial news. The FT famously set out to report "Without
Fear and Without Favour", and declared itself to be the friend of the honest financier, the
respectable broker and the legitimate speculator; and the enemy of the closed stock
exchange, the unprincipled promoter and the gambling operator. Perhaps as a consequence,
its initial circulation was modest.
The preoccupations of 1888 were not very different than today. Editions of the FT 125 years
ago contained stories on economic development in China, the health of Spanish government
finances, and the state of Irish banks.
What is clear in those early editions is the decidedly international flavour of a London
investor's interests - from tramways in Buenos Aires to copper mines in Portugal. Since
then, London has been a truly international financial centre. In 1913, at the twilight of the last
great wave of globalisation, 71 foreign banks had London offices. A century later, there are
nearly four times as many. Today, almost twice as much international banking activity is
booked here as anywhere else.
London is the home of global markets as well as global banks. Almost half of all turnover in
over-the-counter (OTC) derivatives takes place here. London's share of global foreign
exchange turnover is almost as high and it remains a major hub for trading in gold. UK
insurance companies have around 10% of the global market.2 Extending the net further, the
UK is home to the third largest "shadow banking system" with assets of $9 trillion.3
The emergence of London as a financial centre in the nineteenth century owed a lot to the
UK's position as the world's greatest trading nation. Britain accounted for as much as a
quarter of world trade and produced around a tenth of global GDP.4 Over the following
1
At around this time there were 701 accountancy firms operating in the City, and over 2000 firms of solicitors. See David
Kynaston's book "City of London: The History" (Chatto & Windus, London, 2011).
2
See "Fund Management September 2013" published by TheCityUK, available at
http://www.thecityuk.com/research/ourwork/reports-list/fund-management-2013/.
3
See the Financial Stability Board's "Global Shadow Banking Monitoring Report 2012", available at
www.financialstabilityboard.org/publications/r_121118c.pdf.
4
The world trade share estimate is constructed using data from Dimsdale et al. (2010), Lewis (1981), ONS, UN, World Bank
and WTO. Full references are: Dimsdale, N., Hills, S., and Thomas, R. (2010), "The UK recession in context: what do three
centuries of data tell us?", Bank of England Quarterly Bulletin, No. 50, December; Lewis, W. A. (1981), "The rate of growth
of world trade, 1830-1973", in Grassman, S. and Lundberg, E. (eds) The World Economic Orders: Pasts and Prospects,
Palgrave Macmillan. For the output share, the source is Maddison. International comparisons of historical output are fraught
with measurement issues. Data are available only for 1870 (9%) and 1900 (9.4%), and cover a relatively small sample of
countries, hence the stated share for 1888 is only an approximation.
125 years the UK's shares of world trade and output have fallen to around 3%. Despite some
ups and downs, London has remained a centre of global finance.
Partly as a consequence, the size of the UK's financial sector relative to its economy has
increased dramatically. When the FT was in its infancy, the assets of UK banks amounted to
around 40% of GDP. By the end of last year, that ratio had risen tenfold.
As we have recently been painfully reminded, a specialisation in financial services carries
risks as well as rewards. And those risks will grow, unless we put global banks and markets
on a sounder footing. Suppose, for example, that UK-owned banks' share of global banking
activity remains the same and that financial deepening in foreign economies increases in line
with historical norms. By 2050, UK banks' assets could exceed nine times GDP, and that is
to say nothing of the potentially rapid growth of foreign banking and shadow banking based
in London.
Some would react to this prospect with horror. They would prefer that the UK financial
services industry be slimmed down if not shut down. In the aftermath of the crisis, such
sentiments have gone largely unchallenged.
But, if organised properly, a vibrant financial sector brings substantial benefits. Today
financial services account for a tenth of UK GDP and are the source of over 1 million jobs.5
Two thirds of those are outside London, including jobs in asset management in Edinburgh,
transaction processing in Bournemouth and insurance in Norwich. Being at the heart of the
global financial system also broadens the investment opportunities for the institutions that
look after British savings, and reinforces the ability of UK manufacturing and creative
industries to compete globally. Not to mention that financial services represent one of the
UK's largest exports.
