Governance of the Bank of England’s balance sheet: principles of engagement

Introduction

1. The Bank of England’s balance sheet is used by the Bank to achieve its policy goals, in line with its statutory objectives. Those goals include: (1) to maintain price stability; and (2) to protect and enhance UK financial stability, including through (2a) providing liquidity facilities that allow eligible firms to borrow cash or to swap illiquid assets for more liquid ones (liquidity insurance); (2b) providing liquidity including to solvent but temporarily illiquid financial firms (lender of last resort); and (2c) addressing market dysfunction that may threaten UK financial stability. In light of these policy purposes, decision-makers within the Bank have the following interests in the balance sheet:

• The Court of Directors has an interest given it is ultimately responsible for managing the risk profile of the Bank’s balance sheet in relation to financial and non-financial risk;
• The Monetary Policy Committee has an interest as it must have sufficient control at the margin, of sufficient instruments capable of affecting overall monetary conditions – defined broadly as the quantity of inside money and the general level of market interest rates – in order to maintain price stability as set out in the Government’s remit letter for the MPC;
• The Financial Policy Committee has an interest in the use of the Bank’s balance sheet in that it advises the Bank, and, where appropriate, makes recommendations within the Bank, in relation to the use of its balance sheet for the purpose of protecting and enhancing the stability of the UK financial system, consistent with the Government’s remit letter for the FPC; and
• The Prudential Regulation Committee has an interest regarding the scope of the Bank’s liquidity insurance facilities and the principles which underlie their design and use, given they support the safety and soundness of PRA-authorised firms.

1. This document sets out the principles of engagement for these different committees in relation to the Bank’s balance sheet.footnote [1] The relevant Principles of Engagement have been agreed with each committee and will be reviewed every three years.
2. The Bank’s Executive is responsible for the day-to-day management of the Bank’s balance sheet,^{footnote [2]} including the design and implementation of balance sheet operations. Within the Executive this responsibility ultimately rests with the Governor in line with the general delegation from Court to manage the affairs of the Bank.^{footnote [3]} Onward delegations have been made to other Executives, including the Deputy Governor for Markets, Banking and Resolution, who has a prescribed responsibility in relation to the Bank’s balance sheet operations under the Bank’s Senior Manager Regime (and who has lead responsibility within the Executive for overseeing the application and review of the Principles set out in this document).footnote [4] The Governor has also constituted a number of Executive level committees which supports coordination within the Executive in relation to policy, risk and operational matters that may span a number of the Bank’s functions, including in relation to the Bank’s balance sheet. Deputy Governors and Executive Directors across the Bank, including the PRA, attend these committees to ensure effective cross-Bank coordination and information exchange.

A. Principles of engagement with the Court of Directors

Interest in the balance sheet

A1. The Court of Directors (Court) has statutory responsibility for managing the Bank’s affairs, while specific policy responsibilities are reserved to the policy committees. Court is, by statute, responsible for the Bank’s financial affairs. It must:

• determine the Bank’s objectives for financial management and monitor the extent to which have been met; and
• keep under review the internal financial controls of the Bank with a view to securing the proper conduct of its financial affairs.

The “Matters Reserved to Court” sets out how Court goes about discharging these responsibilities. This includes Court approving the Bank’s financial and risk management frameworks and its risk tolerance. ARCo reviews the Bank’s risk profile and evaluates actions being taken by management to bring risks within tolerance. Court delegates to the Executive the day-to-day management of the Bank, including the discharge of statutory functions, while reserving certain key decisions for itself, including those related to the risk profile of the Bank’s balance sheet in relation to financial and non-financial risk.

Matters for approval in ordinary circumstances

A2. In relation to the management of the risk profile of the Bank’s balance sheet, Court approves:

Strategy & Management

• the Bank’s objectives (including its objectives for financial management) and strategy;
• the Bank’s financial framework as updated from time to time;
• the Bank’s risk tolerance statement and its framework for monitoring and managing risk;

Balance Sheet Operations & Other Transactions

• the objectives of the Bank’s balance sheet operations and also any other changes to the frameworks for monetary policy or liquidity insurance that may result in a material increase in the risk exposure of the Bank;
• any foreign exchange intervention beyond £1bn;
• any commitment of the Bank’s resources to support a resolution of a firm;
• any loan, commitment, balance sheet operation or other transaction which is not in the ordinary course of the Bank’s business, except where the Governor determines that the matter should be considered by the Transactions Committee (see paragraphs A9-11 below).

A3. In considering any new balance sheet operations that may be determined necessary by the Executive (or statutory policy committees), and which may result in a material increase in the risk exposure of the Bank, the role of Court is primarily to assess whether those operations lie within the Bank’s Court-approved risk tolerance. The Executive should provide Court with evidence to support that assessment, including assurance that appropriate measures will be taken to ensure that the proposed operations are within the Bank’s risk tolerance (as set out in the risk tolerance statement approved by Court, covering both financial and non-financial risks).

