My Lords, while these are challenging times for financial markets and economies around the world, the Bill before the House today is a timely package of reforms to improve the UK’s system for ensuring financial stability and protecting depositors.
I am very grateful for the indications of cross-party support for the Bill. Before turning to the substance—the context and content—of the Bill, it is worth saying a few words about the use of the No. 2 Bill procedure. On 26 November, my noble friend the Government Chief Whip set out to the House how we intended to proceed with the Banking Bill in the current Session, with the support and agreement of the usual channels. The No. 2 Bill before the House today is identical in every respect to the Banking Bill that is expected to arrive from the other place; the procedure allows us an additional fortnight to consider the Bill, which I am sure noble Lords will agree is entirely to the benefit of the House.
As noble Lords will be aware, the key provisions of the Banking (Special Provisions) Act 2008—that is, the emergency legislation used to deal with banks such as Northern Rock and Bradford & Bingley—will expire on 20 February 2009. Therefore, it is necessary for the Banking Bill, the long-term permanent replacement for the special provisions Act, to be passed and in place in time by that deadline.
To take as much time as possible to prepare and consult on this legislation in advance of its introduction into Parliament, something which the Government have been pressed to do by stakeholders on all sides of the debate, the Banking Bill has been through three formal rounds of consultation, including over the Summer Recess, to which many hundreds of detailed responses have been received. The Banking Bill was then introduced in the other place in early October, as soon as possible after the Summer Recess, and was carried over to the current Session. The Banking Bill is expected to complete its passage in the other place and be received by this House tomorrow. It is then expected that Second Reading of the Banking Bill will be taken formally as first business on Thursday. At this point the No. 2 Bill will be dropped and all further consideration in this House will be on the Bill brought from the Commons. By agreeing to this procedure, and enabling this Second Reading debate to go ahead today, noble Lords have ensured that the Bill can begin Committee stage when we return from the Christmas break.
I am, as I said at the outset, very grateful to the Members opposite for their commitment to work with us to secure the passage of the Bill while enabling it to receive the fullest scrutiny possible, as is appropriate for such important legislation. I am very hopeful that we will continue to work together in this vein as it progresses through this House.
I turn now to the context in which the Bill is being considered. As noble Lords will be aware, events in financial markets over the past year or so have posed significant challenges for business, authorities and economies across the world. Over the past 18 months the Government have been working, together with the Bank of England and the Financial Services Authority, to tackle these issues in the UK and at an international level. The Government have stepped in on several occasions to protect the stability of the UK’s financial system—in the case of Northern Rock and Bradford & Bingley—using powers provided by the Banking (Special Provisions) Act. But that legislation was only ever designed to be temporary. The need for proper, permanent arrangements to ensure financial stability and protection for depositors in the UK is clear.
Today's Bill is a central part of the Government’s package to strengthen the UK’s framework in this area. The decisive and comprehensive action that we have taken to improve the capitalisation and liquidity of UK banks is another fundamental element of the package. The Bill is the result of an extensive process of consultation, including three consultation documents issued jointly by the tripartite authorities. We have consulted with key industry participants and experts, and of course, we have had vital input from the Treasury Select Committee. The Government have also established an expert liaison group, placed on a statutory footing by Clause 10, which will help the Government to shape secondary legislation under the Bill, in particular the crucial area of partial transfer safeguards, on which we have recently consulted.
The Bill also represents the Government’s considered response to some of the key lessons learnt during this period of financial turbulence. It provides a permanent addition to the UK framework for financial stability and depositor protection. These arrangements will provide the UK authorities with a refined and proportionate set of tools to deal with difficulties in the banking sector, which can affect depositors and the wider economy. It is vital to get these proposals right to ensure that the UK’s framework is sufficiently robust to deal with future, as well as current, challenges. The Bill provides the right framework and range of powers to ensure this.
The Bill includes elements designed to: first, implement a special resolution regime to enable the authorities to deal effectively with a failed bank and reduce its impact on depositors, taxpayers and the wider economy; secondly, enhance consumer confidence and strengthen consumer protection; thirdly, strengthen the authorities’ institutional arrangements, primarily through enhancing the Bank of England’s role in financial stability; and, finally, implement measures to reduce the likelihood of individual bank failure.
I turn to the detail of the legislation and speak first to Parts 1 to 3. The Government are introducing a special resolution regime, or SRR. This SRR will replace the temporary powers taken in the Banking (Special Provisions) Act passed earlier this year. In most situations in which a bank gets into difficulties, these can be resolved through normal regulatory interventions or voluntary action. However, as we have seen recently, bank failures will sometimes occur and they can damage confidence, disrupt financial markets, harm depositors and generate significant costs to businesses and the economy as a whole.
The objectives of the SRR include protecting and enhancing financial stability and confidence in the banking system, protecting depositors and protecting public funds. The SRR provides the authorities with a wide range of tools to meet these objectives. These include the transfer of a bank or its business to a private sector purchaser, the transfer of the bank’s business to a bridge bank or, as a last resort, taking a bank into temporary public ownership. Further, a new bank administration procedure is put in place to support partial transfers of a bank’s business.
The Bill also creates a new insolvency process for banks, the bank insolvency procedure, that can be used, where appropriate, to enable prompt financial services compensation system payments to eligible depositors and also provide for the winding up of a bank’s affairs.
We have set out clear roles for each institution in the SRR, appropriate to their expertise and responsibilities. The FSA will place a firm into the SRR when it considers that the bank is failing or will fail threshold conditions, which relate, among other things, to capital and liquidity requirements.
The FSA will also have responsibility for continuing to supervise firms and for implementing any necessary regulatory actions. The Bank of England will be the lead authority in the SRR and responsible for administering the regime. This complements and builds on its existing role with regard to financial stability.
The role of the Treasury will centre on the protection of public finances and overall public interest, as well as ensuring compliance with international obligations. The Treasury will also be responsible for the temporary public ownership tool. I understand that this division of responsibilities has been supported by stakeholders. The Bill will also establish compensation mechanisms to provide for the assessment of any compensation to be paid to those whose property rights have been removed or interfered with.
If noble Lords will allow me, I should mention, at this point, the two additions to the Bill that my right honourable friend the Chancellor of the Exchequer signalled in his recent Pre-Budget Report. These additions will increase the legislation’s effectiveness in allowing the authorities to deal with risks to financial stability and to safeguard London’s competitiveness as a global financial centre. They will extend the Treasury’s powers under the special resolution regime to allow it to take bank holding companies into temporary public ownership in cases where the resolution of only the deposit taker within a banking group would not by itself be sufficient to prevent a serious risk to financial stability, public funds, or both.
The second addition is in response to the experience of the administration of the failed US investment bank, Lehman Brothers’ UK subsidiary, Lehman Brothers International. The Government propose to take a power in the Banking Bill to introduce, by secondary legislation, and after a formal review, a new special insolvency procedure for investment firms that hold client assets or client money. The Expert Liaison Group, established by my honourable friend the Economic Secretary to the Treasury, will help the Government in this area. I intend to lay these amendments for discussion in Committee and look forward to debating them in far greater detail with noble Lords at that time.
I turn to Parts 4 and 6. The Bill also contains measures to help to restore consumer confidence and strengthen consumer protection. It will ensure that, in the case of a bank failure where eligible depositors need to be compensated or their accounts need to be transferred, the Financial Services Compensation Scheme can always have access to sufficient liquidity to make timely payments by enabling the National Loans Fund to make loans to the scheme.
The Bill allows for the introduction of pre-funding. I reiterate, as both my right honourable friend the Chancellor and my honourable friend the Economic Secretary made clear in the other place, that the Government recognise that this is not the right time to introduce pre-funding. However, we believe that it is important to take a power to provide the option of introducing pre-funding in the future if the circumstances make it appropriate to so do. Of course, there would be full consultation before the regulations were laid and they would be subject to full debate under the affirmative procedure.
Complementing these measures, as part of the new bank insolvency procedure, there will be a statutory objective for a bank liquidator to work with the FSCS to ensure a fast payout to eligible depositors or to arrange the transfer of their accounts to another institution.
Part 4 also includes the power to require the scheme, and therefore its levy-payers in the financial services industry, to contribute to the costs of a special resolution regime. This contribution will be capped at the amount the scheme would otherwise have had to pay in compensation to depositors if the bank had been wound up. There are also some small improvements to the legal framework for the scheme in the Financial Services and Markets Act 2000.
As noble Lords will be aware, these improvements to the funding base and legal framework of the Financial Services Compensation Scheme are complemented by the changes that the FSA has already made, in line with its existing statutory authority under the Financial Services and Markets Act 2000, to increase the maximum level of protection offered by the compensation scheme to £50,000.
In addition to improvements to general protection arrangements, we will also ensure that holders of Scottish and Northern Ireland notes are afforded a similar level of protection to that enjoyed by holders of Bank of England notes. We have worked closely with issuing banks and other stakeholders in Scotland and Northern Ireland to ensure that these provisions are fully supported, and I am pleased to say that they are.
We are taking action to strengthen the authorities’ institutional arrangements, primarily through enhancing the Bank of England’s role in financial stability. The Bank will have a new statutory objective for financial stability and the range of tools available to it in its pursuit of that objective will be extended and enhanced. It will take a leading role in the execution and implementation of the special resolution regime and in the oversight of the inter-bank payment system. The Bill also provides for improved governance arrangements to support the Bank in the execution of its role.
Finally, turning to Part 7, it is fundamental that we take action to reduce the likelihood of individual bank failure. The FSA already has extensive supervisory and regulatory powers under the Financial Services and Markets Act, and is taking forward a comprehensive supervisory enhancement programme. But there are further steps that we can take: we are legislating to make changes to allow the authorities to take action more effectively to prevent banks getting into difficulty. These measures include new information-gathering powers for the FSA and improvements to the flow of information between the tripartite authorities. The Bill also allows for short-term non-disclosure of emergency lending by central banks, which will help to ensure that such support can help the bank pull itself out of trouble without compromising confidence.
Before the House is a comprehensive and serious piece of legislation; it is a key element in the Government’s enhancements to the UK framework for financial stability and depositor protection. But the Bill is only part of the story, and it may be useful to spell out other actions which the Government, the Bank of England and the FSA have taken or are taking to complement its provisions.
As noble Lords will be aware, the Government have taken decisive action to recapitalise and strengthen the UK’s banking sector and provide support to institutions facing difficulties. The Bank of England has taken action to improve the liquidity position of the banking sector through its special liquidity scheme. The credit guarantee scheme was launched on 13 October as part of a comprehensive package of measures to address the extreme stress in financial markets and to prevent the collapse of the banking sector. The Government expect that by the end of 2008 approximately £100 billion of guarantees will have been made to participating institutions.
