Will Global Interest Rates Fall Further?

Mark Carney, Governor of the Bank of England gave a speech “[De]Globalisation and inflation“.  One passage in particular is highly significant. He discussed the impact of globalisation on inflation, and suggests that there are likely to be further downward pressure on real world interest rates, partly thanks to changing demographics and the relative pools of global investment and global savings. The net result is more investors looking for returns, compared with investment pools – which explains the bidding up of asset prices (including property and shares) while returns to investors continue to fall. The point is, this is structural – and wont change anytime soon. Indeed, he suggests real world interest rates could go lower, with the flow on to inflation.

For the past thirty years, a number of profound forces in the world economy has pushed down on the level of world real interest rates by as much as 450 basis points. These forces include the lower relative price of capital (in part as a consequence of the de-materialising of investment), higher costs of financial intermediation (due to financial reforms), lower public investment and greater private deleveraging. Two other factors – demographics and the distribution of income – merit particular attention.

Bank research estimates that the increased retirement savings as a result of global population ageing and longer life expectancy have lowered the global real interest rate by around 140 basis points since 1990 and they could lead to a further 35 basis point fall by 2025. The crucial point is that these effects should persist after the demographic trends have stabilised because the stock, not the flow, of savings is what matters.


By changing the distribution of income, the global integration of labour markets may also lower global R*. The changes in relative wages in advanced economies have shifted income towards skilled workers, who have a relatively higher propensity to save. Rising incomes in emerging market economies may be reinforcing that effect as saving rates are structurally higher in emerging market economies, reflecting a variety of factors including different social safety regimes.

The high mobility of capital across borders means that returns to capital will move closely together across countries, with any marked divergences arbitraged.

As a consequence, global factors are the main drivers of domestic long-run real rates at both high and low frequencies. For example, Bank of England analysis suggests that about 75% of the movement in UK long-run equilibrium rates is driven by global factors. Estimates by economists at the Federal Reserve deliver similar results.


Global factors also influence domestic financial conditions and therefore the effective stance relative to the shorter-term equilibrium rate of monetary policy, r*.

The presence of borrowers and lenders operating in multiple currencies and in multiple countries creates multiple channels through which developments in financial conditions can be transmitted across countries. For example, changes in sentiment and risk aversion can lead to international co-movement in term premia, affecting collateral valuations and so borrowing conditions.

Work by researchers at the Bank of England, building on analysis by the IMF, shows that a single global factor accounts for more than 40% of the variation in domestic financial conditions across advanced economies. For the UK, which hosts the world’s leading global financial centre, the relationship is much tighter, at 70%.

Highlighting the openness of the UK economy and financial system, a third of the business-cycle variation in the UK policy rate can be attributed to shocks that originate abroad.

One important channel of global spillovers is of course monetary policy. In coming years, it is reasonable to expect global term premia to rise as net asset purchases could shift significantly from the situation during the past four years when all net issuance within the G4 was effectively absorbed.

Is the global financial system any safer than before?

The latest Bank of England KnowledgeBank discusses the impact of regulation since 2007.  They discuss, capital, shadow banking and banker remuneration.

The financial crisis that struck in 2007 was among the worst on record. And it was global in nature. Financial markets seized up, world trade plummeted and the global economy went into recession. The cost of supporting banking sectors around the world reached $15 trillion. And the impact on people’s lives was severe. Many lost their jobs or saw a fall in their wages.

What’s been done to fix the global financial system?

A decade on since the start of the crisis, what’s changed?

After the crisis hit, the G20 – made up of the leaders and central bank governors from 20 major economies – set up the Financial Stability Board, which is tasked with monitoring the global financial system and making recommendations to make it serve society better.

Since then, various reforms have taken place. The video below summarises these changes: from the amount of ‘capital’ banks need to have, to new rules on bankers’ pay. While there is more work to be done, the video argues that the global financial system is today safer, simpler and fairer than it was a decade ago:

Bank of England extends direct access to RTGS accounts to non-bank payment service providers

The Bank of England has announced that a new generation of non-bank payment service providers is now eligible to apply for a settlement account in the Bank’s RTGS system.