More broadly, London's markets serve a vital global role. London acts as Europe's window to
global capital; is a centre of emerging market finance; and can play an important role in the
financial opening of China.
The UK's financial sector can be both a global good and a national asset - if it is resilient.
It is not for the Bank of England to decide how big the financial sector should be. Our job is to
ensure that it is safe. The UK can host a large and expanding financial sector safely, if we
implement a reform agenda that extends well beyond domestic banking.
That is not to suggest that the focus on reforming domestic banks has been misplaced.
Following the crisis, it was imperative to fix first the fault lines at the core of our system, with
initiatives ranging from rebuilding the capital of major UK banks and building societies, to
changing the structure of compensation and the responsibilities of senior officers. In tandem,
some major banks are working to change their cultures.6
But reforms of domestic banking are far from sufficient for a global hub like London. Now is
the time for a greater focus on what's needed for resilient international banking and robust
global markets. This will require sustained international engagement. Unlike in the early days
of the FT, the UK can no longer dictate standards. Rather than ruling the waves, we must
spur collective action through a demonstrated commitment to openness and the promotion of
better ideas in Europe and at the G20 via the Financial Stability Board (FSB).
More fundamentally, such engagement would be timely because globalisation itself is under
siege. Cross-border capital flows have fallen sharply since the crisis. Multilateral trade
liberalisation has stalled, to the detriment of global prosperity.
If we are to stem this tide towards financial fragmentation we must make global finance more
resilient. That serves both national and global interests.
Accordingly, I will concentrate today on three core elements of the Bank of England's new
Financial Stability strategy: creating resilient global banks, building robust markets and
conducting central banking for global markets. These initiatives support a fourth leg of our
strategy: improving the supply of finance in the UK. You will hear more about supply-side
initiatives, aimed for example at rebuilding securitisation and supporting SME lending, in
coming months.
2. Strengthening the resilience of international banking
Making international banks safer is fundamental to a renewed globalisation.
To this end, new global standards for capital and liquidity have been agreed. The major
global banks have raised $500 billion of new equity over the past few years and are on
course as a group to meet the Basel III standards more than four years in advance of the
deadline. In the UK, all major banks and building societies now have in place credible plans
to achieve the Bank of England's thresholds for capital and leverage.
To finish the job, international regulators need to agree over the next year new rules for
capital to be held in banks' trading books, a simple leverage ratio and a guideline which
governs the stability of banks' funding.
Alongside these efforts to increase resilience, our focus is on solving the problem of banks
that are too big to fail. Systemic resilience depends on being able to resolve failing banks in a
way that does not threaten the entire system. Fairness demands the end of a system that
privatises gains but socialises losses. And simple economics dictates that the UK state
cannot stand behind a banking system that is already many times the size of the economy.
Moreover, without a credible means to resolve failing banks, regulatory Balkanisation will
continue as national regulators seek to protect their own interests, threatening the efficient
operation of the international financial system and accordingly London's competitiveness.
To avoid these risks, we need to make the resolution of global banks a real option.
Successful cross-border resolution requires coordination and cooperation between
authorities across multiple jurisdictions. This will only work if all authorities are confident that
global resolutions will deliver domestic financial stability and protect local services.
Crossborder cooperative agreements will help, but fine words must also be backed up by harsh
economic incentives. Operating structures of banks must be made consistent with
resolvability and, above all, banks must have substantial loss-absorbing capacity that
cascades through their group structures.
At the St Petersburg summit in September, G20 leaders mandated the FSB to develop these
proposals. The Bank of England is now working intensively with other authorities and the
financial industry. Our aim is to complete the job by the next G20 Summit in Brisbane.
By increasing the resilience of banks and tackling too big to fail we can help make London a
safe global banking centre. But that is far from sufficient; we must also dramatically improve
the resilience of global markets.
3. Creating robust markets
To do so, we need first to consider how measures to increase the resilience of banks affect
the functioning of markets. For example, the combination of higher capital held against
trading books, the new leverage ratio, and the proposed Volcker restrictions on proprietary
trading have already combined to reduce dealer inventories across a range of securities.7
With dealers less willing to deploy capital against large market moves, volatility has
increased and liquidity fallen in the face of shocks such as the potential shift in US monetary
policy earlier this year.