The Government have conducted a review of how these arrangements have worked in practice. The outcome, as announced yesterday, is a set of proposals to change how the fee for use of the scheme is calculated, the length of the scheme and the currencies in which guaranteed debt may be issued. The overall effect of these changes will be to enhance the effectiveness of the scheme in supporting stability in the financial sector and maximise its impact on wider economic stability through supporting lending to the economy.
In addition, the FSA is taking further action to promote financial stability and protect depositors under the powers granted to it by the Financial Services and Markets Act. The chairman of the FSA, the noble Lord, Lord Turner, is conducting a comprehensive review of the UK’s system of regulation, and the FSA is now implementing a supervisory enhancement programme to improve the supervision of regulated firms.
The Government are also working with banks to ensure that households and businesses have access to the financial services and advice they need. Indeed, as announced in the Pre-Budget Report, we are bringing together a new lending panel of trade bodies, regulators, industry and consumer groups to monitor lending both to businesses and households. As I have already mentioned, there has been a significant improvement to depositor protection, with the FSA’s increase to £50,000 of FSCS protection to depositors.
The problems affecting financial markets in the UK at the moment are common to markets around the world. These measures, and the provisions of the Bill, should be considered in the context of the steps which the UK is also taking in conjunction with our international partners to secure a constructive global response to current global challenges. The UK, as the next president of the G20, is working actively to pursue the steps agreed at the recent Washington summit, including work around transparency, capital requirements and other issues. We also continue to work with our European partners to ensure that appropriate steps are taken across the European Union and the European Economic Area to strengthen financial stability.
The Banking Bill provides a set of measures to enhance the UK’s framework for financial stability now and for the long-term. The Bill presents a comprehensive and proportionate legislative response to recent events which will stand the test of time. It is important to get this legislation right. I look forward to our deliberations over the coming weeks. I am determined that this House is able effectively to scrutinise and debate the Bill’s provisions while we work to gain Royal Assent in a timely manner. This is an important piece of legislation that will enhance the ability of the authorities to secure the financial stability of the UK both now and in the future. I commend it to the House.
My Lords, I thank the Minister for introducing the Bill and for clearly explaining its contents. However, the highlight of the day will be the maiden speech of the noble Lord, Lord Smith of Kelvin, who is a welcome addition to the select band of chartered accountants in your Lordships' House. I am sure that his experience will contribute greatly to the quality of our scrutiny of the Bill.
As the Minister explained, the Banking (Special Provisions) Act 2008, which was rushed through Parliament last February to allow the Government to nationalise Northern Rock, will expire in the middle of February. I confirm that the Official Opposition have agreed that in these difficult times it would be undesirable for the Government to be without legislative cover in case there are further crises in the banking world. Hence, we are co-operating with the Government to ensure that the Bill that will arrive from another place later this week becomes law before the 2008 Act runs out. To that end, my noble friend George Osborne has signalled that we shall not challenge the Government in the Division Lobbies of your Lordships' House on an important aspect of the Bill on which we and the Treasury Select Committee in another place disagree with them: whether the Bank of England, rather than the Financial Services Authority, should hold the power to initiate the stabilisation regime in Part 1.
Our approach on co-operation during the passage of the Bill and our forbearance on the issue that I have just mentioned in no way signal that we shall not subject the Bill to our customary scrutiny. There are many issues on which we and, more importantly, the financial services industry, which will be affected by the Bill, have concerns. We shall be pressing those concerns with some vigour and, if necessary, we shall seek the opinion of the House.
We recognise that the Government have made some constructive changes during the Bill’s passage in another place, notably the statutory recognition of the banking liaison panel, the modification of the Henry VIII powers in Clause 75 and on draft secondary legislation and the draft code of practice. However, we think that there is still some way for the Bill to travel. I hope that the Minister will be prepared to listen to the concerns expressed on the Bill. It might seem attractive to him to exploit the political goodwill that we bring to the Bill in allowing its speedy passage on to the statute book, but I hope that he will not be tempted to ignore reasoned and reasonable opposition. We have not taken a total vow of abstinence from dividing the House.
There is one recent lesson from the United States that we should keep in mind when scrutinising the Bill. In the wake of the Enron scandal, the US passed, at great speed, the well meaning Sarbanes-Oxley legislation. It has imposed significant costs and has driven international companies away from US capital markets. I do not want us to look back on the passing of the Banking Act 2009 and find that it has become our Sarbanes-Oxley. Our financial services sector is an important part of the UK economy and London has, until very recently, been seen as the best place to do business and has attracted global capital and global players. However, London developed in part because of the weaknesses of other capital markets, and we should always remember that other financial centres would relish the opportunity that might be presented if we get the Bill wrong.
If we cast our minds back to last year when the Northern Rock crisis first emerged, a number of things were not right. The tripartite arrangements were not robust, the FSA had fallen down on its prudential regulation responsibilities and the Bank of England claimed that its hands were tied in various ways. The Government have attempted to deal with some of those issues in the Bill, but there are some gaps. One area that we will examine in Committee is whether the regulatory objectives for the FSA, as set out in the Financial Services and Markets Act 2000, are well formulated. For example, there is no mention of prudential regulation. The first objective is to maintain confidence in the financial system. That was certainly not achieved in 2007, but the objective itself is flawed. It is not framed in terms of creating or maintaining a financial system in which confidence can be placed. The FSA’s job appears to require it to create confidence in the financial system whatever its quality, and that cannot be right.
In 1997, the Government removed a crucial role from the Bank of England in relation to overall debt levels. It has not been restored in the Bill, and we want the Bank to have a duty to monitor debt levels and to write to the FSA if it believes they are too high. The FSA should then modify its approach to supervision and regulatory capital.
Let me now turn to the detail of the Bill. We support the broad outline of the special resolution regime as set out in Parts 1, 2 and 3 although, as I have already mentioned, our preference is for the Bank of England to be in the driving seat rather than the FSA. We have other important reservations about this part. The Minister will be aware that the banking industry is at one in its concerns about the partial transfer provisions of the Bill in relation to set-off and netting arrangements, which are an integral part of the way in which financial institutions do business with each other and with other counterparties. The definitions in Clause 48 remain problematic. The safeguards set out in Clauses 47 and 48 rely on secondary legislation to produce a legally robust solution that will underpin legal certainty for set-off and netting arrangements. While this gives flexibility, it of itself creates uncertainty.
While there is a general view that the code of practice is helpful in giving an understanding of how the SRR regime will work in practice, it adds absolutely nothing to the area that requires legal certainty, because it would not help the giving of legal opinions on instruments. If the Government insist on secondary rather than primary legislation to achieve the safeguards, that will create an uncertainty because there will inevitably be a gap between Royal Assent and the coming into effect of related secondary legislation. That could be damaging to financial markets. In Committee, we will want to discuss with the Minister whether that uncertainty can be mitigated.
While I am on the subject of secondary legislation, I remind the Minister that the House awaits the imminent publication of the report of the Delegated Powers Committee on the Bill. When the Banking (Special Provisions) Act was passed earlier this year, the Government, unusually, chose to ignore the very clear recommendations of that committee in relation to the affirmative procedure. I hope that the Government will commit to accepting the recommendations of the committee, whatever they are in this instance. We start from the very firm position that the committee’s recommendations should rarely, if ever, be ignored.
There are other concerns about Part 1. I have already mentioned the ghost of Henry VIII in Clause 75, and my noble friend Lord Howard will pick that up further when he winds for these Benches. The banking industry believes that Clause 4 omits an important objective for the customers of banks, in that they need to be assured of continuity of service. Customers do not simply need their money back; they need to be able to pay their bills and receive their income, much of which now proceeds on an automated basis. The Government rightly protected this when they dealt with Bradford & Bingley, but they seem to have forgotten its importance in this Bill.
There are also concerns about the test for the SRR in Clause 7 and on the provisions in Clauses 63 to 67 about providing services and facilities after a partial transfer. These will be fruitful areas for our discussions in Committee, as will the need for post-legislative scrutiny, to which my noble friend Lord Howard will speak later.
We also have a concern that Part 1 applies to UK incorporated banks and does not apply to branches. We have seen the problems that UK branches of foreign banks can cause, and we are surprised that the Bill makes no attempt to deal with those issues. We will pursue this further in Committee.
We have welcomed the increase in compensation limits in the Financial Services Compensation Scheme to £50,000, but we have been clear in our opposition to pre-funding, which is provided for in Part 4. Just because there is an element of pre-funding in the United States should not drive policy in this country. No reasonable amount of pre-funding will ever cope with the aftermath of the failure of a major bank, and the lack of pre-funding in the existing scheme has not been an impediment to date. We do not believe that the existence of an order-making power is appropriate; it would be appropriate for primary legislation if and when the case were ever made for pre-funding.
In addition, there are concerns, particularly among those outside the banking community, about how the costs of the compensation scheme are to be borne. We will need to return to that in Committee. As well as the cost of the Financial Services Compensation Scheme, the banking industry has considerable concern about the cost more generally of this Bill. The impact assessment’s estimate of costs of between £2 million and £4 million is regarded as bordering on the absurd. I understand that further data will be available soon; we will certainly need to revisit that issue in Committee.
Part 7 contains changes in respect of the Bank of England, some of which are probably of more interest to such old court hands as the Minister and me. The financial stability objective for the Bank is specified for the first time. I do not believe that, in practice, the lack of a statutory objective has had any impact on the Bank’s action—or lack of it—in the recent past, but it is no bad thing to set it out in law. If we are going to do so, we should also make sure that it is properly defined, which this Bill makes no attempt to do. We shall also be examining the role of the new financial stability committee within the Bank, and its relationship to the Court of the Bank of England. We shall be proposing changes to the tenure provisions set out in this Bill, to avoid unseemly speculation over the reappointment of the Governor of the Bank of England. We believe in transparency but are far from convinced that the requirements of Section 6 of the Bank Charter Act 1844 should be swept away in their entirety. I am aware that the Bank of England would like it removed, but we need to reflect on what has been put in its place, which, as far as I can see, is absolutely nothing.
This Bill has a very broad Long Title in making “provision about banking”. That will leave much leeway for the House to put forward other suggestions for improvements in the banking sphere. We certainly have some in mind in the light of current difficulties with bank lending, and there will be others. We shall, as usual, work diligently with the aim of improving this legislation. We have committed to ensuring that the Bill becomes law by the time that the Banking (Special Provisions) Act ceases to have effect, but that does not mean that we are a pushover on this Bill. There are plenty of days on which we could sit between now and 20 February, and we are prepared to use as many of them as it takes to complete our normal processes of scrutiny.