Holding their own settlement account at the Bank enables these non-bank PSPs to apply, for the first time, for direct access to the UK’s sterling payment systems that settle in sterling central bank money, including Faster Payments, Bacs, CHAPS, LINK, Visa, and, once live, the new digital cheque imaging system.

The new Settlement Account Policy includes non-bank PSPs delivers on a commitment made by the Governor of the Bank of England in summer 2016.1  This policy change is designed to ensure that the UK’s payments infrastructure keeps pace with the changing structure of the financial system.  It marks the first step in a much broader renewal programme designed to deliver a materially stronger, more resilient, flexible and innovative sterling settlement system for the United Kingdom in the years ahead.

The Governor of the Bank of England said today: “I am delighted that the Bank of England, the FCA and HM Treasury are working together to stimulate competition and innovation in payment services by widening access to the UK’s payment systems to non-bank payment service providers. In parallel this should support financial stability through greater diversity and risk-reducing payment technologies.”

These changes will enable non-bank PSPs to compete on a more level playing field with banks.  In turn, reduced dependence on bank competitors for access to payment systems will allow non-bank PSPs to offer a wider range of payment services.  These factors will all help to increase competition and innovation in the provision of payments services.  In the longer term, the innovation which stems from this expanded access should promote financial stability by:

  • creating more diverse payment arrangements with fewer single points of failure;
  • identifying and developing new risk-reducing technologies; and
  • expanding the range of transactions that can take place electronically and be settled in central bank money.

At the same time, as the Governor made clear last summer, these benefits cannot be allowed to come at the cost of reduced resilience of RTGS. That is why the Bank has been working over the past year with the Financial Conduct Authority (FCA), HM Treasury, HM Revenue & Customs, the Payment Systems Regulator (PSR) and the payment system operators to develop a comprehensive risk management framework to ensure the continued resilience of the Bank’s RTGS service.

Before non-bank PSPs can open a settlement account, they will need to demonstrate compliance with this risk management framework. A number of legislative changes also need to complete their passage through Parliament. As a consequence, the Bank’s expectation is that the first non-bank PSPs will join RTGS during 2018.

To assist firms interested in exploring direct access to UK payment systems and RTGS, the Bank, FCA and the major payment systems operators are today publishing a guide providing more detail on the requirements and application process.  In the first instance, interested firms should contact the relevant payment systems operator to discuss these issues further.

BOE Warns Popular 35-Year Mortgages Shackle Consumers With “Lifetime Of Debt”

From Zero Hedge.

Consumers in the UK have been on a credit binge since the Bank of England cut its benchmark interest rate to an all-time low as investors braced for the widely anticipated economic shock of Brexit – a shock that, unsurprisingly, has yet to arrive, despite warnings from the academic establishment that a “leave” vote would trigger an imminent economic catastrophe. And now, with total credit growth rising at 10% a year, the BOE is warning that the increase in unsecured lending is becoming increasingly unsustainable.

While the central bank is less concerned with mortgage debt than credit-card debt and other types of consumer credit, some at the bank are beginning to worry that the growing demand for long-term mortgages will shackle borrowers with a lifetime of debt, according to the Telegraph.

 “British families are signing up for a lifetime of debt with almost one in seven borrowers now taking out mortgages of 35 years or more, official figures show.

Rapid house price growth has ­encouraged borrowers to sign longer mortgage deals as a way of reducing monthly payments and easing affordability pressures.

Bank of England data shows 15.75pc of all new mortgages taken out in the first quarter of 2017 were for terms of 35 years or more. While this is slightly down from the record high of 16.36pc at the end of 2016, it has climbed from just 2.7pc when records began in 2005.”

The steady rise has triggered alarm bells at the BOE, prompting regulators to warn that the trend risks storing up “problem[s] for the future” if lenders ignore the growing share of households prepared to borrow into retirement. Indeed, bank figures show one in five mortgages today are between 30 and 35 years, up from below 8% in 2005, as the traditional 25-year mortgage becomes less popular.

