BOE Power Shift Takes Hold as Regulation Role Crystallizes

The Bank of England officially takes on powers to regulate the financial industry this week, marking another step in one of the biggest revamps of the institution in its three centuries.

Legislation conceived in 2010 came into effect yesterday to realize the government’s plan to scrap the Financial Services Authority and restore regulation to the central bank, which it lost when it was given operational independence in 1997. The institution will also wield new powers for financial stability.

The six-year-old financial crisis has prompted a rethink of the Bank of England’s role in the economy, and it’s already embraced its new tools, ordering banks last week to raise more capital against potential losses and to better account for risks. Further changes are afoot as officials revamp its monetary-policy mandate before the arrival of Mark Carney to replace Mervyn King as governor in July.

“It’s arguable the scope of the powers, the range of powers, is now greater than any other central bank,” said Charles Goodhart, a founding member of the BOE’s Monetary Policy Committee in 1997. “The bank has got a lot at stake over the next few years and there’s going to be awful pressure on the incoming governor.”

Banking supervision will be done by the Prudential Regulation Authority, a new unit of the central bank. In addition to taking on 1,300 staff from the now-defunct FSA, the BOE’s Financial Policy Committee, charged with assessing broad risks in the financial system, is now operating on an official basis after two years with interim status.

‘Herd-Like’ Behavior

“History reveals repeated episodes of herd-like chasing of high headline returns during exuberant phases of the credit cycle,” Paul Tucker, deputy governor for financial stability, wrote in a contribution to a book published today by the central bank. “Eventually that will recur.”

“Nor can we completely eliminate the interlinkages within the system that can propagate distress,” Tucker said. “But the emerging new rules of the game can lean against stability-threatening exuberance and will make the international financial system much more resilient.”

Conservative Prime Minister David Cameron began the overhaul after the 2010 election. His government says shifting financial oversight under one roof, and alongside monetary policy, will plug holes in the previous system that led officials to miss signs of the brewing crisis.

System Reset

“The changes coming into effect today are the start of resetting the system of financial regulation in our country,” Chancellor of the Exchequer George Osborne will say today, according to comments issued by his office in advance. “They do away with the discredited system that failed to sound the alarm as the financial system went wrong.”

While King has helped steer the change, he will only get to experience the full results for three months. He is due to retire at the end of June after two decades at the BOE.

King also won’t have the chance to work with the full potential scope of the new mandate for the MPC. While Osborne last month gave the MPC more leeway to meet its inflation target, he also asked it to review the potential merits of forward guidance. That assessment isn’t due until August.

BOE Power

In the meantime, the MPC is under pressure to revive growth. The U.K. is facing the threat of an unprecedented triple-dip recession even after the central bank cut its key rate to a record low, pumped 375 billion pounds ($570 billion) into the economy and started a program to stoke lending.

The concentration of so much power in one institution has led to calls from lawmakers for greater oversight. Andrew Tyrie, chairman of the cross-party parliamentary committee that scrutinizes the central bank and the Treasury, has led questioning on the BOE’s governance and operations.

“The old approach to the Bank of England, which is a very strong top-down and very centralized decision making, is going to be challenged with this set of responsibilities,” said Jens Larsen, chief European economist at RBC Capital Markets in London and a former BOE official. “It’s already being challenged by the circumstances they find themselves in, and the way Mark Carney and the organization responds is key.”

Axel Weber, the chairman of UBS AG and former president of Germany’s Bundesbank, expressed concern about new central-bank powers during a debate in London last week with King and Federal Reserve President Ben S. Bernanke. In addition to a potential “diversion from the core mandate,” he said it may be a risk to pile so much responsibility in one place.

“As they get a larger core role in the economy, we do have to see the downside this could potentially mean,” Weber said. “It heightens the risk that a central bank, if they get it wrong, they could get it wrong across a number of issues.”

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