My Lords, I thank the Minister for his careful presentation of the Bill. Like the noble Baroness, I look forward to the maiden speech of the noble Lord, Lord Smith of Kelvin. This is an important Bill, the principles of which we support. Despite its general title, it deals with only a small proportion of the big issues currently facing the banking sector. It is worth recalling that when we passed the Banking (Special Provisions) Act in February, there was a general view that the travails which had overwhelmed Northern Rock were largely due to particularly reckless lending policies by that institution, and that the bank’s demise did not foreshadow the near-collapse of the entire banking sector. However, that is what we have seen in recent months. Nobody, in February, foresaw a situation in which the Government would not only have to take over another failing bank, Bradford & Bingley, but would be forced to part-nationalise half the entire banking sector. Nor did we foresee that the Government would also, in effect, have to guarantee all interbank lending to stop the whole system simply seizing up, far less that such a dramatic commitment of government funds would, at best, be partially successful.
The Bill, in some senses at least, seems to have been overtaken by events. Given the nationalisations and part-nationalisations, and the consolidation in the bank and building society sector over recent months, the likelihood of the measures of the Bill being brought into action—for the foreseeable future, at least—looks small. Most of the immediate issues facing the banking sector are not covered in the Bill. I will mention only four. First, how are we to get the banks lending again on terms which are not prohibitive to business? The Government are committed to putting the Banking Code, which covers these and other matters relating to the banking sector, on a statutory basis, but not in this Bill. Indeed, I understand that the code will be introduced via FSA powers, and will not be subject to parliamentary scrutiny at all, which is a great pity.
Secondly, the Bill does not deal with the role of government direction to the banks in which the Government have recently taken a shareholding, which, in our view, is extremely important in terms of the way that the banks are managed. My colleague, my noble friend Lord Smith of Clifton, talked during the debate on the Queen’s Speech about the appointment of directors to such banks. The Bill is silent on that.
Thirdly, the Bill does not deal with how to ensure that the banking market operates in a competitive manner, given that the size of the merged Lloyds TSB/HBOS and the disappearance of many independent banks and many former building societies means that we have a much more concentrated banking sector than any noble Lord would have thought possible a year ago. Fourthly, the Bill does not deal with the need for countercyclical management of the capital adequacy rules. That is not surprising, perhaps, given the international nature of the issue, but it is a question for the whole banking system.
Arguably, any one of those measures is more pressing than those in the Bill, given the nature and extent of the Government’s current commitments to support the banking system. We will be looking for opportunities to ensure that these issues are properly debated in the months to come.
We will have the pleasure of spending most of January debating the Bill in some detail. Our approach will largely mirror that set out by the noble Baroness. Given that in another place consideration of the previous Bill was at best cursory in Committee, with most amendments not even being taken, your Lordships’ House has been given an additional responsibility to test as far as we can all the issues with which we have some difficulty. That is what we will do over the next month.
Depositor protection is at the Bill’s heart. Its options regarding failing banks are designed to ensure that depositors are adequately protected, and, if a bank fails altogether, that depositors quickly receive the cash due to them under the depositor protection scheme. We agree with the BBA that continuity of service should be a priority, not least because even the best run protection scheme will take time and cost to put into place and will cause all kinds of disruption to the way in which affected depositors manage their day-to-day financial affairs. In the worst cases, the Financial Services Compensation Scheme will have to come into operation. Here we share some of the concerns expressed about the details of how the scheme would operate in practice—for example, how to offer adequate and fair support for those with temporary large balances, the question of whether the guarantee would apply to gross or net exposure, and whether the scheme would apply to each brand or each banking licence.
We are also looking for government action at EEA level to provide that all banks operating in this country should sign up to the host state compensation scheme. This provision, if it had been in place earlier in the year, would have significantly reduced the difficulty faced by UK depositors and the UK authorities in dealing with the Icelandic banks.
We also have questions about the pre-funding provisions. We agree with the principle that the financial sector, rather than the general taxpayer, should be responsible for funding any payouts under the Bill. However, we agree with the Government that it would be counterproductive to introduce a pre-funding scheme at present. In our view, any funding scheme raises a number of issues which have not yet been satisfactorily resolved—for example, about the relative amounts of funding which will be required from different sectors of the financial services sector as a whole, so that contributions could be broadly related to the risk associated with each type of product provided.
Rather than seek to resolve these issues now, given that pre-funding is not on the table in the foreseeable future, it would seem sensible to return to them once the current crisis has passed. For this and for other reasons, we will also argue that the Bill should have a sunset clause attached to it, so that Parliament can reassess it as a whole when we return to more normal banking conditions. I was mildly encouraged by what the Minister in the other place, Ian Pearson, said on Report in respect of sunset clauses—that there were contexts in which he would not reject the concept. I hope the Minister will endorse this approach.
If depositor protection is the single main focus of the Bill, it has become clear that great care needs to be taken to ensure that the rights of other creditors are safeguarded to the maximum extent, not least to meet the other objectives of the Bill. As both the Minister and the noble Baroness have spelt out, the banking industry is extremely concerned about the detailed rules which will apply in cases of a partial transfer of assets and the potential, if these rules are not right, that they could lead to major disruption of the marketplace.
These are issues being considered by the expert liaison group and I hope that when we come to Committee these concerns will have been effectively addressed by the Government via that mechanism. Given that the differences which remain in this area appear to have little to do with issues of principle between the Government and the banks and everything to do with the detailed drafting of the legislation, I hope it will be possible to deal with them via that expert liaison group.
The Treasury approach to this Bill, which has involved consultation and efforts to take the banking sector along with it, appears to be pretty good. The very fact of having the expert liaison group and the intention that it should aim to iron out remaining differences before the Bill is passed is a welcome advance on the traditional Treasury approach. Despite the phenomenal grasp of the technical details possessed by both the noble Baroness, Lady Noakes, and the Minister, it seems to make much more sense for this kind of detailed technical issue to be dealt with outside the Chamber rather than within it.
One issue which runs like a leitmotiv through the Bill is the relationship between the Bank of England, the FSA and the Treasury. While I fully accept that each of the three bodies will have an important role to play if the Bill is invoked, it does nothing to reassure me that some of the apparent muddle which characterised the early stages of the Northern Rock saga will be avoided in future. The key question is: who pulls the trigger to institute the special resolution procedure and when? I am concerned and puzzled about the role of the proposed Financial Stability Committee, a sub-committee of the Court of Directors of the Bank of England that consists of bank executives and non-executives to advise on protecting and enhancing the stability of the financial system. It is also expected, however, in the words of the Minister in another place, to advise executives on,
“crucial decisions regarding banks and the operation of the special resolution regime”,
often in “fast-moving situations”.—[Official Report, Commons, 31/10/08; col. 245.]
Responsibility for triggering the special resolution regime rests with the FSA, not the Bank. I can just about see a logical separation between the roles of the Bank and the FSA, with the Bank responsible for the overall stability of the financial system and the FSA worrying about the financial state of individual banks and other financial institutions. If one of the key roles of the Financial Stability Committee, however, is to enable people who are close to the financial markets to influence decisions about how to deal with unfolding problems of individual banks, would it not be more appropriate if this advice were given direct to the FSA, which pulls the trigger? This should particularly be the case during rapidly moving events, which are typical when we move towards this kind of special resolution regime.
With regard to when the trigger can be pulled, we share a widespread concern that the present provision in the Bill—namely, that it is not reasonably likely that the Bank can continue without the regime—is too permissive.
Another area of concern which has been widely expressed relates to the near blanket order-making powers under Clause 75. In Parliament we often worry about Henry VIII powers with regard to the parliamentary system and the role of the Executive, but in this case there is real concern in the banking industry that the provisions, particularly in retrospection, could have a damaging effect upon the operation of the banking system. I hope this can be dealt with in an acceptable manner via the expert liaison group. We will, however, also want to see what the Delegated Powers Committee says when it reports later this week.
We support the aims of the Bill and many of the detailed provisions that it contains. However, there are areas where further amendment is needed, and we look forward to ensuring that that occurs before the Bill leaves your Lordships’ House.
My Lords, standing here in this Chamber, it is impossible not to be struck by a great sense of history. I hope that I am not about to create history of my own by being the first maiden speaker to be booed. Noble Lords will understand my concern: I began life as an accountant; I moved into banking; I was in private equity; I moved into fund management, although not pyramid schemes; and I am now the chairman of an energy supply company. So clearly my careers adviser at school did not factor popularity strongly into the advice that he gave me.
However, it is to the industry in which I spent the majority of my career—banking—that I want to direct my observations today. The Banking Bill, which noble Lords are considering, contains several measures aimed at promoting stability in the banking sector. Stability is undoubtedly what is needed in these institutions, which I guess until recently most of us believed were run very prudently for depositors and borrowers.
The keystone of stability in the banking system is confidence, and confidence has been shaken. Small savers and borrowers lost confidence in their high-street banks. Small and medium-sized businesses lost confidence in the availability of lending. The confidence of even large corporations has been undermined in an attempt to roll over existing debt, and at the base of this pyramid of uncertainty is a loss of confidence between banks themselves. That situation could have profound consequences for every one of us, and there may still be bad news to come.
This Bill and other regulation should play a role in restoring confidence. I welcome initiatives such as the loan guarantee scheme, the monitoring of lending, deposit protection and so on. However, there are other things that we can do, such as reducing complexity and increasing accountability. Warren Buffett, who is probably the world’s most successful investor, says:
“The market, like the Lord, helps those who help themselves. But unlike the Lord, the market does not forgive those who know not what they do”.
As an aside, I know that that should be “forgive them”.
Some sophistication and complexity is necessary, but the UK taxpayer is now suffering because of decisions taken at institutions where risk was not truly understood. Perhaps I may give noble Lords an example that baffles me as a banker who cut his teeth in an earlier era—that of collateralised debt obligations, and in particular CDOs whose underlying asset is a pool of sub-prime mortgages. To get a feel for the complexity of CDOs, the prospectus for a typical mortgage-backed security stretches to 300 pages. To create a CDO, you take a tranche of those mortgage-backed securities and add 50 more tranches from other mortgage-backed securities. To understand that CDO, you have to read 50 times 300 pages, which amounts to 15,000 pages. This is not prescribed reading over the holiday period, but if you look at the notes to the balance sheets of the 2007 accounts of the major banks in this country, you will read against some large numbers the legend “CDO squared”. I will leave it to the mathematically minded to decide how many pages you need in order to understand such an instrument, yet these products are, in part, what have laid low many of the world’s biggest banks.
Why has that happened? It has happened because the banking environment of the past decade or so has allowed it. Financial innovation in products such as CDOs is very profitable, and it chimed easily with the reward system that existed for senior management in some of the banks and other financial institutions. However, it was also validated by an investor community looking for strong returns and by politicians, commentators and customers who were all looking for wider share ownership and more available credit. When the sun was shining there was no real incentive to ask, “What’s in these products we’re buying?”.
