Haldane Eyes Shadow Banking as New BOE Panel Targets Bubbles

The U.K. Financial Policy Committee may target unregulated bank transactions as it seeks to prevent bubbles and end the “Chuck Prince dynamic,” said Andrew Haldane, a Bank of England official and member of the new panel.

The FPC must “advise government when we think risks have migrated outside of the conventional banking system into what is these days called the shadow banking system,” Haldane said in an interview in London yesterday. Evidence of “banking-type activities” in “non-regulated parts of the system” could compel the FPC to ask the government to expand its powers.

The interim FPC meets tomorrow for the first time as part of Prime Minister David Cameron’s shake-up of banking regulation. The panel will be chaired by Bank of England Governor Mervyn King, who is due to speak in London later today. Haldane, executive director for financial stability at the bank, said officials are still deciding what tools will be used to shield the economy from financial risks.

Haldane said lenders will welcome an end to the “Chuck Prince dynamic,” where the former Citigroup Inc. (C) Chief Executive Officer was quoted in 2007 as saying that so long as rivals were taking big risks, he would too. Haldane said the FPC may solve the problem of banks being powerless to act against the tide when the environment is “a bit on the risky side.”

“It’s beyond the capacity of any one firm to stop the merry-go-round but if someone, the FPC, can slow that down that might actually benefit the banks,” he said. “This ought not to be an antagonistic relationship. It saves them from themselves.”

‘Fragile State’

As they protect the economy from banks’ exuberance, policy makers must ensure their rules don’t impede the pickup in credit needed for the recovery, Haldane said. Hampering lending is “a risk we need to be conscious of because we’re in a fragile state of the cycle.”

The central bank will hold a press conference on June 24 to discuss the results of tomorrow’s meeting.

Authorities have warned that shadow banking, which includes structured investment vehicles used to move transactions off balance sheets, could be used to evade attempts by regulators to clamp down on excessive risk taking.

The remit of the FPC “requires that we raise a flag in that situation and make the case for regulatory change,” Haldane said. Before the financial crisis, the FPC “might have said, and this is with 20-20 hindsight, ‘Banks, if you’ve got these off-balance-sheet SIVs and conduits, you must consolidate them onto your balance sheet today, because this is banking activity in all bar name.’”

Asset Bubbles

The shadow-banking system had liabilities of about $16 trillion in the first quarter of 2010, the Federal Reserve Bank of New York said last year. It “contributed significantly to asset bubbles in residential and commercial real-estate markets,” the Fed said.

Financial Stability Board Chairman Mario Draghi said in April that the board would enlarge “the regulatory perimeter” to include the “most important segments” of shadow banks. The FSB, a global regulatory body, said it would propose rules “to strengthen the regulation and oversight of the shadow banking system,” by November.

New rules must be on a “broadly equal footing” across countries because capital flows internationally, Haldane said.

The FPC also has to take into account a U.K. economy that’s stalled in the six months through March. At the same time, the government’s plans for the biggest fiscal squeeze since World War II have undermined consumer confidence.

Pre-Emptive Action

The costs of risk-averse banks “are felt as a repressed financial system, an absence of innovation, a higher cost of capital for customers,” Haldane said. “People aren’t feeling chipper right now about putting money to work.”

The FPC’s so-called macro-prudential toolkit aims to address changes in leverage and risk so that excesses don’t damage the wider economy, which conflicts with the approach taken by former U.S. Federal Reserve Chairman Alan Greenspan.

“We’ve learnt a lot and moved on from the Greenspan hypothesis, whereby if you see a bubble, you watch it, but don’t do anything about it, other than mop up the damage from when it pops,” Haldane said. “Now we’re moving to a world of greater pre-emptive action.”

While the FPC can remove constraints on credit, it’s can’t force lending and borrowing, any more than the bank’s Monetary Policy Committee can by lowering its benchmark interest rate, Haldane said. The bank held the rate at 0.5 percent this month.

No Compulsion

“You can’t compel people to borrow or lend,” he said. “What you can do is try and ensure as far possible that policy doesn’t get in the way of balance sheet repair and spending or lending.”

The FPC is part of plans for the biggest regulatory overhaul since 1997, in which the Financial Services Authority will be abolished and most of its powers returned to the Bank of England. The interim panel will have power only to recommend action until its status is approved by Parliament in 2012.

Chancellor of the Exchequer George Osborne will back proposals to erect firebreaks around consumer-banking units of British firms during his annual Mansion House speech to bankers in London this evening, and King will speak at the same event.

To contact the reporters on this story: Jennifer Ryan in London at jryan13@bloomberg.net; Ben Moshinsky in London at bmoshinsky@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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