It might be for the convenience of the House to know that I have imposed, on account of the level of interest in this subject, a six-minute limit on each individual Back-Bench contribution, such limit to take effect when the mover of the motion has completed his speech. I would add also for the benefit of the House that I have selected neither of the amendments on the Order Paper.
I beg to move,
That this House, concerned that no action has so far been taken which would prevent a recurrence of the financial crash, calls upon the Government to establish a clearing house for approval of all financial derivatives and to set in place alternative mechanisms to remove the implicit taxpayer guarantee, other than to purely deposit-taking banks, in the event of any future banking collapse.
The motion is on the Order Paper through the good offices of the Backbench Business Committee, and I take this opportunity to congratulate the Committee and its Chair on the way in which, in my view, they have already opened up Parliament to valuable new procedures and paved the way for important debates that might otherwise not have happened. I hope and believe that this might be one of them.
I begin with the words of the managing director of the International Monetary Fund, Dominic Strauss-Kahn, who a few weeks ago told Stern magazine that he thinks a second financial crisis is almost inevitable given the paucity of reform and the vulnerability of the financial system, and that next time round it may well be impossible to persuade taxpayers to fund bail-outs. I do not believe that is an exaggeration, and the latest travails of the eurozone serve only to underline those fears.
It is worth noting that we in the UK have more bank lending as a proportion of our gross domestic product than even the Irish—some £7 trillion, which is five times our GDP. If we are to prevent a repetition of the financial crash, it is clear that its causes must be identified and dealt with by appropriate means. I argue that those causes, in the main, include: an over-lax monetary policy that encouraged an excessive leveraging culture; extreme light-touch regulation that left too much to the markets; the development of a vast global market in credit derivatives, which were not well understood, and which Warren Buffet, the world’s second richest man, notably described as
“financial weapons of mass destruction”;
the role of enormous bonuses, which drove recklessness; a banking structure so over-concentrated in the lead banks that when disaster struck, they were judged to be too big to fail, with catastrophic consequences, as all hon. Members well know, for national debt and the budget deficit; and a banking model that linked speculative investment with retail deposit taking, both of which were protected by an implicit taxpayer guarantee. I hope that that description is accepted on both sides of the House.
All those causes need to be dealt with, and yet none has been. Given the limited time, of which I am very conscious, I want to concentrate on the most important. First, financial derivatives are a perennial candidate for causing the next crisis, because they add opacity and leveraging to the financial system. Credit default swaps, a £65 trillion market, and collateralised debt obligations, which are one of the most common derivatives, urgently need regulation.
I will give way to the right hon. Gentleman, but having heard what Mr Speaker said, I am reluctant to take more interventions, precisely because this is a very short debate—only three hours—and many wish to speak. We already have a six-minute limit, and I have too often been at the back of the queue, unsuccessfully waiting to be called at the end.
I am grateful to the right hon. Gentleman, and I shall refrain from intervening at great length for the very reason he gave. Will he explain to the House why over the past decade the UK banking regulator allowed the huge expansion of balance-sheet risks of all kinds, and why it did not demand more cash and capital?
I mentioned light-touch regulation in the City of London, which we have had since the Thatcher era and through the Blair era. I believe that that needs to end. We want not excessive but adequate and proper regulation, and for the past three decades, in the so-called neo-liberal era, we have not had it.
Derivatives should be approved by the regulatory authority before they can be issued. At that stage, they can be either prohibited or accepted, perhaps with certain conditions attached. The key point is that transparency is essential. It is worth noting that the recent Dodd-Frank Wall Street Reform and Consumer Protection Act seeks to achieve that by requiring that all derivatives are traded on public exchanges.
Linked to that is the role—or perhaps the scandal—of the credit rating agencies in allocating a spurious status to some highly dubious securities. Light-touch regulation in this country has evaporated into virtual deregulation. Credit rating agencies were paid by the very institutions whose credit worthiness they were supposed to be assessing. By granting the highest rating, as they so often did, they made it easier for the banks that were securitising and further repackaging debt to create the greatest possible number of securities with the lowest possible regulatory cost. That practice should never have happened, and I believe that it should always be prohibited where there is a serious conflict of interest, as there was in that case.
The hon. Gentleman makes a good point of which we need to take account, but I still think that the credit rating agencies potentially have an important role. They are listened to in the market, are the basis on which financial transactions take place, and should be trusted, but in the present circumstances they are certainly not. However, I am grateful for his question.
On bonuses, there is outrage among not just Opposition Members but, for example, right-wing Governments in Germany, France and Sweden, that a banking system that owes its continued existence to massive Government intervention should pay itself mega salaries and bonuses entirely out of line with the top of business, let alone ordinary taxpayers. There is outrage especially because those gigantic bonuses often drove the recklessness in the first place. The overweening power of the banks attracts almost universal hostility, especially given that 90% of investment bank profits, in an era of austerity, are directed not at strengthening balance sheets, at shareholders through dividends, at customers through lower fees or at taxpayers, but at bonuses.
France, among several others, has demanded a mandatory cap and that there should be no guaranteeing of bonuses, but Whitehall, as usual of course, argues that it would not be practical. However, if the G20 Governments insisted on limits and made continued liquidity provisions dependent on compliance, no bank could refuse. I believe that Her Majesty’s Government should now be taking the lead in the G20 not in succumbing to lobbying from the City of London and the British Bankers Association, but in reining back bonuses on a much greater scale than we have so far seen, and to much lower levels, and in ensuring that they be paid only in exceptional circumstances.
On the broader question of averting future financial crises, attention has so far largely focused on enhancing capital control, but that does not actually have a good record in this regard. At the outset of this latest crisis, virtually all financial institutions across the globe had capital adequacy of between one and two times the minimum Basel regulatory requirements—at least at that level, and in some cases twice as much. Basel III, which has just reached its provisional conclusions, is scarcely any improvement. The core top-tier capital requirement is only 4.5%, and the contingency capital requirement is only 2.5%. Of the EU’s top-50 banks, 45 already meet that standard, and Basel III is actually proposing that the requirement not be introduced until 2019. This is simply nowhere near good enough. A much better possibility might be counter-cyclical capital controls, enforcing different levels of bank capital at different stages in the economic cycle. I can see the point of that, but I suspect that it would leave open the problem of the degree of ratchet and the timing of it. I suspect that that would be far too problematic.
An alternative approach—many have talked about this—is the introduction in Britain of something like the Volcker rule, restricting banks from undertaking certain kinds of speculative trading, notably proprietary trading. Of course that would certainly stop banks doing what they are doing at the moment, which is trading on their own books with the money of depositors. The key point, however, is that it would not overcome the too big to fail problem when applied to investment banks. For example, I do not think it would prevent a repetition of the collapse of Lehman Brothers; neither would it address the interconnectedness—the Chancellor was speaking about this a few moments ago—of today’s banks, with counter-party relationships and exposure between commercial and investment banks, and insurance companies. That is the problem. I say this with regret, but any rule-based reform is almost certain to face the risk of regulatory arbitrage, because financial institutions invent ever more sophisticated products that are simply aimed at getting around regulatory controls. I therefore do not think that what I have described is an adequate answer. For all those reasons, the force of argument and the balance of advantage point strongly towards separating retail from investment banks, in establishing distinct, narrow banks that are conservative, transparent institutions with no financial instruments or incomprehensible balance sheets.
I am grateful to the right hon. Gentleman. On that point, does he agree that the Government have done the right thing by creating the Vickers review? The review will examine, in depth and carefully, without rushing a reform, whether structural reform of the banks is required, and will give us guidance on how to protect ourselves from the too big to fail problem.
I entirely agree with that, and I was just about to make the same point myself. I hope I can also take the hon. Gentleman with me when I say that Parliament should have the opportunity to express its views to the Vickers commission before it reports, rather than simply making comments when its work is virtually a fait accompli. Indeed, that is one of the purposes of this debate.
The key advantage claimed for the model that I am describing is that it would remove the implicit taxpayer guarantee—that is, the capacity of the financial conglomerates to use retail deposits, which are implicitly guaranteed by Government, as collateral for proprietary trading; or, as the Treasury Committee put it, I think rather nicely, banks playing
“at a high-stakes casino table with…taxpayers’ chips.”
I have a lot of respect for this model, but the crux of it is that the withdrawal of the taxpayer guarantee would be a sufficient deterrent to prevent investment banks from engaging in highly risky investments that might collapse, with serious and far-reaching consequences for the national economy. The real question—which I do not think enough people have asked—is whether that is likely to be true. The fact is that if a financial institution outside the protected narrow banking boundary threatened systemic contagion, it is difficult to believe that the Government would not attempt some form of bail-out. I therefore have to say, regrettably, that I doubt whether the narrow banking model could, by itself alone, be relied on to overcome the problem of moral hazard and too big to fail.
Does that mean that there is no solution to the too big to fail problem? Not necessarily. There is an alternative to narrow banking as a means of preventing a bank from gambling away other people’s money, which is the recent Kotlikoff proposal in the US. It is a proposal that deserves serious consideration—consideration that I hope the Vickers commission will give it. In the US context, it is proposed that all financial companies become pass-through mutual funds. They would have a 100% equity ratio, to ensure bank solvency, and the payments function of banks would be performed by cash funds that would be 100% reserve—for example, through Treasury bonds. Such banks could, of course, still initiate new mortgages and new loans, but these would not be funded through deposit accounts until they had been sold to a mutual fund. The key point is that the bank would never hold them; in other words, the bank would never have an open position. Banks would not own assets—apart, of course, from their offices and so on—and they would not then be in a position to fail or trigger a bank run. That is a significant proposal.
For those—and there are plenty of them—who want to take greater risks beyond a cash-based mutual fund, there are already hundreds of investment avenues that would continue to be available, such as foreign exchange, derivatives, real estate, hedge funds and all the rest. The key difference with this limited-purpose banking would be that any failure in such investments would be incurred by the investor, not by the bank. That is the crucial point. There would be no problem with the banks being too big to fail or trying to insure the uninsurable risk of financial contagion. Critically, there would be no future claims on the taxpayer.
This reform would overcome a critical market failure without the need for any vast new complex regulation. I say that for the benefit of those on the Government Benches. It is, in effect, a market solution. It is true that it would not necessarily prevent asset bubbles—I do not think that anything can do that, certainly not in this area—but under limited-purpose banking, such bubbles would not threaten the entire financial system. Anyway, there would be nothing to preclude some form of macro-prudential authority from having oversight in this area. I think that that would be a very good idea.
I am not suggesting that this reform would be a panacea, because I do not believe that a panacea exists in this area. It should, however, be thoroughly investigated by the Vickers commission and, I hope, by the Government. I do not think it is an exaggeration to say that at present Britain has the most profoundly dysfunctional banking system of any G7 country. It came nearer to collapse than any other in the autumn of 2008. I believe that we need to break up the mega-banks, with their addiction to mortgage lending. We need smaller banks and, in particular, specialist business banks such as infrastructure banks, housing banks, green banks, creative industries banks and knowledge economy banks. Only that kind of fundamental reform of the banking system, involving all the elements that I have described, can provide the foundation for the economic and social transformation of this country that we all want. I commend the motion to the house.
I congratulate the right hon. Member for Oldham West and Royton (Mr Meacher) on securing this debate. He made some important, and actually rather sensible, points and gave a powerful critique of the status quo from a position on the left. However, as a free marketeer, I have to disagree with him. I believe that we need a free-market critique of the status quo, but the centre-right has failed to think critically about the status quo for too long. The right hon. Gentleman has therefore done us a great service by forcing Conservative Members to ask the questions that for years we have failed even to ponder. We are in this mess not because of an absence of the free market but because we do not have a proper system of free-market banking. It was not the markets that caused the banking mess that we are in; the markets called time on other people’s unsustainable folly. They called time on an unsustainable credit boom and on the folly and stupidity of central bankers.
