An open letter to the chancellor of the exchequer

Dear Chancellor,

Congratulations on becoming Britain's finance minister. This may have been the job you have always wanted; you certainly have plenty to do, not only on getting the budget back into shape but also on financial regulation.

You and your colleagues set out your policy agenda in an agreement published last week, but the statement leaves some big questions unanswered and a lot more precision will be needed before you have a coherent policy.

Your statement says that you "will bring forward proposals to give the Bank of England control of macroprudential regulation and oversight of microprudential regulation."

Your statement does not mention the abolition of the Financial Services Authority (FSA), and it seems that you have changed your mind about that. So the tripartite structure is to remain, but with the parties having somewhat different roles. In what way will they be different? Allow me to put forward six sets of questions you might like to consider when you fill in the detail on how you plan to regulate Britain's financial markets.

First, oversight is a pretty imprecise word. What will oversight of microprudential regulation mean in practice? How close will oversight be? Will the Bank of England will be able to overrule the FSA in individual cases, for example large banks? If this is the case, it will be necessary to be clear about when and how this can happen. Will the Bank set policy guidelines for the FSA? If so, what will the guidelines be about? Such guidelines might have important implications for monetary policy, so will they be decided by the Monetary Policy Committee? Will they be published?

A second question follows: if both the Bank and the FSA look at the micro side, how much duplication will there be? At a time of strained finances, having two sets of regulators might seem an extravagance, not least at a time when the FSA's budget has recently been increased. The costs, not just to the authorities but also to the banks, will need to be considered carefully.

Third, oversight of one body by another suggests divided responsibilities. Who will be ultimately responsible for microprudential supervision? As a member of the Treasury Committee asked in relation to Northern Rock, "who's in charge?"

Turning to the start of the statement: What exactly will macroprudential regulation consist of? The Bank has published a paper on the subject and Lord Turner has made a speech. Both suggest a profound change in the relationship between the monetary authorities and the commercial banks, with the authorities making judgments about which kinds of lending are desirable and which not. What is the new government's view? Who would be answerable for the decisions made by the monetary authorities?

Fifth: What will be the relationship between the Treasury and the Bank as regards financial regulation? The Treasury has to call the shots in the end if there is any question of using public money to support a distressed bank. Will the Treasury give instructions to the Bank about how to manage its financial stability function, as it does about its monetary policy role (i.e. the inflation target)? Will the instructions include an instruction to promote competition in banking? Will they be published? Will the Treasury also oversee the FSA? If so, how will its oversight be related to the Bank's oversight?

My final question is this. Periodic problems in financial stability seem inevitable, even If they aren't predictable. If you make the Bank responsible for them, you run the serious risk of damaging its public reputation and thereby its credibility in monetary policy. So the question for you is: are you sure this is wise?

Yours sincerely,
Bill Allen