Banking Law - Lecture notes 1-8 PDF

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The Bank of England: Structure, roles and functions of the Bank of England stands at the head of the banking sector but powers extend beyond regulatory power of bank Bank of England Quarterly Bulletin : Feb 1996 ‘ As the central bank of the United Kingdom, we are committed to promoting the public go...

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The Bank of England: Structure, roles and functions of the Bank of England - stands at the head of the banking sector but powers extend beyond regulatory power of bank

Bank of England Quarterly Bulletin: Feb 1996 ‘As the central bank of the United Kingdom, we are committed to promoting the public good by maintaining a stable and efficient monetary framework as our contribution to a healthy economy’ (Eddie George, Former Governor of the BoE) In pursuing that goal BoE has 3 core functions: • Maintaining the integrity and value of the currency; • Maintaining the stability of the financial system (both domestic and international) and • Seeking to ensure the effectiveness of the UK’s financial services. Functions of BoE can be examined in the context of 2 main roles: • maintaining price stability; and • ensuring financial stability. BoE works together with other institutions to secure monetary and financial stability, including with: HM Treasury - Government department responsible for financial and economic policy; and Other central banks and international organisations, with the aim of improving stability/oversight of the international financial systems. 1. Maintaining Price Stability Under s11 Bank of England Act 1998-- BoE is to pursue the key objective of monetary policy and delivery of price stability and to support for the government’s economic policy. • Monetary policy is directed at maintaining the value of sterling and to providing a framework for non-inflationary economic growth. • BoE’s focus is on fighting inflation as part of the key objective to deliver price stability and support the government’s economic policy. • •

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In 1997 the Chancellor, Gordon Brown, announced BoE would be granted operational independence over monetary policy. Under the terms of the Bank of England Act 1998 (came into force on 1 June 1998) BoE's Monetary Policy Committee - given sole responsibility for setting interest rates to meet the Government's inflation target. If inflation overshoots or undershoots the Govt target by more than 1%, the Governor has to explain in writing to the Chancellor why, and how the Bank will remedy the situation. Stable prices and confidence in the currency are the 2 main criteria for monetary stability. Stable prices are maintained by seeking to ensure that price increases meet the Government's inflation target.

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BoE meets this target by adjusting the base interest rate which is decided by the MPC and through its communications strategy, such as announcing interest rates. The meet once a month to review interest rate and public announcement is made. It gives business confidence Bank is also responsible for the implementation of monetary policy decisions through its operations primarily in the money market, but also, as agent for the Government, in the gilt-edged and foreign exchange markets.

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Price stability = the wider economic goals of sustainable growth and employment achieved by the BoE influencing interest rates

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Monetary Policy and interest rates are set by the The Bank of England’s Monetary Policy Committee MPC has devolved responsibility for managing monetary policy. However, Treasury has reserve powers to give orders to the committee if required in the public interest and by extreme economic circumstances - such orders must be endorsed by Parliament within 28 days

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2. Financial Stability objective The Financial Services Act 2012 established the Financial Policy Committee (FPC): • To mirror the MPC/ to spearhead the Bank's new mandate on financial stability. The FPC is responsible for macro-prudential regulation of all UK banks and insurance companies; and • The Financial Policy Committee monitors risks and resilience of the financial services sector. Financial Policy Committee • FPC meets quarterly with the objective of identifying, monitoring and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system. • secondary objective is to support the economic policy of the Government including its objectives for growth and employment (s9C (1)(a),(b) BE Act 1998) Functions of FPC: • Monitors the stability of the UK financial system to identify and assess systemic risks • Gives directions to the Financial Conduct Authority and Prudential Regulation Authority in relation to macro-prudential measures – e.g., capital requirements, or loan to value ratios for house purchases • Makes recommendations within the Bank, to the Financial Conduct Authority, the Prudential Regulation Authority, other financial institutions and the Treasury introduced stress testing for banks • Makes recommendations on the Bank`s financial stability strategy and publishes a biannual Financial Stability Report •

The 1997 memorandum of understanding (updated in March 2006 ) sets out the terms under which the BoE, the Treasury and the FPC work toward the common aim of increased financial stability

Financial stability is achieved through: • supervising individual institutions and markets; • monitoring the links between financial markets; • analyzing the health of the domestic and international economy; • co-operation with other financial supervisors, both nationally and internationally; and • promoting sound and efficient payment and settlement arrangements. • • • •

Maintaining financial stability involves protecting against threats to the whole financial system. Threats are detected by the Bank's surveillance and market intelligence functions. The threats are then dealt with through financial and other operations, both at home and abroad. In exceptional circumstances, the Bank may act as the lender of last resort by extending credit when no other institution will.