Banking is undoubtedly corporatist. To put it another way, if one were to read Ayn Rand’s “Atlas Shrugged” and to replace the words “railroad” and “rail company” with the words “credit” and “bank”, one would get a pretty good description of what has been going on in recent years. We have had a failure of the free market in the allocation of credit in this country. It is extraordinary that we compound that failure by talking ourselves into seriously suggesting that politicians and technocrats should ration credit. The absence of a pricing mechanism at the heart of the banking system is ultimately what caused the credit boom and the banking failure. In a normal market, when demand for a product increases, the price for that product goes up. That, in turn, stimulates supply.
In banking, unfortunately, things are a little different. When demand for credit increases, the price—the interest rate—is kept low or constant. Pricing does not therefore stimulate increased supply. On the contrary, a supply of additional credit is not met through higher savings. It is met by the creation of candyfloss credit—by banks being able to conjure up credit out of thin air. Banks do not meet the additional supply of credit by encouraging more people to save; on the contrary, they continue to lend IOUs on the basis of IOUs on the basis of IOUs. At the height of the credit crunch, for every pound deposited in a bank, IOUs had been written out some 44 times through the miracle of fractional reserve banking.
Banks have a legal privilege to conjure up credit out of nothing that ultimately stems from their ability—this is an extraordinary fact—to call a depositor’s deposit their own, to treat it legally as if it were their own, and to lend against it many times. It is that practice that has resulted in a credit pyramid and runaway credit booms, unrestrained by the pricing mechanism that would normally apply and would normally restrain demand and supply. The demand is unrestrained, the supply is unrestrained, and the price is low. The result is Ponzi credit bubbles. An incredibly distortive and disruptive effect is created every 20 or 30 years in supposedly free-market economies that have corporatist banking at their heart, and it leads to sugar-rush booms.
If a whisky distiller sold empty bottles or a food manufacturer sold empty food packets, they would be done for selling thin air, yet banks are essentially allowed to sell empty IOU promises—and people dare to call that the basis of the credit system that fuels capitalism. No wonder capitalism appears to be at risk. We have a crony system of corporate capitalism rather than free- market banking.
Since the credit crunch, experts in orthodoxy have talked about three different solutions, the first of which is low interest rates. We have had pretty low interest rates, and do you know what? It has not really stimulated an increase in the supply of credit. That should not surprise us. Keeping prices low does not stimulate production. Secondly, people have printed more money: big government has shored up a big corporatist banking pyramid on the back of the real wealth creators. It is a system of indirect taxation, inflation and debauching the currency. Thirdly, people have talked about breaking up the banks.
I disagree with all those proposed solutions, but I take issue particularly with the idea of breaking up the banks. I think that instead of crude institutional separation of the banking system, we need an alternative that allows legal separation within existing banking structures. We need a new legal status for deposits, so that a depositor who opens an account can choose to ensure that his deposits are legally his property, and the bank cannot endlessly lend against them. That would not abolish fractional reserve banking, but it would allow us to decide over a long period, organically, whether we needed to move away from the banking system that we have at present, which allows endless candyfloss credit to be manufactured.
Banks do need reform, but I do not believe that they need more controls. We need to address fundamental flaws in the banking system, but in a way that ensures that the pricing mechanism allocates the supply of credit properly. We need less from central banks and fewer controls from central bankers, not more.
It is a pleasure to be able to contribute to this important debate. I thank my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) for having the good sense to persuade the Backbench Business Committee to secure it. It is also a pleasure to follow the hon. Member for Clacton (Mr Carswell). I agreed with some of his remarks, particularly the one about breaking up the banks.
When I was preparing for the debate, I had occasion—and a little more time than I expected, owing to my difficult journey from Scotland to London today—to examine an excellent study of the banking crisis by three major economists in a book entitled “Balancing the Banks”, by Mathias Dewatripont, Jean-Charles Rochet and Jean Tirole. Jean Tirole’s chapter in particular details, in very precise order, the reasons for the crisis and makes several points. First, it deals with the crisis in United States home loans, which spread to other sectors and other countries. The staggering expansion in the level of securitisation partly explains the difficulties that the US banks got into. Between 1995 and 2006 the proportion of loans that were securitised rose from 30% to 80%, and the proportion of sub-prime loans that were securitised increased from 46% in 2001 to 81% in 2006. Jean Tirole also points out the lack of high-quality collateral backing many of these loans, which particularly came to our attention when the inter-bank bond and derivatives markets simply froze up. Added to that, excessive liquidity fed the demand for securitisation. As my right hon. Friend the Member for Oldham West and Royton pointed out, monetary policy was also very loose, particularly in the United States, and the performance of credit rating agencies hardly covered them in glory.
Another important point in understanding what went wrong is the failure of international regulation of the banks. For example, the level of off-balance-sheet liquidity support increased hugely, especially in America. There has also been a need to rediscover what prudential regulation of the banking system should be about. It should be about, first and foremost, protecting small depositors and investors, but also containing the domino effects of systemic risk.
We should therefore welcome some of the recommendations of the Basel Committee on Banking Supervision. The key failure of Basel II was its reliance on pro-cyclical capital controls, and one of the Basel III reforms we should welcome is the introduction of counter-cyclical buffers. I think it is also true to say that Basel II was too complex. It was based on a pillar structure that was both difficult to understand and unable to anticipate systemic risks to the banking system or, indeed, manage financial innovation. As my right hon. Friend pointed out, it was unable to predict the chaos that credit default swaps and collateralised debt obligations would create throughout the world. There needs, therefore, to be an increase in the capital and liquidity banks should hold.
I disagree, although only slightly, with my right hon. Friend in one respect, however. Basel III does introduce a powerful counter-cyclical element of up to 2.5%, which may be significant in preventing future problems. There is also a balance to be struck.
The hon. Gentleman raises an interesting point. I was about to make the point that Basel III strikes a balance between protecting the taxpayer and the state and promoting economic growth. I understand the banks have been lobbying to try to diminish some of the effects of holding extra capital. Indeed, when I met a representative from Lloyds Banking Group in Glasgow on Friday, he lobbied me to take that position.
What we have witnessed is a crisis that began in the housing and asset price markets in America. It spread to other countries and to the banks of other countries, and it has now also spread to the state. It is important that the taxpayer can see that there are buffers to prevent the state from having to bail out banks across the globe. Having a counter-cyclical element should help achieve that.
The Government should continue the work the previous Government did in pursuing the issue of getting a global deal on bankers’ bonuses. If they do not, or if they are unable to achieve a global deal, the UK and the EU should be prepared to take a lead in giving greater transparency and reducing some of the terrible incentives to sharp practices in the last decade.
Across the world, we are seeing the terrible effects of a credit crunch causing a banking crisis, in turn causing a deficit crisis and then a growth crisis. In the coming months and years, we need to put in place a policy that sorts out the system for good. We need a policy that learns the lessons from the crisis and ensures the taxpayer never has to foot a huge bill for the terrible behaviour of a greedy few.
I thank the right hon. Member for Oldham West and Royton (Mr Meacher) for securing this debate, which is a valuable one to be having in the House. I draw the attention of hon. Members to my entry in the Register of Members’ Financial Interest, which is a legacy of my spending 18 years in the banking industry. Before Labour Members get a bit too excited by that revelation, as many have unfortunately done in the past, I should say that for the past three or four years I felt that the profession of banker was possibly the worst to have in the eyes of the public, but that was before I became a Member of this illustrious House.
The motion states that we want to
“prevent a recurrence of the financial crash”.
Obviously we are all united on that, but it is important that we examine the causes of the crash, which we could debate for a long time and go round in circles. I am sure that many rational people will disagree on the responsibilities of banks and bankers. I may have misunderstood the motion, but it seems to suggest that banks are entirely responsible for the financial crash. That is wrong and it does not do justice to Members of this House or to our constituents in preventing something like this from happening again.
The financial crash happened because too much money was chasing too few assets—financial assets or real assets such as real estate. There are three principal reasons for that, the first of which was that world financial reserves, particularly in the east, were growing at a substantial rate. Indeed, they continue to do so, as more people in the west consume goods from the east. To give just one illustration, China’s financial reserves in 1990 were $165 billion but today they are $2.65 trillion. Those reserves needed to find a home.
The second reason is that commodity prices have grown substantially, partly as a result of the growth of the east and other emerging markets, and that has led to a substantial increase in sovereign wealth funds, both in the middle east and in other markets. Those funds also needed to find a home, and they created a colossal wall of money when combined with the financial reserves.
The third reason is something that bankers have called the “Greenspan put”. Alan Greenspan became chairman of the Federal Reserve in 1987, just before the Wall street crash, and one of the first things he did when he found a problem in the financial markets and a potential crisis brewing was to lower interest rates as quickly and as substantially as he could. That happened again when the US Federal Reserve led the way after the dotcom bubble burst in 1991, again when Russia had problems and there were problems in Asia, and it has just happened again. Bankers have got used to that approach and it results in what the markets call a “put”, whereby they feel they can sell assets if things go wrong. That has encouraged bad behaviour and a moral hazard: the idea among many bankers of “heads we win, tails the taxpayers lose.”
In addressing these issues, we must not forget those key facts about what caused the crisis. However, bankers did play a significant role and there are things about banks that we need to examine. Although there are issues to address in respect of financial derivatives, I would not make that the key priority. The first thing to examine is the idea of retail banks and commercial investment banks acting as one entity, because that seriously needs to be looked at.
I started working in the banking industry in New York in 1992. Under the Glass-Steagall Act, which was in place at the time, the bank I worked for had to have a completely arm’s length relationship with its retail banking division. That made a big difference to the risks the bank took or even contemplated taking. That situation changed in the late 1980s in Britain, when the big bang took place and the implied Glass-Steagall arrangement disappeared, and it formally changed in the United States in 1999 when that Act was removed. It is vital to examine that. The second thing to look at is, as has been mentioned, banking capital itself.
There are some considerable merits in that model and given what has happened we should consider it seriously. I hope that the Vickers commission does that.
Secondly, we should consider the banks’ capital requirements. It is right that under Basel III capital requirements should be lifted. The core tier 1 capital requirement will be lifted from about 2% for banks to about 7%. Some points are still missed, however. The focus is far too narrowly on the default risk of assets and we have strange incidences even with default risk—for example, under the new proposals industrialised sovereigns are still considered to be risk free. As we speak, Ireland’s 10-year Government bonds are trading at more than 11%, Spain’s 10-year bonds are trading at more than 6% and Germany’s are trading at more than 2.5%, but they are all treated as zero-risk weighted and no risk capital will be set aside. No account is taken of liquidity, either. One of the largest problems for banks over the past three or four years was lack of liquidity, but the capital requirements do not take full account of that.
One of the biggest mistakes that made Britain’s situation far worse than that of other countries was the change in regulation when Tony Blair’s Government first took office. The jobs of people at the Bank of England, who knew what they were doing, were taken over by people at the Financial Services Authority, who did not know what they were doing. I remember an FSA audit where the chief auditor of my credit derivatives book, which had a market value of more than €100 billion, was a 27-year-old with a degree in biology. It is no wonder that problems started to happen. We do not necessarily need more regulation, just smarter regulation.
There are many issues to consider that we could debate for a long time. Banking regulation is one such issue, but we do no service to our constituents if we merely focus narrowly on it when we consider the lessons of the financial crisis.
I compliment the hon. Member for Bromsgrove (Sajid Javid) on a thoughtful speech. At one point, I disagreed with him and at other points I found myself very pleased with the sentiments that he expressed. The Backbench Business Committee deserves congratulation for tabling the motion and I hope we will have more opportunities to discuss the subject in Government time. We must reach consensus if we are to get this right.
I worry, particularly against the background of what is happening in Ireland, that we are going too slowly. There was an argument in the beginning that we should not do things in haste and that was sensible, but three years on from the time Northern Rock went down we should be starting to implement some of the measures, not merely discussing them. I know that there is an international context, but on the domestic front we should be further forward than we are.
The Government’s amendment mentions matters such as “regulatory architecture” and “prudential regulation”, both of which are part of the package that is going through the Select Committee on the Treasury and that will eventually come to the Floor of the House. I am not sure that they alone will matter. Basel III, according to the Governor of the Bank of England, “won’t prevent another crisis”. I think that is fair.
