Author: Dr Alan Brener
Published: 25 January 2022
This note briefly considers the issues of macroprudential political legitimacy and the concept of the ‘turbulent frontier’. It goes on to consider how conduct of business regulation may mitigate some of these risks.
Macroprudential policymakers are very conscious of the political legitimacy issue. Consequently, there is a risk that they may shy-away from employing macroprudential tools that may be seen as being too effective. This is particularly relevant for macroprudential policies with quantitative effects such a loan to value (LTV) and debt to income restrictions (DTI). Imposing such borrowing limits has a direct effect on individuals. This may be seen as encroaching on the role of the elected government and may challenge the political legitimacy of macroprudential policymakers.
The central issue is that macroprudential policy is ‘fundamentally a politico-economic concept’. There is a very close relationship between the economic regulatory policies embedded within the macroprudential framework and the effect on societal objectives. Consequently, macroprudential policies have, by their very nature, ‘redistributive consequences’ and thus, ‘cannot rely on a firm foundation of legitimacy’. Indeed, ‘the question of legitimacy, in spoken or unspoken form, haunts much of the debate’.
It may be possible to found political legitimacy on technocratic power operated by a ‘technocracy’ of experts and the ‘rule of the knowers’ or ‘epistocracy’ may lay a claim to political legitimacy. Moreover, there is a belief that this provides a ‘naïve notion of escape from politics and substitution of the voice of the expert for the voice of the people’. However, reliance on ‘expertness’ may be ‘incompatible with the democratic political process’.
Baker describes a paradox in that ‘efforts to depoliticise macroprudential policy by allocating power and responsibility to unelected central banks’ may end by politicising central banks themselves. This has been reiterated by Tucker who believes that macroprudential policy decisions which have a direct distribution effect on individual citizens should be left with elected politicians.
The boundary can be seen when macroprudential policies directly affect individuals. For example, Mervyn King described his experience in his response to the Treasury Select Committee in 2009: ‘I gave a speech in 2005 which had quite a big impact; it was all over the front pages of the usual tabloid press. I got a lot of letters saying ‘How dare you talk about house prices!’… I should not be intervening and making comments about house prices’.
Additionally, Adair Turner, in his response before the Parliamentary Treasury Select Committee stated, ‘I have to say that I think if we were to roll back and the [regulator] had come out in 2004 and had started aggressively challenging the mortgage banks to cut back on lending, I suspect that the predominant reaction of many people, including perhaps many people in this House, would have been to tell us that we should not be holding back the extension of mortgage credit to ordinary people; that we were preventing the democratisation of home ownership….we would have been pushed back politically if we had’. As the Governor of the Bank of England at that time said to the same Committee, ‘Westminster and the Government would have been lobbied; it would have been a pretty lonely job being a regulator’.
There is also a danger of ‘responsibility creep’. The geopolitical concept of the ‘turbulent frontier’ on the expansion of empires can also be applied to macroprudential policy. The ‘turbulent frontier’ describes how many empires expand where trouble on the edges of the empire results in an attempt to contain the issues by moving troops to occupy the adjacent valley. Unrest then migrates to a further valley and the process is repeated. Similarly, it is likely that macroprudential policy will be extended to encompass one aspect of the economy after another, as risk migrates to the next ‘valley’. Pursuing this risk will complicate the macroprudential policymaker’s relationship with those responsible for macroeconomic, microprudential and fiscal policies. To avoid this happening, it needs to address a range of issues. These include: how macroprudential policy relates to microprudential and conduct of business regulation; the need to manage excessive expectations; and the recognition that any belief that macroprudential policy can be ‘fine-tuned’ is a chimera.
To a significant extent these issues may be addressed by placing more emphasis on conduct of business regulation.
Conduct of business regulation
Previously, the UK’s Financial Policy Committee (FPC), within the Bank of England, saw the importance of its power to designate the interest rate to be used in undertaking mortgage affordability calculations used as part of the conduct of business regime. Oddly timed, and for reasons that are not clear, the FPC is currently proposing to remove this interest rate ‘stress test’.