A4. Where an operation is judged by Court to lie within tolerance, responsibility for detailed design, delivery and balance sheet operation rests with the Bank’s Executive, engaging with the relevant statutory policy committees as appropriate, in accordance with the principles in this document. If a proposed operation is judged by Court not to lie within tolerance, the Executive would be responsible for proposing a revised approach, or additional mitigants, to bring the operation within tolerance, as judged by Court.

Other engagement in ordinary circumstances

Oversight and review

A5. As part of its statutory functions, Court is responsible for keeping under review the Bank’s performance in relation to its objectives and strategy and for monitoring the extent to which objectives in relation to financial management have been met. Court is also responsible for keeping under review the internal financial controls of the Bank with a view to securing proper conduct of its financial affairs. Court receives regular reports from the Executive on balance sheet management.

A6. Court may commission ex post reviews, including by the IEO, into the balance sheet operations conducted by the Bank.

A7. Court is supported by the Audit and Risk Committee (ARCo), a sub-committee of Court, in carrying out its oversight responsibilities. ARCo is responsible for: reviewing and reporting to Court on the effectiveness of the Bank’s risk management framework and internal control systems; reviewing regular assessments of the Bank’s risk profile and assessing whether the Bank’s risk profile is consistent with ensuring the delivery of its objectives; and evaluating the actions being taken by management to manage or mitigate risks or bring them within tolerance.

A8. Court has delegated to the Governor ultimate responsibility for ensuring that the Bank has a risk profile consistent with ensuring the delivery of its objectives and with the Court-approved risk tolerance framework. The Executive Director for Risk reports to the Governor and shares this responsibility for mitigating risk across the Bank and has the right to escalate matters involving financial risk to the Governor (with an alternate line into the Chair of ARCo).

Engagement in extraordinary circumstances

Transactions Committee

A9. Transactions Committee (TransCo) is a sub-committee of Court, the role of TransCo is to advise the Governor where the Governor determines that it is not practical (for example, for reasons of short notice) to consult Court or seek Court’s approval, about any loan, commitment, balance sheet operation or other transaction which is not in the ordinary course of the Bank’s business.

A10. Extraordinary transactions that may be considered by TransCo include (but are not limited to):

• balance sheet operations or Emergency Liquidity Assistance to one or more individual firms, that go beyond the Bank’s published frameworks;
• liquidity support via the Resolution Liquidity Framework or any other public sector backstop funding mechanism;
• the formation, acquisition or disposal of a subsidiary of the Bank and the appointment of directors or officers to any such subsidiary either in connection with the exercise of the Bank’s powers and functions under Part 1 of the Banking Act 2009 or in connection with compliance by the Bank with any direction given to the Bank by HM Treasury under Part 4 of the Financial Services Act 2012;

A11. In carrying out its responsibilities, the role of TransCo is primarily to assess whether extraordinary transactions lie within the Bank’s risk tolerance. The Executive should provide TransCo with evidence to support that assessment, including assurance that appropriate measures will be taken to ensure that the proposed transaction is within the Bank’s risk tolerance, as set out in the risk tolerance statement approved by Court, covering both financial and non-financial risks. The Governor must report any decision made to Court at its next scheduled meeting and outline how any actions taken fall within the Court-approved risk tolerance framework.

Managing potential conflicts between the Bank’s Committees with regards to balance sheet operations

A12. The Bank of England Act 1998 does not assign management of the Bank’s balance sheet to any of the statutory policy committees and does not prescribe a hierarchy between the Bank’s monetary policy and financial stability objectives. The objectives are generally expected to be complementary in nature, and there are established mechanisms in place to avoid conflicts arising. These include coordination within the Executive, cross-membership of the statutory policy committees, and the principles of engagement with those committees set out in this document.

A13. In the event that a conflict cannot be resolved through the use of these mechanisms, the Governor will consult the Chair of Court about the process to be followed to resolve it. Recognising that policy decisions must be taken by the responsible committees, the Chair’s role would be to recommend a process to mediate the conflict rather than determining the outcome.

B. Principles of engagement with the Monetary Policy Committee

Interest in the balance sheet

B1. The Bank’s statutory Monetary Policy Objectives are to maintain price stability within the United Kingdom and subject to that, to support the economic policy of His Majesty’s Government including its objectives for growth and employment, in line with the Government’s remit letter for the MPC.

B2. The MPC has sole statutory responsibility within the Bank for formulating monetary policy. The MPC must therefore have sufficient control at the margin, of sufficient instruments capable of affecting overall monetary conditions – defined broadly as the quantity of inside money and the general level of market interest rates – in order to maintain price stability.

B3. The MPC has no responsibility in respect of the risk profile of the Bank’s balance sheet. As further explained in Section A that responsibility lies with Court, or as may be delegated by Court to the Bank’s Executive. For this reason, the MPC does not have sole decision-making authority over changes to the risks on the balance sheet or key parameters of balance sheet operations determining those risks. Responsibility for the detailed design, delivery and operation of balance sheet facilities is vested in the Bank’s Executive, which is accountable to the Bank’s Court for the use of the Bank’s balance sheet. The Executive will seek to ensure that, where feasible and appropriate, such facilities are structured in ways that maintain separation between delivering the statutory committees’ respective objectives (including through the adoption of separate processes).