So, Basel III, regulatory architecture and prudential regulation are what the Government initially—certainly in this low-key debate—are putting forward as important. They are secondary to an acceptance by those who are in the banks and who own the banks of the fact that they need regulating and that they should share the objectives of the regulators. Sadly, in the past three years I have not seen any signs that that has been accepted at a senior level in the banks. If we were to look for one person, organisation or thing that started or caused the crisis, we would be wrong, but central to it were the banks’ securitisation exercises and adventures, which paralysed the whole financial structure and the wholesale markets. They must be accepted as a major part of where we are now and of what we have gone through.
The last bank bail-out—for the Royal Bank of Scotland, Lloyds TSB and HBOS—cost £37 billion and we were told that there would be conditions on staff bonuses, but nothing has happened in the past three years. Does the hon. Gentleman agree that one of the things that annoys people the most is the bonuses that go to staff members when the banks are not doing their job?
The hon. Gentleman makes a very powerful point which links with a point I was about to make. I have described the regulatory structure. There are differences between regulators throughout the western world, but the fact that they were all caught out shows that structure is secondary and that changes to structure alone will not prevent another crisis. We have all been affected despite those different structures, so one cannot attack regulatory structures or see them as a salvation. I regard such restructuring as simply rebuilding the Maginot line: it shows the public that we are doing something, that we are hard at work and that there is something concrete, but when it comes to effectiveness, it would suffer from the same deficiencies as the original Maginot line, so I do not think that structure matters.
If the banks, the bankers and their shareholders do not accept that they have to change their practices then what do we have? We have no regret from the banks and no acceptance that they played a part in events. Let us consider their behaviour over bonuses.
Let me finish my point and I certainly will. The behaviour of the banks over bonuses at the senior level is obscene and offensive to every one of our constituents. At a meeting on Saturday morning, I spoke to someone whose wife works for Halifax. She is going to lose her job. If one speaks to people in every part of the community one finds that they are looking forward to 2011 with great worry and concern because more than 100,000 of them are going to lose their job in the public services alone.
Excuse me for a second. Given the amount of money that the state has pumped into the banks to rescue them, it is unacceptable that bankers and senior bankers still, at this stage in the game, demand obscene bonuses at levels that many people could never think of earning even when they have worked all their life. That shows a state of mind that is not exactly right. We hear that if all that does not work, Bob Diamond will take business away from the UK. What on earth is the point of spending time building up a regulatory structure if that is the attitude? For safety, I join the hon. Member for Bromsgrove (Sajid Javid) in thinking that Glass-Steagall is a good alternative, but unfortunately for us both, as we move in that direction the Governor of the Bank of England seems to be moving in the opposite direction. We can never pin that man down, can we? I think that is the direction we should go in.
In the minute that remains, I shall explain the reasons other than safety why I support a move in that direction. I know that this might mark me out as old-fashioned, but I want the retail banks to go back to the fine role that they have historically played in financing individuals and small and medium-sized enterprises. That was their function and they did it very well, but that has been lost because the emphasis has shifted to the investment side of banking. If we are talking about rebalancing the economy, the engine for growth must be the banks. If we can get them to move across to their old role and let the investors go off and play their casino games, our real interests will be satisfied because we will get people in the financial world to focus on the productive side of the economy.
It is always a great pleasure to speak after the hon. Member for Leeds East (Mr Mudie), who is a colleague on the Treasury Committee. He always talks a lot of sense and has explained clearly how frustrated people in Britain feel about bankers’ bonuses.
I am amazed at the wording of the motion. To suggest that no action has been taken so far to prevent a recurrence of the financial crash is quite bizarre.
To give a cautious answer, I think there was an element of both.
Last week, I had a meeting with senior bankers and the chief counsel of one bank. They certainly have the sense that the world has changed dramatically for them since the financial crash. As we would expect, both internal and external forces have combined to change things significantly. Tier 1 capital ratios are already significantly higher—from the 2% core at the time of the crisis to about 7% now, which is after all what Basel III will require. Leverage is significantly lower, at an average of 20 times, from about 38 times pre-crash—a considerable change. Many banks welcome the existing proposals to establish a clearing house for over-the-counter derivatives.
According to Hector Sants, the Financial Services Authority has quadrupled the extent of its regulatory investigations. He has even made comments about how afraid banks should be of him. The Bank of England special liquidity scheme still provides about £130 billion of liquidity to banks, enabling them to switch illiquid but good assets for Government bills. All those things are important changes, and they are only a few of the steps taken so far.
Still to come, in 2011 and 2012, are the new regulatory structures in the UK and Europe that will radically improve regulatory accountability. Instead of the FSA looking to the Bank of England and the Treasury for solutions—as in the case of Northern Rock—we will in future have a far stronger Bank of England. It will not just have responsibility for monetary policy and as lender of last resort; the Governor will also be ultimately responsible for individual bank supervisions and, critically, through the Financial Policy Committee, for the overall health of the financial system.
To speak of no action is completely wrong, but that is not to say that a lot more could not be done. It certainly could, and especially about two things: accountability and competition. Specifically, the competition issue worries me at all levels of banking. If we go back to Adam Smith and “The Wealth of Nations”, we see that to have successful free enterprise, we must have free entry and free exit for market players, but looking over the past 20 years, we see that consolidation in banking and the increasing costs of regulation have helped to create an industry where there are huge barriers to entry.
Absolutely. I was about to make exactly that point. Not only have there been far too few new entrants, we have seen only recently that banks are unable to fail; we cannot risk allowing a bank to fail, as the situation in Ireland has highlighted yet again. Regulation has trumped competition for too long.
It is not simply a matter of being too big to fail. Some of the biggest continuing concerns are about the medium-sized banking sector in the States and in Germany. The same mistakes must never happen again. We need to look to where the next crisis will come. It is absolutely key to introduce more competition and more accountability, and I would consider three areas.
I should not look to split retail and investment banking, which are artificial barriers. They may have worked in the 1920s and 1930s, but now they are too big a grey area. We simply could not do it. Bankers would just find clever ways to get round such measures.
I declare an interest. I have been in banking even longer than my hon. Friend the Member for Bromsgrove (Sajid Javid), as I have been in investment banking and funds management for 23 years. I assure the House that I have seen from all ends how clever bankers are when they want to get round something.
To address competition in the retail and mortgage markets, I would consider ways to let account numbers follow the consumer—one of the biggest barriers to moving an account, as we probably all know. I should love to know how many Members in the Chamber have changed their bank account or mortgage account recently. It is a huge headache. If we let the account number follow the consumer, that would immediately create far greater competition and far greater choice and availability of moving. It could also remove barriers to entry.
Secondly, to address competition in wholesale markets, I would consider giving the new Consumer Protection and Markets Authority a specific competition objective, which would mean that one of its roles would be as a specialist competition commission—not just the Office of Fair Trading, but a specialist commission—that would consider whether, in a particular sector or in a particular geographic region, a bank had a monopolistic or oligopolistic market share. It ought to have a statutory ability then to enforce its recommendations.
Does my hon. Friend agree that the role of regulators in promoting and sustaining competition in the UK financial services market has been greatly complicated by the decision of the previous Administration to allow the merger of Lloyds and HBOS, and to waive all competition criteria which would normally have been applied to such a merger?
That is absolutely right. We are certainly in a worse position than we were pre-crisis in terms of a lack of competition and massive market share. The five top players in the UK dominate the mortgage market, the retail market and much of the wholesale market.
The third thing I would do is ensure proper pricing of bank risk. That is where one of the fundamental problems has been. Credit ratings agencies are culpable in their own activities, and banks are culpable in following the lead of credit ratings agencies and not bothering to do their own proper credit analysis. Part of that I put down to the fact that it has been far too easy for professionals and retail investors simply to buy bank debt and equities, without bothering to do their own analysis because there has been an implicit Government guarantee. The credit ratings agencies have automatically made them all double A or triple A, so it seemed like a no-brainer.
Unfortunately, there has been no downside, and something must be done to change that radically to ensure that there is a downside to investing in bank risk. Measures such as living wills, and subordinating bond-holders to depositors and equity owners, are ways to ensure that in future it is not the taxpayer who pays for banks’ mistakes.
Finally, if competition and accountability are to be the revolution in financial services for the future, it is essential—going back to what the hon. Member for Leeds East, my colleague on the Treasury Committee, was saying—that bank directors take some responsibility. Directors who break a bank should be fired, without bonuses, pay or early pension, and if criminal negligence can be shown, the ultimate penalty of prison should not be ruled out. Accountability is key.
I, too, congratulate my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on initiating this important debate. I welcome the fact that we are conducting it in a reasonably non-partisan way. I have listened with interest to the comments of my fellow Treasury Committee members, and the last three contributors in particular. Although I do not agree with everything that has been said, there is much common ground.
My general approach is that we should not set out to destroy the City. It makes a valuable contribution to our economy, not least to the tax take of the Exchequer. I spent much of my legal career working there and I know that a number of other Members present also worked there for some time. The important thing is that we reform the City so that it is run in the interests of all the British people, not in the interests of a few people in the square mile, as often seems to happen. Above all, let us reform it so that never again do any of our constituents have to pick up the tab for the mess in the sector.
We should be clear. All major political parties and Governments across the world bear responsibility for allowing what happened to develop. Let us face it: the consensus pre-crash was for a light-touch model of regulation. However, we should not forget—this is where I differ from some other Members—that it was ultimately the bankers who were to blame. Now we have to resolve what happened.
I disagree with the motion in that it suggests that nothing much has happened. I am glad to hear that other Members disagree with that. Let us look back to the G20 in April 2009 and recall what was achieved there, following the leadership demonstrated by the former Prime Minister. I remember him being ridiculed as he went around the world trying to galvanise consensus on a set of outcomes, but the summit produced outcomes that have been built upon. Three come to mind. First, the leaders resolved to establish the Financial Stability Board, the successor to the Financial Stability Forum, and as a consequence the world has a standing body of Finance Ministers, regulators and central bankers, which seeks to provide early warnings of financial risks and has a greater mandate to promote financial stability globally.
Secondly, the leaders who attended the summit took concerted action to improve the quality and quantity of capital in the banking system, and I endorse the comments of the hon. Member for South Northamptonshire (Andrea Leadsom), one of my Treasury Committee colleagues, because what came out of it—with the FSB and the Basel Committee on Banking Supervision working together —helped to produce more stringent capital adequacy requirements and the minimum equity requirement will go up to 7%. Perhaps it is regrettable that that will not happen until 2019, and perhaps it could be sped up, but it has definitely made a difference.
Thirdly, the leaders resolved to endorse and implement new principles on remuneration, and, as a result, in the March Budget the former Government put in place the apparatus within which a remuneration disclosure scheme could be enacted.
Does the hon. Gentleman agree that, if there is greater transparency on bonuses, the threatened diaspora of bankers will be nothing more than hot air?
The apparatus would help to introduce greater transparency on bonuses, because if we want to do something about reckless remuneration we need to know about it. I speak to many people in the City, and, although some of course disagree with the measure, many accept that it needs to be introduced. Action was taken, but some measures are still outstanding.
I am going to make progress, because I do not have much time.
I welcome the introduction of the independent banking commission, which the new Government were right to set up. Without pre-empting the commission, I firmly believe that we should separate retail from investment banking. There is some consensus on that, but it is a question of degree.
I am afraid I am going to continue.
Do we go for the Dodd-Frank model, which has just been implemented in the United States, or the Glass-Steagall model, which was in place from the 1930s until recently? Mervyn King has moved a little on the issue. At the Treasury Committee last week, he was very clear that he would not give his view on it until the Vickers commission reports, but Lord Turner doubts that it is possible to separate proprietary trading from commercial banking. That is why I am sympathetic to the Glass-Steagall model, but I am happy to see what the banking commission comes forward with.
I shall conclude by considering some wider issues. I should like two key outcomes from the reforms currently being implemented. First, to pick up on the comments of my hon. Friend the Member for Leeds East (Mr Mudie), we need to return to the notion of our banks as a utility. They are a utility and should be treated as such, because they are absolutely essential to our everyday lives. We have lost sight of their purpose, because we have a allowed a big, shadow banking structure to evolve while 1.75 million adults on lower incomes do not have access to basic banking services. I should like us to introduce a universal banking obligation, so that everybody has access to such services. It is a great shame that the Government have decided to do away with their commitment in the coalition agreement to introduce a people’s bank through the Post Office, because that would have been very good.