On the other hand, with limited proprietary positions, banks generally emerged from a
summer of stress unscathed. Certainly, no one wants to return to the days when major
dealers' trading books were crushed under the weight of worthless leveraged super senior
debt.
To strike a balance between making banks safer and maintaining adequate market liquidity,
we need to draw lessons from the financial crisis, when contagion from stressed banks
spread rapidly through the global financial system via counterparty credit concerns, liquidity
hoarding and mass deleveraging. In this environment, core funding and OTC derivative
markets seized up and conditions were set for the panic that ensued.
By contrast, markets with greater transparency and more robust trading and settlement
infrastructure, such as equity markets and exchange-traded futures and options, performed
rather better. Prices were not always to participants' liking, but these markets remained
open.
London should lead the way in ensuring that fixed income and derivative markets meet such
standards. At the FSB, the Bank of England is helping to devise reforms that increase
transparency, build more robust infrastructure and encourage better collateral management.
Since collateral management is a cornerstone of resilient markets and goes to the heart of
central banking, let me take a few minutes to expand on it.8 Collateral reduces credit risk
between market participants and supports market-based sources of credit to the real
economy. It is central to the functioning of OTC derivatives markets and the funding of the
shadow banking system. Since market-based finance needs good collateral to grow
sustainably, its availability directly influences the supply of finance to British households and
businesses.
The use of collateral is not without risks. When collateral values rise, fixed haircuts allow
banks and non-banks to borrow more, pushing up asset values further. The reverse is also
true. This inherent pro-cyclicality exposes the system to sharp corrections in collateral
values. In extremis, a sell-off in financial markets leads to higher haircuts, a run on repo and
ultimately a market freeze.
To reduce these risks, the FSB has proposed minimum regulatory standards for collateral
valuation and management as well as a schedule of numerical haircut floors to repo
transactions. The FSB also now requires central clearing of "standardised" derivative
transactions to limit exposures between counterparties, promote efficient netting of positions
and moderate collateral cycles. New minimum capital and margining requirements for
bilateral OTC derivative trades will similarly protect banks from defaults of their
counterparties while reducing procyclicality in the system.
The combination of such reforms and the experience of the crisis will mean that institutions
both need more collateral and need to manage it better.9 Fortunately financial markets know
how to innovate. Investor expectations for liquidity are changing and models for risk
intermediation should evolve in ways that reduce balance sheet usage.
4. Central banking in global markets
Central banks need to keep up. In particular, we can catalyse more efficient and effective
private collateral management by backstopping private markets.
Lombard
140 years ago in Street, Walter Bagehot expounded the duty of the Bank of
England to lend freely to stem a panic and to make loans on "everything which in common
times is good "banking security"." Bagehot was particularly scathing on the Bank's failure at
that time to state a "clear and sound policy" on this general topic writing "...until we have on
this point a clear understanding with the Bank of England, both our liability to crises and our
terror at crises will always be greater than they would otherwise be."10
140 years on, the Bank has a clear and sound policy. It is set out in a revised Sterling
Monetary Framework (SMF), published today.11 The new framework builds on the lessons
learned throughout the financial crisis and draws on the recommendations made by Bill
Winters in his review of our system.12
Five simple words describe our approach: we are open for business.
Our facilities are not ornamental. They are there to be used by banks to access money and
high-quality collateral. We are offering money and collateral for terms. The range of
longer
assets we will accept in exchange will be wider, extending to raw loans and, in fact, any
asset of which we are capable of assessing the risks. And using our facilities will be
cheaper. In some cases the fees are being more than halved.
Banks can be confident that, when they want to use our facilities, they will be allowed to
access them. Because we are both the supervisor and the central bank, the strong
presumption is now that, if a bank meets the supervisory threshold conditions to operate and
has signed up to our framework, it will be able to use our facilities.
