CORRECTED (OFFICIAL)-BoE's gilt interest transfer to government under new scrutiny

Tue Nov 20, 2012 2:17pm EST

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(Removes earlier incorrect statement by Winters on BoE gilt cash transfer affecting BoE capital, recasts with new statement from Winters)

* BoE structure blamed for governor circumventing deputies

* New structures may not make crisis response easier

By David Milliken

LONDON, Nov 20 (Reuters) - A Bank of England decision to hand over interest payments on the central bank's gilt holdings should not lead people to assume it is immune from future losses from other programmes, the author of a report into the BoE said on Tuesday.

Bill Winters, a former co-CEO of J.P. Morgan Investment Bank, addressed the decision during an appearance before a parliament committee, where he was presenting one of three independent reviews published earlier this month into the BoE's readiness for another bank crisis.

Some economists and opposition politicians have already criticised the Nov. 9 decision by finance minister George Osborne and BoE governor Mervyn King to return more than 35 billion pounds ($56 billion) of interest from the BoE's gilt holdings, purchased as part of its quantitative easing programme to spur the economy.

"The decision on the appropriate level of capital for the Bank ... should be a conscious decision. It shouldn't be backed into by the profits that happen to be there at a point in time. At another point in time there could be losses," he said.

Winters also said that he hoped that the BoE's supervisory board, known as its court, would be consulted on future decisions to transfer funds to the government.

Answering a legislator's question, Winters said that the money to be transferred to the Treasury was the BoE's capital, but in a later statement issued via the central bank, Winters said this was incorrect.

"I did not think the question of the appropriate level of capital of the Bank of England should be judged on the basis of the cash flow position of the APF," he said.

"In my more detailed responses to questions, my language may have given the impression that the decision to transfer cash from the APF reduced the Bank of England's capital. I did not intend to convey that, and in fact, the transfers decision has not affected the Bank of England's capital position."

The BoE and government say the decision brings BoE practice into line with the U.S. Federal Reserve and the Bank of Japan, but critics say the move is aimed at boosting the government's chances of meeting politically sensitive debt reduction targets.

Although the Treasury has indemnified the BoE against future losses on its quantitative easing programme, Winters said the BoE may need to look more closely at other exposure from other programmes that is not similarly protected.

"Funding for Lending is a very innovative programme, but exposes the Bank to real risk. It is not indemnified by the Treasury, and the Bank has not increased its capital on the back of a much more substantial increase in its riskiness," he said.

MORAL HAZARD MISTAKE

Separately, Winters said King's strong concerns about the moral hazard created by helping banks had slowed the BoE's response to Britain's first bank run in a century in 2007, when Northern Rock collapsed.

The BoE's unusual governance structure - where deputy governors are appointed by the finance minister, not the governor - also encouraged King to ignore them in favour of managers a level below, Winters said.

However, he rejected lawmakers' suggestion that King's management style had left the central bank "paralysed" in a crisis, or that too little dissent was voiced.

British financial regulation is changing in response to the crisis, with many responsibilities returning to the BoE next year.

But Winters said a future BoE governor would face a big challenge coordinating three internal bodies setting monetary policy, financial conditions and day-to-day supervision, as well as relations with external bodies.

"It's more complex operationally and managerially," he said.

This view was shared by former policymaker Ian Plenderleith.

"It is extremely important to be clear about precisely who is responsible for what well ahead of a crisis," Plenderleith said. "Whether it will work in practice, we can only see."

* For details, see ($1 = 0.6284 British pounds) (Additional reporting by Olesya Dmitracova; Editing by Ruth Pitchford, Ron Askew)

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