A. Willingness to Act

8. The new framework gives the BoE a clear financial stability mandate. The BoE did not have a statutory responsibility for financial stability until its introduction by the Banking Act of 2009. The new statutory objective (“to contribute to protect and enhance financial stability”) was further strengthened with the Financial Services Act in 2012 (“to protect and enhance financial stability”).⁹ Financial stability is pursued through: (i) macroprudential and microprudential policies; (ii) financial operations including as lender of last resort; (iii) the BoE’s role as a resolution authority; and (iv) BoE supervision of key payment, clearing, and settlement infrastructure.

9. The FPC, tasked with helping the BoE meet its financial stability statutory objective, is at the center of the macroprudential framework. The FPC is established as a statutory decision-making body at the BoE.¹⁰ It consists of five BoE members (Governor, three Deputy Governors—including the head of the PRA—and the Executive Director for the analysis of threats to financial stability), the head of the FCA, four external members chosen by the Chancellor from outside the bank, and a non-voting member from Treasury. The appointment of external members brings a broader range of expertise to the Committee, and may help in keeping the discussion focused and challenging the views of the BoE executives. There are requirements on the personal independence of external members in legislation (the Chancellor is required to consider conflicts of interest before making an appointment), the FPC Code of Conduct and in the public appointment scrutiny by the Treasury Select Committee.

10. The FPC’s functions are to identify, monitor, and take action to mitigate systemic risk (that is, risk to the stability of the U.K. financial system as a whole or of a significant part of it). This includes risks attributable to structural features of financial markets, to the distribution of risk within the financial sector, and to unsustainable levels of leverage, debt or credit growth. The framework requires the FPC to take into account policy trade-offs when performing its duties. In particular, the FPC has a secondary objective to support the economic policy of the Government and is required, when practicable, to accompany its decisions with a cost-benefit analysis.

11. The legislative framework provides channels to promote the dialogue and interaction between the FPC and the Treasury, while safeguarding the Committee’s independence. For instance:¹¹

• Treasury representative at the FPC. A Treasury representative sits at the FPC but does not hold voting rights. In practice, the line between dialogue and undue interference could at times be hard to assess and therefore needs to be actively monitored by the framework’s accountability mechanisms. In 2013, under public scrutiny, two FPC members had differing views on the role played by Treasury in the discussion on the capital needs for the two part state-owned banks. Importantly, both members agreed that the interaction with Government had not had a material impact on the recommendation made by the FPC.¹² This example illustrates how the public scrutiny mechanisms established in the framework play an important role so FPC members continue to act based on their own best judgment.

• Remit and recommendations letters from Treasury. Legislation allows Treasury to make recommendations to the FPC on how to interpret its mandate (i.e., the responsibility of the Committee in relation to its objectives and matters it should have regard to when exercising its functions). While the FPC is required to respond to these recommendations, it is free to disagree and not act in accordance. Additionally, the Treasury is required to specify its economic policy, so the FPC shall take it into account as part of its secondary objective, subject to its primary financial stability objective. These letters are now commonly referred to as “remit letters” (see, for instance, BoE webpage) but are not equivalent to the MPC’s remit letters. The latter complete the MPC’s both primary and secondary objectives, and include no recommendations subject to the Committee’s discretion. Referring to the former as “recommendation letters” could help make this distinction more evident.

12. The FPC’s decision making arrangements also promote the framework’s willingness to act. Legislation requires the chair of the FPC to seek consensus wherever possible, but if consensus cannot be reached, a simple majority voting arrangement is in place. A summary of the Committee’s deliberations is to be reflected in the meeting records. In practice, FPC members have put a strong emphasis on seeking consensus and all decisions to date have been unanimous. While seeking consensus is always desirable, it is important going forward that the preference for consensus is not interpreted as a hard requirement. This could risk paralyzing or delaying policies, or potentially making members compromise more than is desirable. In line with this observation, when discussing the decision process for the calibration of the CCB, the FPC acknowledged that the discrete nature of the decision may not always lend itself to a consensus-based process and agreed to be flexible in its approach to setting the buffer.¹³

13. Finally, the mandates of the microprudential regulators (the PRA and the FCA) are aligned with the BoE’s stability objective. The PRA’s general objective requires it to promote the safety and soundness of the firms it regulates, focusing on the adverse effect they may have on financial stability. The FCA’s “integrity objective” includes protecting and enhancing the soundness, stability and resilience of the U.K. financial system. This alignment of objectives can reduce conflicts, help foster engagement, and increase compliance with recommendations, by ensuring that powers assigned to these agencies can be used in the pursuit of financial stability. Since implementation of the new regulatory framework, it has placed a strong emphasis on enhancing the resilience of the financial system. This environment is less prone to conflicts between the macro and microprudential authorities. As a result, the alignment of mandates and the resolution of potential conflicts have yet to be tested.