Profitable businesses are good news for all of us and in recent years the City of London has built a great global story of success. However, banking has an unwritten “licence to operate”. It has much more of a social function than many other businesses. That is why governments and regulators around the world, through taxpayers’ money, have recognised that these are businesses that cannot be allowed to fail.
As a good Scottish chartered accountant, which, I hope, is tautology and not seen as an oxymoron, my instinct tells me to follow the money. When a banking system has become too complex to achieve that, then something has gone badly wrong. Tackling this is down to corporate governance and strong people. Several years ago, I chaired a Financial Reporting Council group tasked with giving advice to audit committees. Our recommendations, which are now part of the Combined Code on Corporate Governance, had a strong underpinning theme: the quality of the people on the committees and the boards of the companies. Shareholders rely on company boards and governance structures to protect their investment and third parties depend on them too. That means people who are brave enough to ask the simple question at the right time. I suspect that that has not happened at a number of companies in the past couple of years. In some cases, it is clear that bank boards have failed to ensure that the risk and complexity have been fully understood and evaluated.
To conclude, I have been fortunate towards the end of my business career to be involved in working with young adults in employment, education and training. Their attitude is quite different from mine at their age. I was looking for a reasonable salary and promotion prospects. This generation is far more caring. They bother about how a company behaves and about whether a company shares the values that they share. What they see now are huge businesses suffering because, in essence, they have lent money to people who cannot afford to pay it back. Stripping away the complexity that was described earlier, that is exactly what has happened. Stability will come back to our banks, but in return for taxpayers' indulgence, they owe it to the next generation to grow again by behaving responsibly and with relative simplicity.
My Lords, I am really delighted to have the opportunity to congratulate the noble Lord, Lord Smith of Kelvin, on a most excellent maiden speech. I find myself with much in common with the noble Lord: I am an accountant, no longer practising of course; I was the vice-chairman of the BBC and he was a governor after me; I have some interest in banks, in a modest way as an investor, unlike him as a director; and he seems to have a sense of humour, which I like to think I share too. He also comes from Scotland, and there is something I did in my past which bears some relationship that he will know about only too well.
The noble Lord was also in the FSA, which I want to have a word about later. He was a chairman of a group on audit committees and produced a combined code of guidance. I assume it was all before we heard about toxic assets. I may later be a little critical of banks, auditors and the FSA, and I hope that the noble Lord will forgive me, as I am not being personal. We heard a most excellent maiden speech, and I hope that we will hear often from the noble Lord in the future, because he has a lot to offer to the House of Lords and to Parliament. I hope we will hear from him on many occasions.
I agree with my noble friend Lord Myners on the Bill itself and the need for recapitalisation of the banks, which is fairly self-evident these days. My noble friend spoke often of the need for financial stability—with which I also agree—and used the words “financial stability” many times. He also spoke about the credit guarantee scheme. He told us that £100 billion—we do not use the word “million” anymore, and I assume that we will soon be talking only of trillions—had been taken up from the credit guarantee scheme. I am delighted to hear it because, as I understood it, the scheme had not been working too well because, I am told—not that I believe anything I read in the papers—the cost to its users was too high. Perhaps my noble friend will say a word about that and also tell us whether this borrowing—the capitalisation of £37 billion and £100 billion or possibly £250 billion in due course—will count against the £118 billion, the figure in the Pre-Budget Report that we are likely to see by next year. Clearly, those guarantees represent a lot of borrowing and I hope it will never happen, although the £37 billion will. Perhaps the Minister can tell us whether, as I assume, those are classed as investments.
I declare a modest interest in banks, particularly the one of which the noble Lord, Lord Smith of Kelvin, was a director, the Royal Bank of Scotland, in which I took up a modest rights issue at 200p a share, not long before the Government paid 65p on behalf of taxpayers. I noticed that the reason given for choosing that price was not that there was any due diligence or sight of the balance sheet, but that they took an 8.5 per cent discount on the closing price of the shares on 10 October and then a further 1.5 per cent initial charge. Since then, we have learnt rather more—although we still do not know enough—about toxic assets and we have heard of further losses which the Royal Bank of Scotland has had in recent weeks or months. I do not know whether that price was good or bad for taxpayers.
I quote what my noble friend Lord Myners said to me in response to a Written Question about how toxic assets are to be valued now, which I am sure many of us will be interested to know. It is a complex Answer:
“Current accounting standards set out rules governing the disclosure of off-balance sheet transactions, where these are not required to be consolidated into group accounts. Similarly, current standards provide for recognition and classification of transactions involving derivatives”.—[Official Report, 12/11/08; cols. WA130.]
I shall leave it there. I am sure what the noble Lord was telling me will be clear to the House, although it may not be clear to everyone who takes even a slight interest in these matters. Did the current accounting rules come into effect before or after 10 October? When we chose that price, did my noble friend know about the off-balance sheet transactions and the figures in the affairs of the Royal Bank of Scotland?
I turn to my right honourable friend the Chancellor and what he said about how the Government have a mind to manage the banks in their control, whether 100 per cent or where they have simply a majority holding. In his letter to John McFall, the chairman of the Treasury Select Committee in another place, the Chancellor said,
“the Government’s investments will be managed on a commercial basis by an arm's-length company”.
I hope that that is a contradiction in terms as regards what the Government really have in mind. I hope that the talks with the banks now will be more than arm’s length—more twisting arms—but I do not know. It seems to me to be a contradiction in terms even if the banks sign up to some sort of code. The plain fact is that if they are to be run on a purely commercial basis by an arm’s-length company, which the Government are to set up, how on earth can we have any practical influence on how those banks will be managed in the future? I hope that my noble friend can tell us exactly what is going to happen. How will they tie the management down?
There will be specific cases where the banks will have to decide on a commercial basis whether they should lend or not lend. What will we do? How will we ensure that they maintain certain levels of lending? We are told that they are going to stick to the 2007 lending levels. Surely that is meaningless because, if they are being run on a commercial basis, how can they stick to the particular level of lending of any year? When he replies, will the noble Lord tell us what this means? Bank lending is as crucial to getting out of this recession as any fiscal stimulus. Why, despite all that has been done and how much taxpayers’ money has been pumped into them, are the banks not lending?
In our debate of 8 December, my noble friend Lord Myners told us that further write-offs of toxic assets are to be expected. How do we know what may be expected? Do we know the size of the toxic assets that are to be written off? It could be that the banks have a lot to write off and will simply balance their books with the money we are providing for them rather than lend it out, as the Government have in mind. I do not know. What I do know is that we have a situation where we are supposedly in control of the banks yet we are not because the relationship has to be kept at arm’s length and on a commercial basis. It does not make sense. Again, perhaps my noble friend will explain this more fully.
If the banks still do not lend despite all the money we have given them, what is the Government’s strategy? Non-executive government directors are being appointed. We have had a lot of non-executive directors of banks, some earning up to £200,000 a year, but what were they doing while the banks were investing, off balance sheet, depositors’ money in all these toxic assets? Did those non-executive directors even know what was going on? Did they ask any questions? Now we are to have government non-executive directors, so perhaps my noble friend will tell us what they are expected to do.
Whether the banks are publicly or privately owned, it is clear that we need stronger regulation, and I am delighted that the noble Lord, Lord Turner, the new chairman of the FSA, seems an able man, whom we have heard in this House and elsewhere. The FSA is now recruiting more people to help in its regulatory activities. My worry is who the authority will employ to do it—more ex-bankers or more accountants, perhaps? With respect to my own profession, we have had accountants who provided clean audit certificates, only to find a few days or weeks later that the banks were writing off vast amounts of toxic assets. How did they value those assets? Does anyone know? For auditors to qualify a set of accounts is a serious matter. If they had qualified the audit certificate of any bank or indeed any company, it is such a serious matter that it would be the end for the organisation. But it is probably even more serious not to have done so and to have let the banks carry on as they were. I do not know what accounting standards are going to be introduced, but we should note the way in which auditors were giving clean certificates to banks only to find shortly after doing so that vast assets were being written off the balance sheets.
I should make it clear to my noble friend that my questions do not in any way seek to persuade the Government to avoid doing what the Bill seeks to do. The Government are right to introduce it and to do the recapitalisation—I want to see a sound banking system—but I am concerned to know how the Government propose to allow the same management that bought all the toxic assets to manage the banks, with everything at arm’s length. We are just talking to them and they still do not lend, so what are the Government now proposing?
I wish to speak about one small part of the Bill rather than the detail, which we will come to in Committee: the special resolution regime, the SRR, in Part 1. My right honourable friend the Chancellor described it at Second Reading in the other place:
“Part 1 provides for a permanent special resolution regime that is at the heart of what is proposed. As hon. Members are aware, it will allow us to accelerate the transfer of … a bank’s business to a publicly controlled bridge bank, on the way to a private sector sale. It will also modify the insolvency procedure and allow us to take a bank into temporary public ownership”.—[Official Report, Commons, 14/10/08; col. 696.]
Could this accelerated transfer to public ownership be carried out not because the banks are insolvent or illiquid but simply because they are not doing the job that we expect them to do? If the Bill does not allow for that, can my noble friend assure us that we will be able to amend it so that it will do precisely that?
I end by referring to a very cautious person, the Governor of the Bank of England. On 6 December Mervyn King said to the Treasury Select Committee:
“The banking system is too important just to be left to its own devices”.
I do not know what he meant by that, but what meaning could it have other than that, if the banking system were left to its own devices, it would be disastrous for this country and the economy? Do the Government agree with the Governor of the Bank of England? If not, what else do they propose? I prefer not to go down the path the Governor implies in that statement but if the current system is not working—we are talking to the banks and they are still not lending—I hope my noble friend can assure us that the Government will not remain at arm’s length from those banks.
My Lords, it is a pleasure to follow the speeches of the noble Lords, Lord Barnett and Lord Smith. As they will hear, I shall attempt to amplify both the content and tone of what they have said. One of the most attractive aspects of your Lordships’ House is that we listen intently to what Ministers say at the Dispatch Box and try to understand what is in the Government’s mind. To that end, I say to the Minister that it would assist the House’s appreciation of the context of the Bill if he was prepared to withdraw a statement that he made in the House on 12 November 2008. He said:
“the Government are not of the view that we are in extreme economic circumstances”.—[Official Report, 12/11/08; col. 654.]
The Minister does not seem to want to withdraw it, so he stands by it.
