Why the Bank of England chose a Canadian

In the search for Mervyn King's replacement, the Bank of England needed a candidate who could successfully balance market reform without stifling innovation. Mark Carney fits the bill perfectly.

The appointment of Bank of Canada’s governor as the new governor of the Bank of England appears to have raised some eyebrows in the UK. Where better, however, to find a new leader for the BoE than the Colonies?

While the BoE’s deputy governor for financial stability Paul Tucker, had been regarded as favourite for the role, Mark Carney, an ex-Goldman Sachs banker and governor of the Bank of Canada for the past five years comes without any baggage into what is going to be a difficult job.

The first foreigner appointed to the BoE governorship in more than three centuries, Carney’s major advantage over a domestic appointee is that he wasn’t part of the system that imploded on the BoE and Financial Services Authority’s watches as the global financial developed.

Instead he oversaw one of the two developed world financial systems and economies that emerged with their reputations enhanced. Those were, of course, Canada and Australia.

That’s not a coincidence. Both systems have very similar regulatory structures and approaches. While in each case the central bank is responsible for financial stability, with a separate regulator for financial institutions, there is a strong level of engagement, coordination and intelligence-sharing between the central bank and the regulator, in Canada’s case the Office of the Superintendent of Financial Institutions and in Australia’s the Australian Prudential Regulation Authority.

The banks in both systems emerged intact (the Canadians did have a slightly larger involvement in sub-prime structured debt products than the Australians) and both economies were largely unscathed.

Two strands of the explanation for their performance were a relatively stronger focus on maintaining tighter monetary policies than was the case elsewhere and strong and conservative regulation of the banks.

Carney made the point back in 2008 that the Canadian banking system – like Australia’s – was significantly less leveraged going into the crisis than its US and European counterparts. Both systems had simple assets-to-capital ratios – leverage – of just under 20 times while US investment banks were geared more than 25 times and the European banks more than 30 times.

Carney’s reputation was such that he was appointed chairman of the Financial Stability Board last year. The FSB coordinates the efforts of national regulators to produce global standards for regulation of financial institutions and systems.

The appointment of the new governor, and the credibility they bring to the role, was critical given that the BoE, which was asleep on the job in the pre-crisis period, has been given a much larger role in overseeing the UK system. The UK Prudential Regulation Authority, formerly part of the FSA, is being merged into the BoE, so Carney will be both a central banker and prudential regulator.

It is, interestingly, a different regulatory model to the successful template provided by Canada and Australia but closer to the old Australian model when the RBA was both the central bank and directly supervised and regulated the commercial banks.

That may have been because of the Northern Rock experience in the UK, which revealed a focus by the FSA on capital adequacy and credit quality but little attention to liquidity, the issue that effectively killed Northern Rock and which remains the source of most acute vulnerability for any financial institutions. Central bankers, as the liquidity providers of last resort, tend to pay more attention to liquidity issues if given the opportunity and the intelligence. While the RBA and APRA have distinct responsibilities they do liaise with each other and there are formal information sharing forums.

Carney, because of his role with the FSB, will presumably bring a global perspective to bear on the BoE and proposed reforms to the UK banking sector.

The UK authorities, at both the political and institutional level, have been quite radical in their suggested structural response to the crisis, during which some of the biggest high street banks were bailed out, and ended up effectively owned, by the UK taxpayer. There is a balancing act between strengthening the foundations of a banking sector and a regulatory overkill that stifles lending and economic activity.

Carney, as chair of the FSB, has led that organisation’s continuing review of the shadow banking system which is producing a push for greater disclosure and transparency and a stronger quarantining of the official system from its shadow counterpart while recognising the potential for the shadow system to help diversify risk, increase the resilience of financial systems generally and be a source of innovation and competition.

It is that kind of balancing act and sophistication that the BoE will need – and all financial systems need – if they are to be both stable and properly play their role within their economies.

There has been some speculation that the Reserve Bank governor, Glenn Stevens might retire or seek a truncated second term when his initial seven-year term expires next year. APRA’s John Laker is also due to retire in the middle of next year.

The likelihood of a foreigner being appointed to either of those roles is remote, given that both organisations have come through the crisis and its aftermath without any scars and more than a few medals.

The federal opposition, which has promised another Wallis-style inquiry into the financial system if it wins next year’s election, might, however, want to use the opportunity provided by the potential for leadership changes at the two key financial regulators to have a fresh look at the regulatory structures.

Any new inquiry would have a close look at the UK model and try to understand why it was chosen rather than the crisis-tested separation of roles that has been successful in Canada and Australia.

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