Prudential Regulatory Authority: Twin Peaks approach to regulation Financial Services regulation is undertaken by PRA – responsible for regulation and supervision of banks, building societies, credit unions, insurance companies and major investment firms. PRA has 3 statutory objectives: • to promote the safety and soundness of the firms it regulates; ( • an objective specific to insurance firms to protect policyholders; and • a secondary objective to facilitate effective competition. • ( s2B,2C ,2H FSMA 2000). Aim is to promote the safety and soundness of firms it regulates – responsible for regulating over 1500 institutions. Focus is to prevent harm firms can do to the stability of the UK financial system. To have confidence of retrial consumers; Financial Conduct Authority has 3 objectives: • (i) protects consumers • (ii) enhances integrity of financial system • (iii)promotes effective competition. Banks are dual regulated by the PRA and FCA with the latter’s focus on protecting the customer base Special Resolution Regime • Banking Act 2009 –gives wide powers to BoE and Government to manage ailing banks: can act as a negotiator • Private sector transfer – facilitated by BoE; • Bridge bank transfer – BoE transfers all or part of failing bank to new bank; • Temporary public ownership – Treasury implements this - e.g. Northern Rock; and • Introduces a bank Insolvency Procedure – this happened in financial crisis under - facilitated in the finical crisis 1987 when serval banking isn’t here in financial difficulties, there was no statuary basis at the time, they was emergency legislation was required for gov to intervene, since then, the measures have been put into effect through BA 2009

- special procedure to allow the ailing bank to go into liquation, the BOE ensures that the bank is managed in a way that consumer confidence is protected

Lender of Last Resort • Stability of the banking (and financial services) sector rests on the confidence reposed in it by the public -- depends on customers being able to redeem their bank deposits on demand. • Role of LoLR normally falls on the central bank (BOE) -- serves to protect depositors, maintain confidence and prevent widespread panic withdrawals and damage to the wider economy. •

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Term LoLR may be used in different ways but reflects the provision of discretionary liquidity to a financial institution or to the banking sector as a whole where systematic risk may endanger the confidence in bank In exceptional circumstances and with approval of the Chancellor, BoE may undertake official financial support to limit the credit problems affecting particular institutions, spreading to other parts of the financial system. LoLR support can be provided not only where a solvent institution finds itself temporarily short of liquidity but also where the insolvency of a banking institution may raise the fear of systemic collapse. Such borrowing is not usually resorted to by Commercial banks, except in times of severe crisis. However, the need for such a credit line is a feature of banking business – because bank assets are largely illiquid term loans whilst liabilities tend to be unsecured short-term deposits repayable -- on demand and on a first come first repaid basis.

SRM Global master Fund LP v The Commissioners of Her Majesty’s Treasury [2009] EWHC 227 (Admin) • Claimants challenged the legislation relating to the assessment of compensation payable to former shareholders of Northern Rock Plc following its nationalization (February 2008). • Argued provisions of legislation concerning assessment of their compensation were unfair and incompatible with their rights under Article 1 of the First Protocol to the European Convention on Human Rights. Court considered views of Eddie George (former governor of BOE)in his lecture ‘The Pursuit of Financial Stability’ He explained the factors the Bank will consider when deciding whether/how to intervene in its role as a LoLR and he outlined the principles that guide BoE in making decisions: • (i) Bank ‘[did] not see [its] job to prevent each and every bank from failing. The possibility of failure is necessary to the health of the financial system, as it is to the efficiency of all other economic activity.’ Lord George cited Bagehot:

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‘Any aid to a … bad bank is the surest mode of preventing the establishment of a future good bank.’ Supporting a bad bank will discourage the establishment of good banking practices (ii) Overriding principle is that BoEs support, whatever form it takes, is directed to safeguarding the financial system (and therefore preventing damage to the wider economy) -- not the institution itself.