14. In practice, the FPC has been fairly active during its first years of operation. A total of 42 recommendations or directions have been issued since the interim FPC began operating.¹⁴ This includes measures to address systemic risk (notably in the banking sector), but also to set up the macroprudential framework itself (for instance, by making recommendations on the macroprudential toolkit). The U.K. ranked among the most active users of macroprudential policies in the EU during 2014, according to a review conducted by ESRB (2015).¹⁵

FPC Recommendations/Directions

(number per year)

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Sources: IMF staff based on FPC meeting minutes.Note: Keeping countercyclical capital buffer at zero is not counted.

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FPC Recommendations/Directions

(number per year)

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Sources: IMF staff based on FPC meeting minutes.Note: Keeping countercyclical capital buffer at zero is not counted.

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FPC Recommendations/Directions

(number per year)

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Sources: IMF staff based on FPC meeting minutes.Note: Keeping countercyclical capital buffer at zero is not counted.

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B. Ability to Act

15. The new responsibilities of the BoE have been matched with an expanded set of powers. Legislation grants the FPC powers of recommendation and direction. The FPC can make recommendations to any party (including the rest of the BoE and the Treasury), and in the case of the microprudential regulators (the PRA and the FCA), such recommendations can be made on a comply-or-explain basis. That is, regulators must comply with the recommendation as soon as is practical or explain publicly in writing why they have not done so. In addition, the FPC has the power to direct the microprudential regulators to deploy specific macroprudential tools that are prescribed by the Treasury, and approved by parliament, for these purposes. The set of tools under the direct control of the FPC is still evolving, as discussed in the next section. Directions and recommendations to the PRA and FCA may not relate to specific institutions but to all or “types of” institutions (such as systemically important institutions).¹⁶

16. The U.K. authorities have adequate information collection powers. The BoE may direct the microprudential regulators to provide information available to them or that they have the power to request.¹⁷ Each microprudential regulator has information collection powers from authorized entities for the purpose of their respective functions (which as discussed, take into account financial stability).¹⁸ Moreover, the PRA has a duty to collect information relevant either to the stability of individual financial institutions or the U.K. financial system more broadly. To this end, the PRA has the power to require additional information relevant to U.K. financial stability beyond PRA-authorized firms (the so-called “financial stability information power”).¹⁹ This includes, among others, managers of UK-related investment funds, service providers critical to authorized entities, and other entities critical for financial stability as prescribed by the Treasury. To date, the authorities have not felt the need to exercise this power to collect information, relying on other alternatives instead. More generally, the FPC may issue recommendations, including requests for information, to other regulators and authorities as needed.

17. Moreover, the new framework includes provisions to adapt to the potentially evolving nature of systemic risk. The FPC may make recommendations to the Treasury pertaining to the categories of firms outside the scope of the PRA’s regulation from which it may collect information specifically for the purpose of financial stability. This allows for closing data gaps beyond the regulatory perimeter of regulation without modifying the perimeter. The FPC may also make recommendations to the Treasury on the perimeter itself, including on the division between regulated and unregulated activities as well as on the split of responsibilities between the PRA and the FCA.²⁰ Finally, the FPC may also make recommendation to the Treasury to adjust the macroprudential toolkit (including on the need for further powers of direction).²¹

C. Coordination and Cooperation

Domestic

18. The framework includes several formal mechanisms to foster the coordination and cooperation across different agencies whose actions have a material impact on financial stability. There are strong complementarities and interactions between macroprudential, microprudential and monetary policies. The new framework cannot be effective if the different bodies work in silos, so several mechanisms for cooperation have been established. For instance:

• Coordination between the FPC and the microprudential regulators relies on a variety of mechanisms, including information sharing responsibilities, the references to financial stability in the mandates of the microprudential regulators, the duty of the FPC to have regard (as far as possible) to the microprudential regulators’ objectives, and overlapping memberships across their governing bodies.²² As described above, the FPC has power of directions over some of the microprudential regulators’ tools, and may make recommendations, including on a comply-or-explain basis.²³

• Housing both the FPC and the MPC within the BoE and with overlapping memberships facilitates effective information sharing and forming a common understanding of key economic judgments and each committee’s likely policy response. The members of each committee are able to attend the other committee’s briefing meetings. Each committee has been prompted, in its remit and recommendation letter from Treasury, to be clear on how it has had regard for the actions of the other in its own policymaking.

