“DEAR Mark Carney. It’s your first day as governor of the Bank of England, so welcome to Britain. Now you must start to meet the huge expectations that have built up in anticipation of your arrival. You will need to make radical changes to the structure of the Bank of England and the way it has approached many issues until now. Despite Sir Mervyn King’s protestations to the contrary, the Bank made many mistakes in the run up to, during and following the crisis. Those mistakes are continuing to hamper the economy today, and you will need to rectify them if you are to succeed.
Your primary task must be to address the weakness in credit growth, which has seen lending to corporates fall by some £57bn since 2008. The strategy of trying to stimulate the economy through ultra low interest rates and QE has been blunted by the impact of making the banking system ever safer. Faced with the requirement to ratchet up capital ratios, banks have been forced to delever and only offer credit on terms that are capital efficient. This lies behind the weak growth in credit, particularly to smaller firms. King’s parting shot of forcing more capital onto the banks and imposing a leverage ratio will only continue this trend.
Pressure on bank balance sheets has to be lifted if credit growth is to return. Funding for Lending and the recent release of liquidity will help, but policy must go further. First, it must be made clear to banks that the latest exercise in redefining the capital they need will be the last. There should be no more shifting of goalposts. That will encourage banks to use the extra capital they generate through profits to increase lending rather than boost ratios.
Second, QE should be dropped in favour of credit easing. One reason the US economy has recovered faster than the UK has been this different approach to unconventional monetary policy. Instead of buying gilts, which has no effect on credit growth, the Monetary Policy Committee should buy packages of SME loans and mortgages from the banks. This would be the cleanest way to lift pressure from balance sheets and encourage them to create new credit. The banks should be told they would need to use the freed up capital to lend.
These are short-term measures. Longer-term changes must include changing the Bank’s culture. Under King, it became too academic and internally-focused. This was why it missed warning signs in the run up to the crisis, and why it has not understood how to stimulate the economy since. The Bank should hire staff from financial institutions and place its own staff on secondment more often. The last decade has shown how economics and financial stability are joined at the hip. The Bank needs experts in both. The appointment of Charlotte Hogg as chief operating officer was positive, given her background in finance. You should encourage the Treasury to look in a similar direction when they appoint the two new deputy governors to replace Paul Tucker and Charlie Bean over the next year.
The challenges are real, but the opportunity is there. If you choose the radical approach, we believe you can meet those high expectations.”