For both, but particularly for an independent central bank, authority is a vital attribute. It is bound to be eroded if the body defending the currency that it issues is also responsible for supervising banks, since it can never hope to be wholly successful in the latter role - as the Bank of England painfully discovered in 1984 when the Johnson Matthey Bank collapsed. Then, as over BCCI, the Bank was considered not to have been sufficiently alert and zealous. True, it subsequently did a good job recovering the funds lost as a result of Johnson Matthey's undiscriminating lending policy. But the scars to its reputation lingered on before being dwarfed by the cataclysm of BCCI and the largest fraud in banking history.
The Bank's supervisory tasks range from maintaining a prudent ratio between capital and lending to proportional limits on lending to individual customers or business sectors. Prior to 1979, fringe banks were regulated under the Companies Act by the Department of Trade and Industry. The Bank of England took on formal powers as a regulator of all banks under the Banking Act of 1979, the weaknesses of which were shown up by the Johnson Matthey Bank failure. But even a revised Act and a manifest need for a more proactive supervisory policy failed to avert the BCCI disaster. It showed that the Bank's methods of guidance had not adapted adequately to the realities of London as an international banking centre.
For a new banking board to achieve the right balance would not be easy: too tight a regulatory strait-jacket would drive foreign banks away from London. In both Germany and the United States, the two roles have been separated. The reputations of the Bundesbank and of the Federal Reserve would not stand as high if they were also directly responsible for banking supervision.
Finally, the Bank of England's present dual responsibility creates a potential conflict of interest. At a given moment it may feel obliged to recommend an increase in interest rates. Yet it might know that such a rise would create difficulties for a number of the banks that it supervises - by putting highly leveraged companies out of business and so raising the level of bad debt.
The Bingham report notes the possibility of a division of the Bank's responsibilities, but unwisely rejects it. The force of the case for a divorce may be measured against the question of whether the Governor should resign over the BCCI disaster. Were he solely responsible either for monetary management or for banking supervision, the answer would be clear enough: if the former, no; if the latter, yes. As it is, the title of Governor has been devalued along with the Bank's reputation - to the detriment of its authority in both fields.Reuse content