There’s also the unaffordability question. That borrowers are opting for longer mortgage terms means they’re finding rent and mortgages are growing increasingly unaffordable, a worrying sign as credit expands.

David Hollingworth, a director at mortgage broker London & Country, said the trend showed that an increasing share of borrowers were “struggling with affordability pressures, and deciding that lengthening the term will offer leeway” as house price growth continues to outpace pay rises.

Sam Woods, the chief executive of the Prudential Regulation Authority, has said policymakers are watching developments closely.

“If lenders become too narrowly preoccupied with the profile of the loan in the first five years” and not look at the entire profile of the loan when assessing affordability “this could store up a problem for the future,” he said in a speech.

While interest rates are expected to stay low, the pound’s 15% drop against the dollar since the last year is driving up the price of consumer goods, adding to the pressure on borrowers. Prices of consumer staples are growing at an annualized rate of 3%, far more than interest rates on savings accounts.

BOE Fintech Accelerator Shows Promise

The Bank of England published summaries of the third round of Proofs of Concept (POCs) completed by its FinTech Accelerator. It nicely shows some of the potential innovation applicable to the finance sector.

The FinTech Accelerator was set up a year ago to deploy innovative technologies on issues relevant to the Bank’s mission and operations. Working in partnership with FinTech firms the Bank is seeking to develop new approaches, build its understanding of these new technologies and support development of the sector.

The latest PoCs covered four important areas of the Bank’s work:   analysing large-scale supervisory data sets; executing high-value payments across currencies and borders; identifying and applying cross-cutting legal themes from regulatory enforcement actions; and measuring performance on the Bank’s internal projects portfolio.

Further details on each project can be found in the individual write-ups, but in summary:

  • We worked with Mindbridge Ai, a machine learning and artificial intelligence firm, to explore the analytical value of using artificial intelligence tools to detect anomalies in supervisory data sets. Using a sample set of anonymised reporting data, we found Mindbridge’s user interface to be intuitive, allowing the user to explore a time series of each variable, whilst comparing the results to industry averages. This PoC enabled our internal team of data scientists to compare and contrast their own findings and the underlying algorithms being used, providing a complementary layer to the Bank’s work.
  • In our PoC with Ripple, we looked into how distributed ledger technology (DLT) could be used to model the synchronised movement of two different currencies across two different ledgers, as part of the Bank’s wider research into the future of high-value payments. Although the Bank has already concluded that DLT is not sufficiently mature to support the core RTGS system, the learnings from this exercise with Ripple have reinforced the Bank’s intention to ensure its new RTGS system is compatible with DLT usage in the private sector, and has  highlighted areas where we would like to conduct more exploratory work.
  • We worked with Enforcd, giving a group of staff from our Regulatory Action Division (RAD) access to a cloud-based database of regulatory enforcement actions with supporting commentary and trend analysis. Having easy access to relevant published regulatory enforcement decisions can be an important input to financial firms’ overall compliance programmes. This PoC demonstrated how technology could potentially facilitate compliance and the development of best practice in some key areas of regulation.
  • Lastly we ran a proof of concept with Experimentus, using their ORB tool, to analyse historic Bank of England projects and visualise how they had performed against a range of standard key performance indicators (KPIs). This PoC allowed us to explore whether our existing test data were sufficient to carry out effective KPI reporting, and where further data collection might be needed.

Commenting on these latest POCs, Andrew Hauser, Executive Director for Banking, Payments and Financial Resilience, said:

“We have learnt a great deal through these latest Proofs of Concept, both in terms of what FinTech can do, but in also in terms of how it can help us work, think and communicate differently.  The breadth of topics covered by these projects, and the Accelerator programme as a whole, shows how much central banks potentially have to gain from continued engagement with the sector in delivering their mission of monetary and financial stability.”

The Accelerator invited applications for its fourth round of PoCs in April 2017 and expects to announce the successful firms shortly.

Find out more about the work of the FinTech Accelerator.

UK Tightens Banking Controls

The Bank of England released their June 2017 Financial Stability Report. They announced a number of measures which together tighten controls on the banks, in response to growing risks in the system from strong lending momentum. They confirmed the need to act, ahead of any impending crisis, by thinking about “tail risks” in the system.

