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House of Commons Hansard
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Reforming Financial Markets
08 July 2009
Volume 495

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With permission, I shall make a statement on the Government's proposals for reforming financial markets. Copies of our proposals are contained in a document that is available in the Vote Office.

The world economy has been hit by a severe financial crisis, which has resulted in the worst economic downturn for well over 60 years. Its origins lie in failures in the banking system around the world. Financial institutions in many countries simply took on too much risk. They became over-reliant on wholesale funding and too exposed to particular products, and irresponsible pay practices made banks take unnecessary risks.

It is also clear that some financial institutions appeared to have little appreciation of what was going on inside their own businesses. However, regulators and Governments too must learn from the events of the last two years, and understand better the risks that come from rapid globalisation in the financial system.

Our economy has a clear need for well-managed, well-functioning banks and financial institutions to perform a vital set of functions, channelling investment and helping people to save and plan for the future. The financial services industry is also a major employer in this country—of over 1 million people—and it will continue to generate wealth for our country in the future.

Our central objective must be to ensure that, as we come through the downturn, we reform and strengthen our financial system and rebuild it for the future, with consumers who are better informed, financial institutions that are better managed, and markets that are better regulated. The proposals that I will set out today build on our previous reforms to provide a new settlement that is open, competitive and effective and able to meet the needs of both business and families; that inspires trust and confidence on the part of businesses and consumers; that ensures robust regulation that reduces the likelihood of failures without preventing innovation; and that provides effective mechanisms for dealing with the failure of financial institutions should they occur.

I want to take steps to help consumers make better informed choices. To ensure that they are given access to free impartial financial advice, we will legislate to introduce a national money guidance service and impose a levy on the financial sector to help fund it. We will also legislate to consolidate Financial Services Authority resources to provide separate independent consumer education, setting up a lead provider of consumer information and personal finance education. Consumers will also get more protection, along with a greater right of redress and access to compensation if things go wrong. We will also improve arrangements for depositor protection, including legislation to pre-fund and expand the role of the Financial Services Compensation Scheme.

Because of the events of the past two years, there are fewer firms in the market providing financial services. It is essential that we retain competitive markets, as they play a key role in providing consumers with value and choice. We want to see greater competition and greater choice for consumers, as well as a bigger role for mutuals and building societies, so the Office of Fair Trading and the FSA will ensure that we maintain competition in the market for financial services. As we come out of this downturn, we need to promote a competitive market that enables new entrants—which may include non-banking institutions—and innovation to benefit consumers and businesses. In that way, we will see better informed consumers who have greater choices in a more competitive market.

We also need banks and financial institutions that are better managed. We need a change of culture in the banks and their boardrooms, with pay practices that are focused on long-term stability, not short-term profit. The FSA now has powers to penalise banks if their pay policies create unnecessary risk and are not focused on the long-term strength of their institutions. From now on, I will require the FSA to report every year on how financial institutions are complying with their new code of practice for remuneration, and how it will deal with firms that do not comply.

Bank boards and institutional investors must also become better equipped to do the job and understand their businesses, with more effective risk management and greater independence of non-executives, who must not be afraid to ask searching questions. Next week, Sir David Walker will report on measures that will deliver improved corporate governance at financial institutions, ahead of his final report in the autumn.

Building on reforms already made, my proposals today will strengthen regulation of the financial system. They will cover three areas: first, new regulatory powers to allow tougher regulation of individual firms; secondly, measures to deal with the potential failure of institutions that could have a significant impact on the economy; and thirdly, a strengthened framework for financial stability to deal with system-wide risks in today’s more complex and global markets. We will continue to work with other countries to deal with what is, at heart, a global problem.

I asked Lord Turner to make recommendations, which the FSA is now implementing, to strengthen the regulatory regime and increase the intensity of supervision. They will strengthen the rules to ensure that banks hold enough capital as a buffer against losses, to introduce a back-stop power ensuring that banks do not over-extend themselves by lending too much when they do not have the strength to do so, and to increase the focus on bank liquidity so that they are able to carry out their business at all times. Those measures will help ensure that financial firms are stronger, more resilient, and better able to serve the needs of our economy.

I will also introduce legislation in the autumn to give the FSA a new statutory objective for financial stability, and extend its powers to ensure that it has the appropriate rules to deal with different risks in individual banks, and tougher powers and penalties against misconduct, and that it can take account of new developments in the financial sector—including expanding regulation where necessary, for example for systemically important hedge funds.

We need to ensure our resolution regime can deal with financial institutions of all sizes, including banks that are very large or complex. As these banks are often global, we also need an international mechanism for resolving large multinational banks, and we will bring forward proposals to G20 Finance Ministers when they meet in London in the autumn.

At home, we can better deal with risks by ensuring that safeguards are in place—for example, by making banks hold capital at a higher level that reflects not only the possibility of failure, but its cost. By introducing higher standards and transparency, the FSA can also improve the functioning of key markets, such as the derivatives markets, so that problems in one institution are less likely to spread through the entire system. The FSA and the Bank of England will make institutions put in place practical resolution plans that can be deployed in the event that they get into difficulties.

