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G20 Summit

Volume 489: debated on Tuesday 17 March 2009

On 2 April, leaders of Governments from around the world will gather in London. Between them, those leaders represent 85 per cent. of the world’s economic output, and they have rightly given themselves a bold agenda for the meeting. They have set themselves the tasks of stabilising financial markets, agreeing on how to support citizens through the recession, reforming and strengthening the global financial and economic system, putting the world economy back on track to growth, and addressing the needs of the world’s poorest countries. That is more than a day’s work, but, of course, work behind the summit has been going on for some time and will continue beyond it.

I suspect that the 2 April summit will be something of an audit on progress to date and will include a further push to deliver across a broad range of important priorities. The test of 2 April is not whether the fine detail will be signed up to in each of the five objectives that I have mentioned; it is whether there is agreement on, first, what needs to change; secondly, on the broad principles for how that change is to be met; and, finally, on the delivery mechanisms for ensuring that that change happens. Of course, a consensus across all of those points needs to be secured.

Out of the broad agenda that has been set for 2 April, I shall concentrate on international regulation. I welcome what the Chancellor said to the House yesterday in his statement on the Finance Ministers’ meeting, which will be held ahead of the 2 April meeting. He said that “there is significant consensus” that financial supervisory and regulatory regimes need to be strengthened both nationally and internationally. He went on to give some insight into the detailed areas beneath that. For example, he mentioned the need to address the issue of capital and liquidity rules and to devise countercyclical devices. He also mentioned the need to address the issue of capital adequacy. In fact, the list of the work that needs to be addressed under that broad heading is much longer. I rehearsed the full list in a previous Westminster Hall debate, and I do not intend to repeat it again today.

I make no apology for returning to my criticism of the Basel accords, which currently cover international banking regulation, and the philosophy that underpins them. I do not think that that philosophy has yet been abandoned, but it is now highly questionable. As the Minister knows, the Basel accords took years to write, but it has taken only a few months to demonstrate their woeful inadequacy. There are two main problems with them. First, they are reliant on internal risk basing, which means that the banks effectively define and measure their own exposure to risk. The banks also decide the extent to which the risk that they themselves have defined needs to be covered. That is first problem with the Basel accords, and it has been exposed by what has happened in the past six months or so.

The second problem is that the system applies to banks that are huge global institutions. It is worth pointing out that the capitalisation of some of the world’s largest banks will exceed the size of some of the countries represented around the G20 table. The system applies to global banks that are subject only to various national regulatory regimes. That is a serious imbalance, and it means that those individual national regimes cannot move far away from each other for fear of creating capital flight, whereby banks move to a more relaxed regulatory regime. The minimum guidelines necessary are therefore set to ensure that capital flight does not take place and yet the measures and definitions of risk that are used are in fact written by the banks themselves.

Although many years of labour were spent in trying to bring about the Basel agreement, it was dead on arrival. The agreement has now been overtaken by events, and it proved irrelevant due to the search for yield on the part of the banks. That led to the innovation that we have seen and the emergence of extremely complex forms of securitisation. The search for yield decreased the degree of transparency across the banking system and increased the amount of off-balance sheet activity. Ultimately, it led to a loss of control on the part of the boards, because, frankly, they did not understand what the people running the banks were doing with those fancy instruments. There has also been a loss of control on the part of the regulators, because they could not keep up with the degree and complexity of change that was taking place.

I am sure that the Minister is aware of the extent of the problem and I hope that he will agree that confidence in the Basel approach has, in fact, collapsed and that there is evidence that many individual country regulators are already abandoning the Basel guidelines and substituting rules of their own. That leaves a supervisory vacuum that must be filled by internationally agreed core standards for banking regulation. As I have said, I think that the Chancellor hinted strongly at that in his statement to the House yesterday, and I would welcome the Minister adding more insight into the Chancellor’s thinking.

It seems that there is a consensus that something needs to be done, but, ahead of 2 April, an argument is emerging about how it is to be done. I would be interested to know where the Government stand on that argument, which I shall now outline. Some people are now saying that Glass-Steagall legislation needs to be revived. That legislation was introduced in the United States in 1933 following the Wall street crash and the emergence of the great depression. It was introduced by the Roosevelt Administration to impose a separation between retail and investment banking, and it was designed to break up the extraordinary power of J. P. Morgan and to restore the power of federal government in terms of setting economic policy. However, the crucial technical change that the legislation made was to impose a clean break between retail banking on the one hand and investment banking on the other.