They reintroduced a counter-cyclical capital buffer, which was removed after the Brexit vote.

They are concerned about systemic risks from high loan-to-income mortgage lending, and said lenders should use a 3% serviceability buffer from their standard variable rate and also confirmed the limit on lending with a LTI of 4.5 times will be an ongoing feature of the market.

Mortgage lending at high loan to income ratios is increasing and the spreads and fees on mortgage lending have fallen. If lenders were to weaken underwriting standards to maintain mortgage growth, the FPC’s measures would limit growth in the number of highly indebted households. This would have material benefits for economic and financial stability by mitigating the further cutbacks in spending that highly indebted households make in downturns.

Here are a some of the interesting slides. The proportion of investor loans in the UK sits at around 17% of all loans, compared with 35% in Australia – yet the UK authorities are concerned at this level and have taken a number of steps to reduce momentum in this sector of the market.

Higher DSR households are much more likely to default, the UK are tracking this, yet in Australia there is no reporting on DSR by the regulators. We are relying on LVR, which is a poor measure of risk, as it depends on property values.

Likewise, they also show that Loan to Income (LTI) is important in that higher LTI households have less disposable income, and in a crisis are more at risk; plus their inability to spend has a depressive impact on economic growth. Once again, they track this, and have policy on the limit of mortgages above 4.5 times. In Australia, there is no regular flow of information on LTI, no policy on this, and yet we face significant economic slow-down as highly leveraged households cut their spending.

You can watch the presentation.


The Financial Policy Committee (FPC) aims to ensure the UK financial system is resilient to the wide range of risks it faces.

The FPC assesses the overall risks from the domestic environment to be at a standard level: most financial stability indicators are neither particularly elevated nor subdued.

As is often the case in a standard environment, there are pockets of risk that warrant vigilance. Consumer credit has increased rapidly. Lending conditions in the mortgage market are becoming easier. Lenders may be placing undue weight on the recent performance of loans in benign conditions.

Exit negotiations between the United Kingdom and the European Union have begun. There are a range of possible outcomes for, and paths to, the United Kingdom’s withdrawal from the EU.

Some possible global risks have not crystallised, though financial vulnerabilities in China remain pronounced.

Measures of market volatility and the valuation of some assets — such as corporate bonds and UK commercial real estate — do not appear to reflect fully the downside risks that are implied by very low long-term interest rates.

To ensure that the financial system has the resilience it needs, the FPC is:

  • Increasing the UK countercyclical capital buffer rate to 0.5%, from 0%. Absent a material change in the outlook, and consistent with its stated policy for a standard risk environment and of moving gradually, the FPC expects to increase the rate to 1% at its November meeting.
  • Bringing forward the assessment of stressed losses on consumer credit lending in the Bank’s 2017 annual stress test. This will inform the FPC’s assessment at its next meeting of any additional resilience required in aggregate against this lending. The FPC further supports the intentions of the Prudential Regulation Authority and Financial Conduct Authority to publish, in July, their expectations of lenders in the consumer credit market.
  • Clarifying its existing insurance measures in the mortgage market, designed to prevent excessive growth in the number of highly indebted households. This will promote consistency across lenders in their application of tests to assess whether new mortgage borrowers can afford repayments.
  • Consistent with its previous commitment, restoring the level of resilience delivered by its leverage ratio standard to the level it delivered in July 2016 before the FPC excluded central bank reserves from the leverage ratioexposure measure. The FPC intends to set the minimum leverage requirement at 3.25% of non-reserve exposures, subject to consultation.
  • Overseeing contingency planning to mitigate risks to financial stability as the United Kingdom withdraws from the European Union.
  • Building on the programme of cyber resilience testing it instigated in 2013, by setting out the essential elements of the regulatory framework for maintaining cyber resilience. It will now monitor that each element is being fulfilled by the relevant UK authorities.