United Kingdom: Membership of the Bank of England Policy Committees

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, 2013Q3. Updated by IMF staff.Note: ED= Executive director; DG=Deputy Governor.

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United Kingdom: Membership of the Bank of England Policy Committees

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, 2013Q3. Updated by IMF staff.Note: ED= Executive director; DG=Deputy Governor.

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United Kingdom: Membership of the Bank of England Policy Committees

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, 2013Q3. Updated by IMF staff.Note: ED= Executive director; DG=Deputy Governor.

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19. A number of initiatives within the BoE seek to take advantage of the complementarities between its different responsibilities. During 2014, key senior staff at the executive level moved between policy areas.²⁴ The BoE has launched the “One Bank, One Mission” three-year initiative, to promote increased connectivity and a common culture within the BoE.²⁵ This includes via sharing of information and analyses, and more frequent joint meetings between the MPC, the FPC, and the PRA Board. To guard against the creation of silos, the strategy stresses that all BoE staff work to support all three policy-making committees of the BoE.²⁶ In practice, analysis that goes to the decision-making committees on areas of common interest is typically produced jointly by staff across the different areas of the BoE. The FPC has held joint briefings and discussions with both the MPC and the PRA Board on topics of common interest, including stress testing, long-run risks from China, and housing policy. To further enhance the interaction between the MPC and FPC, four joint briefing meetings have been scheduled for 2016. Finally, as part of the strategic plan, the BoE has launched a coordinated research agenda focusing in particular on the intersection between policy areas (i.e., monetary, macro and microprudential).

20. The experience so far suggests the BoE recognizes the important interactions between different policy functions and emphasizes the need for coordination and cooperation. For instance:

• Forward guidance and knock-out. When the MPC first engaged in forward guidance for monetary policy, it provided the FPC with a knock-out power. That is, the guidance would cease to hold if the FPC judged the monetary policy stance posed a significant threat to financial stability that could not be contained by the combination of micro and macroprudential tools available. As a result, the FPC had to consider the stability risks of low-for-long rates on a regular basis, while monetary policy remained as a last line of defense.

• Stress testing exercise. Since 2014, the BoE stress testing exercise is conducted jointly by the FPC and the PRA Board, drawing on expertise from across the Bank, including macroeconomists, financial stability experts and supervisors. Therefore it brings together the microprudential assessments of banks with a macro perspective on risks to which the sector must be resilient.

• Housing market. Under the direction of the FPC, the BoE, PRA, and FCA took coordinated and consistent measures to mitigate risks related to the housing market. The FPC considered developments in the U.K. housing sectors drawing on a macroeconomic assessment provided by the MPC’s forecast and policy analysis from across the BoE. In 2014, it worked through the FCA to require lenders to apply a stressed affordability test, and it worked through the PRA to limit high loan-to-income ratio loans by banks and building societies.

21. Interactions between BoE and FCA staff have recently increased and are set to deepen further, as the FPC broadens its focus beyond the core financial system. During the first years of operation of the FPC, it advanced its relationship with the PRA further than with the FCA.²⁷ This was due in part to the significant focus on the banking system during those years. As the work on rebuilding the resilience of the banking sector progressed, the FPC has broadened its focus on risks related to other financial sectors and systemic non-financial risks. In this context, interactions between BoE and FCA staff have strengthened significantly over the last year. The FCA has had a more active participation in the briefing stages of the FPC rounds. Joint working and coordination groups have been established to focus on risks related to asset management and market liquidity, hedge funds and cyber risks. Going forward, joint work between BoE and FCA staff will be ongoing as they undertake a series of deep dives into various industries to determine levels of systemic relevance. This will provide an opportunity for further relationship building, coordination, and flow of information.

D. Accountability

28. The new responsibilities and powers assigned to the BoE have been matched with stronger accountability arrangements. An effective accountability framework is particularly important in the U.K. framework, as it vests a lot of authority in the BoE, which has operational independence to achieve its financial stability objective.³¹ The BoE is accountable to the general public and Parliament (through the Treasury Select Committee of the House of Commons). There are a number of inherent difficulties in establishing an effective accountability framework. For instance, the objective of financial stability is hard to quantify and the failure to preserve stability could become known with a considerable lag.³² In addition to a clearly-assigned well-defined objective, the accountability framework relies on a broad range of required communication tools, inquiries by the Treasury Select Committee (Parliament) and reviews by the Oversight Committee (BoE).

