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Financial Stability and Depositor Protection

Volume 471: debated on Wednesday 30 January 2008

I am today laying before Parliament “Financial Stability and Depositor Protection: Strengthening the Framework” (Cm 7308). This consultation document sets out the views of the Government, the Financial Services Authority (FSA) and the Bank of England, building on responses to the joint discussion paper, “Banking Reform—Protecting Depositors” published in October 2007. The Treasury Select Committee’s report published on 26 January has informed the consultation document published today and I am grateful for its positive contribution.

Recent months have seen a period of sustained turbulence and instability in global financial markets, with financial firms across the world affected. A response to these episodes requires action, not only from the UK authorities, but also from international firms and institutions. The Government propose to bring forward legislation after consultation, alongside actions by the FSA and the Bank of England, to address five key objectives:

Strengthening the financial system

The interconnectedness and complexity of today’s financial systems require international actions to increase stability and resilience, such as:

improving and strengthening risk management by banks, including stress testing and liquidity management; and

improving the functioning of securitisation markets including valuation and credit rating agencies.

Reducing the likelihood of banks failing

The high costs for the wider economy and society if a bank gets into difficulty require that further steps be taken to reduce the likelihood of this happening. It is proposed to:

strengthen the regulatory and supervisory framework, including requirements for banks to provide information to the FSA at short notice and more formal regulation of payment systems;

change the framework for provision and disclosure of liquidity assistance.

Reducing the impact of failing banks

It is neither possible nor desirable to prevent banks from failing in all circumstances. However, important new arrangements are proposed to enable failing banks to be dealt with in a way that minimises the potential impact on financial stability. These include:

the introduction of a “special resolution regime” within which there would be a range of tools to resolve a failing bank in a more orderly manner, including an accelerated method to transfer its business to a healthy bank—a “bridge bank”, deployment of a restructuring officer and a “bespoke bank insolvency procedure”; and

proposals to ensure that banks have in place practical arrangements to lessen the impact of any failure.

Effective compensation arrangements

It is important that consumers have full confidence in, and understanding of, the compensation scheme in the event of a bank failing. To improve current arrangements we will consult on:

a potential increase to the compensation limit for deposits, and the coverage of certain balances above the limit;

making changes to enable the financial services compensation scheme to make payments within one week of a bank failing; and

ways to increase consumer awareness of the scope and operation of the compensation scheme.

Strengthening the Bank of England and improving coordination between authorities

The current tripartite arrangements provide the appropriate framework for managing financial difficulties and crises. However, improvements to how these arrangements work in practice are required. Important changes will be made, including:

providing the Bank of England’s role in financial stability with a statutory footing and better governance arrangements in the Bank to support new statutory obligation; and

strengthening the memorandum of understanding, applying lessons from the operation of COBR during crisis conditions, and improving external communications.

In addition, it is vital that co-operation across borders works effectively. Current market events have demonstrated both the benefits and the difficulties of achieving this. Work with international partners will continue to:

improve co-ordination of approaches to international financial stability issues; and

introduce early warning system on global financial risks, improve cross-border crisis management.

The Government are determined that their response is proportionate and appropriate, and will therefore consult actively on these proposals, seeking discussions with financial institutions, consumer representatives and counterparts from across the world to ensure that the final arrangements are effective and deliver the five objectives set out here.

I am also announcing today that the Queen has been pleased to approve, under the Bank of England Act 1998, that Mervyn King be reappointed Governor of the Bank of England for a period of five years when his present term of office expires on 30 June 2008. His leadership and experience will continue to prove invaluable to the Bank of England.