When a bank seems likely to fail: • The central bank must at least consider the option of supporting it but frequently BoE does no more than that. Bank thinks about support but may decide against it. • However, there are circumstances when Bank may decide that -- were an institution not to meet its obligations as they fell due - it would pose a serious threat to the financial system as a whole. Lord George said that BoE involvement: • is not designed to give special protection to bank depositors, or to safeguard position of its employees, nor is it based on a wish to help shareholders or management, who should expect to be penalized. • Support given by the BoE might help the bank and its various shareholders, but that this: would be essentially as a by-product of meeting our wider objective. Only issues for BoE are what (a) effect the failure of the institution would have on the system as a whole; and (b) should be done to protect the system from contagion. - objective is to protect economic system as a whole, so issue is what effect of the failure of the system on the economic system as a whole and what should be done to protect the economy Eddie George Cont: • … In reaching a decision on support BoE takes care not to be predictable… And it is essential that no one-should expect support as a matter of course... • there is nothing automatic about our acting as a LoLR, and even if we did decide on support no bank should assume that it would be immune from penalty. BoE’s role as LoLR and responsibility for safeguarding depositors through helping maintain confidence in financial services fits comfortably alongside Banks traditional responsibility for the stability of the financial system as a whole. Further Reading: • Eddie George, The Pursuit of Financial Stability, https://digital.library.lse.ac.uk/objects/lse:med847xad; • Bank of England Quarterly, The Bank of England: How the pieces Fit Together, Eddie George, 1996, https://www.bankofengland.co.uk/-/media/boe/files/quarterlybulletin/1996/the-boe-how-the-pieces-fit-together; • Hauser A., Lender of Last Resort Operations During the Financial Crisis: Seven Practical Lessons from the UK; p.81 https://www.bis.org/publ/bppdf/bispap79e.pdf

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BIS Papers 79 Re-thinking Lender of Last Resort, 2014, bis/org/publ/bppdf/bispap78.pdf

(role as gov banker) Banker to the Government • The Bank of England has, from its inception, acted as the primary banker to central government. The Exchequer, the central account of the government is kept with the Bank of England, along with other government accounts. • Services the Bank performs on a daily basis - similar to the services provided by any bank for its customer. • Bank also manages Govt borrowing operations on the open market. • Bank manages new issues of government bonds and stocks - advises the government on the terms appropriate for an issue, publishes a prospectus, receives applications and issues and allots the bonds and stocks. Bank will arrange the ‘underwriting’ of the issue. • BoE maintains a register of stockholders and is responsible for the payment of dividends to stockholders on the due dates. • BoE operates on a daily basis in the money markets -- both buying (thereby putting money into the economy) and selling Treasury bills (thereby taking money out of the economy) to smooth out shortages and surpluses of money in the economy. • Purpose of these operations is to maintain an orderly market and funding government activity by selling Treasury bills Quantitative Easing • QE - term used to describe a form of monetary policy used to stimulate an economy when the use of interest rates, which are already at, or close to, zero have failed as a stimulus. • First used in March 2009 when due to financial crisis economy and business was facing instability – interest rates were cut to 0.5% and a programme of QE was announced. Purpose of QE - When economy is faced with instability and consumers are worried about job losses and reduce spending - businesses may lay off workers. Bank didn’t want to lend to consumers or businesses - Normally, BoE will encourage spending by cutting interest rates. - Lower interest rates make it cheaper to borrow money, so it's easier to buy a new house, or car, or expand your business. - At the same time the lower interest rates mean you get less interest on your savings, so less attractive to save money so people spend.