E. Tradeoffs and Risks

37. Concentrating responsibilities and powers within the BoE favors coordination but increases the potential of creating a “groupthink” mentality. Housing a range of policy functions under the BoE and the overlapping membership of policy committees play an important role in promoting coordination. At the same time, this carries the risk that a few senior officials may end up having a disproportionate influence on policy making. The framework includes safeguards against this risk of groupthink. Crucially, the FPC external members bring a different range of knowledge and insights, and are less likely to be absorbed in the “institutional view.” The Treasury Select Committee and the Oversight Committee should continue to watch that deliberations are effective and that external members feel empowered to challenge the identification of risks or assessment of the appropriate policy response. There are also other alternative venues to challenge a dominant view. For instance, as discussed above, the Treasury may at any time make recommendations to the FPC on how to interpret its mandate (i.e., the responsibility of the Committee in relation to its objectives and matters it should have regard to when exercising its functions), which must specify in writing its intention to comply or the reasons not to do so. In its most recent remit and recommendation letter the Treasury prompted the FPC to seek, when appropriate, the views of industry participants, academics, other regulators and the public.

38. Looking ahead, the effectiveness of the framework will largely depend on a continued strong focus on financial stability. An effective macroprudential framework is crucial for the U.K. financial system to remain a global public good, given its size and systemic nature. The crisis tilted the focus of policy-making toward a stronger emphasis on financial stability but maintaining that culture will require ongoing effort. While the framework includes several provisions to promote the “willingness to act,” the challenge of maintaining a robust stance on financial stability in one of the world’s largest financial centers should not be underestimated. As memories of the last crisis fade, external pressures for inaction are likely to intensify and, within the BoE, resources on FPC issues could potentially be squeezed due to competing demands from other of its policy functions. Parliament, the Treasury, and all agencies involved—first and foremost the BoE—have a responsibility in protecting against this risk. As discussed above, the FPC itself should persist in its efforts to promote a better understanding by the general public of the FPC’s role and responsibilities.

A. Process and Risk Monitoring

40. The FPC has established a functional process for identifying systemic risk and mapping risks into policy action. The FPC follows a quarterly schedule, with the dates of formal policy meetings pre-announced at the BoE’s webpage. A typical quarterly cycle consists of four stages: (i) the briefings on financial developments and financial stability risks; (ii) the FPC discussions on key financial stability issues and potential macroprudential policies (issues meetings); (iii) the policy-making FPC meeting (policy meetings); and (iv) the communication of risk assessments and policy decisions. The FPC is supported in these areas by a broad range of staff:

• A dedicated FPC secretariat, housed within the BoE, is responsible for coordinating the wideranging inputs to the FPC and for supporting its output, including some of its public communications.

• A dedicated financial stability directorate at the BoE provides a substantial portion of the analytical support to the FPC. Responsibilities for systemic risk monitoring are organized mainly by sources of risk: real economy (households and corporates), banks, and markets and nonbank financial institutions. Cross-cutting issues are usually covered jointly with staff in other parts of the BoE or the FCA.

• Staff in other parts of the BoE (including the PRA, the Markets and the FMI Directorates), the FCA, and occasionally the Treasury, also provide critical briefing inputs.

Briefing inputs take a variety of formats, ranging from short notes to in-depth reports, and presentations by senior staff at the BoE and the FCA. While some briefing inputs are requested by the FPC, some others are provided on the initiative of staff. The FPC and the PRA Board receive a joint Quarterly Risk Pack setting out staff views on main risks to financial stability and supporting analysis. This is a key ingredient of the FSR.

41. The authorities analyze a broad range of indicators to detect the build-up of systemic risk. Out of that broad range, a subset of so-called “core indicators” is made publicly available in each FSR (or more frequently in some cases). These core indicators are organized around tools, in order to guide the FPC use of its direction powers. This has two implications:

• First, because a variety of tools may target the same risk and because some of the indicators are measures of resilience (instead of risks), this approach may lead to repetition of indicators across tools.

• Second, because “core indicators” are selected for those tools over which the FPC has direction powers, this approach has less indicator-coverage for those risks that are dealt with (by the FPC) using recommendation powers. For instance, the current set of “core indicators” provides good coverage for identifying risks related to broad-based expansion of credit and to the household sector, but more limited coverage for risks related to the corporate sector and liquidity mismatches in the core financial sector.

United Kingdom: Typical FPC Quarterly Cycle

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, Third Quarter 2013.Note: FSR= Financial Stability Report.

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United Kingdom: Typical FPC Quarterly Cycle

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, Third Quarter 2013.Note: FSR= Financial Stability Report.