Our Discount Window will be open every day for those firms requiring a bespoke facility with
lagged disclosure. Its price will be lower. We will hold monthly repo auctions to provide
predictable and regular access to high-quality collateral in exchange for a very broad range
of collateral. And in times of actual or prospective stressed conditions we stand ready to
provide cheap, plentiful money through more frequent auctions.
None of this means financial institutions are excused from the need to manage their balance
sheets prudently. But as Bill Winters observed, more exacting liquidity requirements mean
the conditions for using central bank facilities can be less stringent (and more effective). This
is one example of the synergies that arise from the return of banking supervision to the
central bank.
With our announcements today, we are building a liquidity framework for the markets of
tomorrow. In the markets of today, initial usage of these facilities is likely to be limited. The
MPC's stock of asset purchases and the Funding for Lending Scheme currently provide all
the liquidity and collateral that the sterling system needs. But as these operations are wound
down over time, we expect to see banks making increasing use of our new permanent
facilities.
While today's announcement is significant, it does not mark the end of history for the Bank of
England's market operations. We will continue to evolve our approach as the financial sector
changes. In particular, we need to respond to two big questions.
First, should the Bank of England allow non-banks to have access to our regular facilities?
After all, our responsibilities for financial stability run much wider than the banking sector.
Institutions that play a central role in markets, like broker-dealers, are obvious first
candidates. We will also consider the case for opening them to other participants including
financial market infrastructures. If the scope of access to central bank facilities increases, the
scope of regulation can be expected to expand in a proportionate manner.13 Backstopping
the collateral management of a range of institutions should reduce the need for the Bank to
act as a Market Maker of Last Resort.14
Second, given that we host an international banking system and global markets, to what
extent should the Bank of England provide liquidity in currencies other than sterling? As
markets evolve, banks and markets here may need backstops in other currencies in our time
zone before business opens for the Federal Reserve and after it has closed for the Bank of
Japan.
Although the Bank of England can supply limitless quantities of sterling, we rely on other
central banks for access to their currencies. In response to the crisis, a network of swap
agreements between advanced economy central banks was established giving us the ability
to provide a range of currencies to UK-based institutions.
This network of swap lines should not necessarily be limited to the G7 economies. In June,
the Bank of England signed such an agreement with the People's Bank of China, reflecting
the growing international role of the Renminbi. That dovetails with the possibility of
establishing a Renminbi clearing bank in London and our decision to include branches of
Chinese banks in our broader policy of openness to hosting foreign wholesale banking
activities.
Helping the internationalisation of the Renminbi is a global good, consistent with London's
historic role. But rest assured that the Bank will act in a manner consistent with our domestic
responsibilities. As my colleague Andrew Bailey said last week, our risk appetite for foreign
branches will largely be determined by whether their activities in the UK are covered by
credible recovery and resolution plans.15 As always, renewing globalisation and building
resilience go hand in hand.
5. Conclusion
After perhaps the worst financial crisis in the FT's long lifetime, it is reasonable to expect
financial services will again grow in importance.
The process of financial deepening in emerging markets is only beginning. In Europe, there
is a strong case for greater reliance on robust financial markets relative to weakened banks.
The UK stands to benefit because of London's place at the heart of the global financial
system. Properly structured, this creates investment opportunities for British savers,
reinforces trading ties for UK firms and improves access to credit for the real economy
across this country. London's international markets in turn provide a valuable service to the
global economy. These benefits, on both sides, will be greatest as part of an open, integrated
global financial system.
The Bank of England's task is to ensure that the UK can host a large and expanding financial
sector in a way that promotes financial stability. Only then can it be both a global good and a
national asset.
To those ends, we are working to complete the jobs of making banks more resilient and
tackling too big to fail. We are making markets more robust in order to turn the shadow
banking system from a source of risk to a pillar of resilience. And we are changing how we
backstop private firms' liquidity management. These efforts will help set the stage to improve
further the supply of credit within the UK.
Let me put my point more succinctly, in the style of the FT 125 years ago. The Bank of
England today is the friend of resilient banks, continuous markets, and good collateral; and
we are the enemy of taxpayer bailouts, fragile markets and financial instability.
Our circle of friends - like the FT's readership in its infancy - is expanding. As it does, the
UK is helping to renew globalisation to the benefit of all.