We are then asked to believe that what the Bank of England calls,
“the largest financial crisis … in human history”,
must have blown up in the 12 days between 12 and 24 November, because by the latter date the Government had a completely different view. On that day in another place, the Chancellor of the Exchequer, describing where we were, used the phrases,
“not seen for generations … extraordinary … times … exceptional economic circumstances … disastrous … unprecedented global crisis”.—[Official Report, Commons, 24/11/08; cols. 489-90.]
I do not know whether the Minister wants to withdraw the statement now.
Apart from torturing the Minister—a totally honourable activity, by the way—it is for your Lordships’ House to be crystal clear about the true context of the Bill, to which the Minister himself referred. Apart from the Minister, the rest of us see this Banking Bill as a response to a crisis that was at the heart of an economic crisis that is now claiming jobs, careers, companies, families and livelihoods every day. The beleaguered citizens of Britain want to know what the Banking Bill will do to prevent this from ever happening again. If the Bill had a subtitle, it would be, “How to Lock a Stable Door After the Horse Has Bolted”. But that is not what we want, nor what the people in the Gallery and the public are interested in. We want to build a stable with such solid doors and such a powerful lock that this horse can never bolt again.
I am not interested in apportioning blame for this crisis. I am well aware that some people would say that it was a failure of free markets, while others would blame a failure of regulation. I do not mind at this moment. I would like the Government to accept the help of your Lordships’ House and the many experts in it—we heard from two of them just now—in ensuring that this never happens again. To do that, we have to know how this banking crisis came about. The noble Lord, Lord Smith, touched on that. I shall attempt my own description, and I assure noble Lords that it will make their hair stand on end. If it is complex, I hope that your Lordships will forgive me; it is in order to assist your Lordships’ House in identifying precisely how the crisis came about. Perhaps in his winding up the Minister will point your Lordships to the clauses in the Bill that will prevent the recurrence of the events that I am about to describe.
The record seems to show that this economic war was started by an acronym. The noble Lord, Lord Smith, said as much. To explain, I recommend a game for your Lordships to play. It will be a fine game at dinner parties over Christmas. It involves uttering a sentence and then inviting participants to translate it into plain English. The game is best played with people who own or run a bank. Here is the sentence: “I use CFDs in my SIV to buy CDIs, or CDOs, in the CDS”. Some of us have great friends who own or run banks, and I have played this game with them. They know that these acronyms exist and they can say what the letters stand for, but I assure your Lordships that they cannot explain what they mean. For example, the most distinguished former Governor of the Bank of England, the noble Lord, Lord George—the iconic Eddie George—confirms the point in a recent pamphlet for the Politeia think tank. Writing about these banking acronyms, he says that, as Governor of the Bank of England, he did not understand,
“how they were rated or related”.
These are the acronyms that brought the world to its knees.
This horse bolted with two leaps. We have to take our hats off to the startling simplicity and creativity with which it was done. I hope that noble Lords will forgive me for this description; I think that it is important to explain. In the beginning, the banks took deposits and it was understood that they made loans equal to the deposits that they had taken. That was the original idea of banks. The centuries went by and the view arose that that was unnecessarily restrictive on banks and that, as all the depositors did not ask for all their money at the same time, it was reasonable for the banks to lend a multiple of the money that they had on deposit. Then the question arose of what the multiple of what was on deposit might reasonably be.
At this point, I have to introduce your Lordships to the Basel Committee on Banking Supervision, a body consisting of central banks and the regulatory authorities of the world. They look at what they call the key point—how much capital banks need to put aside against the types of financial operational risk that banks face. In the history that I described, they arrived at Basel II in 2004. The important thing about Basel II is that the committee makes recommendations, provides a forum and encourages. In other words, it has no force of law.
The brilliant and creative people to whom I referred earlier, in the investment banks and probably in Wall Street, wanted to find a way to lend more; they wanted to find a way around those capital ratios. They hit on a brilliant idea—this was the first leap—in the SIV, the structured investment vehicle. This SIV, for reasons that I do not understand but on which the noble Lord, Lord Smith, may enlighten us at another stage, could be taken off the balance sheet of the banks. That was a key point raised by the noble Lord, Lord Barnett. That was the benefit of the SIV: it was there to take the loans out of the balance sheet so that the banks could lend more and stay within the ratios laid down by Basel II. But they were no longer loans; they were investments. This was not a loan book but a market for investments. That is what happened to enable the banks to lend more, which they did.
That was leap number one, but it was not the end of the brilliance. The banks started to lend more and got interested in the so-called sub-prime market of residential property in America. The sub-prime market is not, as one might imagine from reading the newspapers, some sort of ghetto in Cleveland. It is pretty much all the US residential market, apart from 64th Street and Madison Avenue in New York. The banks started to lend more and move down this enormous amount of residential property. Here they came to a second restriction, requiring a second brilliant leap. The reason why I am putting this to the Minister is that I am anxious for him to say what this Bill will do to prevent a recurrence of exactly what I describe.
The second leap was that, as they went further down the sub-prime market in America, the rating agencies started to say, “Well, this doesn’t look to us like triple-A-rated security”. Apparently you cannot sell anything in the banking world that is not triple-A. The banks hit on a really brilliant, original, creative solution, which was insurance. If they could say to the rating agencies that there was nothing wrong with these loans or investments that they had made and that they deserved a triple-A rating because they were insured, who could argue with that? They were insured and, therefore, they received their triple-A rating.
I hope that noble Lords will forgive me for the history, but they can now see how, when this crisis arose, it was all such a shock and why it is all still unravelling today. The noble Lord, Lord Barnett, said that he did not know. I assure him that not the Minister, not the Treasury, not the FSA, not the Bank of England, not the US Federal Reserve board, not the US Treasury Secretary and not the Chancellor of the Exchequer knew. Nobody knew about what I have just described. So we arrived at a position when the shock arose, when a request that banks routinely make to their customers—that they show them their balance sheet—was one with which the banks themselves could not promptly comply. One day, as the noble Lords, Lord Smith and Lord Barnett, said, the auditors of the banks will explain how this was possible. It is a mystery to me. It would be helpful to your Lordships’ House if the Minister could say in winding up how the Bill will deal with those two specific crucial moments that led up to and made this crisis.
I end by imposing on the House my own small suggestion for how such a crisis can be averted in the future. This does not relate to the two points that I have made, which I leave to the Minister. I was pleased to see that the Government do not regard the remit of the Bank of England as sacrosanct. This Bill amends the remit of the Bank of England, as set out in the Bank of England Act 1998. Proposed new Section 2A(1) in Clause 228, Part 7, gives the Bank a new objective, which is,
“to contribute to protecting and enhancing the stability of the financial systems of the United Kingdom”.
The Government have opened the door to amending the remit of the Bank of England and I hope that noble Lords will accompany me through it.
Shakespeare taught us that human beings can have a fatal flaw. So, too, can legislation. The Bank of England Act 1998 has a fatal flaw. It has three words too many, which my Bill aims to delete. Section 11 in Part II of the Bank of England Act misdefines the role of the Bank by obliging it to focus on controlling inflation to the exclusion of all else and then compounds the error by defining inflation to exclude all the debt/housing/mortgage problems that caused the crisis.
The record seems to show that the top officials of the Bank of England were like top generals given the wrong orders. The fault lies not with them but with the legislation that created them. This is why I introduced in your Lordships’ House just after Questions today—and I am grateful to the usual channels for allowing me to do so—the Bank of England (Amendment) Bill. I will bring forward an amendment in Committee stage of this Bill to give effect to the change in the Bank of England’s remit proposed in my Bill. The amendment is based on the unremarkable proposition that officials of the Bank of England have sufficient wisdom and breadth of vision to see the whole economic picture and that they should not be forced to wear legislative blinkers that blind them to how an economic disaster such as this one can arise during a period of low inflation.
A Labour Prime Minister once won a famous post-war election with the slogan:
“We won the war. Now let’s win the peace”.
One day soon I hope that the Government will be able to say—and we will help them—that we won this economic war. Let us be sure to win the peace, too.
My Lords, before getting down to the speech that I have prepared, perhaps I may remark on what my good friend the noble Lord, Lord Saatchi, has just said about the Bank of England remit. When the Bank of England Bill was going through your Lordships’ House, my noble friend Lord Barnett and I tabled an amendment precisely along the lines that the noble Lord, Lord Saatchi, wants to see. Essentially, the Bank of England Bill should have adopted what was in the Humphrey-Hawkins Act for the Fed, whose criteria were inflation and a high level of employment.
My Lords, that is right. We presented that proposal to the Government. My noble friend Lord McIntosh, who has just reminded me what the provision actually said, was on the Front Bench dealing with that Bill, so he was the one who rejected what my noble friend Lord Barnett and I proffered. My noble friend and I were very annoyed at the time.
Many years later I have reflected on that, and I can now think of a reason why the Government adopted the remit for the Bank of England Bill that they did. After 18 wasted Tory years, with our side coming into power, it was vital that we were credible as regards economic policy making. Central to that credibility would be a commitment against inflation; therefore, I have a feeling that what lay behind the rejection of the proposal my noble friend and I put forward was a desire in the early days to establish the credibility of the new Government regarding inflation.
I freely add the point that it never occurred to me 10 years ago that anything like what is happening today was possible. Indeed, my favourite joke is that, if any student had described the present state of affairs to me, I would have said, “Don’t waste my time. That’s a completely impossible state of affairs”. In some sense, when I cannot sleep at nights I still say to myself that it cannot be happening, I must have missed some essential fact, but that is by the way.
This is a Second Reading debate, so I wish to devote my speech to general principles. Fundamental to this Bill is that banks—or, more generally, deposit-taking institutions—are of special importance to the economy. Most other types of private enterprise do not have special legislation devoted to them, involving a special resolution regime to deal with failure, an administrative procedure relevant to a so-called partial transfer of business, a special insolvency procedure et cetera. Why is that so? What is the case for saying that banks are of such significance? In considering this question, we must also be aware that, in addition to what is in the Bill, there is the regulatory regime or regimes to which they are all subject and which, again, the Government propose to strengthen.
As opposed to the Official Opposition’s Front Bench, I am not an apologist for all the bankers; quite the contrary, in this country and elsewhere the bankers have behaved appallingly. They have taken excessive risks, and the reason for that is simply greed. There is no doubt about what the bankers were up to.
The Treasury Select Committee in the other place published a superb report on Northern Rock. It highlighted some regulatory failure, but that is secondary to the main fact that the banks caused the trouble in the first place, with sub-prime lending and the marketing of toxic assets. I say again to the noble Lord, Lord Saatchi, that I keep a list on my desk of all the acronyms. I remember what they are but always have to go back to the original sources to work out what they do, and by the time I have gone back, I have forgotten them again; therefore, I would fail totally in his party game.