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United Kingdom: Typical FPC Quarterly Cycle

Citation: IMF Staff Country Reports 2016, 160; 10.5089/9781475574920.002.A001

Source: Hall, S., A. Pattani, and P. Tucker, “Macroprudential Policy at the Bank of England,” Quarterly Bulletin, Bank of England, Third Quarter 2013.Note: FSR= Financial Stability Report.

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Importantly, the “core indicators” are just a subset of the broad range of indicators that the authorities review on a regular basis (which indeed do provide proper coverage for risks related to the corporate sector and liquidity mismatches in the core financial sector). For the purpose of accountability and communication, the authorities may consider organizing “core indicators” around types of “risk” and “resilience”, instead of tools. This approach could better portray the FPC’s broader monitoring of risks, reduce duplication of indicators, and align better with the new structure of the FSR.⁴⁷ For example, the tables in Appendix 3 map the current set of BoE core indicators into the set of core indicators identified in IMF (2014) to monitor four categories of risks in the time-dimension (i.e., risks stemming from broad-based expansion of credit, the corporate sector, the household sector, or liquidity mismatches). The grouping could be further refined with the creation of a “resilience” indicators group. A possible disadvantage of this approach would be that, for those risks that are dealt with using recommendation powers (such as funding liquidity risks in the core financial sector), it would provide a less clear mapping from systemic risk analysis to potential policy action.⁴⁸

42. In addition, the authorities rely on analytical exercises and qualitative information to inform their judgment. No single set of indicators provides a perfect measure of systemic risk, so the assessment must inevitably rely on judgment. The annual concurrent stress testing exercise is an integral part of the authorities’ assessment of the resilience in the core financial system. The stress testing framework is reviewed in detail in a separate Technical Note. Qualitative information plays also an important role. Market intelligence is drawn from an extensive contact base, including a wide range of financial agents and institutions, and covering a wide range of markets. It provides insights beyond publicly available data that may be useful to identify incipient sources of financial instability. The PRA and the FCA provide regular updates on key developments and supervisory intelligence.

B. Data and Information

43. Progress has been made in addressing data gaps in recent years. Significant progress has been made on data regarding bank interconnectedness, regulated mortgage lending and derivatives and securities markets. Some of the progress reflects the implementation of EU legislation (such as European Market Infrastructure Regulation (EMIR) requirements on transaction level data on derivatives) or participation in voluntary international initiatives (such as the G20 Data Gaps Initiative recommendations to address key information gaps for G-SIBs).⁴⁹ Other progress reflects targeted activity to address specific data gaps (such as the collection of banks’ large capital market exposures to other banks, nonbank financials, non-financial corporates and governments, and the FCA collection of data on the performance of regulated mortgages).

44. However, material gaps remain and the authorities should continue their efforts to address them. Areas where major gaps in data availability remain include in building a complete picture of the U.K. flow of funds, activities of nonbank financial institutions, and in the buy-to-let mortgage market. A significant gap in the U.K. flow of funds framework is on securities holdings. Data on buy-to-let mortgage lending (which are not regulated products) are patchy, with limited coverage on mortgage features such as loan-to-value and interest-coverage ratios. The authorities are aware of these gaps and work is underway to close them. The strategy to fill those gaps includes a joint work program between the BoE and the Office for National Statistics to improve flow of funds statistics, joint work between the Bank and the FCA to improve information on nonbank financial institutions, and BoE in-house data collection and joint work with the Council of Mortgage Lenders on the buy-to-let mortgage market.

C. Perimeter

45. The FPC has committed to hold, at least annually, a dedicated discussion on risks and regulation outside the core banking sector.⁵⁰ The FPC has so far had two dedicated discussions on the regulatory perimeter in June 2014 and June 2015. The FPC framework to assess systemic risk of financial activities considers sources of fragility (such as leverage, liquidity/maturity transformation, imperfect credit risk transfer), and three key transmission channels:⁵¹

• The provision of critical services. These include: intermediating savers and borrowers, insuring against and dispersing risk, and payment services.

• Risks to systemically important counterparties. Problems in the nonbank financial system can impact providers of critical financial services, such as banks or insurers.

• Disruption to systemically important financial markets. Problems in the nonbank financial system can transmit distress to systemically important markets.

Additionally, the assessment takes into account the adequacy of existing regulation in addressing risks from activities.