UK Minimum requirements for eligible liabilities and own funds (MREL)

Given the current debate about “Unquestionably strong” banks, it is worth reading the Bank of England’s approach to minimum loss-absorbing capacity these institutions must hold, and how it can comprise both ‘going concern’ and ‘gone concern’ resources.

The Bank of England published a Statement of Policy on our approach to setting MREL (a minimum requirement for own funds and eligible liabilities) for UK banks, building societies and the large investment firms on 8 November 2016.

These rules represent one of the last pillars of post-crisis reforms designed to make banks safer and more resilient, and to avoid taxpayer bailouts in future. Banks are now required to hold several times more loss-absorbing resources than they did before the crisis, while annual stress tests check firms’ resilience to severe but plausible shocks. Banks are now also structured in a way that supports resolution. The Bank of England now has the legal powers necessary to manage the failure of a bank, and significant progress has been made to ensure there is coordination between national authorities should a large international bank fail.

The new rules will be introduced in two phases. Banks will be obliged to comply with interim requirements by 2020. From 1 January 2022, the largest UK banks will hold sufficient resources to allow the Bank of England to resolve them in an orderly way.

What is MREL?

MREL is a critical part of a resolution strategy. It determines the minimum loss-absorbing capacity these institutions must hold, and it can comprise both ‘going concern’ and ‘gone concern’ resources.

Going-concern resources, typically in the form of common equity, absorb losses in times of stress and ensure that a bank can keep operating and that it can maintain the supply of credit to the economy.

Gone-concern resources, typically in the form of debt, absorb losses when a bank undergoes resolution or is placed into insolvency.

Smaller institutions that provide banking activities of a scale that means that they can be allowed to go into insolvency if they fail, will satisfy MREL by simply meeting their minimum regulatory capital requirements as a going concern. There is no gone-concern requirement for these firms. More detail on the capital framework for bank capital is set out in the Supplement to the December 2015 Financial Stability Report.

But larger banks and building societies with a size or functions that mean they have a resolution plan involving the use of the Bank’s resolution tools will be required to hold additional MREL beyond their going-concern requirements.

In addition, firms are expected to hold going-concern capital buffers on top of these requirements. The buffers are calibrated to recognise systemic importance or idiosyncratic exposures, and are intended to be used so that banks can absorb losses without breaching minimum requirements. As these capital buffers are not permitted to count towards meeting MREL, they add to the total loss-absorbing capacity of each bank.

How much MREL must larger firms hold?

The MREL for large firms is needed in a resolution both to absorb losses and to recapitalise their continuing business. Our policy is that from 1 January 2022 they should be required to hold both their going-concern requirements together with additional MREL of an amount equal to those going concern requirements. In other words, their MREL will be two times their going-concern requirements.

These UK firms will become subject to interim requirements on 1 January 2020, prior to the final requirements coming into force in 2022. We will review our approach to calibration of the 2022 MREL for all firms before the end of 2020, before we set final MRELs. In doing so, we will have particular regard to any intervening changes in the UK regulatory framework, as well as institutions’ experience in issuing liabilities to meet their interim MRELs.

Table 1 below provides the estimates of the interim and final consolidated MREL requirements that we have sent to each of the UK’s global and domestic systemically important banks. As a firm’s MREL will depend upon its going concern requirements in a particular year, these 2020 and 2022 MRELs are simply indicative and are based on the calibration methodology set out in our Statement of Policy, with reference to the firms’ minimum capital requirements and balance sheets as at December 2016.

In addition to the global and domestic systemically important UK banks, there are eight other UK banks and building societies that currently have a resolution plan that involves the use of resolution tools by the Bank (rather than reliance on the insolvency regime). These are:

  • Clydesdale Bank
  • The Co-operative Bank
  • Coventry Building Society
  • Metro Bank
  • Skipton Building Society
  • Tesco Bank
  • Virgin Money
  • Yorkshire Building Society.

Table 2 provides the average of the indicative 2020 and 2022 MRELs and total requirements for these other firms.

We have provided an average for these firms as publishing MRELs for each of them would also reveal the firm-specific element of their capital assessments, many of which have not previously been disclosed. Accordingly, the Prudential Regulation Authority will consider its disclosure policy and undertake the appropriate consultations before a final decision on publishing individual MRELs for these firms is taken.