There is, of course, a debate to be had about whether Governments should restrict the size of banks or separate different types of banking, as happened in the United States in the 1930s. I believe that that is a simplistic solution, which fails to take into account the complexity of today’s financial system. Small banks as well as large banks can threaten financial stability, as in the case of Northern Rock. Equally, both retail and investment banks, in different parts of the world, have failed in the past year, and it is not only banks that can affect stability, as we saw in the example of the American insurance company AIG. In addition, the approach of one regulator for one category of institution deemed to be systemically important and another regulator for the rest seems to me to miss the point, because what is systemically important can change rapidly, as we have seen in the past two years. Instead, the regulatory system has to recognise and respond to the complexities of individual institutions, and that is what we are doing.

We also need to strengthen the framework for financial stability. That is a question not only of institutional powers and responsibility, but of better understanding what is happening in the markets. No simple fixes—no institutional reform—could have prevented these problems from occurring. There are different institutional frameworks in countries across the world, but no one model has been successful in insulating a country from the current crisis. Although regulatory arrangements were not the cause of the current problems, we need the right institutions to maintain financial stability and we must ensure that they have the right tools to do the job.

The move in this country to a single regulator 12 years ago addressed problems with the previous regime of multiple self-regulators, which did not reflect the changing nature of financial markets, and our approach has been adopted by many other countries. However, 10 years on, the world had moved on again; some of the global problems of the past two years went beyond the scope of existing regulation, while others were simply not given sufficient attention by regulators and central banks. In this country, the authorities have been able, over the past year, to deal quickly and effectively with a number of financial stability issues, such as those relating to the Dunfermline building society and Bradford & Bingley, but further reform is now needed.

We will therefore legislate to set up a new council for financial stability, which will bring together the Bank of England, the FSA and the Treasury. It will not only deal with immediate issues, but will monitor system-wide financial stability and respond to long-term risks as they emerge. That needs to be done on a formal statutory basis. The council will draw on the expertise of the FSA and the Bank, which are and will remain independent of Government, by looking at their regular reports—the financial stability report and the financial risk outlook—and formally responding to their recommendations. In that way, when risks or threats to stability are identified they will be addressed. This body will do that in a way that is transparent and accountable—so that people can see how and why decisions are made—with the regular publication of minutes. The council’s responsibilities will be set out in law, with published terms of reference. In discussion with the Treasury Committee and the House, we will consider how to increase accountability through greater parliamentary scrutiny.

We have already taken significant steps to improve the way in which we monitor and manage risks to the financial system as a whole, through more systematic use of stress testing of financial institutions, for example. The proposals that I am making today will further strengthen our ability to identify and deal with systemic risks, and will ensure that the authorities can be held to account for their actions. We also need to consider what further counter-cyclical measures are needed, in order to allow us to lean against the credit cycle and prevent the build-up of risks that could threaten the stability of the financial system. The principle of leaning against the cycle is easy to agree, but deciding what action to take and when to take it is far more complex. At the moment, there is no clear consensus here or abroad, but I believe that central banks will have an important role to play in that area.

Today’s global market for finance means that new measures can be effective only if they are implemented on a broad international basis, so under our presidency of the G20 we will continue to press for measures to strengthen the international regulatory architecture, building on the proposals agreed in April. In Europe, too, we will argue for enhanced monitoring of system-wide risks, while retaining the crucial link between national regulators and Governments. By working internationally, our efforts can help us deliver more effective supervision of global banks, stronger international standards, and a more responsible global financial services sector.

We intervened to stabilise the banking system, while retaining a clear view that banks are best managed and owned commercially and not by the Government. We intend to return our stakes in the banks to the private sector, in a way that brings best value to the taxpayer, promotes competition and maintains stability, and we will use the proceeds to cut Government debt. We are empowering consumers, supporting better corporate governance and strengthening regulation, so that our financial sector can continue to be an engine of prosperity. I commend this statement to the House.

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I thank the Chancellor for his statement, although frankly almost all of it was splashed over the front pages of today’s newspapers. Once again, Parliament comes last, instead of coming first.

Of course, there are some elements of the White Paper that we welcome: the improved consumer advice; David Walker’s report on corporate governance, to which we look forward; a much better resolution regime for failed banks, which is clearly necessary; and the Chancellor’s remarks on pay and bonuses, although he could have set a better example with the pay and bonus package for the chief executive of RBS. However, in most part, this White Paper is a totally inadequate response to what has happened over the last two years.

For a start, the White Paper contains no serious analysis of what went wrong. I received a copy of it only 20 minutes ago, during Prime Minister’s questions, but the only admission that I can see of any responsibility for what happened is the sentence that states that

“the crisis has shown that aspects of prudential and macro-prudential supervision…were insufficient.”

That is the understatement of the century, given that half the British banking system has had to be nationalised. It also ducks every difficult question that needs to be addressed if we are to protect our society and our economy from a repeat of the mistakes that have caused such trouble. How do we replace the failed tripartite regime? What tools do we need to stop the excessive debt levels that did so much damage to our economy? How do we ensure that we have a banking system that competes across the world, and offers families and small businesses in this country the services that they are currently denied in this credit crunch, without the British taxpayer picking up the bill for the mistakes that are made? None of those difficult questions is properly addressed today; every single one is left to the next Government to deal with. It is more of a white flag than a White Paper—a complete surrender of this Government’s responsibility to fix the system for regulating the City that they created and which so spectacularly failed.