46. The perimeter exercise is broadly in line with FSB’s high-level policy framework for oversight of shadow banking. Specifically, it is in line with the following principles: the authorities are in charge of defining and keeping up to date the regulatory perimeter, the emphasis is on economic functions (activities) rather than legal forms (entities), the focus is narrowed where there is maturity or liquidity transformation, leverage or imperfect risk credit risk (“sources of fragility”), and the adequacy of the existing regulatory framework is taken into consideration. Additionally, the FSB calls for proportionality to risks, which is in line with the analysis of key transmission channels in the U.K. framework.

47. The assessments so far have been conducted at a high-level and the work to better-understand certain risks is still ongoing. Over the last two years, systemic risks arising from activities conducted in 30 different types of institutions and markets have been assessed. The authorities have been mindful of the ongoing international (and domestic) work to reform and understand the nonbank financial system, as well as data gaps that acted as impediments to a full assessment of risks. To continue to monitor activities in the 30 sectors (and new activities that may arise), the BoE is developing a monitoring framework involving key metrics for each sector. The intensity of the systemic risk monitoring will depend on the judgment of systemic risk in each sector.

48. The FPC has begun a regular comprehensive analysis of activities beyond the core banking sector (“deep dive”) to complement the annual review. Deep dives involve a detailed assessment of systemic risk associated with each activity, including: a description of fragilities, an assessment of transmission channels to financial stability, a review of existing mitigants and ongoing European/international policy work in this area, and the identification of any residual gaps in addressing fragilities. Deep dives will help identify data gaps, and to the extent necessary, will explore potential policy remedies. The FPC has decided initially to focus on five activities: (i) investment activities of open-ended investment funds; (ii) investment activities of hedge funds; (iii) securities financing transactions; (iv) non-traditional non-insurance and investment activities of insurance companies; and (v) derivative transactions. A review of the deep dives conducted to date will be published in the July 2016 FSR.

D. Macroprudential Toolkit

49. Legislation grants the FPC a broad set of powers of recommendation and direction. The conduct of macroprudential policy is not limited to those designated tools over which the FPC has directions powers. Other policies (including micro-prudential or even non-financial) may better deal with certain types of risks. Indeed, to date the FPC has maintained a broad scope of interest and has operated mostly via its recommendation powers (also, many direction powers did not become available until recently). The Government has expressed a preference for giving the FPC powers of direction over tools that are: specific (i.e. only extend to regulatory aspects that are clearly delineated), subject to sufficient national discretion, and focused on system-wide rather than firm-specific characteristics. In turn, the FPC sees benefits in having a relatively narrow (“parsimonious”) set of direction powers, in terms of accountability, policy effectiveness and building a public reaction function for the Committee. Implementation of directions may be timelier than for recommendations.⁵² As a result, direction powers are generally related to mitigating risks in the time dimension, while structural risks will typically be dealt with using recommendations (Appendix 4).

50. Powers of direction have been established over tools that mainly target risks from excessive leverage and credit growth (including property markets). To date, those tools encompass sectoral capital requirements for residential (including mortgages) and commercial property exposures, sectoral capital requirements for intra-financial sector exposures, limits on LTV ratios and DTI ratios on owner-occupied mortgage lending and the leverage ratio (including a countercyclical leverage ratio buffer and a leverage surcharge for systemically important institutions). The FPC also sets the countercyclical capital buffer rate for U.K. exposures under Basel III (implemented in Europe under CRR/CRD IV),⁵³ As such, these powers can be used to enhance the resilience of the core financial system, and to address risks from broad-based expansions in credit, property market (owner-occupied residential and commercial real estate), and financial interconnectedness. The coverage of these direction powers is mainly those U.K.-authorized firms that fall under CRD IV/CRR (i.e., banks, building societies and investment firms), although some housing tools can be applied more broadly.

51. The statements of general policy for such tools are broadly in line with Fund guidance (IMF 2014). The FPC is required to publish a policy statement for each of its direction powers. Directions are used within a clear framework, with a strong macroprudential mandate for varying policies over the cycle. Each statement covers a description of the tool, its likely impact on financial stability and growth (both a description of the channels and an estimation of its impact), and the circumstances under which the tool is expected to be used. The use of tools is supported by “guided discretion,” where a set of core indicators is routinely reviewed (as described above), but decisions are based on judgment that takes account of all available information (including market and supervisory intelligence, and stress testing results). Tools are more likely to be adjusted the greater the deviation from historical benchmarks and the more homogeneous the picture painted by different indicators is. All statements published so far recognize the potential for policy leakages, which therefore need to be monitored and may require a recommendation to expand the perimeter. Additionally, in all statements the FPC expresses its intention to cooperate with cross-border authorities to ensure that macroprudential decisions are implemented effectively and that cross-border leakages are dealt with appropriately.