Secondly, I agree with the hon. Member for South Northamptonshire that we need greater diversity in the sector. It is dominated by a few major players, and there has been only one start-up entrant in the market, Metro bank, since 2008. In particular, I should like serious consideration to be given to breathing life into the mutuals sector. Why do we not seriously consider remutualising Northern Rock and Bradford and Bingley, as opposed to privatising them, so that we increase the diversity of providers in the sector for our constituents?
There is no magic bullet when it comes to reforming financial regulation. The previous Government made a good start; it is absolutely crucial that the coalition Government build on that.
It is a pleasure to follow the well-crafted speech of the hon. Member for Streatham (Mr Umunna). I, like him, welcome the chance to debate this important issue. I must preface my remarks by declaring, in the interests of transparency, that I too used to work in the industry. I worked on both sides of the regulatory fence—as a regulator in policy and supervision roles, and in the insurance and banking sector—prior to entering the House.
The depth of anger felt by our constituents is very much underestimated in the City and in Canary Wharf. Constituents might hear the technical jargon that is often used in such debates, but they are not confused by what went on: they know that senior bankers made big mistakes yet kept their massive payments; they are incredulous that the banks have returned so quickly to paying bonuses, as the hon. Member for Leeds East (Mr Mudie) said; and they are frustrated that the rhetoric of reassurance from the banks is so often at odds with their own experience as customers, particularly when it comes to the fair treatment of customers.
As my hon. Friend the Member for South Northamptonshire (Andrea Leadsom) pointed out, the motion is—dare I say it—poorly drafted when it states that “no action” has taken place. Indeed, the hon. Member for Streatham endorsed that view from the other side of the House. There has been a flurry of regulatory initiatives, such as more intensive supervision by the Financial Services Authority following its admission of regulatory failure over Northern Rock; and on derivatives, which the motion mentions, the capital requirements directive will subject contracts that are not cleared through a funding house to higher capital requirements. So, action is taking place. Likewise, the Government’s amendment rightly focuses on structure and, indeed, prudential policy, but it is silent on the key issue on which I shall concentrate: enforcement against individuals in banks.
Before doing so, I must say that so far the debate has been silent on the short-termism fostered by the pension fund management, and in particular on the pressure that that puts on chief executives, who risk being fired if they do not add shareholder value. In banks, people fear missing the targets set by their chief executive more than they fear the regulator.
Is not one of the serious issues with bonuses, and the point that my hon. Friend makes, that there emerged a kind of cool option, whereby bankers could receive a bonus but never lose out? Should the system not be reformed, so that bankers are able not only to receive a bonus, but to incur a loss? That would align them more with the return on whatever their bank is up to.
My hon. Friend is absolutely correct, and I shall come on to consider the quantum of fines that have been imposed, because it makes very strongly the point that he makes.
On the regulatory structure, I am sure that my hon. Friend the Financial Secretary to the Treasury will talk about the changes that the Government are rightly making, because we need to be clear who is in charge in the event of failure. The tripartite system did not make that clear. However, I am sure that he, like the previous Chancellor in his White Paper, accepts that there is no single institutional model to insulate us from a future crisis.
The Government are also right to focus on prudential policy, but I caution against a reliance on policy itself, because we need only look at how often it has changed. We are already on Basel III, Solvency II and MiFID II —the markets in financial instruments directive—and the next debate is on commission in the retail sector, which has been debated for many years.
To give a specific example of the flaws in new policy, let me direct the House to “best execution”—one of the features of MiFID that required banks to shop around to obtain the best price. It will not surprise Members to discover that when banks shopped around they happened to find, in accordance with their written policy, that the best possible price just happened to be the one offered by their investment banking arm. Notwithstanding, therefore, the limits of new structures and policy, I believe a clearing house for derivatives would be a welcome step and a key component in addressing opaque financial instruments, such as securitisations, which stopped people obtaining the required visibility in respect of bank balance sheets and which was central to stopping banks lending to each other. Alan Greenspan’s claim that derivatives efficiently dispersed risk throughout the financial system ignored the concentration of risk in individual firms. We need only look at AIG to see the effect of that sort of concentration of credit risk.
A perhaps more technical point is that clearing houses should be more consistently valuing collatoralisation requirements across all banks. The reason for that is the different requirements that apply to UK and German banks, for example, in terms of their capital standards and liquidity requirements.
The most glaring issue that needs to be addressed is that of enforcement—in particular, the lack of transparency that goes to the heart of the sense among constituents that people have had a one-way bet. That was the point to which my hon. Friend the Member for Dover (Charlie Elphicke) alluded. To give an example, the failure of enforcement and the lack of a taxpayer’s guarantee has been material, particularly now that investment banks are not partnerships; I do not think that many partnerships would have leveraged their capital up to 40 times, as many of the banks did. Put simply, the alignment of interest between shareholders who provide the capital and employees who allocate it is not as strong as was historically the case. That is one of the features of a shadow banking system in which the banks had no long-term interest in the securitisations that they structured and underwrote. We would not allow such a thing with an aviation or pharmaceuticals company; they could not design and profit from products that they expected to fail, as Goldman Sachs did with the Abacus deal.
In the final minute allocated to me, I turn to the quantum of fines. To put the matter in context, no fine has been imposed on any senior executive at HBOS, HSBC, Barclays, Lloyds or Royal Bank of Scotland. The biggest three fines, applied to Northern Rock, amount to less than £1 million—that is, less than the chief exec earned as a bonus the year before. The fines were subject to 20% and 30% discounts as a result of early settlement and on the grounds of hardship. For that reason, our constituents feel that no one has been held accountable. They have seen people walk away with the profits without being held accountable for the things that went wrong. As the Minister looks at the structure and policy, we also need to learn the lessons of why enforcement against individuals has failed.
I begin by congratulating the Backbench Business Committee and my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on securing this debate, which has been illuminating and measured. I join the hon. Member for North East Cambridgeshire (Stephen Barclay) on the important point that he made at the beginning of his speech: in the City, there has been a lack of recognition of the depth of anger among many of our constituents. The hon. Gentleman is right about that, and I hope that this debate can start to set that issue right in some way.
I want to make three swift remarks. My first is about the tripartite arrangements. I want to take the House back in time. I well remember when interest rates were set by politicians. In many ways, our tripartite arrangements have been a success. As economists predicted before the change, Bank of England independence aligned to inflation targets has allowed an independence, a clarity, a robustness and a rule-based approach. It is important to recognise that. We have been discussing a lot, and people have rightly raised, some issues to do with the failures of regulation, but we need to recognise why we changed to the tripartite arrangements and consider the importance of that change in 1997.
However, today I want to suggest that we cannot just question and consider regulation, important though that is; we need to look for a change of culture in the financial services sector as well. Many people have already recognised the imbalance in respect of the major role that financial services play in our economy, but I do not think that that imbalance is mainly regional—it is not a case of London and the south-east versus the rest of the UK at all. We know of the importance of banking in Scotland, and in my own area of Merseyside, many people work in the financial services sector or in organisations that contract to it. In 2007, such activity amounted to 14% of PAYE and 27% of corporation tax.
I want to make the point that the impact of the sector is not just that regulation might help or hinder small business; as we have all seen, it also has a massive impact on public services. Getting right the structure, regulation and culture of the sector is one of the most important jobs that we have to do.
I turn to the importance of the changes that we all want. First, on regulation, the issue is about not just capital requirements but the work that Basel III might—and must—do on liquidity requirements. In many ways, the credit crunch is misdescribed; it should be described as a “liquidity crunch”. The question that we need to ask of all banks relates to their access to liquidity as much as to capital.
Whoever has the supervisory powers, whether the Bank of England or the Financial Services Authority, it is important to determine what those macro-prudential powers actually are. Furthermore, we must have a credible means, transparent and understood by all, of dealing with failed banks. A process needs to be in place. People have mentioned living wills. We need to make sure that what happens with failed banks is understood by all, so that the risks lie with shareholders and people within the system rather than with an implicit taxpayer guarantee. We will see that as the place that we are trying to get to.
Finally, I leave the House with this thought. If we are to understand the crisis that we went through in 2008-09, we must realise that it was not merely a crisis of regulation. The commission on banking reform that the Government rightly set up should listen to the Chartered Institute of Bankers in Scotland. It has warned Sir John Vickers that new regulation will fail if it is not combined with
“a firm commitment to embedding a culture of high ethical, professional and technical standards amongst bankers throughout the industry”.
That point is really important. Those of us who see the importance of the financial services sector want a change in its culture as much as a change of regulation. That has to be about high ethical standards.
In conclusion, I hope that the measured nature and thoughtfulness of this debate will send a message to all about the seriousness in which we hold these reforms.
Thank you, Mr Deputy Speaker, for letting me catch your eye in this debate; this is a little different from the last time that I spoke. I remind you, Mr Deputy Speaker, that it is not the size of the dog, but the size of the fight in the dog that decides who wins.
This is an important debate because we need a vibrant, strong and confident banking sector if we are to see the essential growth that all hon. Members desire for our economy. Before we look to the future, it is important that we should address the problems of the past, including the very recent past.
Many Labour Members seem to be keen simply to bash the bankers and blame them for the financial crisis and recession rather than look at the causal and contributory parts played by their own former Treasury Front Benchers, including the former Chancellor and Prime Minister, the right hon. Member for Kirkcaldy and Cowdenbeath (Mr Brown). He has much to answer for, and I wish that he were in the Chamber more often so that he could do so.
In fairness to many hon. Members who have spoken from both sides of the House, I should say that there has been a recognition that although the crisis was not 100% the fault of the bankers, they bear a huge part of the responsibility. As I said when I spoke, I think that before the crash there was a consensus around the world that tended towards a light-touch regulatory regime. That is something for which everybody, on both sides of the House and in legislatures throughout the western world, has to take responsibility. That has been acknowledged in the Chamber. Will the hon. Gentleman acknowledge that that sentiment has been expressed during this debate?
The hon. Gentleman makes that point, but the previous Government encouraged and took part in an orgy of credit: in fact, they led it, and invited individuals and corporations to join in, safe in the knowledge that the former Prime Minister said that he had ended boom and bust, which now sounds as ridiculous as King Canute claiming he could turn back the tide. The taxpayer now has the hangover from that 10-year orgy of credit.
Under the former Prime Minister’s watch, the Bank of England deliberately stoked a consumer boom that led to spiralling house price inflation and massive levels of personal debt. This is not just my opinion, but that of the previous Governor of the Bank of England, the late Lord George, who said of that period:
“We knew that we were having to stimulate consumer spending. We knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.”
That approach led to 20% house price inflation when the consumer prices index was running at 2%, led to financial institutions such as Northern Rock offering 120% mortgages, and ultimately led to a run on a British bank and the financial crisis of 2007. Opposition Members might blame America, global markets, or even the fact that we are not in the euro, as ridiculous as that sounds, but this misguided belief, and the hubris of the previous Prime Minister in believing that he had ended boom and bust, helped to contribute to the banking collapse. It is fascinating that the shadow Home Secretary—or perhaps I should say the shadow shadow Chancellor—stated that the cause of the deficit was not the previous Government’s borrowing, but rather the collapse of tax revenues. He failed to recognise that tax revenues based on rapid house inflation and excessive consumer credit are totally unsustainable.
The failure of the previous Prime Minister’s regulatory regime also contributed to the problem. It was clear in the early part of the decade that the UK had an unsustainable consumer credit funding gap: the IMF said so, as did the previous Governor of the Bank of England. The power to regulate had been transferred from the Bank of England to the Financial Services Authority and the Treasury, with an inadequate definition of roles and responsibilities. It was an absolute disaster, as was shown at the height of the Northern Rock crash, when Mervyn King was asked, “Who is in control?” and his answer was, “That depends on how you define ‘in control’.” The answer was that nobody was in control, and no one could see who was in control. One cannot have a third of a problem—one wants all of the problem or none of it. That was part of the difficulty.
