We cannot achieve and maintain financial stability on our own. Above all, it requires recognition of the public interest in financial stability. Thirteen years ago, at the annual banquet for the Bankers and Merchants of the City, in June 1997, just over a month after the Election of that year, commenting on the new regulatory arrangements, the then Governor of the Bank, Eddie George, said that the direction of financial services regulation was driven in part “by a rising tide of public expectations in terms of both the prudential and the behavioural standards required of financial intermediaries”. Eddie George was undoubtedly correct that the public will and should expect more in terms of the standard of business of firms. But history now tells us – painfully – that on the way to higher standards there was a terrible lapse in which too many people in our industry forgot that preserving financial stability is the duty that we all owe to the public. The fact of the matter is that the public has every right to expect us to act in their interest. This means that we cannot have attitudes which put short-term gain first on the basis that the stability of the financial system can be tomorrow’s objective, for the next person. But in order to achieve this, we need to be very clear on the benefits of financial stability. One of the questions I get asked most frequently is how we will ensure that the lessons of the crisis stick.
A primary focus of the new Prudential Regulation Authority will be on determining whether the business models, governance and systems and controls of firms will enable them to satisfy the public interest in financial stability in future states of the world. That requires both a macro and micro prudential view, and for the two to come together to reach forward-looking judgements on whether financial stability is likely to be preserved in a range of plausible future outcomes. This range of outcomes is important, and it also underlines the need to build up the role of stress testing. Such testing is an important mechanism for describing the forward-looking view though it should continue to evolve from a binary pass-fail world into one where it is a toolkit to test a range of possible future states of the world and thereby judge the wider resilience of firms. The PRA will exercise judgement in the supervisory actions it takes, so that firms are likely to be able to meet its objectives, policies and rules over the medium term horizon. Firms will need to demonstrate to the PRA that they are robust to a variety of states of the world, including unanticipated stress scenarios. However, since it is not possible for any forecast to cover all possible outcomes, there will always be some probability of firms failing.