Andrew Bailey: Progress on prudential regulation and three areas to complete Speech by Mr Andrew Bailey, Deputy Governor of Prudential Regulation and Chief Executive Officer of the Prudential Regulation Authority at the Bank of England, at the City Banquet, Mansion House, London, 22 October 2015. *  *  *  My Lord Mayor, Ladies and Gentlemen – it is a great pleasure to be here again at the regulators dinner, and it is very good of you to entice so many people here tonight with the prospect of an evening with regulators. I won’t speculate on how this ranks on the scale of evenings spent in our cosmopolitan capital city. It is also a great pleasure to be speaking here tonight with Tracey. This evening I want to describe the progress we have made on prudential regulation and then examine a number of topical issues for the PRA and the Financial Services industry: the Senior Managers and Certification Regime; structural reform and ring fencing; and what the PRA is doing to pursue its secondary objective on competition. A common theme here is getting the incentives right to support good outcomes in relation to both prudential and conduct objectives. Progress It is over eight years now since the financial crisis began in this country. And to continue Tracey’s theme for a moment, it is possibly salutary to recall that amidst the many bad events of Autumn 2007, England reached the Final of the Rugby World Cup.
Interest rates which determine savings and investment decisions and therefore have a stronger impact on the economy typically have longer maturities. In order to impact the economy, monetary policy impulses must therefore first be transmitted from the money market to the capital market. The money market and the capital market are linked by expectations. Neglecting transaction costs and risk premiums, the expectations theory of the term structure views the long-term interest rate as an average of the shortterm interest rates expected to prevail until the maturity of the respective bond. Although current shortterm interest rates have some effect on longer-term bond yields, the expectations theory of the term structure tells us that it is primarily expected future short-term interest rates which determine bond yields. In practice, due to uncertainty about the future evolution of short-term interest rates and due to time-varying risk premiums, the longer the maturity, the weaker the link between current short-term rates and long-term rates. Therefore, in practice, a central bank would often find it difficult to guide longer-term interest rates to a level commensurate with what it considers to be the optimal monetary policy stance. Assuming a flexible exchange rate regime, the exchange rate is arguably the quickest transmission channel for monetary policy, particularly in open economies. Exchange rate movements rapidly affect prices (via import prices) and subsequently demand (by boosting imports and slowing down exports, or vice versa). In theory, monetary policy impacts exchange rates via the yield curve and from there via interest rate parity relations.