So where do we go from here? I am a firm believer in sound money. A sustainable banking system is one where lending policies are closely in sync with the projected economic activity of the people it serves, not driving them.
Does the hon. Gentleman recall, as I do, that the previous Conservative Government left the country with a deficit of 3.4% which was going towards ongoing spending, unlike the debt in 2008, which accorded with the “borrow to invest” rule? In relation to sound money, what does he think about that?
I thank the hon. Lady for her point. She, like me, was not in this place at that time. I was in business running a corporation. I fixed the roof while the sun was shining, and I put my company into net credit three months before the banking crash happened.
We need a Government—and a regulator—who do not deliberately go to sleep at the wheel for political advantage, as the previous Government did. We must never let a bubble like the one that built up under the previous Government build up again. Our plan for growth depends on a sensible and sustainable banking system alongside more powerful incentives from Government. We must never return to the bubble that ended in the financial crisis and allowed banks to lend unsustainably under a tick-box regulatory system and a short-termist, feckless Government concerned more with political advantage than with the long-term interests of the country. In short, we need to look at creating a body that is solely in charge of financial stability and has responsibility for macro-economic supervision.
It would be tempting to go into some detail on derivatives. Indeed, I have written a public paper about what should happen with over-the-counter derivatives, but suffice it to say that, for the purposes of this debate, I wholeheartedly support the proposal put forward by my right hon. Friend the Member for Oldham West and Royton (Mr Meacher), which is part of the solution. The concept that all derivatives could be exchanged in the way that he proposes creates complexity and is unsustainable, but the idea that there should not be large-scale clearing house involvement is of great importance.
The opaqueness of the current situation spreads beyond the financial institutions into the largest corporations, which represent about 7% of a market that is specifically concentrated on this country. That is part of the meat of the issue, and it surrounds the financial crisis that we and the rest of the world faced. Very little attention has been given to this in recent times, or at any time since the financial crisis, but the principle must be one of transparency. Otherwise, we get insider trading—the sharing of information. Whether it is done legally because laws are not strong enough or illegally, there is an imperative towards insider trading because it is so lucrative. This opaqueness is fundamental to the problems that we have had, and we have seen it in other sectors such as insurance.
That opaqueness, together with huge bonuses—however they are described by the industry—will lead to people making unsubstantiated claims and reckless gambles. If they have no personal liability—in other words, if they are gambling with other people’s money—which is precisely the problem we had in the run-up to the financial crisis, then there is no comeback, and banks can go out of business. We have seen that with the biggest banks, including Lehman Brothers. One day, the executives are seen scuttling out with their files, and the next day—or perhaps a year or two later—they are coming back into the financial world with more huge salaries and huge bonuses: ever onwards, ever upwards. That is the mentality that underpinned the crisis.
It is not only I or my right hon. Friend the Member for Oldham West and Royton who have this problem but the head of the stock exchange, who said to the Treasury Committee, in relation to the lack of clearing houses and the risks involved, that we are potentially sowing the seeds of the next financial crisis. The conflict between the stock exchange, and others who backed it, and the Government needs to get greater public exposure because it is fundamental to the Government’s weakness in failing to understand that instead of short-term remedies, the creation of transparency is fundamental to the solutions we need.
There were three major problems in the financial crisis. First, we have heard about people living beyond their means—well, the people who were living way beyond their means in this case were those in the financial institutions. That was not properly recognised at the time, or properly regulated. They were borrowing money against something they did not have—a hope, an expectation, a guess for the future, presuming that it would come right in the end—and of course they were personally incentivised so to do.
Secondly, there is off shoring. We have not done enough in this House—I am critical of the previous Government in this respect, as well as the current one—to deal with the British dependencies that are fundamental to the opaqueness of off-shoring. We can do a significant amount about that.
Thirdly, the big investment banks are ferociously competitive in some areas and form an oligarchy in others. They allow no real competition and dominate with their excessive fees and powers. If we get on top of that, the House and the Government—whichever party is in power —will be able to avert future financial crises. If we fail to do so, the next crisis, whether it is in the short or medium term, could hit us just as ferociously as the last.
I rise to speak against the motion, not least because of the argument made by my hon. Friend the Member for South Northamptonshire (Andrea Leadsom) that implicit in the motion is the suggestion that the Government have done nothing to avert a future banking crisis. I also believe that the motion is too prescriptive at a time when these matters are being considered in detail, not least through the Sir John Vickers commission. This Government set up the commission and released its issues paper as recently as last September.
Huge complexity, tensions, conflicts and dangers are inherent in the development and implementation of policies that are designed to stabilise the banks. Many hon. Members have spoken about banks being too big to fail. It is true that if we have banks that are too big to fail, there is moral hazard in the actions of those who run them, because they always know that the taxpayer is there to back them up if necessary. In such situations, there is an element of unfair competition in that larger banks, backed by the taxpayer, can afford to take larger risks. However, we are also told by many in the industry that size is a function of competitive advantage and that being big is important in global markets.
Many hon. Members have rightly mentioned capital asset ratios. It is important that banks strengthen their balance sheets and that Basel III is implemented, yet there are inherent dangers even in that. PricewaterhouseCoopers has estimated that the implementation of Basel III in the UK will result in £600 billion put into increased capitalisation, which could in turn reduce growth by between 1 and 2%. I therefore welcome the fact that Basel III will not come into full effect until about nine years’ time.
That is precisely my point. If we speed up the rate at which the banks have to recapitalise, there is a real danger that we will choke off the supply of lending. There is an argument that lending is not just about supply, but about demand. Companies are not taking up many existing bank overdraft facilities, so it is conceivable that there is an issue with demand, as well as with supply.
We have heard a great deal about the importance of united global action. In an internationally competitive world, there is such a thing as regulatory arbitrage. If one jurisdiction adopts a particularly light approach to regulation, vast sums of money can flow in that direction. However, as the Chancellor of the Exchequer has pointed out, our country needs to retain flexibility to reflect the particular conditions in our banking markets.
I agree with many of the comments on the importance of transparency in corporate pay, and in particular bonuses. I accept that because banks can ultimately turn to the state and the taxpayer for support, we have a right to take an interest in that matter and to see that fair dealing prevails. However, I concur with Sir David Walker’s recommendation that we should act in a united way globally so that we do not disadvantage countries that might move on their own.
We have heard very little about taxation on banks. I congratulate the Government on being the first to introduce a permanent tax on banks. However, the arguments about taking out capital that banks might otherwise lend also pertain to that measure. We want the banks to lend more, but the picture is not clear as to why they are not lending, as I alluded to in response to my hon. Friend the Member for West Suffolk (Matthew Hancock). It may not be just a lack of supply owing to recapitalisation and a greater aversion to risk among the banks, but to do with a lack of demand among companies, many of which are focusing on paying down debt, rather than taking on more.
My hon. Friend the Member for Orpington (Joseph Johnson) and the hon. Member for Bassetlaw (John Mann) mentioned competition. This country has a highly concentrated banking sector and it became more concentrated after the financial crisis, when some foreign lenders withdrew and some banks amalgamated. Lloyds and RBS make up 50% of lending to the retail, mortgage and small and medium-sized enterprises sectors. That is a huge degree of concentration. There are high barriers to entry to banking, not least the very regulation that we are discussing. Over the past century, the only new high street bank, disregarding demutualisations, has been Metro Bank, which was created last year. On the other hand, Australia and Canada have highly concentrated banking sectors and seem to have been spared the worst of the financial crisis.
I welcome the Government’s approach to Basel III and their setting up of the Financial Policy Committee, along with its oversight role in relation to the Bank of England and the Financial Services Authority. I particularly welcome the setting up of the Independent Commission on Banking under Sir John Vickers, which has been welcomed broadly by business, including in a recent speech by Richard Lambert, the director general of the CBI. I welcome some of the approaches that the Government are taking to encourage equity finance to increase above the current level of 1 or 2%.
I fear that stalking the perimeters of the debate on the Government side and perhaps at the heart of the debate on the Opposition side is the idea of bashing bankers and of revenge. The hon. Member for Streatham (Mr Umunna), who I think is no longer in the Chamber, denied that that was what he said. However, when he was speaking, I jotted down his reference to bankers being “to blame”. That is the kind of populism that we must get away from; emotionalism must not triumph over the rational when we consider such issues.
This is a highly important sector in which we have a world-leading position and we must retain that. Protectionism, trade imbalances and exchange rates are threats, but I argue that we must not lose momentum on banking reform, particularly in countries that have not been as swept up in the crisis as we have, for what has bitten us may yet come round to bite them.
I speak not as somebody who has a banking background, but as somebody who represents part of a city that built much of its prosperity over the past 20 years on the financial services sector. I was encouraged and pleased to see many large banking organisations making their headquarters in the city and am hopeful that we will retain as many as possible, although there is a risk in such a situation as this that we may not. That industry has been extremely important for the city and has stimulated many other industries, not least property and construction. However, as we have seen, there are clear dangers in becoming over-dependent on the financial sector, as opposed to other parts of the economy, and we must reflect on that.
Like all Members, I represent people who were baffled by a lot of what happened, and who remain baffled by what is happening. They feel that whoever is responsible, we have gone wrong somewhere in how we deal with what should be fairly simple matters such as how we can borrow and lend, and grow our economy. Although it might be naive to think that we could return to the simplicity of savings and loans organisations such as that featured in the film “It’s a Wonderful Life”—it is a good time of year to think of that—we do need to return to some of the variants of financial services that we appear to have lost.
In the rush to demutualisation, with nearly all the building societies being turned into banks, we lost something very important in the sector. That has left a lot of distrust among many people. We talk about encouraging individuals to put their trust in saving, which is important for aspects of our economy, but many people do not have the faith and trust to do that. That cannot be healthy. It would be helpful if there were small and medium-sized organisations in which they had that trust.
I echo the view of my hon. Friend the Member for Streatham (Mr Umunna) that we have an opportunity to reconsider the mutual path when banks cease to be owned by the taxpayer. Those banks can go down a different road from the one that they have trodden. I hope that we will be able to consider that, because it would be healthier and better to have variety in our banking sector.
We hear many different views about whether there was too much or too little regulation. From the perspective of the consumer of banking services, it sometimes feels as though there were a lot of regulation of little things and not enough of the big things. When I get another letter from the bank to tell me about some small change in interest rates, or not even that, I feel that things have gone too far, especially when it is accompanied by a big booklet that, frankly, I do not read. I am sure most people do not. That is regulation taken to its extreme. Equally, however, it cannot be right that an organisation such as the Royal Bank of Scotland, which is of great importance to my city and country, was able to become so full of its own importance that it could decide to buy into ABN AMRO, which was the cause of a lot of its problems, without someone saying, “Stop. Halt. You can’t do this.”
Similarly, on the whole question of remuneration and bonuses, the ordinary person does not feel that what is happening is right or fair. They want us as parliamentarians to take a strong view on the matter. This debate is important, because there has been what some people would find a surprising degree of agreement and consensus that action needs to be taken. We need to translate that into not just a Back-Bench debate but Government action. If we do that well, we will restore people’s trust not just in banking but in politicians.
Like other Members, I welcome this debate and congratulate the right hon. Member for Oldham West and Royton (Mr Meacher) on securing it. I will oppose the motion for two reasons. First, I believe that the Government have acted briskly within the terrain of the current debate. I will speak about that terrain, because I believe it should be moved. Secondly, I should like to challenge the notion that we should have a clearing house for over-the-counter derivatives.
I believe that the question of whether a clearing house should be provided, and under what circumstances, is a matter not for legislators but for the market. The problem with derivatives is accounting rules that allow profits to be recognised many years in advance, and that substantially reduce the capital requirements for derivatives in comparison with loans. That, of course, is inflationary in itself, stoking the activity that has caused the problem.