Let me press the Chancellor on some specifics on the conduct and content of regulation. First, on the tripartite regime, he must see how dysfunctional it has become. Institutional jealousies and blurred lines of responsibility mean that everyone gets involved but no one is in charge. Let us remember where this all began—with the arrogant decision from the new Chancellor in 1997, without warning or consultation, and in the teeth of the opposition of the late Eddie George, to remove banking supervision from the Bank of England. My right hon. Friend the Member for Hitchin and Harpenden (Mr. Lilley), the then Shadow Chancellor, warned from this Dispatch Box that it would leave no one responsible for the liquidity of the banking system or to guard against systemic collapse. Sadly, that prophecy turned out to be all too true. No one was responsible for liquidity. No one was looking at systemic risk. Even the FSA itself admits that it took its eye off prudential supervision. When the crunch came over Northern Rock, no one knew who was in charge. Almost two years later, we still do not know who is in charge. The Chancellor should have come here today to bury the tripartite system, not to praise it. The only thing that stops him is the vanity of the Prime Minister who refuses to admit that he made such a fundamental mistake.

The same applies to the content of regulation. The first half of Lord Turner’s report contains the most damning critique of what went wrong with this Government’s economic policy. He points to the “major and continued macro-imbalances” in the British economy. He says that the failure to spot this was

“one of the crucial failures of the years running up to the financial crisis”,

and he says that the

“vital activity of macro-prudential analysis...fell between two stools”.

What does this White Paper propose to do with that vital activity in future? It puts it between two stools again. After two years of thinking in the Treasury—wait for it—we are going to have a council on financial stability that will bring together the Treasury, the Bank of England and the FSA. I thought that that was what the tripartite regime was supposed to be about all along. We do not need another divided committee. We do not want more divided responsibilities. We need clear lines of accountability that run all the way to Threadneedle street. They do not exist at present.

Instead of clarity, what we get from the Government is confusion. The Governor of the Bank of England appeared before the Select Committee on the Treasury two weeks ago, and he said:

“We were given a statutory responsibility for financial stability in the Banking Act, and the question…to which I have not really received any adequate answer from anywhere, was: what exactly is it that people expect the Bank of England to do?”

We are none the wiser after this White Paper. Perhaps it would have helped if the Chancellor had shown the White Paper in draft to the Governor of the Bank of England two or three weeks ago instead of in recent days.

Is it not absolutely clear that the Bank of England now has to be given not just the responsibility but the tools for macro-prudential regulation? Can the Chancellor confirm that there is not a single new power for the Bank of England in the White Paper? The Bank of England should have the power to call time on debt, as we suggested almost a year ago; it should be able to set counter-cyclical capital rules in conjunction with other countries—and, by the way, that would be a much better use of international co-operation than the current proposals from the European Commission, which are ill conceived and damaging to the UK—and it should have the statutory powers to intervene when the structure of a financial institution threatens the whole economy, so that, in the Governor’s words, it can force its “sermons” to be listened to.

The Bank of England cannot do any of those things unless it has the experience and knowledge of their day-to-day regulation. Let me make it clear to the Chancellor today that the next Conservative Government will abolish the tripartite system, and let me tell Parliament first—unlike his policy—that we will put the Bank of England in charge of the prudential supervision of our banks, our building societies and our other significant financial institutions. We have learned from this crisis the old truth that one cannot separate central banking from the supervision of the financial system and that sound regulation is not just about a checklist of rules but about the authority to exercise judgment and to see the bigger picture.

Sitting alongside a stronger Bank of England we will have a powerful regulator to protect consumers—a regulator with the clout and focus not just to add more health warnings alongside the acres of small print that already come with financial products but to stamp out unfair practices such as mis-sold payment protection insurance and excessive bank charges. We will set out the details of that in our own alternative White Paper later this month. Will not the choice be clear then?

We have today a submission from the Labour party, which will be implemented in full only if it is re-elected, and proposals from the Conservative party. The Labour party wants to stick with the financial system that failed us, which it created. We propose to overhaul that system and put the Bank of England in charge. People will know at the next election that if they want to change the way in which the City and our banks are regulated, they need to change their Government.

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The hon. Gentleman seems to be trying to reduce this debate to a football match between the Bank of England and the FSA. It is not a matter of which institutions do what. It is about ensuring that the regulatory system delivers on making sure that it has tougher regulation. The hon. Gentleman argues that the Bank of England should take over the prudential supervision and regulation of what he calls important banks, building societies and insurance companies. That is not a power that the bank is seeking at the moment, but he is entitled to hold that view. I have said on many occasions that we can argue about where to draw the line as to who does supervision of banks, who does supervision of building societies and who does consumer protection, but the key issue is ensuring that regulators can do their jobs properly, that they have the tools to do their jobs and, crucially, that they bring to bear the right judgments whenever problems arise.

The hon. Gentleman will recall that, 10 years ago, one of the reasons why we ended self-regulation was that, quite simply, it did not work. He will recall, too, that in the past there had been criticism of the Bank’s regulation of BCCI and Barings. The fact that there have been mistakes in institutions is not a good reason for saying that we have to tear everything up. I believe that we should build on the strengths of the system that we have. It does not matter where we draw the line—when it comes to a crisis and to identifying problems in the future, we will need the Bank, the FSA and, because a cost will inevitably be involved, the Treasury at the same table.