The Co-operative Bank has been excluded from the calculation of the average because the firm is currently seeking a sale, which has the potential to significantly affect The Co-operative Bank’s balance sheet. Therefore an indicative MREL based on The Co-op’s balance sheet today may not be a useful guide to the eventual requirement.

Building the Infrastructure to Realise FinTech’s Promise

An excellent speech by Mark Carney, Governor of the Bank of England which paints some useful pictures about the future of Fintech and the need to break the mould.

To its advocates, FinTech will democratise financial services. Consumers will get more choice and keener pricing. SMEs will get access to new credit. Banks will become more productive, with lower transaction costs, greater capital efficiency and stronger operational resilience. Financial services will be more inclusive; with people better connected, more informed and increasingly empowered. And tantalisingly, FinTech could help make the system itself more resilient with greater diversity, redundancy and depth.

These possibilities are why the Bank has already taken a number of steps to encourage FinTech’s development. The PRA and the FCA have changed their authorisation processes to support new business models. The New Bank Start-Up Unit, created in 2016, works closely with firms seeking to become banks. Already, four new ‘mobile’ banks have been authorised.

The Bank also established a FinTech Accelerator last year. Since then, we have worked with a number of firms on proofs of concept ranging from strengthening our cyber security to using AI for regulatory data, and improving our understanding of distributed ledgers.

Today we are opening our 4th round of applications to the Accelerator. We are looking to work on new proofs of concept on maintaining privacy in a distributed ledger and applying a range of big data tools to support the Bank’s analysis.

More broadly, the Bank is working to ensure that this time the right hard and soft infrastructure are in place to allow innovation to thrive while keeping the system safe.

Let me expand briefly with three examples.

The Right Soft Infrastructure

First, with respect to soft infrastructure, the Bank is assessing how FinTech could change risks and opportunities along the financial services value chain. We are then using our existing frameworks to respond where necessary.

We are disciplined. Just because something is new doesn’t mean it should be treated differently. Similarly, just because it is outside the regulatory perimeter doesn’t mean it needs to be brought inside. We apply consistent approaches to activities that give rise to the same risks regardless of whether those are undertaken by old regulated or new FinTech firms.

Some of the most important questions we are considering include:

  • Which FinTech activities constitute traditional banking activities by another name and should be regulated as such?
  • How could developments change the safety and soundness of existing regulated firms
  • How could developments change potential macroeconomic and macrofinancial dynamics including disruptions to systemically important markets? And
  • What could be the implications for the level of cyber and operational risks faced by regulated firms and the financial system as a whole?

To illustrate some of the issues, consider how FinTech is affecting the financial services value chain (Figure 1).

At present, the most significant changes are taking place at the front-end, where innovative payment service providers (PSPs) are providing new user interfaces for domestic retail and cross-border payment services through digital wallets or pre-funded eMoney.Other aspects of the customer relationships are being opened up. For example, aggregators are providing customers with ready access to price comparison and switching services. This will increase further when aggregators gain access to banks’ Application Programme Interfaces (APIs).These new entrants are capturing potentially invaluable customer data which can be used to target non-bank products and services.

In their current form, these innovations are simply a new front-end to the banking system where FinTech providers take a slice of customer revenue and loyalty but none of the associated risks.They have generally avoided undertaking traditional banking activities. So for now, absent a substantive change in business models or scale of activities, the FPC is unlikely to want to bring these firms into the regulatory perimeter.The changes to customer relationships resulting from FinTech competition could, however, reduce customer loyalty and the stability of funding of incumbent banks. If this happens, the Bank of England would need to ensure prudential standards and resolution regimes for the affected banks are sufficiently robust to these risks.

The Right Hard Infrastructure

A second, related example is how the Bank is working to develop the financial system’s hard infrastructure to allow innovation to thrive while keeping the system safe.Specifically, the Bank is widening access to some of its systems to include PSPs in order to boost both competition and system resilience.