Not only has regulation of derivatives been of poor quality, but derivatives are susceptible to regulatory arbitrage. Indeed, as was mentioned earlier, financial institutions employ large teams of very intelligent people specifically to construct derivatives to arbitrage away the regulations that are put in place. A clearing house would obfuscate counterparty risk, with unintended consequences, and, as clearing houses always do, it would reduce the demand for cash balances in banks, thereby promoting inflation. For all those reasons, I believe it falls to us as legislators to create the right environment for banking, based on property and contract, not to mandate any particular solution such as a clearing house.
To challenge the terrain of this debate, I should like to take the House back to a landmark in the development of British monetary and banking orthodoxy—the Bank Charter Act 1844, also known as Peel’s Act. It represented the victory of the currency school over the banking school. The former had realised that systemic crises and banking collapses were largely attributable to the excess creation of fiduciary media—that is, claims on money not backed by a fund of actual money. The Act, introduced by Peel, therefore eliminated the practice of banks issuing their own notes. Unfortunately, the currency school had not realised the economic equivalence of notes and demand deposits, so the Act left the banks virtually unmolested in their ability to issue fiduciary media.
My hon. Friend the Member for Bromsgrove (Sajid Javid) mentioned the wall of money that hit the markets, and we might reasonably ask where that wall of money came from. It has become common practice to say that interest rates were too low for so long, and therein lies the insight. When that happens, people are encouraged to borrow and the banks are encouraged to extend fiduciary media well in excess of real savings. Low interest rates ought to indicate prior production and real savings, but when central banks deliberately suppress interest rates and issuing banks pour fuel on the fire by issuing fiduciary media, what we find is that wall of money hitting the market. In our case, that money principally headed off into the housing market.
At the heart of our difficulties is the fact that there was an omission in the 1844 Act. The deposit-taking banking system is built upon that Act and a body of case law, which have left the banks with the legal privilege of treating demand deposits as their own property. That allows the system as a whole to create a wall of fiduciary media. That is the heart of our crisis, but it is not part of the mainstream contemporary debate, and I believe that it should be.
In the last minute of my speech, I should like to touch on some other issues that have not formed part of the debate, the first of which is risk management. The entire brilliant edifice of modern financial theory is built on the assumption that risk in markets follows a Gaussian distribution, but that is not true. Market events follow a long-tailed distribution, as Mandelbrot and others showed. I very much wish that risk managers would take that into account in their strategies.
If we were to look more broadly at the money and banking system, and ask ourselves how we could characterise it, we would find central planning, legal privilege, the socialisation of risk, Government monopoly, complex regulations that are often arbitraged away and, of course, ad hoc intervention. We would not find clear property rights, freedom of contract and the consequences of bearing one’s own risks.
We have a lot to do in money and banking, but we must transcend the problem of blaming individual bankers. Yes, individuals have done much wrong, but the system is deeply flawed and we can trace its flaws back to the development of the British monetary orthodoxy. It is that orthodoxy that we must challenge.
I congratulate my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on introducing this debate. I do not know whether he remembers it, but five years ago he spoke in Gloucester about the economy—I was the Labour party candidate in Cheltenham—and warned that the banks were out of control. A lot of people looked on that uncharitably, but, sadly, he was proved right, which is why we are having this debate.
The debate is important because there is great anger out there about bankers. No matter what Government Members say, people blame bankers. When I first came to the House, BBC Wales ran a profile of me, the last sentence of which was:
“Since leaving university he’s worked in bookmaking and in banking, which contrary to widespread belief are different professions.”
Yes, there is a difference. I come from a family of bookmakers —my father and my mother were both bookmakers—and the one thing that was drummed into me as I was growing up was risk. As bookmakers, we understood risks, which is why we had odds. We always knew what would happen if we could not cover our losses.
When I joined the bank, naively I thought that I was joining an institution that I could be proud of and that set standards to which other industries could aspire. Unfortunately, I discovered that it was completely and utterly different from that. I was told to lend to whomever I could. I still do not understand the logic of saying to somebody who cannot afford to pay their bills every month, “Mr Customer, you need a £10,000 loan to get you through.”
I got a warning for refusing to lend someone £25,000 in an unsecured loan, because—I was told—I was not thinking about the shareholders. That is the major problem. When I said to my manager, “This can’t go on. This is madness—we’re just writing people off,” he replied, “Son, it’s a sign of the times. You wouldn’t go into a shoe shop and expect not to buy shoes.” However, there is a difference. A person who goes into a shoe shop and buys the wrong shoes will get blisters; a person who goes into the bank and buys the wrong loan loses their house. The people at the bank did not understand that we were dealing with people’s lives. They were arrogant and blasé—“We can’t fail; we’re great banking institutions”—regardless of the Barings bank failure in 1991. I well remember the chief executive of Barings at the time saying, “It isn’t terribly difficult to make money in the City, old boy,” but the bankers ought to have learned that it is terribly difficult for builders and plumbers to earn money.
The essential truth is that banking is simple—a bank lends money to someone and makes money through the agreed interest rate—but the banks made it complicated. In the debate this afternoon, I have heard about derivatives and arbitrage, but the average person who walks into their bank will think, “What relevance do derivatives and arbitrage have in my life?” The banks made lending into mathematical equations—someone mentioned a biology graduate—and sold debt on, so the money came from several different sources. Eventually, that massive tower block collapsed when the person at the bottom failed. I have been reading Ha Joon-Chang’s “23 Things They Don’t Tell You About Capitalism”, in which he argues that we should ban complex financial instruments. That is an outrageous thing to say, but if bankers and economists do not understand such instruments, how can anybody else be expected to do so?
Before I finish, I want to return to the anger that people feel. In an article in The Sun today headlined, “Bank chiefs grab £15 million bonus”, I read that Stephen Hester of RBS will receive £2.4 million, that Eric Daniels of Lloyds Banking Group will receive £2.3 million, that John Varley of Barclays will receive £3 million and that Peter Sands of Standard Chartered will receive £3.2 million. What message does that send to people? That money is absolutely obscene, including to people who work for those banks. I go back to my experience of working in a high street bank. We were kept on deliberately low wages. The only thing that kept us going was the promise of a bonus. They would say, “We want you to bring in so many leads so stay till 7 o’clock at night. Forget about your family. You’ve got to earn money and put some bread on the table boy.”
That is still going on. Someone came to my surgery the other day and said, “I have to work till 8 o’clock every night because I’ve got to speak to the people I did not speak to in the day. I’ve got to get leads.” No amount of Government legislation or regulation will change that.
For people earning £12,000 a year and struggling to pay the bills, the pressure is on to stay after work and phone up leads to earn a quarterly bonus just to get through. That is not right. They should be paid a living, decent wage, which is what the Opposition support. I hope that everyone else will eventually do likewise.
Finally, as I said, no amount of Government regulation or legislation will change that culture. We need to say to the bankers, who were to blame for the economic crisis, “Either you change your culture, or the crisis will happen all over again.” We had better start opening our eyes to that.
One of the odd things about this debate is that those of us who believe that structural reform of the banking sector is necessary are characterised as being anti-free market, anti-capitalist and anti-banking. I am none of those things. In fact, I believe in the necessity of such structural reform precisely because I am pro-capitalism, pro-banking and pro-free market. The case for some kind of firewall, along the lines of the one introduced by Glass Steagall, is irrefutable. That will be considered by the Vickers commission over the next year but that is no reason not to discuss it here.
I intended to address that later in my remarks, but I shall take it head on. Lehman Brothers was a bad bank and it rightly went bust. However, that affected a whole lot of other banks, which required massive Government bail-outs, because there was no firewall. Nothing in my remarks will imply that retail banks such as Northern Rock will never go wrong or need to be saved. Frankly, my hon. Friend’s example makes my point rather than contradicts it.
Two or three hundred years ago, capitalism was developed by joint stock companies, which was a clever and wonderful thing. If such companies made the right decisions and were wise, they prospered and grew. The other side of that was that companies failed if they made unwise decisions or mistakes, lost money, or failed to recognise risk—Gaussian distribution or not. In the past 15 to 20 years, unintentionally, a new type of company has emerged. Such companies are not subject to the same penalties for risk as other businesses. That creates moral hazards and poor decisions. In the end, that was a large contributing factor to what happened in this country two years ago.
The arguments in favour of a firewall are overwhelming, but what are the arguments against it? The principal argument against a firewall has been the subject of the most intense banking industry lobbying imaginable, and I hope that when the time comes to legislate, hon. Members and the Government do not bow to it.
The first argument is that such a separation implies that investment banking, derivatives and all that goes with that are casino-type activities and of less value to society. I do not think that at all. I sold my business to investment bankers, I like investment bankers and I understand why we sometimes need derivatives. I have no problem with those instruments, but I do have a problem with the fact that if the people using them mess up, they cannot go bust, because there is not a firewall between their activities and the rest of the banking world. That is the problem.
The second argument was raised just now by my hon. Friend the Member for Central Devon (Mel Stride)—the Northern Rock and Lehman Brothers example. I will not repeat what I said, except to say that Lehman Brothers should have been allowed to go bust, but should not have been able to bring in billions of dollars of taxpayers’ money after it, as it did.
The third argument is that a firewall would be too complicated: banking has now got global and is so mixed up that we cannot separate out investment banking and retail banking. Well, we can. The Basel III agreement contains a requirement that the capital considerations for each part of the banking portfolio be different. That can be done.
The fourth argument is that we can do all this with capital ratios and that if we impose them on banks we will not need this firewall, this separation. That is partly true, but actually they are not mutually exclusive—we need both—and, as was said earlier, capital ratios, unless we are careful, will shrink bank balance sheets and reduce lending at a time when we want more credit. What I am proposing would not do that.
The fifth argument is that, if we did this in this country, in front of the rest of the world, it would put our banks at a competitive disadvantage. That might be true—it is a reasonable argument—but I would say two things in response: first, the banking sector in this country is about four to five times as significant, as a proportion of GDP, as it is in any other country, so we ought to be leading the world in this regard. It matters more to us. Secondly, even if the argument is right, it is not a reason for us not to try to get the world behind us, create these firewalls and get this under control.
My hon. Friend makes a compelling case. Will he consider the case of fixed-rate products—fixed-rate savings or fixed-rate mortgages—because it seems to me that such products are bound to bring the savings and loans business into contact with the investment business, through interest rate swaps?
I thank my hon. Friend for that intervention. My third argument was that these things are all so complicated and mixed that we cannot separate them out in the way I propose. I made the further point, however, that we have to do that, under Basel III. However, as recently as 15 years ago, firewalls were in place, so it is not that difficult and it can be done, if there is the will. The requirement on moral hazard is such an overriding necessity of capitalism that when it goes, it is terribly dangerous. And it has gone now, which is the guts of what we have been talking about for most of this afternoon.
I am not the only one saying that. Paul Volcker, who was previously head of the Federal Reserve, and John Reed—not the John Reid who used to sit on the Labour Benches, but the John Reed who used to run Citigroup—have asked for this firewall to be put back in place. The Governor of the Bank of England, too, said that of all the different ways we could choose to organise a banking system, the way we have chosen to do it in the UK is among the worst imaginable. We have to act on this. It is very important, and I hope that, notwithstanding the Vickers report, the Government will show leadership on this matter.
I want to speak briefly at the end of what has been a very interesting and informative debate, which I commend the Backbench Business Committee on securing.
I welcome some of the measures that the Government have already taken, so in the light of this debate, I hope that the motion, which states that the Government have taken no action, will not be pressed to a vote. Many Members have accepted that the measures on tax, including a permanent tax on banks, the Vickers review into banking structures, the international push for transparency and the action taken to bring banks together to work on bonuses show that a strong work programme is in place already.
I do not want to take up time, because I have a couple of minutes at the end of the debate, but the hon. Gentleman picks up on a point I was going to raise. I did not say that no action has been taken. My motion states that
“no action has so far been taken which would prevent a recurrence of the financial crash”.
That is a very different proposition.
I thank the right hon. Gentleman for that intervention, because it brings me precisely to the final thing that the Government have already proposed, and which I think is central to preventing a recurrence of the financial crash: the decision to move the powers for prudential regulation to the Bank of England and to strengthen those powers.