I believe that the present system of co-ordination between the Bank, the FSA and the Government needs to be strengthened, reformed and put on a proper basis. Why do I say that? When the Bank of England next warns that there is a risk building up or that perhaps there is too much credit flowing, someone needs to react to it and to do something about it. That is why we have to have both the Bank and the FSA at the same table. That is why I believe that the arrangements between the three institutions need to be strengthened and that is why I am making these proposals.

I do not believe that what the hon. Gentleman is proposing—that one can somehow say that some institutions are systemic and some are not—would work. For example, three years ago people would not have argued that Bradford & Bingley, Northern Rock or the Dunfermline building society would have been of systemic importance to this country. However, the truth is that when they got into difficulties they were systemic. That was why we had to do something about them to stop the problems from spreading wider. I do not believe that the divisions that the hon. Gentleman is proposing are workable. I believe that the measures that we have at the moment need to be strengthened and improved to ensure that in future, when these warnings are seen, they can be dealt with and the people who are charged with the responsibility can be held to account.

I agree with the hon. Gentleman that this has international implications—I am grateful to him for recognising that—particularly if one wants to dampen down the availability of credit. In today’s globalised market, we cannot do that in one country alone. We need an international agreement and to ensure that people are working in the same way, and that is why international co-operation is very important.

Finally, I am very sorry that the hon. Gentleman did not get the document on time. I can assure him that I saw a man with both the document and the statement leave the Treasury shortly before half-past 11 this morning. I have no idea how the hon. Gentleman got the statement and not the document.

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I acknowledge that there are many things in the paper that can be welcomed—which, indeed, we have advocated in the past—but their implementation has a timeless quality, as if we are on a kind of progression from White Paper to Green Paper to blank paper. Almost all of the important recommendations would happen after the next general election. I know that a couple of weeks ago the Chancellor was advocating that banks prepare living wills; one rather gets the feeling that this is a living will for the Chancellor.

Having advocated macro-prudential regulation of bank reserves for five years or so, I very much welcome the Government’s embracing it. Surely it must be right, however, that in anything that requires an understanding of the overall economy the Bank of England must have a central role—not a unique role, but a central position. That is not clear from the statement.

I welcome, too, the strengthening of consumer protection. We have at last got to the idea of generic independent advice, but it has taken 10 years of campaigning by Citizens Advice and others to get there. I am not clear, however, about how the Government continue to preserve a fragmented system of consumer protection with responsibilities confusingly divided between the FSA and the Office of Fair Trading. Will that be clarified?

I welcome, too, the emphasis on competition. However, does the Chancellor buy the argument of the European Commissioner, Neelie Kroes, who said that, if we are to have real competition in British banking, banks must be broken up and subdivided, and in particular the Lloyds-HBOS merger might have to be unscrambled? Does the Chancellor agree?

The big issue, as the Chancellor rightly emphasised, is the major question about the banks that are too big to fail, too big to supervise and too big for the taxpayer to underwrite. He correctly said that small banks as well as big banks can go wrong—that is absolutely right—but is there not a fundamental problem that when very large interconnected banks try to be the biggest investment bank in the world, the exposure to the British taxpayer is then wholly unacceptable? Therefore, these banks have to be subdivided for that reason.

The Chancellor is looking over the distant horizon at necessary reforms, but may I suggest to him that key problems exist today? The publicly owned banks are not responding to the borrowing needs of sound British companies, and the bonus culture is being reinstated in publicly owned banks that are owned by the taxpayer. There is a complete lack of direction, and I suspect that a central reason for that is that the Government are so desperate to get the publicly owned banks back into the private sector quickly that too little attention is being given to defining the public interest.

I suspect that the White Paper will be received in the City with a great sigh of relief. It is yet another indication that we are getting back to business as usual.

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On the last point, I think that most hon. Members agree that we need to toughen up the regulatory system significantly. We need to make changes, but we must not lose sight of the fact that this is an industry that employs over 1 million people in this country, more than half of them outside the south-east of England. It is important that we do not give the impression that we would rather be shot of it, because it is quite important. In the past nine years, it has contributed more than £250 billion in tax revenues—quite a useful sum. When it recovers, I hope that it will continue to make a contribution in the future.

The hon. Gentleman asked about selling. If he looks at the White Paper he will see that we make it clear that we will sell when we think that the time is appropriate. We do not have an artificial time scale and we are not under any pressure to sell, but it will not have escaped his notice that just at the moment the shares in the two banks that we own are worth slightly less than we paid for them. He therefore need have no fear of being confronted with a quick sale: we will do what is right to achieve the best value for the taxpayer.

On lending, I agree with the hon. Gentleman that it is important to try to get credit flowing in the economy again. That is a key part of what we are doing. Mortgage lending and the availability of lending for mortgages have increased but more needs to be done in certain sectors of business lending, such as to small and medium-sized enterprises, and especially to the medium-sized ones. For example, I welcome today’s announcement by Prudential of a fund worth £1.5 billion specifically geared to medium-sized companies. That is an example of a non-bank bringing together pension funds, local authorities and its own funds to make money directly available to medium-sized firms, and it is a useful step in the right direction.