52. The authorities have given careful thought on how to use tools that had not been available before (and how to communicate it). This includes:

• CCB. The CCB will be used primarily to increase the resilience of banks. The policy strategy aims to match the resilience of the system to the changing scale of risks it faces. The assessment relies on judgment informed by a set of core indicators, market and supervisory intelligence and stress-testing exercises. The FPC intends to set the CCB above zero before risks become elevated, with the CCB in the region of one percent when risks are neither subdued nor elevated. The U.K. strategy favors moving early and gradually, taking into account the uncertainty in measuring risks, the 12-month implementation lag and the likely lower costs of allowing banks to adjust via retained earnings. If risks in the financial system crystallize, the FPC may cut the CCB rate, including where appropriate to zero percent.

• Leverage buffers. The policy strategy for the leverage buffer is to scale it up in proportion to any countercyclical capital buffer on U.K. exposures and also for systemically important banks. The principle behind the FPC’s leverage requirements is that they are 35 percent of a firm’s risk-weighted equity requirements. As with the risk-weighted equity buffers, the FPC views the purpose of the additional systemic and countercyclical leverage buffers as to absorb the impact of stress.

• LTV/DTI. When implementing its LTV/DTI tools, the FPC could apply limits based on two parameters: the LTV or DTI ratio threshold, and the proportion of the flow of new mortgages that lenders could extend above that threshold (either in volume or in value). As such, the tool allows for more flexibility than a hard cap on LTV or DTI ratios.

53. Tools to address funding liquidity risks in the core financial sector sit with the PRA and may be influenced by the FPC via recommendation. Following the global financial crisis, an overhauled liquidity framework was introduced. As part of this framework, the PRA provided firms with individual liquidity guidance advising them on the amount and quality of liquidity resources appropriate to the firm’s circumstances. In 2012, the interim FPC made a recommendation to relax liquidity requirements taking into account the contingent liquidity provided by the BoE. The PRA is now transitioning to a new liquidity regime, following the introduction at the EU level of the Liquidity Coverage Ratio (LCR), which aims to ensure firms’ short-term resilience to liquidity risk. The LCR is formally phased-in from 2015 until 2018.⁵⁴ However, by FPC recommendation, the PRA moved ahead of schedule and applied an initial transitional requirement higher than stipulated in the CRR (i.e., 80 percent instead of 60 percent LCR ratio). The EU version of the Basel Committee on Banking Supervision (BCBS) Net Stable Funding Ratio (NSFR) will be introduced in 2018, aiming to increase the resilience of firms to liquidity risk over a longer time horizon.

54. The FPC may influence policies towards systemically important firms using its recommendation powers. In line with FSB principles, the U.K. authorities rely on intensified supervision, enhanced loss absorbency and improved resolvability and resolution to mitigate risks from “too big to fail.” Structural reforms within the U.K. banking system are being implemented to ensure the continuity in the provision of core banking services, facilitate effective resolution of systemic banking groups and increase their resilience. For the largest deposit takers, the Financial Services (Banking Reform) Act 2013 requires the ring-fencing of critical activities (such as deposit, payment and overdraft services to individuals and small businesses) within banking groups.⁵⁵ The ring-fence is to be implemented by the PRA by 2019. In 2013, the FPC established as a medium term priority to review from a macroprudential perspective, and where necessary act to influence, the design and implementation of reforms to address “too-big-to-fail”. For instance, the FPC has kept under review: (i) the process for identifying U.K. domestic systemically important banks (D-SIBs); (ii) macroprudential objectives to consider when setting the height of the ring-fence; (iii) protocols around stays in derivative contracts; (iv) policies on resolution and on recovery and resolvability; and (v) the U.K. framework for ‘gone concern’ loss-absorbing capacity.

55. The framework for applying higher loss absorbency requirements to systemic institutions is a shared responsibility.

• The identification and additional loss absorbency requirements for global systemically important banks (G-SIBs) lie with FSB. G-SIBs are identified in an annual assessment according to a framework developed by the BCBS and implemented by PRA.⁵⁶ The FSB initial list of banks that will be subject to a G-SIB capital surcharge starting in 2016 includes four U.K. headquartered banks (Table 1). G-SIB buffers will be phased in to come into full force by 2019.