The UK has led the world in innovation in the wider payments ecosystem. And we are committed to keeping pace with customer demands for payments that are seamless, reliable, cheap, and ubiquitous. Our challenge is how to satisfy these expectations while maintaining a resilient payment systems infrastructure.That’s important because the Bank operates the UK’s high-value payment system ’RTGS’ which each day processes £1/2 trillion of payments on behalf of everyone from homeowners to global banks. Understandably, we have an extremely low tolerance for any threat to the integrity of the system’s “plumbing”.

Currently, only 52 institutions have settlement accounts in RTGS. Indirect users of the system typically access settlement via one of four agent banks. These indirect users include 1000 non-bank PSPs at the front-end of the financial services value chain. As they grow, some PSPs want to reduce their reliance on the systems, service levels, risk appetite and frankly goodwill of the very banks with whom they are competing.

The Bank has decided to widen access to RTGS to include non-bank PSPs in order to help them compete on a level playing field with banks. The Bank of England is now working with the FCA and HMT to make this a reality, and we will issue our new blueprint for RTGS in early May.

Coordinated Developments in Hard and Soft Infrastructure

My third example of the Bank’s efforts to realise FinTech’s promise is our work with industry to help coordinate advances in hard and soft infrastructure.New technologies could transform wholesale payments, clearing and settlement. In particular, distributed ledger technology could yield significant gains in the accuracy, efficiency and security of such processes, saving tens of billions of pounds of bank capital and significantly improving the resilience of the system.

Securities settlement seems particularly ripe for innovation. A typical settlement chain involves many intermediaries, making it comparatively slow and keeping operational risks high. Industry has begun to work together to determine how distributed ledger technologies could be used to solve these issues at scale.The Bank is participating in several related initiatives. To help distinguish distributed ledger’s potential from its hype, we have completed our own Proof of Concept. We are a member of Hyperledger along with private market participants and tech firms. And we will make our next generation RTGS compatible with settlement in a distributed ledger.

It is not clear, however, that that the only challenges are technological. Indeed, the FCA highlighted earlier this week that settlement times could also be cut using existing technologies. This requires market participants to change their collective practices as it takes more than one intermediary in a chain to compress settlement times.


FinTech’s promise springs from its potential to unbundle banking into its core functions of settling payments, performing maturity transformation, sharing risk and allocating capital.

This possibility is being realised by new entrants – payment service providers, aggregators and robo advisors, peer-to-peer lenders, and innovative trading platforms. And it is being influenced by incumbents who are adopting new technologies to reinforce the economies of scale and scope of their business models.

FinTech could deliver significant benefits to households and businesses across this country and across the world. FinTech can widen access to financial services and bring new sources of credit. It can connect customers better with their finances and empower them more in the process. And new technologies can deliver faster service, greater choice and keener pricing.

As it does, risks will evolve. Changes to customer loyalties could influence the stability of bank funding. New underwriting models could impact credit quality and even macroeconomic dynamics. New investing and risk management paradigms could affect market functioning.

At the same time, the resilience of the system could also be built, through greater diversity in provision of financial services as well as increased redundancy. A host of applications could reduce costs, improve capital efficiency and strengthen operational resilience.

The challenge for policymakers is to ensure that FinTech develops in a way that maximises the opportunities and minimises the risks for society.

We are ideally positioned to realise FinTech’s promise in the UK.The Bank will work with the market and other authorities to build the hard and soft infrastructure the system needs to support innovation and growth, consistent with the City’s best traditions.

UK Bank Capital On The Rise

The latest release from the Bank of England shows that the common equity Tier 1 (CET1) capital ratio for the UK banking sector increased by 0.3 percentage points (pp) on the quarter to 15.1%, 1.1 pp higher than in Q4 2015.

The quarterly increase was driven by small movements in both the level of CET1 capital (increase) and in the level of total risk-weighted assets (decrease).

The reduction in risk-weighted assets was driven by small decreases in most risk categories.