Having quickly welcomed the action already taken, I want to concentrate on prudential regulation. The removal of powers of prudential regulation in 1997 was central to many of the things that Members on both sides of the House have talked about. The hon. Member for Islwyn (Chris Evans), who is not in his place, spoke passionately about how his managers were telling him to lend more no matter what the customer needed. That was part of the rapid expansion of banks’ balance sheets, because there was no prudential regulation at the top of the size of those balance sheets. We also heard, from Government Members, about the rapid, uncontrolled run-up in balance sheets.
The idea of prudential regulation and having an institution exercising judgment, instead of just lots more rules-based regulation, has come of age. After all, the system before 1997, although imperfect, had prevented a run on any bank in the UK for 140 years, so it deserves some credit, and it deserves studying. So why would more discretion and judgment based in strong institutions work better than more rules? There are three key reasons. The first, as we have heard in many contributions, is that although rules can be set down in statute, statute can take a long time to change, whereas bankers can change and adapt very quickly. We have heard a lot this evening about regulatory arbitrage—another example of how financial institutions will change quickly to make the most out of whatever rules have been put in place on the ground. But the system cannot then adapt quickly.
Secondly and crucially, the system cannot adapt to innovations. We have seen massive financial innovation, especially with the development of computers over the past 30 years. However, to blame that innovation itself for the mess we are in ignores the fact that it was the lack of regulations—as my hon. Friend the Member for Warrington South (David Mowat) pointed out so eloquently, regulation is crucial to a functioning market economy—around these new developments and the attempt to regulate through explicit and specific rules, rather than the exercise of judgment, that was the problem.
Is not one issue that mitigates the need for specific rules the regulator’s 11 principles, which act a bit like the 10 commandments? For example: “Principle 1: you must act with integrity. Principle 11: you must be open with the regulator. Principle 3: you must have adequate risk management.” It is inconceivable, given that those rules have legal force, that some of those catch-all principles could not be used in enforcement.
They were not used, and that is the problem. A massive, heavy and expanding rulebook distracted the attention of regulators away from the big picture.
My third point about why discretion rather than rules is the best way for the future concerns the importance of the macro-economy, because we cannot separate monetary policy from banking policy. The size of banks’ balance sheets is crucial to regulating the supply of money in the economy. Having counter-cyclical rules rather than pro-cyclical capital rules, as we had under Basel II, is crucial. The exercise of judgment over a bank’s balance sheet is best done in the same place as the exercise of judgment over the macro-economy. Bringing those two things back together in one institution—the Bank of England—is a better long-term way of trying to wrestle with such difficult judgments than having them in separate organisations, which, as we heard in an earlier, eloquent speech, ended with the tripartite system, in which nobody was in charge.
I do not know whether my hon. Friend is aware of this, but last week the deputy Governor of the Bank of England appeared before the Treasury Committee and said that he felt that the new twin peaks approach would be a much better model. He felt that the advantage was that it would remove the problems of underlap that were so obvious in the previous system. Whereas there might be some overlap under the current proposal, that has to be much preferable to the previous arrangements.
That is a valid and important point. Central to that point is the judgment of people who look forward and have a broad view, looking after the health not only of the banking system, but of the macro-economy, while also having the ability to change the way they regulate according to changes in the economy, so as to take into account new developments, which is critical. Far from being the simple renaming of the institutions, bringing together macro-prudential regulation with regulation of the economy and monetary policy more broadly is central to restoring the ability to prevent the build-up of credit, as happened over the past 15 years.
In my experience it is always better to be anything than a clunking fist.
I will end by saying this. We do not know what the future holds. We know that regulation is not perfect. It is therefore far better to have one person and an institution in charge of the regulatory structure who can exercise judgment to the best of their ability than it is to try to write a rulebook for a perfect system that we know we will never create. That is why I think that the Government have already put forward such a critical change to our financial architecture—a change that I hope will be accepted by the Opposition and which will form the basis of the good economic governance of our country for years to come.
I am going to make only a two-minute speech, Mr Deputy Speaker.
This debate has touched a lot on the technicalities of how the banking system works, but I echo the passionate and eloquent speech by the hon. Member for Islwyn (Chris Evans). Commercial banks on the high street do not all operate between themselves in the same way. There are different clearance rates. Cheques can take up to 10 days to clear, which can put families who are in hardship even further into hardship. In the banks’ eyes, banker’s transfers do not occur on the same day, or even over four days. For example, one of our high street banks—one that is more or less state-owned—will take money out of a person’s account instantaneously, but it will take over four days to transfer that money into another account in the same branch. I have a constituent who has a problem in that he paid off his credit card over the counter in a national high street bank, but was told that it would not be credited instantly and that this would take up to six working days. That is outrageous and should be touched on in the reforms, so that each bank is streamlined with the others. In many countries in Europe, such as Sweden, transfers are seamless and instantaneous. I would like the House to consider that.
I, too, congratulate the Backbench Business Committee and my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on setting up this thoughtful and well-tempered debate. A number of good ideas have been shared among all parts of the House. In fact, there has been much more consensus between the Back Benchers on both sides of the Chamber than between the Front Benchers. We will see whether policy can be shaped by the virtues of our debate, because there has been quite a lot to take away from these discussions.
It is important to reflect on the wide-ranging set of reforms needed to bolster our banks against a repeat of the credit crunch and, as we all want eventually, to create a financial services industry that is sustainable and diverse, and that serves the best interests of both savers and borrowers. There are a number of significant systemic reforms that it is important to reflect on. I shall touch on many of the comments that have been made, but the first point is to look at the motion that is before us. As we can see from the Order Paper, the Government and the Opposition each tabled an amendment to the motion, although neither of us were fortunate enough to have our amendment selected. For our part, although we agree almost entirely with my right hon. Friend, the element in the motion touching on derivatives requires a little more thought.
Many commentators have rung alarm bells about the swirling volumes of derivatives activity in the past decade, with multi-trillion dollar flows and British banks holding at least £l trillion in derivatives. However, derivatives are, for good or ill, a reality of the modern global economy whereby companies and other investors gain exposure to an underlying asset or offset their exposure to that asset without actually buying or selling that asset in the first place. Derivatives are supposed to be designed to reduce risk and volatility for companies, employees and consumers. For example, an airline can hedge—or insure itself—against volatility in fuel prices by taking out a futures derivative, thereby offsetting its exposure to price changes. However, as my right hon. Friend and others have said, the problem is that betting on the future prices of financial assets has proved irresistibly alluring to traders and bankers, who can make billions off the back of this market without having to own the assets on which they are gambling.
There is therefore quite an irony in the fact that products that are intended to help alleviate risk have in many ways massively increased the systemic risk to the economy. Add to that the sheer complexity and opacity, as many hon. Members have mentioned, of some derivative products—collateralised debt obligations-squared, and so forth—and we end up with companies holding derivatives positions that their own management do not understand, failing to appreciate the risks involved. That is why the history of recent collapses has been intricately tied to that problem—including at Bear Stearns, Lehman Brothers, AIG, Long-Term Capital Management and even Barings—yet we have still not properly grappled with it.
The reason why we on the Opposition Front Bench cannot quite support my right hon. Friend’s motion is that it essentially calls for an end to over-the-counter derivatives trading and the introduction of a central clearing house. I can see the attraction of that—the standardisation of products and the stronger likelihood that the regulator could peer inside and comprehend the nature of the risks involved—but the downsides are that derivatives could not be easily tailored to the specific needs of the buyer. With the vast majority of derivatives currently privately traded between two parties, the consequences of that structural requirement for exchange trading in all circumstances could be disadvantageous. For instance, could there be a constraint on the specific maturity of the futures options? Would we be unwittingly re-injecting risk into the economy by constraining the ability to hedge responsibly?
The Opposition need, however, to recognise the urgent and far-reaching reforms that are required. Do we need an urgent and thorough review of derivatives and policy on them? Yes, absolutely: both regulators and markets need more transparency in over-the-counter derivatives activities, particularly given the possibility of greater exchange trading. By the way, we also need greater scrutiny of the role played by the credit rating agencies, as the hon. Member for South Northamptonshire (Andrea Leadsom) and others said, given that they have blessed many products with triple A ratings that did not necessarily translate into reality. Should we require greater registration and transparency in these over-the-counter deals? Yes, absolutely. There is too much secrecy, and the consequences for the taxpayer are ultimately too great.
We do not necessarily need to end all bilateral trading of derivatives, but to pick up where the G20 in Pittsburgh left off in 2009. It resolved to move towards greater exchange trading, but not necessarily the end of all over-the-counter trading. I know that we disagree on this specific point in the wording of the motion, but it is important that we should be responsible when considering some of the reforms that are being suggested. It is good that the Backbench Business Committee has enabled this debate to take place today.
I have doubts about the Government's policy on this because they are leaving it very much to the European institutions to lead on this matter, and leaving it up to the European market infrastructure regulations, which are now emerging as the only likely vehicle for reform. It is striking that Ministers are happy to be led, rather than showing leadership on this matter themselves, especially as the UK financial services industry is at the forefront of many of these activities. I urge Ministers to be far more front-footed on these reforms, rather than hanging back and complaining that details and policy are being foisted upon them.
We also need to consider some of the other regulatory shortcomings that have been raised in the debate, including those relating to bonuses, to management incentives skewing behaviour, and to transparency. I do not want to be too partisan, but I find certain aspects of this situation astonishing. My hon. Friends the Members for Streatham (Mr Umunna) and for Leeds East (Mr Mudie) said that the Government needed to show more leadership on banker remuneration. We have seen the appalling confusion and weak will of Ministers even over listing the number of bankers earning more than £1 million. Even that seems to have been a difficult step for them to take.
It is a particular shame that the Business Secretary is not here tonight—at least we have a couple of Liberal Democrats representing him here—especially as he was so vociferous on this subject exactly a year ago in his article in the Daily Mail. He described the proposal to disclose simply the number of bankers earning more than £1 million as a “whitewash”, saying that it would represent only “a small advance”. He went on to say:
“Shareholders who own the banks and the taxpayers who guarantee them have every right to know who is being paid how much and for what…Directors of public companies are already required to declare their earnings…The failure of Walker to grasp this is compounded by Alistair Darling’s meek acceptance of his recommendations. There are splits in the Government…Taxpayers sign the bankers’ bonus cheques, so we must see the names and numbers on them.”
We clearly do not need to wait to see the Business Secretary’s appearance on the Christmas special of “Strictly Come Dancing”; he is perfectly able to perform his volte-faces, somersaults and U-turns one after the other. He is performing spectacular political cartwheels more often than ever before.
Let us see whether the hon. Gentleman can pirouette his way out of this one. During the last Parliament, probably the largest piece of legislation that went through was the new Companies Bill. Given that my right hon. Friend the Member for Twickenham (Vince Cable) called at that time for more disclosure in companies’ reports about directors’ remuneration, why did not the previous Government rectify that anomaly?
It is difficult for the hon. Gentleman to criticise the previous Government, when they put the statute in place ready to be triggered by the present Government. It is baffling to my constituents and to his that we cannot allow them to see the simple figure of how many multi-millionaire bankers there are. I am not suggesting that we reveal their names, just the number involved.
I am not making an argument for rejecting the Walker review. It recommended the disclosure of the numbers, but it is true that Walker has since changed his tune. The reliance on what he calls “regulatory arbitrage”, and the suggestion that if we were to make that change here in the UK alone, we would suddenly see an exodus of the banking community, are absolutely fallacious arguments. We have a responsibility to show a lead, and surely the Government should be able to do that. It would be invidious if that were not the case.
In the short time available to me, I also want to walk through some of the other proposed changes that hon. Members mentioned. They raised issues about proprietary trading, and there are even more Government Members who are in favour of the Glass-Steagall split between investment and retail banking. There has been an interesting consensus on that. That might not necessarily be the right thing to do, but it is certainly worth consideration by the Vickers commission.
The structure of the sector has also been mentioned, as has the question of whether we need to revisit the issue of competition. My hon. Friend the Member for Edinburgh East (Sheila Gilmore) asked how we could remove some of the constraints on mutuals and credit unions, and on others entering the sector, given that the barriers to new entrants are too high. Indeed, I note the very thoughtful speech from the hon. Member for South Northamptonshire (Andrea Leadsom), who mentioned a number of interesting ideas about how reforms might take place. I was quite taken by her suggestion about consumers’ current account numbers being portable. Other interesting suggestions were also made.
