How has the Financial Policy Committee’s objective changed since its inception?

Author: David Aikman

Published: 9 December 2021

In this article, we take stock of the cumulative effect of the various changes that have been made over time to the Financial Policy Committee (FPC)’s mandate via the Chancellor of the Exchequer’s annual “remit and recommendations” letter.  Our focus is on what impact has there been on the relative balance between promoting resilience and stability versus pursuing other government policy objectives, including promoting financial innovation, the role of the City of London and so on.

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TL/DR:  The FPC’s mandate has been expanded significantly since the first of such letter in 2013. This partly reflects a clarification of the types of risks and vulnerabilities the FPC should concern itself with in pursuing its primary objective, e.g., risks associated with climate change.  But there has also been a marked rebalancing of the FPC’s remit, away, in relative terms at least, from maintaining systemic stability and towards its secondary objective – which includes supporting economic growth, but also increased financial sector competition, international competitiveness, and expanding the supply of finance for productive investment.

A concern this raises is whether these changes risk diluting the FPC’s focus on stability and its independence from day-to-day politics – either directly, or indirectly, by overburdening a committee with already much on its plate. This risk is heightened because the FPC’s stability mandate is imprecisely defined and open to numerous interpretations in terms of what constitutes success (see the blog published on this website by my colleague Richard Barwell on 27 September).

Background

The objectives of the FPC are set out in 2012 legislation amending the Bank of England Act 1988 to create, for the first time, a body unambiguously responsible for preserving systemic stability.

The Committee’s primary objective is to protect and enhance the stability of the UK’s financial system. Subject to this, it has a secondary objective to support the economic policy of the Government.[1] And in pursuing its objectives, the FPC is not authorised to take actions that would in its opinion likely have a “significant adverse effect on the capacity of the financial sector to contribute to the growth of the UK economy in the medium or long term”.

The Act requires that the Treasury specify the Government’s economic policy at least once in every calendar year.  It also allows the Treasury to make recommendations to the Committee about risks it should regard as relevant for pursuing its primary objective, its responsibility in supporting the government’s economic policy, and other matters it should have regard to in its policy deliberations.

This is all set out in a public letter from the Chancellor of the Exchequer to the Bank’s Governor. The letters are published on the Bank’s website (click here for the 2021 version).  There have been ten such remit letters to date since the first in 2013.

In analysing these documents, it should be noted that, in practice, these letters are published only following comments from the Bank, so their contents reflect a two-way process from both the Treasury and the Bank.

Simple comparison metrics

Before we delve into the details of what has changed since the first FPC remit letter in 2013, it is useful to look at some headline summary metrics of how these letters have evolved over the period (see table below).

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The length of the remit letter, measured by word count, has grown by three-quarters since 2013. This reflects two periods where it grew notably:  George Osborne’s letter post the 2015 general election was significantly longer than its predecessors (3,123 words versus 2,240 in the preceding letter); and Rishi Sunak’s 2020 and 2021 letters, which both increased the document’s length notably (to 3,462 and 3,818 words respectively, compared to 2,820 in the preceding letter).

The complexity of the document has also grown. The number of conditional statements – “if”s, “but”s, “when”s etc. – has doubled. And the use of the terms “trade-off” and “conflict” has almost tripled. Alongside this, metrics of reading ease have deteriorated, and point to a document that has become inaccessible to all but a few subject specialists versed in construing complex texts.

These metrics contrast starkly with those in the equivalent remit letter for the Bank’s Monetary Policy Committee (MPC). The original 1997 MPC remit letter contained just 625 words, and the length remained more or less constant through 2012.  In 2013, the word count jumped to 1,492 from 709 words the year before, with new text opening the door to the MPC pursuing forward guidance under Mark Carney’s new Governorship. There has been no increase at all in length since then (the most recent 2021 letter contained 1,466 words).  The MPC’s remit letter is appreciably less complex than that of the FPC by the above metrics.[2]

What are the main changes to the letter since 2013?

Turning to the substance, the remit letter has been expanded mainly in two areas:  section B, which covers the FPC’s primary objective of protecting and enhancing resilience, and second C, which covers its secondary objective of supporting the government’s economic policy. Let’s look at each in turn.

FPC’s primary objective as described in Section B

The changes here have served to clarify the primary objective, highlighting certain salient risks that the Committee should regard as relevant.

Starting with an uncontroversial addition, the 2021 letter reminds the Committee of the essential importance of having in place an adequate risk oversight and mitigation framework for risks stemming from the non-bank financial sector.  It calls for the FPC to publish its detailed assessment of this framework, recognising that addressing such risks requires international cooperation.

The 2021 letter also instructs the Committee to continue to regard risks from climate change as relevant to its primary objective.  While the focus here is purely on the systemic stability risks associated with climate change and the transition to a carbon-neutral economy, the elevated focus given to these risks is not uncontroversial given they are likely to crystalise beyond the normal policy horizon of the FPC.[3]

FPC’s secondary objective as described in Section C

The section covering the FPC’s secondary objective to support the Government’s economic policy goals has been modified significantly since the original 2013 letter, with three major additions to the text.