As far as I can understand it, there was a great deal of corruption involved in the banks in the United States, particularly with the valuation of assets. We do not know whether there has been any corruption here at all, and almost certainly we never will know. In an earlier debate, my noble friend Lord Myners appeared to say that there would be an inquiry into all this, but he then said more recently that he had been misunderstood and did not promise a full investigation of the banking operations in this country in the past few years. Of course one has to accept his word on that, which I do. None the less, we would be better informed of what the banks were up to, why and who was responsible if we had a full inquiry.
Again as background, we must distinguish the banks’ role as money transfer bodies—that is, as part of the payment system—and as borrowing and lending institutions which are meant to get savings into investment via the loans market. As I understand it—this has been a growing problem for the banks, and others with more expertise can tell us more—the banks make very little money from acting as money transfer bodies; therefore, if they are to make money and satisfy their greed they need to get more into the borrowing and lending business.
Related to that is an important economic proposition: financial institutions such as banks operate essentially by borrowing in a liquid fashion and lending in an illiquid fashion, or, as we used to say, borrowing short and lending long. Such a system is inherently unstable. By this is meant that, in normal times, these institutions can function in a stable way but, subject to an abnormal shock, such as what has hit our system and the world system generally, the effects are transmitted from one bank to another in a self-sustaining and dangerous fashion. That means that if depositors at a bank think it might fail, they will start to close their accounts. Once this starts, other depositors will follow suit, thinking that there must be something behind all this. Eventually, even if all the bank’s loans are sound and therefore it is solvent, it will run out of reserves.
If one bank is in trouble, depositors in other banks will have to ask themselves, “Is that bank unique? What about our bank?” and they will start to do the same thing. All this will happen even if the overwhelming majority of banks are solvent and sensible. In other words, as long as some banks have been behaving wrongly and making unsound loans, depositors will not know which they are; therefore, the whole banking system is placed at risk. If there is general depositor insurance, or other forms of underpinning, there is no incentive for any depositors to go into this any further because they are protected.
What makes matters worse is that, if another shock were to hit the economic system, one that did not originate in the banking system, what were sound loans, again, would cease to be so—not in the least surprising. In addition, people who lose their job or who have their income cut cannot service their loans. This, too, becomes a problem for the banks and is what we are observing. All of this amounts to reminding us how unstable the banking system is and how dangerous it is to let it operate on its own.
Milton Friedman argued that the problem of the great depression, which was the biggest crisis of modern times—I have always thought that it was greater than we are going through, but I could well turn out to be wrong—was exacerbated by the Fed’s failure aggressively to expand the money supply. Professor Bernanke pointed out that there was also a real side to this, precisely along the lines that I have put forward: if banks in trouble started to demand the repayment of existing loans, as they did in the great depression, that would add to the troubles, financially, and in terms of spending in the economy. Professor Bernanke, at the head of the Fed and the world’s greatest living expert on the great depression, was absolutely certain he was not going to let that happen again. That is why he operated positively—to the amazement of some of us who recognised him as essentially a monetarist—to increase the money supply in the United States and push in the way that he did. He also seems to have persuaded President Bush also to expand fiscal policy. It is interesting that in our country, my right honourable friend the Prime Minister was doing this ahead of what was happening in the US. I assume he had some very good advisers telling him about all of this. I do not know where they were, but clearly they were not in the Bank of England.
The Monetary Policy Committee had the benefit of one of my old students, Professor Blanchflower, who was taught economics by me. He was in a minority of one for nearly all the period that he was advocating interest rate cuts while everyone else was saying no. As I say, none of the other Monetary Policy Committee members was taught by me at all.
To bring all that together, once the thing goes wrong it is not in the least surprising that it continues to go wrong. It is also not in the least surprising that it is incredibly difficult to get it to go right again. It seems extraordinary to criticise the Government, who are trying hard to get it to go right, and to suggest that they might well get it all right by a snap of the fingers. It takes time. Speaking from this side, all of us must be honest: it is not absolutely certain that it will go right. Anyone who reads the Pre-Budget Report should be aware that the Government themselves are saying that they are doing what they think—and they are entirely right—is the right thing. However, there is no guarantee of certainty.
We are, as my noble friend Lord Barnett said, pursuing the right policies, although there are details on which we can disagree. This leads us to the view that the remarks of the German Finance Minister were completely absurd. We know that what he said was for internal political reasons; he wanted Germany to get a free ride on all the other countries in Europe, plus the United States, so that we would push the thing forward and he would gain all the benefits.
Finally, observing the banks now, two things have not changed—again, I echo my noble friend Lord Barnett: the ethos of greed is still with us, as strong as ever, and the same useless people are appointed as overpaid, blind-eyed non-executive directors. We have a new version of Gresham’s law: bad banking drives out good. I hope that the Bill is the first step towards eradicating that.
My Lords, it is a daunting task to follow such a distinguished economist as the noble Lord, Lord Peston, in this debate, particularly when I find myself in the unusual position of agreeing with much of what he said. I should like to draw attention to my various interests relating to the Bill, and emphasise that I speak here in a purely personal capacity.
Although there are some detailed questions on the Bill that will come out in Committee, and one or two that I should like to raise today, like others, I recognise the need for the Bill. However, my primary question, like that of every noble Lord who has preceded me, is whether those measures are enough or whether we should be taking advantage of the legislation to provide a more complete response. The advantage of speaking at this stage in the debate is that I can put my arguments in the context of those which have been made before.
The Bill is about restructuring and recapitalising banks that are judged to be no longer capable of standing alone without significant risk to the financial system. The first thing to recognise is that restoring capital levels to replace the losses suffered from bad assets is of itself not enough to restore lending to pre-2008 levels. The recent Bank of England financial stability report showed that the leverage ratios of major banks had risen steadily over recent years to reach a median level of 35 times equity capital, with the top interquartile range doubling over the past 10 years from around 25 times equity levels to close to 50 times equity levels. The Bank of England does not do the arithmetic to provide estimates of the average leverage ratio of the banking system, but I think that we can take it from these figures that it has also risen significantly.
This is just the flipside of the coin of the growth in consumer and business indebtedness over the period. Household borrowing has risen over the same period from 60 per cent to 90 per cent of GDP, and bank lending to non-financial companies is also up a third over the past 10 years from just over 20 per cent to around 35 per cent of GDP. This has been accompanied by a simultaneous increase in government borrowing, which is well over 50 per cent of GDP on any measure.
If we are to bring bank gearing levels and their counterpart in consumer and business borrowing levels back to more sustainable levels, and if we are to close the macro-funding gap between domestic saving and domestic borrowing, about which the Bank of England is concerned, the consequence, notwithstanding the views of the noble Lord, Lord Barnett, must, in the short term, be a severe and painful contraction in the total volume of bank lending. It would be helpful if the Minister would accept on behalf of the Government that, notwithstanding exhortations to lend, a major reduction in bank lending is inevitable until bank gearing levels are reduced. This is the degearing effect, about which we hear so much. Can the Government guide us on what level of degearing they expect, over what timescale, and what impact they believe it will have on total lending volumes and nominal GDP?
However, this is not the whole story. Some 35 years ago, I confess that I wrote a rather unexciting doctoral thesis that predicted that in such periods of credit tightening, banks would end up rationing credit to small business customers because the price mechanism would not adjust lending volume quickly enough to restore balance sheet equilibrium and meet regulatory ratios. Although that thesis has gathered much dust over the years, I fear that we are in just such a situation now. The banks which have been wholly or partly nationalised, as the noble Lord, Lord Barnett, described, are no less immune to that problem despite their greater access to secure capital. Bank managers are simply saying no, because they have no other way of trimming back their balance sheets in the time available. The Bill will not fix that problem.
The second and, perhaps, greater short-term problem is, as others have said, that of liquidity. As we know, the shortage of liquidity is not necessarily directly related to capital levels. As the Minister agreed yesterday in the debate on statutory instruments, Bradford & Bingley was judged incapable of standing alone because of its concerns about liquidity, despite having a tier 1 capital ratio of close to 10 per cent. Underlying the shortage of liquidity is the continued unwillingness of banks to lend their surplus liquidity in the wholesale market for fear that when they need the liquidity back it will simply not be available. This, too, is adding to the pressures on banks to rein back their lending and this, too, will not necessarily be fixed by the measures in the Bill.
I accept that, as the Minister said, the Government and the Bank of England have taken steps to address the liquidity issues through purchasing qualifying assets by the Bank of England, selling insurance to guarantee wholesale lending and other measures. Although these schemes have undoubtedly helped, they clearly have not yet solved the liquidity problem, as evidenced by the continued shortage of wholesale money and the continued high cost of interbank funds. Part of the reason is that the costs that the Government and the Bank of England have imposed in these schemes, which seek to penalise banks for their past behaviour, make it less attractive to mobilise funds for the future.
What do we do about this? One response posed by the opposition Front Bench is to guarantee lending to small businesses; that may be part of the solution. Another possibility, mentioned by the noble Lord, Lord Newby, and which should be explored, is to allow regulatory ratios to be relaxed at the trough of the cycle so that we do not expect banks that have just been hit by the equivalent of a one in 200-year exceptional loss immediately to rebuild their balance sheets to the point where they can withstand an equally severe loss happening again immediately.
I wonder whether, in this exceptional situation, as described by my noble friend Lord Saatchi, there is a case for going back to first principles and rethinking more fundamentally what banks are and how they should be structured and regulated. The definition of a bank, set out in Clause 2, is fairly conventional. The truth is that as every economics course teaches, banks are indeed unique and special in their ability to manufacture money supply, where every loan also becomes a new bank liability and where, ever since we moved away from gold specie, bank deposits have counted as a reliable and trusted part of our currency.
As the noble Lord, Lord Smith of Kelvin, and my noble friend Lord Saatchi said, the underlying dilemma we have with the current situation is that banks have taken low risk deposits from customers—deposits viewed by those customers as a trusted part of the money supply—and used them at the edges of their balance sheets to take on highly risky and highly leveraged investments. When those risks come home to roost, as every so often they will, we are faced with the problem we now have of propping up the banks or allowing a collapse in confidence in the money supply. Clearly, a collapse in confidence in the money supply is something which the Government cannot allow. This is not like some other utility. Confidence in the money supply and the currency constitutes the central essence of confidence on which the whole economic system rests.
I propose a possible solution to the problem posed by my noble friend Lord Saatchi. Perhaps we should think radically, call a spade a spade and simply say that all deposits in regulated banks are de facto part of government guaranteed money supply in which consumers, businesses and, indeed, other bank counterparties can have total confidence. The corollary is that institutions which call themselves banks and fall under this protective umbrella would have to meet very tight prudential regulatory requirements. In particular, they would have to limit themselves to low risk conventional loans and investments, something akin to the assets that most depositors have in fact assumed their banks would hold in order to protect their cash deposits. That would not, of course, prevent other financial institutions, or indeed other parts of the same institutions, accepting funds for investment and investing those in more risky assets. However, they would be clearly segregated from those institutions which were known as banks, their investors would be on notice that the higher returns they were offered were in exchange for a higher risk and the security of the money supply would be maintained.