The hon. Gentleman made some broader points, and one of them had to do with the “too big to fail” argument. I understand where he is coming from, but I said in my statement that we must take into account the cost to the taxpayer as well as the wider effects of failure, and that we must regulate accordingly. However, there is a flaw in his argument—I heard him being asked about this on the “Today” programme at 10 past 7—and it is that he seems to back off from the consequences of telling a large bank that it is too big. In response to that, the bank might say, “We’re too big, so we’ll go somewhere else.” Alternatively, dividing such a bank into lots of different companies, as was the case with Lehman Brothers, does not solve the problem. When Lehman Brothers went down, the whole shooting match went down, not just one aspect of it.

The hon. Gentleman made a wider point about macro-prudential supervision. In my statement, I said that given what central banks do, and what the Bank of England in particular does, I anticipated that such supervision would have a wider role, as we work through the present circumstances. The Bank of England is the obvious place for it, but I come back to the point that I made to the shadow Chancellor: wherever the lines of responsibility are drawn, we need a regulator who is able to look at the wider prudential supervision of the system, and the wider financial stability. We also need a regulator who will drill down to the nuts and bolts of every single company.

Whether people like it or not, there is no country in the world whose treasury does not have to be at the table. We know all to clearly that either the law has to be changed or there is a fiscal cost, so three people have to sit around the table regardless of how the regulatory cake is divided. That is something that the shadow Chancellor will not face up to.

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rose

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Order. There are 23 Members seeking to catch my eye and, as ever, I would like to accommodate as many as I can. However, I am looking to each right hon. or hon. Member to ask one brief supplementary question—and of course to the Chancellor of the Exchequer to provide an economical reply.

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The Treasury Committee has made a detailed examination of the banking crisis. It found nothing wrong with the architecture of the tripartite authority, but a lot wrong with the warnings given by the Bank of England and the FSA, which were too weak. I therefore welcome and the establishment of the proposed council for financial stability. We need it to have strength and grit, and I am looking for reassurance from the Chancellor in that regard.

At the core of the matter is the restoration of trust and confidence. Will my right hon. Friend support the establishment of a banking commission, with a membership of lay people and not those representing narrow City interests? That would ensure that the future of the financial sector served the wider needs of society and individuals, and not just the City’s narrow needs.

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I am grateful to my right hon. Friend for his comments. I believe that the reforms that we are making to the relationship between the FSA, the Bank of England and the Treasury will make it much better. The relationship will be on a formal footing, with people able to see exactly what has been discussed and decided. When later questions arise about what happened in response to a particular warning or a concern that has been expressed, people will be able to see what was done. I think that that will make a big difference.

I agree with my right hon. Friend’s general point about ensuring that banking serves the wider community because, after all, financial services are a means to an end. Those wider questions need to be addressed, and I know that the Treasury Committee has looked at them. That is something that I would support.

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The Chancellor seems to have trebled the confusion over responsibility for financial stability by spreading it between the Bank of England, the FSA and the new council for financial stability. Will he explain what powers the new council will have? Page 138 of the White Paper seems to give it three new statutory duties just to discuss risk.

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The Bank of England has a statutory duty in relation to financial stability as well as monetary policy. The hon. Gentleman will know that the Banking Act 2009 gave it powers to deal with a bank that has failed. The FSA deals with the individual supervision of banks, and I announced today that it can now have different rules for different individual banks. That is quite an important change, especially with regard to the matters raised by the Liberal Democrat spokesman, the hon. Member for Twickenham (Dr. Cable). We have one body looking at the overall system, and one looking at the particular. They need to work together and, as I said, whether one likes it or not, the Treasury needs to be at the table because of the fiscal consequences of any action that might have to be taken.

The hon. Gentleman asks who is responsible for doing what, but that depends on what is required. It is obviously for the Bank of England to act on monetary policy, for the Treasury to act on fiscal policy, and for the FSA to deal with an individual regulatory requirement.

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I particularly welcome the proposals for stronger consumer protection, with an improved advice service and a stronger Financial Services Compensation Scheme. The FSCS has been the one organisation to come out of the crisis with real credit after a good performance. How does my right hon. Friend intend to strengthen it?

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We need to arrange that the FSCS is pre-funded. We say in the White Paper that that cannot be done immediately, and certainly not at the present time when so much is at stake. It will be better in the long term, however, if the FSCS is pre-funded, as then it will have money in the event that something goes wrong.

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Does the Chancellor recognise that the City of London has become the financial capital of the world—to the immense benefit of this country—partly because we have always had a system of prudential supervision that was strong, flexible, unified and not rigidly bureaucratic? As my hon. Friend the shadow Chancellor pointed out—and as was predicted by those on the Conservative Benches at the time—that was undermined by the tripartite system. Why, then, is the right hon. Gentleman handing power over to countries with financial systems that have been less successful than ours? Most of our partners on the continent have much more rigidly bureaucratic regulation of their financial systems. Is it not wrong to hand ultimate power over our system to them?

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As a general principle, I agree with the right hon. Gentleman’s last point. His thesis falls down, however, when one realises that the City of London’s reputation and size as a world financial centre have grown over the past 10 years, so his argument that it all somehow went wrong in 1997 does not seem to add up.

Where I probably do disagree with the right hon. Gentleman is that, although I believe that the relationship between national regulators and Governments is very important, we are talking about a global crisis. Part of the problem is that banks that trade across the world have got into trouble, and that needs more international co-operation. It also means that we need to work with Europe, and that is where the Conservative party is making a huge mistake. If it gets into bed with some weird and odd people in Europe, it will have no influence whatsoever over issues that do matter to the City of London.

