The appointment of Ben Bernanke, the former head of the US central bank, to lead a review of the Bank of England's forecasting, comes as the Bank faces criticism for its efforts to control soaring prices and failure to predict their surge.

At the same time the move prompts the question “Do financial regulators make successful central bankers?”

What are the pre-requisites for good financial regulation? The requirements for a successful financial regulator have been developed and codified over the past 40-50 year, as regulation responded to the evolution of expanding international markets, services and instrument innovation.

Stakeholders, that is financial institutions, retail investors, company shareholders need to understand regulators’ objectives and requirements. These objectives should have a clear and well-communicated scope, which is well-understood by all stakeholders- against which performance can be measured and reported.

Moreover, regulators should aim to ensure that principles, rules and guidance are simple, understandable and clear. The regulations should establish appropriate standards of competence and behaviour.

Regulators should ensure in almost all circumstances that the application and outcome of the principles and regulations should be predictable. It should not normally be necessary for anyone to resort to expert judgement or the courts in order to resolve how the rules operate.

Regulation should be supported by robust monitoring and supervision. There should be a firm expectation in the marketplace that regulatory requirements will be enforced in both spirit and letter. It should be recognised that a need for enforcement action represents regulatory failure, not success.

A proportionate approach is important: regulatory requirements, oversight and intervention should reflect the nature, scale, sophistication and complexity of the market participants and the problem regulators are addressing.

Regulators should understand that there are limits to what regulation can achieve, as regulation is often costly. Alternatives should be explored where non-regulatory approaches – such as industry and sector initiatives – could achieve objectives.

Regulators must exercise their powers reasonably, so that disciplinary decisions are transparent and accompanied by clear penalties for non-compliance, with the right of appeal against formal regulatory decisions made by an independent body.

Regulators should keep changes to the underlying rules to a minimum. Where there is justifiable economic, industry or social basis for a material change to the regulations, the justification and impact assessment should be made public, and supported by a clear underlying policy rationale. Regulators should allow adequate time for review, drafting and consultation on new requirements.

Regulators must have a high level of knowledge of financial markets, to identify market failures which it may be possible to address through regulation, to minimise the risk of unforeseen consequences.

It is vitally important that regulators employ a sufficient number of staff who have significant practical experience of financial markets. In-depth dialogue with stakeholders – including those with professional expertise in this area – is also essential.

Regulators should recognise that financial services firms are private sector businesses, and that requirements which make it difficult for such firms to earn a commercial rate of return will undermine their viability over the longer term.

Consumer regulation contributes to consumer protection but has to be balanced with reasonable level of responsibility for consumers and providers. Overzealous or excessive consumer protection is likely to lead to reduced choice and higher prices for consumers.

Regulators should ensure that requirements can cope with financial innovation.

In summary regulators need to develop a culture in financial service, which build trust and confidence in the financial services sector and its participants, including in regulators themselves.

So how do these skills align with those of a successful central banker?

Central bankers do have to develop and build trust and confidence but there are many subtle differences from good financial regulators:

Central Banking skills have evolved over a longer period - since the 1920’s when central banking became an international as well as domestic feature, in attempting to manage the impact of events on financial markets.

The stakeholder group is much wider. It extends from the Government, though financial institutions with whom it directly interacts but has a much greater and more diverse range of indirect stakeholders including financial institutions but more importantly all private sector businesses and all households.

While transparency is important, the Central Bank needs to be publicly reserved and combine an air of mystique through ambiguous language which does not precipitate market disruption.

The timing and mode of operation of the Central Bank should be equally surprising not in what it does but the timing and the way it approaches its functions.

A good Central Bank will have strong leadership which combines good predictive forecasting with intuition, so that it is at the front of the curve in managing the impact of market changes from other financial and geo-political events. As such Central Banks’ actions should not be entirely predictable.

The digital era will require taking on new responsibilities while continuing to provide services to traditional, branch-based banking, which for the foreseeable future will remain present alongside innovative digital services.

Successful adaptation to digitalisation will therefore mean preserving existing competencies and simultaneously developing new ones in the areas of programming, machine learning analysis, and big data processing.

Successful Central Banking a science as it has an organized body of knowledge which contains certain universal truths, but it also an art which require the application of intelligence and creativity. As such, for a regulator to make a successful central banker they would require innate qualities which would make them successful in any field of endeavour.

Bob McDowall

August 2023