My problem with this Bill, therefore, is not that what it proposes is not sensible or necessary given the circumstances we face, but that ultimately it may be inadequate because it is based on perpetuating an unstable banking structure that links government-guaranteed money supply and risky market investment activities within the same legal and financial structures. As my noble friend Lord Saatchi said, this problem has been made far greater than ever before by the multiplication of financial instruments that have allowed banks to extend into areas of risk and investment that were never available in the past.
The next few months will show whether my fears on continued liquidity shortages are grounded. It may be—and I am sure we all hope that this will be the case—that things will return to some kind of normality. Things may ease after the year end, once banks have got through reporting their year-end balance sheets. However, if we are to provide the confidence necessary to fix the liquidity problem in the future against the new background of financial instruments with which we are confronted, we may have to face the need to underwrite all deposits, including wholesale deposits, at regulated banks. If the Government underwrite all deposits, we will need to change the definition of banks in the way I have suggested so that the powers created in this Bill do not have to be used over and over again every time we have a future credit cycle. For that reason, while I do not oppose the Bill, I hope that it can be part of a wider debate which addresses some of the more fundamental questions I have raised. In the mean time, I should like to raise three specific questions on the Bill as it stands.
First, I note that in the appropriately numbered Clause 4, setting out the objectives that will guide a special resolution, subsection (9) states that all the objectives are to be balanced in each case. I wonder whether that is sufficient, or whether subsection (8), which requires action not to interfere with property rights in contravention of the Human Rights Act, must not ultimately take precedence; or, to put it another way, that any action taken must be compatible with the fair treatment of property rights to which the Minister signed up yesterday in the discussion on statutory instruments.
Secondly, in the same list of objectives I notice that there is no mention of the desirability of maintaining open, competitive markets. I should welcome assurance from the Minister that the Government's support for competition, and the benefits of innovation, productivity and consumer value that competition brings, will not be diminished in the current economic conditions. I should like the Government to consider whether that objective should properly be reflected in Clause 4.
While the Bill, as I understand it, does not explicitly deal with arrangements for the government holding company, UKFI, as the noble Lord, Lord Newby, mentioned, I assume that the provisions apply to partial nationalisation as well as full nationalisation. Where the Government are only a partial owner of a bank, can the Minister explain whether government directors and the UKFI itself will be subject to the normal market rules that apply to large shareholders and the proceedings in relation to the companies in which they hold shares, and that adequate board procedures will be required of those companies to allow the remaining independent directors to safeguard the interests of minority shareholders? I look forward to Committee stage.
My Lords, in February this year, as time was finally called on Northern Rock, we were presented with a Hobson's choice. After months of dithering we were rushed into passing the temporary Banking (Special Provisions) Bill, which went through both Houses of Parliament in just over three days.
Today, this House has the opportunity to examine how Britain's banks became so poorly regulated and supervised, and to propose measures which we hope will restore respect, trust and confidence in our banking system. My noble friend Lord Smith of Kelvin emphasised the word “confidence” in his superb maiden speech, and he spoke with the authority of an experienced banker and a fellow chartered accountant.
When I first started my business, I was introduced to a well known businessman who told me something which I will never forget. He said, “Young man, empires are built on trust”. What we have today results from the complete breakdown of trust—the breakdown of trust in the global banking system and on the high street.
I have said it before, and I shall say it again: business is at the heart of Britain's economy, but business cannot function without a robust, reliable banking system. It is the fuel that powers the economic engine. The British banking system—both commercial and investment—was once the pride of the world.
I am not being nostalgic when I say that the Bank of England was the most respected central bank in the world. It was instrumental in helping this country evolve from being one of the world's greatest trading nations to London becoming the world's greatest financial centre. Historically, the City of London, with the Bank of England at its heart, was built on trust, and on the assurance of “my word is my bond”. Sadly, the reforms that took place in 1998, with the best of intentions, unwittingly weakened the role of the Bank of England and undermined its once proud reputation.
Before those reforms the Bank of England had been a bastion of our capital and financial markets. For centuries it served as a shining example to central banks around the world with its tough, fair and effective regulation and supervision of Britain's banks. With a close eye on the markets, the Governor of the Bank of England could draw on a reservoir of executive power and, with a telephone call, summon the chief executives of any bank around the discussion table. I have heard stories of bank chairmen and chief executives, after being summoned by the Governor of the Bank of England, sitting there, if necessary, until the early hours of the morning, to resolve a problem or crisis. The governor was respected. In contrast, we now have a governor who more often than not fights with his hands tied behind his back.
Where did it all go wrong? The situation we are in today—people have tried to analyse it—is a direct result of a prolonged period of low interest rates that have encouraged countless households and businesses to take on staggering levels of debt. Where they led, the Government followed, and our national debt is so colossal that it may be paid off only by our children and our children's children.
As the noble Lord, Lord Saatchi, who is not in his place, said, in this period the banks overgeared by miles. As the noble Lord, Lord Blackwell, said, for every pound of capital on the balance sheet, the banks were, on average, balancing between £33 and £35 of risk. As the noble Lord, Lord Peston, explained, banks have always had, and will always have, significantly less cash and liquidity than the claims they ultimately face, but that ratio was grossly exorbitant and utterly reckless. Gone were the days of the prudent banking practices of having strong deposits on which to base, and on which to lend, and on having healthy margins.
We need to go back to basics. This Bill has to identify who will regulate and supervise our banks after this downturn: the FSA, the Treasury or the Bank of England. I regret the day that we stripped the Bank of England of its power. In 1998, we all applauded the Government's decision to create the independent Monetary Policy Committee. As a committee, immune from government interference but for its composition, this group of nine individuals could act proactively and reactively to try to ensure economic stability. With a healthy target of 2 per cent inflation, the MPC proved a resounding success for almost a decade. It seemed to function so smoothly, but while the Government had strengthened the Bank of England's power to regulate the economy, at the very same time, they had dismantled the Bank's ability to regulate and supervise the nation's banks.
The tripartite system has undermined the Bank of England in its crucial role as supervisor of the banking system. It did not make sense, and it still does not make sense, to have the FSA responsible for banking supervision. It lacks the accountability, transparency and, most of all, capability to supervise our banks. The direct line from the banks to the governor was shattered. The lines of responsibility, accountability and authority all became blurred.
The Northern Rock fiasco exploited this situation to the fullest. We know that as far back as 2006 the FSA classified Northern Rock as a,
“high impact bank under close and continuous supervision”.
Despite that, the FSA did not plan an impact assessment of Northern Rock—wait for this—until January 2009. That is a full three-year delay. It has been said time and again that the FSA was asleep on the job. Worse still, at the end of June last year, when Northern Rock finally admitted that it had serious problems, instead of taking decisive action, the FSA relaxed the technical requirements on the bank, allowing it to free more assets. That was sheer incompetence.
Where was the Bank of England as this drama unfolded? The first warning the governor received from the FSA regarding the potential impact of the credit squeeze on Northern Rock was through a telephone conversation as late as August 2007. The Bank of England was then left trapped in no-man's land, caught between its dual responsibility to provide liquidity support and to secure financial stability. The tripartite system, a merry-go-round in the nice decade, descended in a crisis into a despairing blame-go-round.
I am pleased that the Bill attempts to institute new powers to deal with failing banks through the special resolution regime and the insolvency and administration procedures. However, the Bank of England, not the FSA, needs the explicit statutory power to bring a firm subject under the new special resolution regime. As the proposed system stands, we are still hostage to the FSA's questionable ability to diagnose failing banks and over-reliant on the opaque lines of communication among the tripartite bodies.
Nevertheless, I am delighted by the proposal to place on a statutory footing the Bank of England's central objective to ensure financial stability, and I welcome the proposal for a financial stability committee. However, I am surprised to hear that it will take the form of a sub-committee of the Court of the Bank of England. The reason the Monetary Policy Committee worked so well was because it was independent. The financial stability committee needs the executive authority, independence and power properly to support the Bank in its objective of achieving financial stability. Reasserting the Bank of England's primacy would capitalise on its specialised knowledge and would more effectively integrate the financial stability and institutional stability objectives of the tripartite system more than any amount of tinkering.
There are a number of issues that the Bill fails to address. As the noble Lord, Lord Saatchi, said, much of the responsibility for the sub-prime crisis lies with the credit rating agencies that continued to award AAA ratings for parcels of repackaged sub-prime mortgages that in all truth neither they nor the banks understood. Those ratings were misguidedly based on past mortgage failure rates of under 5 per cent rather than on an assessment of the true quality of the underlying assets. The Bill has to address the relationship between credit rating agencies and the banks. Who is commissioning these agencies, and who is paying the fees? There are huge conflicts of interest here.
Furthermore, there is the issue of the Treasury. What faith can we have in its supportive role to provide direction for the FSA or the Bank when time and again its economic forecasting has proved so incorrect? For example, in April this year, the Treasury was forecasting economic growth of between 1.75 per cent and 2.25 per cent for 2008 before picking up to between 2.25 per cent and 2.75 per cent for 2009, and that was forecast after the sub-prime crisis had begun to unfold in the previous year and after the collapse of Northern Rock. Now we realise that in the third quarter of this year, within a few months of the Treasury's forecast, the economy is actually contracting. How could it get it so wrong in just a few months? This behaviour brings into question the Treasury’s credibility.
I have learnt through building a business that you have constantly to turn threats and obstacles into opportunities. With the Bill, we have the opportunity to rebuild the Bank of England to the strength and standing it had before. We have the opportunity to ensure clear responsibility, accountability, transparency and communication between the Bank of England, the FSA, the Treasury and our nation's banks. We have the opportunity to rebuild respect, trust and confidence not only in the Bank of England, but in our financial markets, which have been crippled by this current crisis. Although I am concerned that it has taken so long for the Bill to come before Parliament—it is almost a year since Northern Rock was nationalised and a year and half since the sub-prime crisis exploded on to the world stage—I hope that it is better late than never and not too late.
As I said in February, and I say again, the eyes of the world—and I mean not just the Germans—are on us. At stake is more than the reputation of a Government or the future of any single bank. At stake is our position as one of the leading financial centres of the world; at stake is the reputation of the United Kingdom; and at stake is the very essence and stability of our entire economy.