The Financial Conduct Authority’s conduct of business regulations have the ability to act as a powerful macroprudential instrument which both protects consumers, by restricting their ability to borrow and credit providers.
Conduct of business regulations are paternalistic and intrusive, requiring lenders to look in detail at the financial position of the potential borrower. They are based on behavioural economics and evidences a lack of trust in consumer judgements; with the post-financial crisis regulations designed to protect borrowers from themselves. The UK has still to go through a full economic cycle post 2007/9 and it is too early to say how effective the post-crisis approach has been. However, if a lender fails to carry out, adequately, the required mortgage affordability process it could be exposed to unsustainable levels of restitution for borrowers.
Although conduct of business regulation in the UK have limitations and have suffered many substantial failures, they may still provide a more effective alternative to reliance on LTV and DTI measures to curb a mortgage lending bubble. Conduct of business policy is focused on the individual borrower. It is based on consumer protection and seeks to protect the latter from over-borrowing. The effects are tailored to the individual and, consequently, are easier to justify compared to the more rarified use of broad LTV and DTI limits. Properly applied conduct of business measures have the effect of protecting the borrower, the lender and the financial stability of the financial system as a whole from inflated mortgage debt and house prices fueled by credit. Conduct of business has the added advantage that its requirements are ‘always on’ since all mortgage advisers are required to be regulated and must comply with the affordability assessment requirements. There is no need for a macroprudential committee to decide to activate the policy tools.
In conclusion, it is evident that macroprudential policy operates at the point where law, economics and politics intersect. The consequences may be that proposals to use of quantitative macroprudential policies that ‘bite’ may recoil in the face of challenges to the legitimacy of the macroprudential policymakers. However, conduct of business regulation may help address some of these issues. They are a focused regulatory tool, which if used effectively, can both protect borrowers and lenders and also achieve macroprudential objectives.
 Anthony Ogus, Regulation: legal form and economic theory, (Clarendon Press, Oxford, 1994), 1
 Giandomenico Majone, ‘Regulatory legitimacy’ in Giandomenico Majone (ed), Regulating Europe, (Routledge, London, 1996) 284-301, 295 and 299
 Tony Prosser, The regulatory enterprise: government, regulation and legitimacy, (Oxford University Press, Oxford, 2010), 4
 David Copp, ‘Reasonable acceptability and democratic legitimacy: Estlund’s qualified acceptability requirement’, (January 2011), Ethics, Vol. 121, No. 2. 239-269, 241
 Marver Bernstein, Regulating business by independent commission, (Princeton University Press, Princeton, 1955), 493
 Ibid, (Bernstein), 493
 Andrew Baker, ‘The bankers’ paradox: the political economy of macroprudential regulation’, (April 2015), LSE Systemic Risk Centre Discussion Paper No. 37, 26-27
 Paul Tucker, Unelected power: the quest for legitimacy in central banking and the regulatory state,(Princeton University Press, 2018), 101
 Mervyn King, answer to question 2354 on 26 February 2009 before the Treasury Select Committee, House of Commons Treasury Committee, Banking crisis, Vol. I, Oral evidence, (HC 144–I [Incorporating HC 1167 i–iv, Session 2007–08]), 281
 Adair Turner, answer to Question 2168 on 25 February 2009 before the Treasury Select Committee, House of Commons Treasury Committee, Banking crisis, Vol. I, Oral evidence, (HC 144–I [Incorporating HC 1167 i–iv, Session 2007–08]), 281
 Ibid, Mervyn King, answer to Question 2354 on 26 February 2009
 John S. Galbraith, ‘The ‘turbulent frontier’ as a factor in British expansion’, (1960) Comparative Studies in Society and History, Vol. 2, No. 2, 150
 Bank of England, ‘Financial Stability Report’, (June 2017), 13. Similar wording is contained in the FPC minutes of 21 June 2017, (4 July 2017), 9 and 10
 Bank of England, Financial stability report, (December 2021), iv and Technical Annex