Since the repeal of Glass-Steagall legislation in the 1990s, some people are now saying, “Well, all we need to do is go back to that and that will solve the regulator problem.” I was astonished to read yesterday that Nigel Lawson has joined the camp of those suggesting that we revert to Glass-Steagall. In his article in the Financial Times he said:

“It is folly to allow core banks to be in a position where they can be brought down by exciting but highly risky investment banking activities.”

I find that a bizarre statement from the man who was Chancellor of the Exchequer in 1986. He presided over the big bang in the City of London, which allowed US investment banks effectively to take over the City and pollute the traditional banking structures, which had rested heavily on that previous separation. He is a strange convert to the cause.

As I have said, Glass-Steagall was repealed in the United States in the 1990s, just as we abolished all credit controls in the big bang of the 1980s. Although there are those who call for a full return to the original Glass-Steagall divide, in reality we cannot just turn the clock back. The infrastructure of the global banking system has become far too complex to revert to a divide that was designed in the 1930s. I do not think that such a divide could be designed now.

The question is what should we do. I am aware that Lord Turner has been asked by the Government to look at what can be done here in respect of the Financial Services Authority’s approach to banking regulation. I believe that he will make recommendations this week on an array of issues that are clearly central to this debate. I understand that he will have things to say about bank capital adequacy, the need to evolve countercyclical mechanisms, liquidity risk management, prudential regulation, the rating agencies, the originate-to-distribute model and the use of market-to-market accounting. All those issues should be on the agenda, and I look forward to what Lord Turner has to say when he reports later this week. The problem is that Lord Turner’s report and recommendations will be targeted at just one regulator—ours, the FSA—whereas the Government’s document, “The Road to the London Summit”, states that we need

“greater surveillance of the financial system as a whole. It is essential that the cross-border co-operation between national authorities is enhanced and that the international regulatory architecture is strengthened.”

There is consensus on the aspiration to tackle international regulation, which is, of course, fine, but is consensus on how that is to be achieved emerging? There is probably agreement on what not to do: try to write one supervisory rulebook for all the world’s banks, governed by and applied by a new world bank regulator. I do not think that that is achievable or even desirable, but nor do I think that today’s balkanised system of regulation—hundreds of different regulators trying to deal with a handful of global banks—can be allowed to continue.

The question as we move towards 2 April and the gathering in London—I would welcome the Minister’s comments on this—is how we will try to bring together, from our position in the chair of the conference, a desire to draft tougher banking regulation, which I believe all European Union states agree on, with a reluctance on the part of the United States to go down that route and some hesitation among G20 members with emerging banking and financial sectors that have an interest in offering bargain-basement regulation to banks that they suspect may be looking to move away from the tougher regimes that might emerge in Europe and possibly North America. I hope that 2 April will be able to resolve those basic points.

I am seeking from the Minister some insight into the Government’s thinking on those questions, but I always try not to pose questions without hinting at some possible answers, so I shall conclude with three ingredients that I think are necessary to ensure the kind of progress on 2 April that I would like to see.

First, we need agreement that the Basel system’s philosophy must be abandoned, and that the underlying principles of that approach just will not work in the post-2009 world. Secondly, there must be agreement to reintroduce Glass-Steagall-style regulation, but not Glass-Steagall itself. Glass-Steagall cannot be resurrected, but what could be achieved is agreement on where the worlds of retail and investment banking should stand separately from each other, so that we can limit future taxpayer exposure, remove some of the conflicts of interest and reduce complexity in the banking system. That should offer us an opportunity to create meaningful and effective banking regulation.

The third and final thing that needs to emerge from 2 April is a system for designing appropriate international regulation. As I have said, we cannot possibly imagine that there will be one super-regulator covering all the world’s banks—that is not realistic—but we might try to work towards something that replicates the general agreement on tariffs and trade. Perhaps we should aim for a general agreement on banking regulation which would have the same kind of recognition, authority and stature as the general agreement on tariffs and trade. That would leave it to individual countries to write the fine details of their banking regulatory codes in ways that suit their own markets, but it would also establish a common core set of minimum regulatory standards, which is missing from the context at the moment.

It would be a terrible thing to waste this crisis. I hope that my right hon. Friend the Minister can reassure us that our Government and the other 19 who get together around that table in a couple of weeks’ time understand that, so that when we look back on this crisis in international banking, we will see it as a turning point, not a lost opportunity.

I congratulate my hon. Friend the Member for Warwick and Leamington (Mr. Plaskitt) on securing this important and timely debate, and I welcome the opportunity to consider with him and the House the important matters that he raised.

