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Financial Institutions (Reform)

Volume 541: debated on Wednesday 29 February 2012

Motion for leave to bring in a Bill (Standing Order No. 23)

I beg to move,

That leave be given to bring in a Bill to enforce strict liability on directors of financial institutions; to require directors of financial institutions to post personal bonds as additional bank capital; to require personal bonds and bonuses to be treated as additional bank capital; to make provision for the insolvency of financial institutions; to establish a financial crimes investigation unit; and for connected purposes.

I draw the House’s attention to my registered interest in Cobden Partners.

In a developed society such as ours, we need a vibrant, dynamic, reliable and robust means of executing payments and intermediating savings to entrepreneurs: we need a good banking system. Unfortunately, as the Governor of the Bank of England said in his 2010 Bagehot lecture:

“Of all the many ways of organising banking, the worst is the one we have today.”

Elsewhere in that speech, he said:

“At the heart of this crisis was the expansion and subsequent contraction of the balance sheet of the banking system.”

We might well discuss why balance sheets expanded so far and which factors and choices drove that expansion, but for today’s purposes it suffices to quote Martin Wolf, writing in the Financial Times on 9 November 2010, who said:

“The essence of the contemporary monetary system is the creation of money out of nothing, by private banks’ often foolish lending.”

Further, on 23 February this year the Bank of England’s executive director for financial stability, Andy Haldane, published an article in the London Review of Books, in which he wrote:

“The continuing backlash against banking, as evidenced in popular protests on Wall Street and in the City of London, is a response not just to the fact that the world is poorer, as pre-crisis riches have turned to rags, but to the way these riches were privatised, while the rags are being socialised. This disparity is nothing new. Neither in the main, is it anyone’s fault. For the most part the financial crisis was not the result of individual wickedness or folly. It is not a story of pantomime villains and village idiots. Instead the crisis reflected a failure of the entire system of financial sector governance.”

It seems that there is an increasingly unified message coming out of the Bank of England.

We must rise above that inadequate story of pantomime villains. Entrepreneurial error and gaming rules in the pursuit of self-interest are nothing new, and the system should have been able to cope. It is that foolish lending of new money, that failure of the entire system of financial sector governance, which must be addressed.

What is to be done? Mr Haldane supplied an answer. He wrote:

“The best proposals for reform are those which aim to reshape risk-taking incentives on a durable basis”.

That is what my Bill intends to do. It aims to reconnect risk and reward in the financial system, and to deal with the moral hazard that allowed the privatisation of vast gains and the projection of vast risks and losses on to the public.

I believe that profit is right and proper when earned through voluntary exchange without force or fraud. Bonuses based on just profits are a good thing. If some people gain but the costs of their actions are forced on to others through state power, however, that is an injustice. It is one from which our constituents are still smarting, and it is one which is causing people to question the basis of our social system. If we are to prosper, we must preserve and extend commercial freedom, promote personal, professional and mutual responsibility and facilitate enterprise under the rule of law. In banking, a business that is categorically different from others, we must ensure that those who stand to gain also bear the risks of their actions. I therefore propose the following measures.

First, on the liability of bankers, board members of financial institutions should be strictly liable for losses—that is, liable without the need to prove fault on their part. In the event of bank insolvency, board members would be subject to unlimited personal liability. Their own wealth—all assets, houses, pensions and so on—would be at risk. In addition, bank directors would be required to post personal bonds that would be potentially forfeit in the event of losses, not as a cap but as a guarantee. Bonds should be at £2 million, adjusted for inflation, or 50% of net wealth. Any board member who resigned would still be subject to unlimited liability and the requirement to post bonds for a period of two years following their resignation, so that they could not run away from impending disaster.

Secondly, bonus payments would be deferred for a period of five years. The bonus pool would be invested in escrow accounts, with appropriate provision for stocks, dividends, stock options and cash.

Thirdly, personal bonds and the bonus pool would be used to make good bank losses. Should a bank report losses over any period, they would be borne by beneficiaries of the bonus pool in the first instance. Further losses would be borne by board members and made good from their posted bonds. Any further losses would then be borne by shareholders in the usual way. Finally, in the event of insolvency, bank directors would be exposed without limit.

Additional measures would cover the definition of core capital and accounting standards, provide a robust definition of bank insolvency, require a new fast-track receivership regime for banks, which is long overdue, and produce a programme to end state support and return financial institutions to normal operations. There would also be provisions relating to EU passporting rules and provisions for criminal investigations and criminal liability.

Those measures are targeted at banks, which are categorically different from other businesses, but whether they can be achieved without extending the scope of the Bill to any company regulated under the Financial Services and Markets Act 2000 is a matter for debate. To promote diversity and competition, wholly owned mutuals and new small banks might be exempted from certain provisions, such as the requirement to post bonds.

The obvious question is who would become a director of a bank under a regime of unlimited liability. Actually, unlimited liability banking has an illustrious history. The two greatest bankers of the 19th century, Nathan Rothschild and J. P. Morgan, both operated highly successfully under unlimited liability. It made them conservative in their risk-taking and reassured counterparties who appreciated what they stood to lose if a deal went wrong. I am grateful to my hon. Friend the Member for Wyre Forest (Mark Garnier) for reminding me that unlimited liability partnerships were relatively common until the 1980s.

The principle of unlimited liability for directors in certain circumstances was placed on a statutory basis in 1929 and remains in section 232 of the Companies Act 2006. My Bill would make bank directors’ duties openly enforceable. Let us not forget that, as colleagues in all parts of the House will know, banks are often quick to require small business directors to provide personal, secured guarantees. What is sauce for the goose is sauce for the gander.

Members will have seen that both HSBC and Lloyds have been engaged in bonus clawbacks, and that, too, establishes the principle that bonuses should be at risk in the event of losses and damage. The banking system is, after all, capable of generating losses so large as to threaten our entire economic system.

Hard-working families and individuals paying tax out of typically modest incomes must never again suffer the injustice of carrying the risks, and consequences of risks, taken in the pursuit of often enormous private returns. Risks must fall to those who take them. Instead of vicarious liability of taxpayers, there must be responsibility in the banking system. The Bill represents an opportunity to free the banking sector and the public from regulatory capture and lobbying. It could raise standards from the bottom up, through the preservation and extension of commercial freedom and the development of professional, personal and mutual responsibility.

The Prime Minister has called for a responsibility revolution, and that is what this Bill would provide. It would end the culture of rewards for failing in the banking system and establish a basis on which London could continue to grow into the future as the world’s leading trustworthy financial centre. It is time for us to say to bankers, “Put your money where your mouth is. By all means make a fortune, but if you want the reward, bear the risks.”

Question put and agreed to.


That Steve Baker, Mr Douglas Carswell, Ian Paisley, Peter Aldous and Mr Richard Bacon present the Bill.

Steve Baker accordingly presented the Bill.

Bill read the First time; to be read a Second time on Friday 27 April, and to be printed (Bill 312).