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The Canadian banking system is pretty solid, with very large banks that are not divided between the retail and investment sectors. Canada has fewer banking regulations than the UK or USA, yet no Canadian bank has failed or been bailed out. Will my right hon. Friend say what lessons he has learned from the stability of the Canadian banking system?

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Over the years Canada has, in many ways, followed the model that we have been moving to, trying to streamline the regulatory system. I remind the House that 10 years ago there were eight or nine different regulators—self-regulating bodies—and also that the Bank of England never, ever regulated all financial institutions. It was frequently the case that a bank would be regulated by three or four different institutions. That made no sense whatsoever and the Canadians recognised that. Everyone should reflect on that.

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Does the Chancellor agree that there are two distinct roles to be carried out, one being the detailed supervision of the rules, best carried out by the FSA, and the other the overall financial strategic control of banks? If the latter role is to be carried out by the Bank of England, will he ensure that the Bank is properly resourced?

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I entirely agree. The hon. Gentleman has put very briefly the point that I was putting to the hon. Member for Sevenoaks (Mr. Fallon). Yes, of course the Bank needs to be resourced to do the job.

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Sir Fred Goodwin famously did not have a recognised banking qualification. Should chief executives be expected to have one?

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The FSA has a responsibility to make sure that people who are charged with running banks are qualified to do so. That was recognised by Lord Adair Turner’s report.

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A moment ago the Chancellor said—I pretty much quote—“I expect the Bank to have a wider role in all this.” Only a few days ago the Governor came before the Treasury Committee and said that he had not been consulted at all about the White Paper or even seen a draft. When did the Chancellor first show a draft of the document to the Governor of the Bank, and why did he not consult him fully earlier?

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I have had many discussions with the Governor of the Bank over the past couple of years about these things, and I will have many discussions with him in advance of the preparation of the White Paper. In particular, I have talked to him about the role of the Bank. If we further develop the powers that may be necessary to lean against credit cycles, I have made it clear that the Bank of England is the obvious place to go. However, the point that I was making is that currently the power to increase or reduce capital requirements, which is the most obvious brake one could put on financial institutions, lies with the FSA. I do not want to end up with a situation in which banks do not know whether the FSA governs their capital requirements, or the Bank of England does. The Bank does not want to regulate individual banking institutions and so on. People can hold different views about that, but I want to make sure there is a clear delineation of who is responsible for what, so that we can better hold people to account for what they do.

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With the international implications of the current marketplace, can the Chancellor tell us what discussions he had with international partners before arriving at the content of his statement today?

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I have, of course, spoken to all my counterparts on several occasions since these problems first arose at the end of 2007. It is interesting that most countries have more regulators than we do. Most of them are trying to streamline the regulatory system—in the United States, for example. Not everybody’s financial industry is in the same position or made up in the same way. What I think the industry and the public want is to make sure that we have a system that is coherent and that works. Above all, we must not lose sight of the fact that no matter what institution and no matter what rules, much of this is ultimately about individual judgment—making the right calls at the right time. That is the problem that occurred in the lead-up to the current situation and that is what we must get right.

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At the beginning of his statement the Chancellor mentioned the importance of competition. Does he accept that the shotgun marriage that he oversaw of Lloyds with HBOS was bad for competition, as well as proving to be a bad deal for both the shareholders and the taxpayer? Will he now do the honourable thing and oversee an amicable divorce?

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The shareholders of both Lloyds and HBOS voted overwhelmingly, separately, for the merger to take place. The process took about three months. I do not know how the hon. Gentleman describes “shotgun”, or whether he would regard a three-month engagement as being sufficient, but both parties were willing participants in the act and the shareholders of both voted to go along with it.

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Although there is no direct read-across to other sectors outside financial services, will my right hon. Friend bring his report to the attention of other regulators? It is important that lessons about systemic failure are learned where appropriate, and the FSA can learn from other regulators about how they have done things—for example, setting up better consumer panels.

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I know that regulators speak to each other where they have common interests or concerns, and I am sure they will do that. I have said specifically in the White Paper that the FSA and the OFT will work closely together in order to ensure that as we come through the downturn, we have a competitive banking system. Especially after the consolidation of foreign banks, it is important that we have choice and competition in the future.

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The remuneration package agreed for Mr. Stephen Hester at RBS is weighted towards the long term and has clawback provisions in the bonus. Is the Chancellor happy that that is an acceptable package, which reflects the kind of long-term measures for remuneration that he said should be put in place, or does he believe that that specific example would lead to different capital requirements?

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I am not against bonuses—I meant to take the point up with the hon. Member for Twickenham—in whatever walk of life, if one can reward people for doing something special or for making an extra effort, particularly if it is designed to build the long-term strength of the bank. In the case of RBS, where there is a new management running a bank with a balance sheet that is almost the size of this country’s wealth—on one view, it is the largest bank in the world—it is important that there is an incentive to help taxpayers get their money back.

The hon. Gentleman asks about penalising. It will be for the FSA to look at each case to ensure that there is a bonus structure or a reward structure generally, not just at the top, but throughout the entire system, that it is built for the long term, and that there is clawback—all the conditions that we set out—otherwise it will visit the appropriate penalties. People in banks must be focused on building their banks for the long term, otherwise we will be back exactly where we started.