I was at the meeting of G20 Finance Ministers and central bank governors on Saturday. It is certainly the case that discussions with our international counterparts and partners have never been more important or more urgent, but we have made some good progress.

We have seen that the crisis in the financial system has spread into the real economy and that every country is now affected. I visited several G20 countries to prepare for the 2 April summit. Last month, I went to Argentina, where I was told that, for some time, people had expected that they would be decoupled from the crisis. They did not have any sub-prime mortgages and their banks did not have much exposure to US banks. It seemed that the crisis would pass them by, but then, suddenly, their exports fell off a cliff late last year. By the time of my visit, it was clear that Argentina, too, was facing serious problems.

A group of African leaders was in the UK yesterday to meet the Prime Minister ahead of the G20 to underline their deep concern about how poverty in their countries will be impacted by the crisis, and the importance to them of the G20’s response. At the weekend meeting, evidence was provided by the International Monetary Fund that showed continuing uncertainty and weakness in confidence around the world.

At the weekend meeting, I was struck by the high degree of agreement among that disparate group of countries about the concerns that we all face. I believe that consensus is emerging on how we can act together. It is framed by the commitments in last year’s Washington declaration, which have been developed subsequently through intensive joint working by Finance Ministries, regulators and central banks. That now provides the basis for leaders at the summit on 2 April.

As my hon. Friend said, there is a firm, shared commitment to doing whatever is needed to return the world economy to growth. It emerged from the discussion that the highest priority is to stabilise the financial system. There is recognition that sustaining lending is fundamental to economic recovery. That very much highlights the concern that he paid most attention to: G20 Finance Ministers are committed to tackling the problems in the financial system head on, and they agreed at the weekend to a common set of principles for dealing with so-called impaired assets.

We agreed that the resources of the international financial institutions need to be substantially increased to safeguard capital flows to emerging markets and developing economies. Finance Ministers made an important commitment not to repeat the mistakes of the past and turn to protectionism as we act with determination to restore growth across all those areas. Instead, we reaffirmed our commitment to open trade and investment, which are essential if we are to end rather than worsen the global crisis.

My hon. Friend raised particularly important issues about regulation of the banking system. As he would expect, much of the weekend’s discussions focused on the question of financial stability, as we cannot fix the economy until we have fixed the banks. It is essential that, in the future, the boundaries of regulation capture all institutions, markets and instruments that could pose a risk to the economy. Over the weekend, we agreed recommendations on how that could be achieved. For example, the G20 committed that all hedge funds or their managers will need to be registered, and that regulation should guard not just against risks to the health of individual firms, but against threats to the stability of the system as a whole. My hon. Friend acknowledged that my right hon. Friend the Chancellor highlighted that in the House yesterday.

My hon. Friend has focused on questions of banks’ capital adequacy, and I agree that we need fundamental steps to strengthen bank capital adequacy, risk management and supervision. That means strengthening the internationally agreed Basel II regulatory capital framework.

In a number of respects, Basel II marks a significant improvement in prudential regulation of banks compared with what preceded it. In particular, it aims to assess more precisely regulatory capital charges in relation to risks. It has only recently been implemented and I do not think it is right to say that it is the cause of the current crisis; it is not even in place yet in the United States. I do not think that the answer is to abolish it. I accept that it needs to be significantly improved in the light of recent events. In particular, as agreed at the meeting of G20 Finance Ministers at the weekend, we must ensure that regulations dampen rather than amplify economic cycles, including by requiring banks to build buffers of resources during the good times, so that they are prepared for more difficult times.

I hear my right hon. Friend say that the Basel system should be improved, but, as I said, my main concern is that, between Basel I and Basel II, although the second was an improvement on the first, there was no departure from the underlying principle common to both—the internal risk-basing approach. That means, as far as I can find out, that there is no independent, objective body assessing the riskiness of any instruments in the banks, and no one independently assessing the degree to which that risk is covered off.

The banks, even with Basel II, are still making their own definition of risk and writing their own risk profiles. They are still measuring risk on their own. That is what got banks into a serious mess and there is nothing in Basel II that will help to overcome it. Unless that principle is departed from, the Basel system will not deliver the kind of regulatory supervision that is essential.