First, the 2021 letter contains an instruction that the Committee should “routinely assess whether it can take actions to support the Government’s economic objectives in a way that will not conflict with [its] primary objective”. This recommendation to view the secondary objective as something to be actively pursued rather than a “have regard to” first appeared in 2020.[4]

Second, it contains a new subsection detailing how the FPC can support the government’s economic policy towards the financial services industry.  The FPC is instructed to take into consideration in its decisions the government’s aims:

• To increase competition and innovation in the UK financial services industry by minimising barriers to entry and ensuring a diversity of business models, including FinTech firms;
• That the UK remains an attractive domicile for internationally active firms and that London retains its position as the leading international financial centre;
• That the UK financial sector captures opportunities arising from the greening of finance;
• To support first-time buyers access to the mortgage market.

Third, the letter contains a new section instructing the FPC to support facilitating the supply of finance for “productive investment”, where doing so does not conflict with the FPC’s primary objective.  This recommendation, which first appeared in 2015 as part of the government’s efforts to tackle the UK’s poor productivity performance, has since been expanded to include a request that the Committee examines how “financial regulation and changes in the structure of the financial system may have affected the balance between financial stability and the supply of productive finance”.

Discussion

The overall effect of the changes to the remit letter since 2013 has been two-fold.  First, clarifying the set of risks the FPC should concern itself with, with the big and not uncontroversial addition being risks associated with climate change.  Second, pressing the FPC to place more weight in its deliberations and actions on its secondary objective of supporting the government’s economic policy, including by supporting competition, international competitiveness and facilitating the supply of finance to what the letter refers to as “productive investment”.  These are areas where there is likely to be a trade-off in the short-term at least with the primary objective of protecting and enhancing resilience.

For readers who share this author’s view that the vital lesson from 2008 is the need for an authority with a laser-like focus on maintaining financial stability, these changes are concerning.  Whether intentional or not, they create the possibility of the Committee diluting its focus on maintaining resilience – either as a direct result of these recommendations or indirectly by overburdening what is already a committee with more than enough to do.  Despite the materiality of these changes, it is noteworthy that there has been little scrutiny of their implications at the FPC’s formal hearings with the Treasury Select Committee.[5]

This risk is exacerbated because the FPC’s primary objective of protecting and enhancing the UK financial system’s resilience is not well defined.  This suggests two routes forward to address this problem. First is for the FPC to commission work to develop options for turning its primary objective into one that can be measured, for which it can be held to account if it fails to respond adequately to threats to stability. Second is for the FPC to highlight more vigorously the dangers that come with these continual additions to its remit.

Finally, while we have framed this piece in terms of changes to the FPC’s mandate, we note that a similar dilution is on the cards regarding the objectives of the UK’s micro-prudential regulators – the government is currently consulting on whether to include growth and international competitiveness in the secondary objectives of the Prudential Regulation Authority and the Financial Conduct Authority.[6]  Arguably, this is the bigger problem given that this is whether the lobbying efforts of the financial industry will be focused.

Endnotes

[1] The meaning of this “subject to” clause is ambiguous.  It could be read as “subject to achieving the primary stability objective” implying a lexicographic ordering of financial stability first and only then economic growth.  But the Chancellor’s remit letters imply a less stark characterisation of the objective as they emphasise that the FPC might face trade-offs between its primary objective and the secondary objective of supporting growth in the short term.

[2] The 2021 MPC remit letter contained 9 conditional statements, 5 instances of the words “trade-off” and “conflict” and had a Flesch reading score of 37.1.

[3] For instance, the ECB’s recent climate stress test notes the potential for losses on corporate loans to rise over time, with “the potential of becoming critical over the next 30 years”, ECB (2021).  The normal policy horizon for the FPC, as defined by its bank stress testing framework for instance, is 5 years.

[4] The notion that the FPC should actively pursue the secondary objective is first hinted at in then-Chancellor Phillip Hammond’s 2017 letter, which states that “the Committee should also have regard to the impact of its policies on [economic growth, productive investment and the UK’s position as an important global financial centre], and seek to support them where appropriate.” [my emphasis]

[5] Looking at the published transcripts of these hearings, there are three occasions where questions relating to remit changes appear. First, a question from Jacob Rees-Mogg MP to Mark Carney in July 2015 (Q48) concerning the potential for conflicts to arise between the FPC’s primary stability objective and its secondary objective to encourage competition in the context of ring-fencing requirements and the bank levy.  Second, a question from John Mann MP also in July 2015 (Q70) suggesting, incorrectly, that one implications of the changes to the remit made that year had been to remove the need to reflect the balance of arguments in the FPC’s record absent a vote.  (An incorrect assertion because the specific language used in this part of the remit letter had not changed.)  Third, a question from Anthony Browne MP in January 2021 (Q20) as to whether the FPC should be given an objective for international competitiveness.  (It already had such a goal in its secondary objective.)

[6] See the Government’s consultation paper ‘Financial Services Future Regulatory Framework Review: Proposals for Reform’.