The Productivity Conundrum

Andy Haldane, the Bank of England’s Chief Economist, explores possible reasons for why productivity growth has consistently been underperforming in relation to expectations – the so-called ‘productivity puzzle’. He suggests that there should be more focus on the “long tail” of less efficient and productive firms, and that cross pollination with more innovative firms may assist.  “There is unlikely to be any single measure which puts productivity growth back on track. But measures which support the long tail of companies, currently operating at low levels of productivity, have the potential to do considerable good”. Harnessing digital platforms in this context may be important.

He says the slowdown of productivity growth has clearly been a global phenomenon, not a UK-specific one. From 1950 to 1970, median global productivity growth averaged 1.9% per year. Since 1980, it has averaged 0.3% per year. Whatever is driving the productivity puzzle, it has global rather than local roots. It seems to have started in the 1970’s and it impacts both advanced and emerging markets.

Productivity growth has consistently underperformed relative to expectations, since at least the global financial crisis. This tale of productivity disappointment, in forecasting and in performance, has been extensively debated and analysed over recent years. Some have called it the “productivity puzzle”.

With each year that passes, and as each new turning point in productivity has failed to materialise, this mystery has deepened. This has led some to conjecture that the world may have entered a new epoch of sub-par productivity growth, an era of secular stagnation. The secular stagnation hypothesis is striking in its gloomy implications for future growth in living standards.

It contrasts with a second topical hypothesis. This posits that we may be on the cusp of a Second Machine Age or Fourth Industrial Revolution, an era of secular innovation.4 This might arise from the rise of the robots, artificial intelligence, Big Data, the Internet of Things and the like. Because of its impact on future living standards, the winner of this secular struggle – stagnation versus innovation – carries enormous societal implications.

A second issue, every bit as topical and important, concerns the distribution of gains in living standards. Specifically, there has been mounting concern over a number of years about rising levels of within-country inequality across a number of countries.

What are the causes of this trend? Is it mere mismeasurement? A fall-out from the financial crisis? The result of monetary policy? Slowing Innovation? Or slowing diffusion rates of innovation?

Sectoral shifts in the economy could plausibly account for some of the fall in productivity growth. There has been a secular shift over time away from manufacturing and towards services, with the employment share in manufacturing having fallen from 17% to 7% since 1990. Because productivity growth in manufacturing is higher than in services, this shift could plausibly account for some of the fall in aggregate productivity growth. Even if we correct for this compositional effect, however, the slowdown in UK productivity growth remains.

Tackling the Productivity Puzzle

There has been no shortage of public policy ideas over recent years for boosting productivity growth. Reports by the IMF and OECD have suggested measures ranging from increased infrastructure spending to improved education and training programmes.58 Earlier this year, the UK Government issued a Green Paper setting out various pillars to support productivity.

In generic terms, these policy measures fall into three categories. First, there are measures which support all companies, irrespective of sector, region or characteristic.

Second, there are measures which support technological innovation – the creation and growth of frontier firms.

A third category of policy measure focusses on the fortunes, not of innovative frontier companies, but the long tail of low-productivity non-frontier firms. These companies have tended to be focussed on somewhat less historically. Indeed, their large numbers and disparate characteristics may be one reason why this is the case. Yet given their scale, the returns to modest improvements in these firms could be dramatic.

As a thought experiment, imagine productivity growth in the second, third and fourth quartiles of the distribution of UK firms’ productivity could be boosted to match the productivity of the quartile above. That sounds ambitious but achievable. Arithmetically, that would deliver a boost to aggregate UK productivity of around 13%, taking the UK to within 90-95% of German and French levels of productivity respectively.

One practical way of doing so is by pairing up companies, frontier and non-frontier, to enable the sharing of best practices. This is effectively a mentoring scheme for firms, the like of which is already common among individuals. What would be in it for frontier companies? A more productive supply chain is clearly in their interests. The public sector could also play a useful nudging role in its procurement practices.

A more ambitious idea still, which I have been considering with Philip Bond, is to develop a virtual environment which would enable companies to simulate changes to their business processes and practices. These platforms are already used by many frontier firms to assess the impact of new technologies and processes on their business. These tools can be created, and tailored to companies’ circumstances, at relatively low cost. This makes them a potentially cost-effective way of facilitating diffusion to the long tail.