Let me say something about how this is working in practice. Basel II, and therefore internal models for credit risk capital, has been available only since the beginning of 2007, although market risk models were recognised before that for regulatory capital. It is certainly true that in many cases banks misjudged the risks, and there are significant questions about the degree of reliance that it is appropriate for regulators to place on internal models, as my hon. Friend said. Regulators and Finance Ministers are now considering questions such as the need to supplement Basel II domestically and internationally, for that reason. However, in the UK, internal risk models for UK banks are required to be approved for use by the Financial Services Authority. That external check is provided and required.

Internal risk rating is complemented in the Basel II framework, and indeed in EU law via the capital requirements directive, by a requirement for supervisors to undertake supervisory review of the bank’s risks and make appropriate adjustments as required. The framework also incorporates the third pillar, around disclosure of key supervisory requirements on a bank, to ensure market discipline. Thus, it is not entirely the case that the banks are left to get on with things.

I am not absolutely convinced about that. My right hon. Friend is entirely right to say that the FSA must look at and, in a sense, sign off the risk assessments that are produced by the banks and handed to it, but is that an equal contest? I do not see that there are the resources in the FSA to do the detailed analysis of the risk measurement that the banks have used to present their thesis. I sense that the FSA takes on trust a lot of what comes from the banks, with respect to their assessment of their own risk. That diminishes the degree to which this is an objective and independent control on the system. It still relies on information that has come from an internal risk-basing approach.

My hon. Friend was right to make the point earlier that Lord Turner will be reporting—I think that will happen tomorrow, and it will be interesting to hear what he has to say—but as he also said, rightly, the matter also needs to be considered at international level.

Among the topics that we talked about on Saturday, on which we were supported, was the development of supervisory colleges, bringing together regulators in a number of countries dealing with major international banks. The development of that system has much to offer us. Another important step that was taken just before the weekend was the expansion of the Financial Stability Forum to include all the members of the G20. I hope that, internationally, we shall have much better mechanisms for handling the relevant issues than we had in the past. I hope, too, that that will mean that we are in a stronger position. That is certainly the intention of everyone who was present on Saturday.

It is also important that we ensure that regulatory regimes do not act procyclically—a big concern in relation to Basel II—to exacerbate the current downturn, and that they manage the transition to a strengthened regulatory regime accordingly. Capital requirements should remain unchanged until recovery is assured. Finance Ministers agreed to set out proposals to strengthen international co-operation, with supervisory colleges and an early warning system comprising the IMF and the Financial Stability Forum.

I have mentioned the expansion of the forum, and many countries—Brazil, Korea and South Africa—had been calling for that for some time. It means that a critical international institution now encompasses a much wider range of interests and provides a better basis for crucial decisions on financial stability.

I hope my hon. Friend will feel that, at least institutionally, we are moving in the right direction and making sure that we have the institutional arrangements we need. It is essential, as we reform our regulatory arrangements, that we do not leave loopholes—several loopholes were exposed by what has happened in the past couple of years—and that our work to provide effective regulation, combat money laundering and prevent tax evasion should not be circumvented.

Finance Ministers agreed that the relevant international institutions should identify which jurisdictions are not complying with international standards on those matters and provide toolboxes of actions that can be taken in response. As I know my hon. Friend is aware, we have been building up pressure on that over recent weeks. The UK, alongside the US, France and Germany, has been very clear that we will not tolerate tax evasion and that we want to seize the London summit as an opportunity to enhance global co-operation on that.

There was, in the days leading up to Saturday’s meeting, a series of major announcements from countries that have not in the past been willing to comply with international standards on tax information exchange—Hong Kong, Singapore and Liechtenstein—culminating in the dramatic announcement by Switzerland last Friday. At the end of Saturday’s meeting at Horsham, the President of Switzerland confirmed in person to my right hon. Friend the Chancellor and to me that his Government had indeed taken that historic decision. I think we can be confident that that will lead to the provision of tax information that has not been available in the past.

Finally, I want to make the point that international financial institutions, which are vital to ensuring that the global economy works well, need to be reformed too, to bring them into line with a changing world. The G20 agreed that emerging and developing economies should have a greater voice. The reform of IMF quotas needs to be concluded by 2011, the heads of the international financial institutions should be appointed on an open, meritocratic basis, and there needs to be reform of the instruments through which the IMF can lend. In those ways, we want to overcome the problem of stigma that has been attached to IMF programmes in the past, to the extent that some countries feel it is politically impossible to contemplate approaching the fund.

I think that the conclusions I have outlined provide a comprehensive framework for getting the global economy back on track, including addressing the issues that my hon. Friend rightly raised.

2 pm

Sitting adjourned without Question put (Standing Order No. 10(11)).