BoE to gain sweeping new regulatory powers

Britain's central bank is already struggling to fulfil its price stability mandate -- inflation is more than double its 2 percent target and still rising -- so it may seem an odd time to be expanding its responsibilities.

The BoE's new risk watchdog, the Financial Policy Committee, will hold its first formal meeting on Thursday. It will discuss where trouble might be brewing for the financial system and what needs to be done about it.

The move is one of a series of changes facing banks in the UK -- and comes as George Osborne, the finance minister, prepares to put his weight behind a plan to make them ringfence their retail operations from their riskier investment banking activities.

The watchdog's toolkit has yet to be formalised but is likely to include the power to demand tougher lending restrictions and higher bank capital requirements if it feels a bubble may be forming.

Under the government proposals, Bank of England (BoE)Governor Mervyn King will chair both the new systemic risk committee, which will meet at least quarterly, and the existing Monetary Policy Committee (MPC) which meets monthly to set interest rates.

Legislation for the new framework will not be completed until late 2012, but questions are already being asked about how King -- and the three other MPC members who will sit on the FPC -- will manage their expanded workload.

Former rate setter Sushil Wadhwani argues that it would make more sense to hand the stability reins to the current Monetary Policy Committee so it could set policy for the two simultaneously.

"I believe it is a poor idea to have two one-club golfers; a single player with multiple clubs to choose from would be preferable," he wrote.

Another worry is the potential for a conflict of interest between the BoE's monetary and financial stability aims.

It is perfectly possible to imagine a scenario in which economic conditions argue for higher interest rates, yet the fragility of the financial system argues for more policy stimulus.

Some analysts believe a fear of destabilising Britain's fragile financial system has already led the BoE to temporarily turn a blind eye to inflation.

Inflation has been persistently higher in Britain than in any G7 economy and had exceeded the BoE's target for 34 of the past 40 months. The majority of rate-setters, however, are in no rush to raise interest rates which have stayed at 0.5 percent for more than two years.

"The MPC judges that attempting to bring inflation to the target quickly risks generating undesirable volatility in output," King wrote in an open letter to finance minister George Osborne last month.

Britain's previous tripartite system of regulation -- which carved up responsibility between the Treasury, the central bank and the Financial Services Authority -- was criticised when the financial crisis struck and there was no single centre of command.

But there are risks that rushing headlong into a new framework throws up a new set of risks, especially when so much power lies in the hands of one institution.

"Assigning single targets to single bodies is no longer workable, but "group-think" remains a big danger," said Jonathan Portes, director of the National Institute for Economic and Social Research.

Copyright Reuters, 2011