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I welcome the White Paper, particularly the points made by my right hon. Friend about changing the financial culture of banks. It sounds, therefore, as though he might like to incorporate in future legislation an excellent Bill restricting the pensions of board members of banks that are wholly or partly owned by the taxpayer. Will he consider the matter?

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I know that my right hon. Friend had a Bill before the House, which she discussed with me. It is important that all parts of the remuneration—pay, bonuses or pensions—are based on reality and what is reasonable, and that they are geared all the time towards helping the bank or similar institution build for the long term, and do not leave it prone to taking short-term risks, which can prove so disastrous.

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May I remind the right hon. Gentleman that on 11 November 1997 I explained to the then Chancellor over eight columns of Hansard why the tripartite regulation of the banks would not work? May I warn the current Chancellor, with more brevity, that his proposals will not work either? May I modestly suggest that he look at my speech before proceeding to legislation?

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I will bear that in mind for my holiday reading over the summer. I have the vaguest recollection that I may have looked into the Chamber in the course of one of those columns and looked back out again. I remember those debates quite well.

As the hon. Gentleman knows, the problem that we had 10 years ago was that the Bank of England never regulated all aspects of financial services. It regulated the banks, but throughout the 1990s it was obvious that many banks had many other interests, such as insurance, that were regulated by other bodies. Such duplication and complication did no one any good. Indeed, the entire self-regulatory regime was pretty discredited by the mid-1990s. As I said to the shadow Chancellor, we can argue for ever and a day about where we draw the line. When the bank or the FSA is doing something, what matters, as the hon. Member for Gosport (Sir Peter Viggers) put it so succinctly, is that a distinction is made between the general supervision of the system, the financial stability, and an organisation that says to each individual, “This is what you should be doing”, drilling down into the nuts and bolts of it. The structure that we have is right. It needs to be strengthened and built on, and that is why I make my proposals today.

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Chapter 9 of “Reforming financial markets” touches on the future regulation of credit unions in Northern Ireland. Does the Chancellor accept that for change to work, the FSA will have to have a strong and active regional interface, which we have not had before? Does he accept that that applies equally to the wider banking market in Northern Ireland, which has very different features from the banking market on this island? If the future arrangements for industrial and provident societies are to work, can we afford to leave the savers of the Presbyterian Mutual Society as casualties by the wayside?

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I am aware of the problems relating to that society, and arrangements are being made to examine what happened and what might be done, but we have to be aware of the implications that there might be for institutions in other parts of the UK.

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Does the Chancellor agree with the Governor of the Bank of England’s assessment that it was not clear how the Bank would discharge its new responsibilities if it could not go beyond issuing sermons? Or did the Governor say that simply because the Chancellor had not shown him a copy of the paper that he brought to the House today?

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The proposals that I put before the House today mean that when the Bank sounds a warning or expresses concern through its financial stability report, there is now a mechanism to make sure that those recommendations do not just lie on a shelf, but have to be addressed and dealt with. That is a major step forward.

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As two of the main causes of the economic breakdown and the credit crunch were the mass-proliferation of toxic credit derivatives and the gross recklessness of the investment arms of the banks, does my right hon. Friend not think it necessary to prohibit, or at least require official approval of, potentially risky derivatives? Given the eye-watering cost of bailing out the banks, how can he justify continuing to give state underpinning to the casino investment banks, rather than limiting that underpinning to the traditional commercial banks?

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On the latter point, the answer is quite simply that investment banks are systemically important, as we have seen in this country and in America. As we saw in America prior to the banking collapse in October, simply letting them go has potentially disastrous consequences. Indeed, it was the collapse of some of those American banks that immediately precipitated the problems. On the wider point, banks need to be properly regulated, but if my right hon. Friend is getting to a point where he can say that there should be some sort of veto from the regulators, I would say to him that that might be more difficult. It is better to have a system that regulates risk within institutions, rather than one that is wider than that.

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I have no doubt that the measures that the Chancellor announced today are worthy of our careful consideration, but the bottom line in reality for many of our constituents is that medium and small businesses are still not gaining the help that is necessary to make them sustainable and profitable. Will the measures assist in getting money to where it is needed?

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The need to get lending going—particularly for small and medium-sized enterprises, but for others, too—is urgent. Measures are already in place to try to ensure that that happens. I know that concerns are being expressed in the different parts of the country and different sectors where that is not happening sufficiently. That is why I welcome the announcement today by Prudential that it intends to lend to medium-sized companies. The SME sector is of particular concern, simply because of its size and the number of people whom it employs, not just in Northern Ireland but in the rest of the country, too. We have to step up our efforts to make sure that we get that lending going.

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I apologise for missing the Chancellor’s first few remarks in his statement. May I compliment him on resisting the seductive structural arguments coming from the Opposition parties, both with regard to splitting up the activities of banks and with regard to doing away with the tripartite system, a move recommended so strongly by the Opposition? Does he not share my surprise at the ease with which a few kind words from the Governor of the Bank of England have persuaded the shadow Chancellor to hand back to the Bank those responsibilities that it previously discharged with such abysmal incompetence, and more? Does the Chancellor not agree with me that the likely consequence of doing what the shadow Chancellor proposes will be that we end up with not just bad regulation, but probably a ruined monetary policy system, too?