Basel III and the question of cushions and reserves are clearly important for guarding against failure and reducing taxpayer liability, but do we need to pay similar attention to liquidity, as the hon. Member for Bromsgrove (Sajid Javid) and my hon. Friend the Member for Wirral South (Alison McGovern) suggested? Should certain institutions have greater cushions and reserves than others? Perhaps that is the subject for a more sophisticated debate at another time.
Other components have to be addressed as well, including the financial capability of consumers and consumer responsibility. Yes, consumers have a right to know more about the products and companies involved, but perhaps it is also important to have a debate about the responsibilities of consumers. That needs to be acknowledged. We need to revisit the question of fairness for the taxpayer, and for public service users, indirectly, as well. Unfortunately, we have heard too much back-pedalling on the banking levy and on the role that the banks need to play in repairing the public balance sheet—[Interruption.] The Minister suggests that he is not back-pedalling, but from what we read—albeit in the newspapers—it sounds as though the Government might reduce the percentages that they want to implement, as announced in the Budget, if they are going to stay within the proposed 0.04% in year one and 0.07% thereafter. I would be more than happy to give way to the Minister on that specific point if he wants to clarify that position once and for all. But perhaps he will keep that for another day. He has also been back-pedalling on net lending targets of the business, although that was in the coalition agreement.
It is important that we have these debates. They show that there is a thirst for democratic accountability on financial services policy. Perhaps one of the lessons that we learn is that simply delegating many of these issues to European institutions or to the regulators is inadequate. There is a democratic deficit, and Parliament has a role to play. Hon. Members who try to find out information on Financial Services Authority reforms and regulations sometimes struggle to get the necessary documentation from the Vote Office, which is not good enough. We need to recognise our role as legislators, because our constituents are watching how we behave. They are watching how we set policy, and they expect us to do that. We should not be blown around entirely by the regulators, by Europe and by the markets. Politicians need to lead, and Ministers need to show greater leadership, and I hope that the Government will do that.
It is a pleasure to take part in this debate, and I congratulate the right hon. Member for Oldham West and Royton (Mr Meacher) on securing it. I would like to pick up on one point that was raised by the hon. Member for Nottingham East (Chris Leslie) when he talked about the Government showing leadership. If I remember rightly, it was his party that said before the election that we could not introduce a banking levy on a unilateral basis. This Government have introduced such a banking levy, and it will raise £2.5 billion in a full year. That is what leadership is about. All that we have heard from the Opposition is that there is more disagreement on policy among the Front Benchers than among the Back Benchers. The problem is that the debate showed that those Back Benchers had more policy than the hon. Gentleman. Nothing in the 15 minutes for which he spoke told us anything about the future direction of the Labour party on the regulation of the financial services sector, other than his vague attempt to justify their decision not to vote for the motion. The right hon. Member for Oldham West and Royton has been hung out to dry yet again by his Front Bench.
It is vital that we learn and act upon—[Interruption.] I ask the hon. Member for Streatham (Mr Umunna) to let me continue. He will have his chance tomorrow in the Treasury Committee. It is good to see that the Leader of the Opposition’s Parliamentary Private Secretary is already revving up for that experience.
It is right for us to learn the lessons of the financial crisis, and to act on them. We must think very carefully about the range of interventions that we make. It was clear from everything that was said today that a range of measures was needed. The hon. Member for Streatham himself said that there was no magic bullet, and that is true. We need to take a range of measures domestically, in Europe, and at G20 level, if we are to learn those lessons of the financial crisis.
Let us begin with what we should be doing at home. We know that the regulatory architecture introduced by the last Prime Minister was fundamentally flawed. As my hon. Friend the Member for West Suffolk (Matthew Hancock) pointed out, he took away the Bank of England’s responsibilities for the regulation of banks. The Bank had the ability to spot threats to financial stability, but it lacked the power to tackle them. The last Prime Minister gave the FSA a dual mandate, which focused on the conduct of business to the detriment of prudential supervision.
Unlike the last Government, we have decided to reform the architecture and the approach to financial regulation, and to implement a structure that works. Before I outline the institutional reforms, let me set out the new approach that we want regulators to adopt. We believe that whether the problem is a threat to financial stability, a flawed business model or the mis-selling of financial products, regulators should intervene decisively and early to minimise its impact on our economy, on financial stability, or on consumer outcomes. The regulators will be required to demonstrate judgment and discretion, which represents a big change in attitude and approach.
However, we do not think that it is enough simply to change the approach; we want the architecture to change as well. We will establish a financial policy committee in the Bank of England with a dedicated focus on macro-prudential analysis and action, to ensure that risks that develop across the financial system as a whole are identified and responded to when that did not previously happen. The FPC will have a strong mandate to protect financial stability, with credible and knowledgeable external membership. It will be able to challenge the prevailing consensus, and to ensure that potential risks are identified, monitored and addressed rather than being ignored, as they were under the last regime.
The new architecture will also ensure that macro-prudential regulation of the financial system is co-ordinated effectively with the prudential regulation of individual firms, and that a new, more judgment-focused approach to regulation of firms is adopted so that business models can be challenged, risks can be identified, and action can be taken to preserve stability. That will be the responsibility of the new prudential regulation authority, which will be an independent subsidiary of the Bank of England.
However, it is not just a question of prudential stability. As a number of Members pointed out today, we also need to reform the way in which we look after the interests of consumers. We will set up a consumer protection and markets authority with a primary statutory responsibility to promote confidence in financial services and markets. Regulation and conduct within the financial system, including the conduct of firms towards their retail customers and the conduct of participants in wholesale financial markets, should be carried out by a dedicated, specialist body with focused and clear statutory objectives and regulatory functions.
As I said earlier, it is also not just a question of regulation. We need to think about the structure of the banking system. It was the last Government who closed down the debate about whether the activities of universal banks should be divided between investment and retail banking. We had the courage to open that debate, which is why we have established an Independent Commission on Banking, led by Sir John Vickers, to examine the structure of banking in the United Kingdom, the state of competition in the industry, and how customers and taxpayers can be sure of the best deal. The commission will consider issues of systemic risk and moral hazard, and will examine the complex issue of separating retail and investment banking functions, which was raised by Members on both sides of the House. It is due to deliver its report to the Cabinet Committee on Banking Reform by the end of September 2011, and its findings will help to shape the UK’s banking sector for decades to come.
One of the issues that has been a focus of international debate is linked to the work of the independent banking commission. Recent interventions have reinforced perceptions that some institutions in particular are too big or too important to fail: the so-called systemically important financial institutions, or SIFIs. They pose a much greater risk to taxpayers and to the efficient working of markets. We believe that it is vital for us to eliminate that source of moral hazard, and to ensure that it is possible to resolve failing firms without triggering a systemic crisis or requiring support from taxpayers. The Government are taking an active role in the G20 and in the Financial Stability Board’s work on the development of a robust, internationally consistent policy framework to address SIFIs and the risks that they pose. We fully support the principle that they should be required to have a higher loss-absorbency capacity than other institutions.
That is just one sphere in which international co-operation is needed. We recognise that financial stability cannot be achieved by any one country operating in isolation. The UK has a commanding position in international financial services, and the industry is global in character. It is therefore vital that we co-ordinate our actions with our international partners to ensure that we have effective means for dealing with threats as they arise. We have consistently argued for strengthened international financial regulation to address the failings that were laid bare by the crisis, and huge progress has been made in strengthening international regulatory standards. Getting these reforms right is vital for financial stability, but it is also vital for the future of our global financial services sector.
Capital was mentioned frequently during the debate. During the crisis, we learned that the banking system lacked the capital that was needed to absorb losses, or the liquidity that would enable it to survive when markets closed. We have been a vocal supporter of the G20’s endorsement of the Basel committee’s reforms to strengthen international capital and liquidity standards. Banks will be required to hold more capital to withstand losses, with the buffer of 2% core tier 1 required under Basel II being replaced by a buffer of at least 7% by 2019. I think that the long transition period gets the balance right. It strengthens the banks’ capital position, but at the same time ensures that banks are able to lend and continue to sustain economic recovery. I believe that this crucial set of reforms will strengthen the resilience of the banking system to the long-term benefit of the economy.
The motion refers to derivatives. I think that the hon. Member for Nottingham East and I agree on one point. I believe that neither of us will support the motion, but we have learnt through the crisis that over-the-counter derivatives in particular lacked transparency and created a complex web of interdependence between the bilateral contract parties, which made it difficult to identify the nature and level of risks involved. The financial crisis has demonstrated how those characteristics increased uncertainty in markets in times of stress, and posed risks to financial stability.
Notwithstanding the comments made by the hon. Gentleman, the UK has shown strong leadership in reforming the derivatives markets. We have continually called for more transparency and central clearing of OTC derivatives. Internationally through the G20 and the Financial Stability Board, and in Europe through the European market infrastructure regulation, we are implementing vital reforms that will address the shortcomings evidenced by the crisis in the derivative markets.
The right hon. Member for Oldham West and Royton has proposed that the Government should establish a clearing house for approval of all financial derivatives. However, in the crisis, the private sector clearing houses successfully unwound the positions of defaulting members. Their prudent risk management meant that they did not need assistance from the public sector, despite being directly exposed to failing institutions such as Lehman Brothers. We therefore believe that clearing houses as private sector entities are able to manage risk effectively, but we also believe that central counter-parties should be bound by high standards given their systemic importance, and that those standards should be harmonised on an international basis. The Government are committed to ensuring that that happens.
The main aim of our reform should be the reduction of systemic risk in the financial sector. It should cover derivatives only when central clearing will indeed bring a reduction in systemic risk. Corporate end-users that trade derivatives purely for the purposes of hedging, as opposed to speculation, will be exempt from the clearing obligation. That will reduce the cost that will be passed on to their customers. I reject the arguments in the motion.
The motion tabled by the right hon. Member for Oldham West and Royton fails to recognise the action that we have taken to reform financial regulation at home and abroad. We have done more in the past seven months than our predecessors did. We are building a new financial regulatory architecture and approach. Banks will hold higher amounts of capital so that their shareholders, and not taxpayers, will bear the losses when the next crisis comes. International reforms must strengthen financial stability, but they should be proportionate and should not choke off economic recovery.
Over the past few months, this Government have led the debate on financial reforms both at home and abroad. We are taking the action that is required to create a much more sustainable and stable financial system, and if the motion is put to a vote, I will urge my hon. Friends to oppose it.
I was astonished to hear the Financial Secretary say he thinks that the regulation of financial derivatives in the last financial crisis was adequate, since it seems to me to be clear that that was not so.
This has been one of the most thoughtful, high- quality and rewarding debates I have taken part in, or heard, in the House for a very long time, and we must thank the Backbench Business Committee for bringing a new tenor of openness and genuine discussion into debates, rather than adversarial confrontation.
For Members who may be considering how to vote, let me state once again that I did not say that no action has so far been taken by the Government; I think they have taken action. I said that no action has so far been taken that would prevent a recurrence of the financial crash, and simply shifting regulation from the Financial Services Authority to the Bank of England is certainly not going to achieve that.
I took a brief note of the most important points made by each Member who contributed to the debate, and I was astonished at the high measure of agreement—I will not say consensus—on the issues and, to some extent, on what ought to be done. These included the following: the problem of the creation of runaway credit; the importance of Basel counter-cyclical capital controls; the separation of retail and investment banking; the need for a rebalancing of the economy, with the banks giving more emphasis to industrial investment; improved accountability and competition; the need for universal banking and the re-mutualisation of some banks, perhaps including Northern Rock; the need for higher ethical standards; the overriding need for greater transparency; the need for equity financing; and the need for greater diversification in banking structure. These are all issues—and I have missed out some—on which I think there is broad agreement across the Chamber.
Having had an extremely valuable debate, I hope Members will carefully consider the terms of the motion, as it is quite modest. It was designed to get broad cross-party agreement, and I hope it will achieve that.