The Bank of England now has extensive powers as a micro supervisor of individual firms and a macro supervisor of the financial system as a whole. Parliament has set objectives for both – primarily, safety and soundness for the PRA,  4  BIS central bankers’ speeches  and the resilience of the system for the FPC. But unlike in monetary policy, we do not have a quantified target – and, to be clear, we do not think that that would be possible. To have such power with limited transparency would be uncomfortable. If nothing else, it would leave the Bank in a position where supervision was of interest only when it obviously goes wrong. We need to engage society – public, Parliament – in debates about the resilience of the financial system and how we are supervising it in the good times as well as in bad times. The FPC and PRA have already taken various steps to help with this – the six-monthly Financial Stability Review, the published Record of FPC policy meetings, the Committee’s statement on the use of its directive powers, the PRA’s Approach document and annual report, and so on. But stress testing can provide a quantum leap in transparency and accountability. For example, the FPC will need to be able to defend its choice of stress against questions and criticisms that the scenarios are too extreme or not tough enough. That will implicitly be a healthy debate about objectives.
The Bank of England – Financial Policy Committee and Prudential Regulation Authority – believe that a regime of concurrent stress testing of banks is an important part of the answer. Following a recommendation from the FPC earlier in the year, the Bank has today published a Discussion Paper setting out plans, to be implemented progressively over a number of years, for just such a stress-testing regime for the United Kingdom. In broad terms, each year the FPC would design a (set of) common scenario(s) that it judges the banking system needs to be able to survive; the PRA would apply those scenarios to the major banks, dealers and building societies, alongside more firm-specific scenarios; drawing on analysis from across the whole institution, Bank staff would analyse capital adequacy under stress drawing on a range of models, including firms’ own models. The results would inform judgments by the FPC and the PRA Board on whether remedial measures were needed. In some degree, both the stress scenarios and the results would be published. That very brief summary leaves a lot of questions unanswered, but suffice to say that we believe that a stress-testing regime can enhance the quality of the Bank’s macro and micro prudential supervision and, over time, underpin confidence in the banking system. In addition, I believe that a stress-testing regime will be very important for another reason: accountability to the public via Parliament.