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I take the view that I have held consistently for the past 10 years. It was right to give the Bank independence to deal with monetary policy. That will stay; I do not think that anyone wants to reopen that decision. It is right, because of its responsibilities, that it should have a view on financial stability. When it comes to the whole question of macro-prudential supervision, if one were to give more powers, the Bank would be the obvious place to go. I honestly do not see the advantages of saying that the Bank should also start to involve itself with the hundreds of different banks, building societies, insurance companies and other financial institutions, because all that that would do is simply move a large chunk of the Financial Services Authority into the Bank, and I do not think that that institutional change would benefit people at present. I would rather build on what we have, and identify the problems that we have.

I repeat a point that cannot be made often enough: institutions are important, and so are the tools to do the job, but at the end of the day, we are talking about a matter of judgment. Frankly, yes, the FSA got things wrong with Northern Rock, and the Bank of England, in the ’80s and ’90s, made mistakes of judgment. We have to concentrate on trying to make sure not only that we have the institutions and the tools, but that people understand what they are doing.

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What caveats and terms and conditions did the Chancellor attach to the provision of the vast sums of public money that were used to bail out our failing banks? Did the banks comply, and if they did not, what sanctions did he put in place?

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I am not sure whether the hon. Lady was present at the many debates and statements that we have had on that subject, but earlier this year, I set out at some length—I think on a number of occasions—the measures being put in place. The hon. Member for Louth and Horncastle (Sir Peter Tapsell), who recommended reading Hansard over the summer, has left the Chamber, but if I am to read his speech, she might want to look at some of mine.

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I thank the Chancellor for advance notice of the statement. I welcome the fact that he spoke of systemic risk, and the fact that there is a chapter in the document about derivatives markets. However, in essence, the four points are simply to call for an EU directive, to work towards “a roadmap delivering…improvements”, to support “international efforts” and to support “the principle of greater transparency”. When will we have real plans to deal with that aspect of systemic risk? When will the markets have access to proper pre-trade and post-trade information, and when will the markets have access to proper, secure pricing data? When will the analysts have all the information that they need properly to identify the risks that such products pose?

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The hon. Gentleman makes a very fair point. We need an open, transparent market, so that people can see what is going on with their derivative products. We can fix some of those issues in this country, through FSA requirements, but some of them need European agreement because they are governed by directives, whether we like it or not. Given the relationship with the United States and the interrelationship with the markets, there are other wider international implications, too. However, on the general proposition that we ought to have more openness, so that people can see what is going on, and crucially so that perhaps some of the people running the banks know what is going on, the more that that happens, the better it will be.

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On that point, there is an overriding need for clarity and certainty in financial regulation, so why are the Government apparently contemplating handing over many of the rule-making and supervisory functions to three new EU financial authorities, so that instead of a tripartite system at home, we have a new hexagonal system of financial regulation, with a bigger hole in the middle, less certainty, less accountability, and more confusion when things go wrong? Is that really what the Government intend?

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No, but we need to recognise—I was going to say “whether the right hon. Gentleman likes it or not”, but I know that he does not—that Europe and the European Union have some influence on the way in which financial markets operate, in relation to directives, capital ratios and so on. The point that I made to the right hon. Member for Hitchin and Harpenden (Mr. Lilley) was that the British Government have to work to fight for the British interest. That is why it is far better if one is able to work with the mainstream political parties, rather than people who are out to lunch.

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The Chancellor made no mention of the credit rating agencies, but they are the canaries of risk in the system and they got it spectacularly wrong in the previous crisis. Is he looking at providing any guidance or a framework for credit rating agencies and, in particular, at tackling the potential conflict that exists because the entities that are assessed pay the agencies’ fees?

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The hon. Lady is right. The Financial Stability Board, which the International Monetary Fund set up, is looking at the issue, because credit rating agencies are mostly American and they operate throughout the world. We have to have international agreement, and in Europe steps are being taken rather more quickly to try to ensure that agencies are properly regulated. She is right that they can be hugely influential, but I have always made the point that a credit rating agency’s advice should be one factor influencing people’s decisions. It should not comprise their total judgment, because it cannot.

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Does the Chancellor accept that his statement, “whether we like it or not”, in relation to the European Union is rubbish and as outrageous as anything we have heard from him for months? Will he accept, very simply, that we can make our own decisions in this House; that those matters do affect every single man, woman and child in this country, and the City of London; and that, for us simply to have to accept that all decisions must come from the jurisdiction of the European Union, to which the so-called national supervision will be subject, is a complete outrage that will lead to all the difficulties, all over again, that we saw with the stability and growth pact and all the other economic paradigms with which the European Union has come forward? His statement is complete rubbish. He knows it. Why does he not just pack it in?

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I know that the hon. Gentleman is obsessed with all things European, and I wonder how he and quite a large number of his colleagues are ever going to be able to make a rational decision about anything in relation to Europe—[Interruption.]

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Order. The hon. Gentleman has asked a question of the Chancellor, who is replying.

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All I say to the hon. Gentleman is that we are part of the European Union, which is an important market to us, and that that means that we should be an active partner in it, fighting the British corner. It means also that we have to be prepared to speak to people in Europe, rather than pretend that they do not exist.