• The PRA, following EBA guidelines for other systemically important institution (O-SII) identification, is responsible for identifying domestic and regional systemically important banks beginning in 2016. The provisions of the capital requirements directive (CRD IV) requiring O-SII to maintain a specific O-SII buffer are not mandatory and the U.K. is not implementing them. However, a systemic risk capital buffer (SRB) will apply to ring-fenced banks and large building societies due to their relative importance to the U.K. economy. The systemic risk buffer will be applicable starting from 2019. The FPC is responsible for establishing a framework to measure the systemic importance of ring-fenced institutions and mapping it into buffer rates. A framework proposal is currently under consultation. The framework will be subject to review every two years. The PRA is in charge of implementing the framework and may exercise supervisory judgment when doing so.

Table 1.

United Kingdom: Global Systemically Important Banks, 2014

Source: Financial Stability Board, 2014.Note: In the 2015 list, which determines the higher loss absorbency requirement that will apply to each G-SIB from 1 January 2017, the Royal Bank of Scotland has been moved to subcategory one. The other three G-SIBs have been kept in their respective subcategories.

Table 1.

United Kingdom: Global Systemically Important Banks, 2014

G-SIBs	Sub-category	G-SIB buffer (in percent)
HSBC	4	2.5
Barclays	3	2
Royal Bank of Scotland	2	1.5
Standard Chartered	1	1

Source: Financial Stability Board, 2014.Note: In the 2015 list, which determines the higher loss absorbency requirement that will apply to each G-SIB from 1 January 2017, the Royal Bank of Scotland has been moved to subcategory one. The other three G-SIBs have been kept in their respective subcategories.

View Table

Table 1.

United Kingdom: Global Systemically Important Banks, 2014

G-SIBs	Sub-category	G-SIB buffer (in percent)
HSBC	4	2.5
Barclays	3	2
Royal Bank of Scotland	2	1.5
Standard Chartered	1	1

Source: Financial Stability Board, 2014.Note: In the 2015 list, which determines the higher loss absorbency requirement that will apply to each G-SIB from 1 January 2017, the Royal Bank of Scotland has been moved to subcategory one. The other three G-SIBs have been kept in their respective subcategories.

• Global systemically important insurers are identified by FSB based on a framework developed by the IAIS that stresses the role of interconnectedness and the extent to which the insurance firms perform non-traditional and non-insurance activities.⁵⁷ Global systemic insurers will face a specific capital requirement (so called Higher Loss Absorbency) starting from 2019. In the U.K., there are currently no plans to designate systemic insurers domestically.

56. Overall, the overarching framework of EU law allows for certain flexibility to respond to financial stability concerns in the core financial system. The FPC cannot give a direction or make a recommendation that would contravene the EU prudential rules for banks, building societies and investment firms (i.e., Capital Requirements Regulation and Directive CRR/CRD IV). Under CRR/CRD IV national authorities have a degree of flexibility when dealing with financial stability matters. Within CRD IV, the CCB, the systemic risk buffer and (to a lesser extent) the G-SIB surcharge are flexible to capture local circumstances.^58,59 Pillar 1 of CRR allows authorities to impose higher capital requirements in respect of residential and commercial property (and intra-financial system exposures) on financial stability grounds. Additionally, in certain circumstances and subject to procedural requirements, a wide range of tools (so called “national flexibility measures”) can be set at a national level to address systemic risk.⁶⁰ There is an associated implementation lag that needs to be taken into account when deciding policy. The Pillar 2 provisions in CRD IV allow imposing additional capital requirements to address risks not adequately captured under Pillar 1.⁶¹ This allows targeting, based on financial stability concerns, certain exposures for which flexibility is not explicitly provided, such as corporate exposures (other than commercial real estate) or exposures in foreign currency. To address liquidity risks, additional liquidity measures could be recommended by the FPC and implemented either under the liquidity requirements under Pillar 2 provisions in CRD IV, or as a national flexibility measure in CRR. Finally, housing tools and the leverage ratio are not covered by the scope of EU legislation and are therefore established under the national legal framework.⁶²

57. The macroprudential toolkit in the U.K. is still evolving, as a number of tools are implemented, the FPC re-assesses its need for further tools and international standards for certain tools develop. A number of tools are still to be implemented over the coming years, including the NSFR (2018), the leverage ratio for banks other than G-SIBs (2018), the SRB for ring-fenced banks (2019), the leverage surcharge for ring-fenced banks (2019), and the higher-loss absorbency requirements for global systemically important insurers (2019). The FPC has requested direction powers over tools related to buy-to-let lending. and Government is undergoing consultation on these tools.⁶³ Further tools may be identified following the work done by the BoE/FCA and internationally on market liquidity issues. Moreover, the FPC has stated that it would consider asking for powers of direction to set bank liquidity requirements and margin requirements in securities financing markets once international standards have been agreed upon.