- acts to simulate the economy but creates no extra money Amount of QE has increased as follows: Financial Crisis 2009: £200 billion; Eurozone Debt crisis 2012: £375 billion; Brexit Referendum 2016: £445 billion; Coronavirus Pandemic 2020: £745 billion Reading on Quantitative Easing • Bank of England, Quantitative Easing, https://www.bankofengland.co.uk/monetarypolicy/quantitative-easing;

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Bank of England, What is Quantitative Easing, thttp://edu.bankofengland.co.uk/knowledgebank/what-is-quantitative-easing/ What is Quantitative Easing and how will it affect you, Ben King, BBC News, 18 June 2020,bbc.co.uk/news/business-15198789

Exchange Equalization Account • BoE manages the Exchange Equalization Account (EEA), on behalf of the Treasury. • The function of the account is to implement any government policy in respect of the exchange rate / make payments abroad (int debts)

Banker to the Bankers • BoE maintains accounts for the clearing banks and other organizations, including the government and its departments, as well as inter-governmental organizations. • Through its role as the bankers’ bank that the BoE is able to perform its function as the central note-issuing authority. • BoE - only institution to have a note-issuing authority and therefore enjoys a monopoly in this role - Notes and Coins are legal tender (Currency and Bank Notes Act 1954, s.1 (2)) •

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Treasury determines the total amount of the currency issue and only a part of it is backed by gold reserves. BoE arranges for printing, distribution and destruction of bank notes – amount depends on government policy and gold bullion held by BoE. Greater part of the notes and coins in circulation, known as the fiduciary issue, is covered by securities issued to the Bank of England by the Treasury. BoE’s role of maintaining balances for the clearing banks serves as a method for settling inter-bank indebtedness arising from payment and other inter-bank dealings. BoE manages the payment systems and helps to ensure stability and confidence in the banking sector. The Banking Act 2009 establishes a formal regulatory framework for oversight of the recognized inter-bank payment systems. Helps to maintain financial stability.

Growth in cross-border financial activity has heightened the importance of UK authorities working effectively/efficiently with their counterparts in other countries. - BoE has regular contact with central banks, regulators, and other authorities outside the UK that have an interest in the maintenance of financial stability. - It also participates in the activities of key international bodies involved in global financial stability work, such as the Financial Stability Board. •

Bank of England and response to Covid 19 Pandemic The COVID-19 crisis has accelerated certain trends: • Temporary closure of shops/restaurants, lockdown led to increase in online shopping (Online sales up by 30% of total retail transactions in the UK in April 2020). • Shops encouraged contactless forms of payment over the use of cash. • ATM cash withdrawals in the UK dropped by around 60%. A recent LINK survey found that 75% of survey respondents are using less cash than before the crisis.

Bank of England Response • Central banks have acted to widen access to financial services at lower costs and facilitate better payments integration. • Innovation has supported financial stability by increasing diversity in payment methods. And innovation could potentially address the longstanding challenges in international payments by making them less costly and cumbersome. Bank of England Response to Covid • Reduced interest Rates to 0.01%; • Working with Govt to encourage consumer confidence –Quantitative easing; • Working with Treasury to support businesses – with large companies buying corporate bonds; • Encouraging clearing banks to lend;

Bank of England and Brexit • BoE recognized the Business uncertainty Brexit created – business investment and growth affected; • Business moved to Europe or Ireland to have to the European markets; https://www.bankofengland.co.uk/monetary-policy-report/2019/november-2019/in-focusuncertainty-and-brexit • And in 2020 BoE Governor told the biggest lenders to prepare for no post Brexit deal at the end of 2020 to maintain confidence in the economy https://www.theguardian.com/business/2020/jun/03/bank-of-england-no-deal-brexit-plansbritain-deadline

Bank of England Response to Covid 19 This lecture examines the Bank of England Response to the Coronavirus Pandemic - to protect the financial sector and consumer confidence and economy • The Bank of England (BoE) has announced a series of supervisory and consumer protection measures designed to help UK businesses and households manage the economic disruption associated with COVID-19. • The regulatory actions are designed to maintain financial stability, ensure the safety and soundness of firms and protect consumers. • The BoE, through the PRA, MPC, FCA and the HM Treasury are working together to protect the economy and the financial services sector against severe disru...