Matters for approval in ordinary circumstances

B4. The MPC has decision making authority at the margin, in respect of the deployment of instruments and facilities that are varied over time with the primary intention of affecting overall monetary conditions in order to maintain price stability. At the present juncture, that includes variations in Bank Rate, the volume of asset purchases financed by the issuance of bank reserves aimed at achieving the remit set by the Government; and foreign exchange intervention.

B5. In the event that key parameters of the Bank’s balance sheet operations are varied with the primary intent of achieving price stability, then their control will pass to the MPC. The MPC will also approve the selection of schemes and structures designed to achieve the price stability objective.

Other engagement in ordinary circumstances

B6. Consultation. On questions which do not come to the MPC for approval, the MPC will nevertheless be informed at an early stage and consulted fully if the Executive is planning prospective changes to the Bank’s balance sheet operations and the design and operation of any new balance sheet facilities, for whatever purpose, in so far as they may have material and/or enduring implications for monetary policy instruments. On occasion such consultation might need to occur at short notice if the change is prompted by urgent market developments.

B7. Advice. The MPC will be given (or may ask for) the opportunity to advise, on a periodic basis, on whether it requires new monetary policy instruments required to meet its objectives. The Bank will take that advice into account in the design and operation of balance sheet facilities.

B8. Information exchange. The MPC will be provided with information on the impact of regular balance sheet operations that have implications for monetary policy instruments as part of each monetary policy round, and the Executive stands ready to supplement that information as required in the light of developments.

B9. Coordination: The MPC will have regard to co-ordination with other policy committees in line with the Government’s remit for the MPC. The MPC will be consulted or informed by the Executive of actions taken by the FPC or Executive which are relevant to the MPC’s interest in the balance sheet and will decide, as appropriate, what impact this has on the formulation of monetary policy.

Engagement in extraordinary circumstances

B10 The MPC has no decision-making responsibility in respect of the provision by the Bank of financial assistance to financial institutions, either individually or more generally. Nor is it responsible for making recommendations to the Bank relating to the provision by the Bank of collective financial assistance to financial institutions or to addressing market dysfunction that threatens UK financial stability – tasks that fall to the Financial Policy Committee. This does not, however, preclude consultation with the MPC concerning any implications of such operations for monetary conditions, which would be for the Governors to initiate, bearing in mind circumstances at the time.

C. Principles of engagement with the Financial Policy Committee

Interest in the balance sheet

C1. The Bank’s statutory Financial Stability Objective is to protect and enhance the stability of the financial system of the United Kingdom. The Bank has wide-ranging statutory responsibilities that contribute to this objective: these include the PRA’s role when promoting the safety and soundness of the firms it regulates; the FMI Board’s powers in relation to financial market infrastructure; and the Bank’s role as the resolution authority. The FPC plays a central role in contributing to the Bank’s achievement of its Financial Stability Objective primarily by identifying, monitoring and taking action to remove or reduce systemic risks to the resilience of the UK financial system, consistent with the Government’s remit letter for the FPC. Accordingly, the FPC has an interest in the use of the Bank’s balance sheet in that it advises the Bank, and, where appropriate, makes recommendations within the Bank, in relation to the use of its balance sheet for the purpose of protecting and enhancing the stability of the UK financial system.

C3. In relation to the use of the Bank’s balance sheet for the purpose of protecting and enhancing the stability of the UK financial system, outside times of stress the FPC will approve the scope and principles which determine the design of balance sheet facilities to ensure they are effective in ensuring the stability of the UK financial system. In the event of material developments the FPC will be asked to confirm that they remain, in the FPC’s view, fit for purpose from a financial stability perspective.

C4. Consultation: On questions which do not come to the FPC for approval, the FPC will nevertheless be consulted (i) if the Executive is planning a material change to its balance sheet facilities intended to reduce financial stability risks; (ii) if the Executive requires the FPC’s assistance to enable such facilities to operate effectively; or (iii) in response to a specific FPC request.

C6. Information Exchange: The FPC will be provided with regular information on the operation of the Bank’s balance sheet facilities intended to reduce risks to financial stability ahead of each quarterly round, and the Executive stands ready to supplement that information as required in the light of developments.

C7. Coordination: The FPC will have regard to co-ordination with other policy committees in line with the Government’s remit for the FPC. The FPC will be consulted or informed by the Executive of actions taken by the MPC or Executive which are relevant to the FPC’s interest in the Bank’s balance sheet and will decide, as appropriate, what impact this has on the FPC’s role in relation to protecting and enhancing the stability of the UK financial system.

C8. In times of stress the FPC advises the Bank on the crystallisation of financial stability risks, their nature and the channels through which they can threaten UK financial stability (while respecting the fact that the FPC was not established as a crisis management committee). The FPC can recommend that the Bank takes action to address the specific risks to UK financial stability that it identified. Prior to the deployment of balance sheet operations to reduce risks to UK financial stability, the Bank will consult or, at a minimum, inform the FPC, bearing in mind the circumstances, such as the urgency of market developments.