A central element of the new Social Contract for banking is that firms must be fit to fail in an orderly way. Working backwards from that ultimate objective will necessarily change the dialogue between banks and their supervisors. Microprudential and macroprudential This is consistent with the government’s plan that the statutory objective of banking supervision should be recast in terms of firms being sufficiently safe and sound to ensure the stability of the system. That is a profound change. Supervisors will need to focus on the big issues. Analysing bank balance sheets and businesses. Applying judgment. To my mind a great bank supervisor is forensic; is capable of substituting their judgment for those of management; but is wise enough to do so only where necessary; and has the personality to conduct the regulatory relationship without unnecessary conflict. BIS central bankers’ speeches  3  In another return to the distant past, the supervisor cannot treat firms as islands. They are part of a system. So, at the very least, supervisors will need to look laterally across peer groups of firms for oddities, and stress test firms’ resilience against short-term and longer-fuse threats from the environment. They will, therefore, need to draw on market intelligence on industry trends from the Bank’s Markets area; insights from the operators and overseers of the clearing, settlement and payment systems; and analysis from the finance and monetary researchers in the Bank.
Conversely, the Financial Policy Committee will – and already has – drawn on briefings from the supervisors as well as the Bank’s existing staff. In other words, this is going to be about making connections, pulling together a varied range of inputs. A measure of the Bank’s success when prudential supervision transfers will be how well we knit them together. The Court of the Bank will play an important role in ensuring that the executive of the Bank delivers on this. What all this amounts to is framing microprudential regulation and supervision to deliver macroprudential objectives. Experience around the world demonstrates that it is hard to keep supervisors focused on the stability of the system as a whole. The UK’s Financial Policy Committee is designed to achieve that. By creating a new institution within the Bank of England, the government is ensuring that stability does not fall by the wayside, into the gap between monetary policy at one end of the spectrum and the regulation of firms at the other. As the Governor of the Bank said recently at the Mansion House, an important part of the FPC’s role will be to steer, to orient the work of the microsupervisors in the light of the assessment of short-term and longer-term risks to stability. That was in evidence at the FPC’s very first meeting, a fortnight ago. The Financial Policy Committee’s first decisions The decision and Record of that meeting were published last week.