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Treasury Committee House of Commons, Committee Office, 14 Tothill Street, London SWlH 9NB Tel 020 7219 5769 Fax 020 7219 2069 Email treascom@parliament.uk Website www.parliament.uk/treascom

Andrew Bailey Esq Deputy Governor, Prudential Regulation Bank of England Threadneedle Street London EC2R 8AH

6 June 2016

Thank you for your letters of 6 January and 26 February, both of which provide useful

accounts of the actions being taken by the PRA in response to the concerns raised by both the

PCBS and the Treasury Committee. There are a number of points that merit further clarification.

Resolution and bail-in

The level of market discipline imposed by shareholders prior to the crisis was found to be

deficient. It is to be hoped that after the development of bail-in debt, bondholders will do

better. The Parliamentary Commission on Banking Standards expressed scepticism about the

workability of resolution regimes, and noted that their credibility would ultimately determine

whether they led to greater market discipline. Recent events in Italy and Portugal are

concerning and suggest that the implementation of bail-in is extremely difficult in practice. It

would be useful for the Committee to know what the Bank has learnt from both of these

episodes and how they have informed its thinking on resolution in a UK context.

Intrusiveness of regulation

Overall, your letters paint a picture of a more intrusive regulator. This is inevitable, and may

be appropriate, given the plainly inadequate standards of regulation prior to the crisis. There

remains a danger however, identified by the PCBS, that the PRA could be regarded as a

shadow director. This would pose risks to the proper operation of the market. It might relieve boards of too much responsibility. It could also pose financial risks to the government. The

PRA has argued that the proper discharge of its statutory duties would not make it a shadow

director. The PRA must ensure that it has persuasive legal assurance on this point. The PRA

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board should keep this risk under review. The Committee would be grateful for renewed

assurances from the PRA on this point.

Competition and inte.rnal modelling

The Committee notes your points concerning the interaction of the risk weighted capital requirement and the leverage requirement. The practical steps that the PRA is taking to reduce the competitive distortions arising from the difference between the standardised capital (SA) and internal modelling (IRB) approaches are welcome, as is your assurance that the PRA is trying to secure sensible modifications of the regime in international discussions. The importance of this has been reinforced by recent Competition and Markets Authority analysis. This highlights the risk that these distortions could act as a barrier to entry or expansion in retail banking, especially in the mortgage market.

Internal modelling remains a source of concern in other respects. First, your letter notes that 'while !RB modelled capital requirements are often lower than the standardised approach, firms using modelled approaches are required to have more sophisticated risk management

capabilities, which ofcourse carry their own cost.' The models are, as I understand it, subject to regulatory approval. However, this was also the case during the early-mid-2000s, when models which had been approved by the FSA were used to justify risk weights for the assets of IRB banks which proved to be hopelessly insufficient. Secondly, the letter states that 'work is underway in relation to constraining !RB modelling (for example where it is deemed that models do not assess risks sufficiently prudently).' The quality of IRB modelling is important. Inadequately-tested models involve great risk. It would be helpful to have a reasonably detailed assurance not only that such modelling is robust, but also that these models are not being excessively relied upon.

Supervisory confidentiality

The PRA has noted that further work remains to be done to improve both the quality of

auditor reporting and enhance the transparency of bank disclosures. The high levels of

volatility in financial markets earlier this year can at least be explained partly by inadequate

bank and regulatory disclosures, leaving markets operating with far from complete

information. Both of your letters illustrate that significant amounts of information remain

confidential between supervisors and the banks. It may well be important that some

information should remain confidential. Nonetheless, the Committee would be concerned if a

'doctrine' of supervisory confidentiality were to restrict unnecessarily the dissemination of

information useful to the market, Parliament and the wider public.

The information in question consists both of material that banks provide to supervisors, but is not released, and of instructions, directions and advice that supervisors issue to individual banks. Those currently allowed to have access to such information are, presumably, certain board members and employees at the bank concerned, and the staff of the regulatory bodies. Shareholders, holders of debt securities and depositors do not have such access. The inability of these last three groups to obtain information relevant to investment decisions can only make it more difficult for them to make good decisions, more likely that they will make bad ones, and increase the probability that risks will be mispriced. If more supervisory information were to be made public, the market mechanism for imposing good behaviour on

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banks might work better, possibly much better. Its manifest shortcomings were brutally exposed in the crash. The case for greater disclosure is now strengthened, not weakened, by the greatly increased intrusiveness and complexity of the supervisory process and of financial regulation. And, of course, the risk of leaks of confidential information - with the attendant volatility - would be reduced by greater public disclosure.

The danger is that regulatory convenience allies with the commercial advantages of non­disclosure, to the dis-benefit of investors, consumers and taxpayers. Although some welcome progress has been made since the crisis, as detailed in your letter, to raise the level of regulatory disclosure, it is still not clear that the optimum point is represented by the current practice. The Committee would be grateful if the PRA Board could set out its approach, in detail, on supervisory confidentiality, to the banks and towards other regulated financial companies. Is the PRA confident that the current balance between secrecy and public disclosure is appropriate? What, if any, supervisory information now kept confidential might, on the grounds of either market or regulatory efficiency, be made public in the future?

RT HON ANDREW TYRIE MP ff. CHAIRMAN OF THE TREASURY COMMITTEE