My Lords, at this stage in a Second Reading debate, when the debate has been about a loss of confidence, why it occurred, who has lost it and how in some principled and large way it might be restored, it may be difficult to return to detailed consideration of the Bill itself. It is really a housekeeping Bill, and has nothing much to do with the global banking or economic crisis. I turn first to the thought that prevention is better than cure. The Minister said that among the Bill’s objectives, which are set out in the regulatory impact assessment, is reducing the likelihood of individual banks facing difficulties. I cannot find anything much in the Bill that will achieve that, and, although I listened carefully, the Minister did not say much that would have the effect of reducing the chances of individual banks facing difficulties.
The second objective is reducing the impact if, nevertheless, a bank gets into difficulties. I cannot really see that there is much effect on the impact of a failing bank. There are arrangements for what to do about it, but as to the impact, it would have to wait to see what sort of a bank it was. The third objective is providing effective compensation arrangements in which consumers have confidence. I do not think that consumers want compensation; it is a very second best. Indeed, if they have insurance policies, they can get compensation through a claim, but they are always aware that the chances are that the premiums will rise. I do not think that that is what people want; I think that people want continuity. The fourth objective is strengthening the Bank of England and ensuring effective, co-ordinated actions by the authorities. We would all have assumed right from the beginning that effective tripartite co-ordination was a given and did not have to be spelt out as a purpose of the new Bill.
I find myself much in agreement with those noble Lords who have said that events have overtaken the Bill. Is the Bill really relevant in any significant way? It might have been relevant a year ago or more, at the start of the problems with Northern Rock, because Northern Rock might have been an exception, but now it does not have the same relevance. Anyway, another route has been chosen, of bank recapitalisation. That is and was necessary. After all, the foreign obligations of our banks have risen from £1,000 billion in 1997 to more than £4,000 billion in 2008. I thought that the purpose of bank recapitalisation was, at least in principle, that no more banks are to go bust. If it had not been for bank recapitalisation and the schemes, what would have happened to the Royal Bank of Scotland and to Halifax Bank of Scotland? The key to where we are—does the Bill achieve this?—is the recreation of confidence. In that regard, the continuity of the operations of banks is a great deal more important than any compensation scheme. One must hope that there will not be such a need in the near future.
There has been a great deal of consultation about the Bill, but my impression is that as the consultation continues—we have another November consultation, for which I think the closing date is 9 January—there is less and less enthusiasm for the Bill in the industry as events unfold. What is the point of debating the difference between a Bank of England bridge bank and a Treasury temporary public ownership bank in present circumstances? What meaning can we give to “temporary”? Taking the example of Northern Rock, we simply do not know. Taking the example of Bradford & Bingley, it seems that there will be nothing left at the end anyway, because the publicly-owned part of the bank is working off its book and there will not be anything to go back into the private sector at the end. In these circumstances, will there be another Northern Rock or Bradford & Bingley? The answer to that is no, there will not, given the bank recapitalisation.
That takes me to the sunset clause in the Banking (Special Provisions) Act. I should be grateful if the Minister could add some greater substance to the claim that 20 February would create a serious public interest problem. What would that public interest problem be? Does he have any information that would lead us to think that there was not a way of dealing with a problem in a bank that did not need this Bill?
The second thing about the Bill is that a better title, between “Banking (No. 2)” and “[HL]”, would be to add “Two’s company and three’s a crowd”. Here, I join the noble Lord, Lord Bilimoria, in saying that we cannot really get into this in this Bill. It has got too far down the road. All that we are being asked to do is tinker at the edges, giving a bit more responsibility to the Bank of England and, by implication, a little bit less to the FSA. The FSA is, frankly, a muddle. Its Act of Parliament makes it a muddle. Its objectives are market confidence, public awareness and the protection of consumers. They are pretty unattainable. They do not sound like the sort of things that, if I were the chief executive of the FSA, I would cheerfully say that I could do.
As to public awareness, how could I make the public aware of all the investment possibilities that there are, having listened to my noble friend Lord Saatchi? The FSA does not understand them, so how on earth can it make the public aware of them? At the same time, all the way through, it must have regard to proportionality, innovation—it certainly has not hindered innovation—and our international position, and it must enhance and not damage competition. This is a mixture to be given to a regulator. A regulator is either a keeper of people’s conscience, or it is in the business of development, but it cannot be in both.
There are two tests in the Bill, and we have frequently heard about one of them today. First, there is the financial stability test. We have also heard from the House of Commons Treasury Select Committee, which said in its report:
“There is no consensus about what financial stability means, how it should be measured and how the balance should be struck between the pursuit of a financial stability objective and other public policy objectives ... Above all, the Bank of England, while being endowed with certain financial stability functions and powers, is not being granted a coherent set of instruments in order to influence financial stability”.
Financial stability is a totally subjective judgment at the moment. There are no objective criteria. It is almost as if the Treasury is being left in a position where it can say from time to time, “We recognise it when we see it”.
The second test is threshold conditions. Here, I cite the Bradford & Bingley example. Threshold conditions apply to deposit-takers. It has been asked in this House what the FSA’s determination was that threshold conditions were not being met, and we have been told that there is no way in which that could be made public.
Schedule 6 to the 2000 Act is vague to the point of unhelpfulness. Paragraph 4 of Schedule 6 states:
“The resources of the person concerned must, in the opinion of the Authority, be adequate in relation to the regulated activities that he seeks to carry on, or carries on”.
Paragraph 5 of Schedule 6 states:
“The person concerned must satisfy the Authority that he is a fit and proper person having regard to all the circumstances”.
Although there is a little more in both paragraphs 4 and 5, it does not add much to the motherhood and pie statement of Schedule 6. There should be much more careful post-legislative scrutiny of the FSA, of the 2000 Act and of the effects of that legislation.
I end with a quotation, which I think will show how far we have come. It is about banking stewardship:
“One sign of your stewardship is the unquestioning trust reposed in you by your clients. People pay in to you across the counter their money, about which they very reasonably care a great deal, with absolute confidence—not only without questioning but without giving the basic principle of the system, or its mechanism, a single thought. They just know that all will be well with their money… If this were not so, the consequences, material and psychological, would be immediate and grave; but it is so”.
That is an address from 1955, made to Barclays Bank.
My Lords, this is not a very satisfactory Bill for a variety of reasons, as many noble Lords have said. It bears all the hallmarks of a hasty, knee-jerk piece of legislation, motivated by a sense of the need to do something. In that way, it is similar to the Dangerous Dogs Act and will probably have as little practical effect as that did. The noble Lord, Lord Saatchi, among others, shares my scepticism. As my noble friend Lord Newby remarked, the opportunity has been missed for viewing the banking crisis in the round and for careful reflection prior to legislative action. That is why the Bill should be subject to a sunset clause.
One problem with the Bill is that, in attempting to rationalise the regulation of the banking system, it merely tries, as many noble Lords have said, to formalise the existing interrelationships between the trio of regulators: the Treasury, the FSA and the Bank of England. The question is whether this will be any more effective than the more informal set of relationships that previously existed. The elaborate network of roles and processes outlined in the Bill is overcomplicated and verges on the Byzantine. Would they have prevented a Madoff crisis in the UK? I very much doubt it.
The collapse of Northern Rock and its subsequent nationalisation, and the later need to pile masses of public funds into the banking system more generally, were primarily caused by the incompetence and greed of directors and senior managers of the banks concerned, as the noble Lord, Lord Peston, has remarked. How far this amounted to fraudulent behaviour in certain cases is still to be determined. As the implications of the extent of the crisis sink in, there will undoubtedly be widespread public demand that any wrongdoing is revealed and the perpetrators punished. In this respect, the US authorities are proving a good deal more active than their UK counterparts. The shysters must be punished, as—somewhat belatedly—David Cameron agreed yesterday.
The other cause of the crisis was the failure of the trio of regulators to discern what was happening and to take appropriate and timely action. As the noble Lord, Lord Bilimoria, and many other noble Lords have said, both the Treasury and, in particular, the FSA were found wanting, while the Bank of England’s oversight powers had been removed a decade earlier. That is why the noble Lord, Lord Bilimoria, wants to see the Bank’s pre-1997 position restored, which I heartily endorse. Because of its earlier standing and reputation, the Bank should be recognised as the lead agent of regulation, rather than a mere partner in a triumvirate. That would help to restore confidence in the system, as the noble Lord, Lord Smith of Kelvin, stressed.
I emphasise, as many other noble Lords have done, confidence rather than trust in this context, following the work of my noble friend Lord Plant of Highfield. He has pointed out that public trust in many areas of life, not least the financial services, has broken down. In any case, that approach was appropriate to a more naive and deferential age. These days, the public want to have confidence in the workings of the private and public institutions. That is what is clearly lacking in the banks. As was said in the course of the peace process in Northern Ireland, confidence-building measures are prerequisites for progress to be made. I say to the noble Lord, Lord Peston, that I, too, have had PhD students. Here I declare an interest. Following the analysis of the noble Lord, Lord Plant, Professor Andrew Massey, my former PhD student, and his co-author William Hutton, a former banker, stressed in a recent CIPFA publication the need for competence in building confidence. Clearly, competence has been at a heavy discount in the banking world of late.
In the debate on the Queen’s Speech last Monday, I drew attention to the need to improve standards of corporate governance generally, but particularly in the financial services sector, and to the related issue of achieving a far better gender balance on the boards of public companies. I specifically asked whether the Government would use the Banking Bill as an opportunity to impose a Norwegian-type requirement that 40 per cent of directors should be women. The Minister did not reply to me and has not so far written to me, despite his undertaking. His silence speaks volumes. We now know where the Government effectively stand on the question of gender equality. I invite the Minister to address this issue in winding up, although I am not holding my breath.
Another major defect of the Bill is that it does too little to improve corporate governance more generally. Effective regulation from the top is only one part of the solution. The other, and much more important, aspect is to try to influence the individual and corporate behaviour of main board directors. That is difficult but it must be attempted. A number of actions can be taken to improve the situation. As I said last week, the function of internal audit must be strengthened. Secondly, external auditors must be more aware that they are reporting to shareholders. As I wrote in the foreword to the fourth edition of Professor Andrew Chambers’s authoritative compendium on corporate governance, one of the problems is the near-monopoly of the big four accountancy firms of the external auditing market, which is deleterious in itself because it makes for a far too cosy and complacent culture.
What I believe would really help is the creation by the Government of a standing conference on corporate governance and business ethics to monitor regularly trade and industry practices and to make recommendations for improvement. Such a body would comprise representatives from the four chartered accountancy bodies, the Law Society, the CBI, the TUC, the Institute of Directors, the Serious Fraud Office and the deans of the main business schools. It should also contain a large element of investor representation. A main function of such a body would be to recommend syllabus changes in professional and postgraduate business training to improve professional competence. Apart from making practical proposals, the body would, in its formation, signal the seriousness with which the Government regard the necessity for better corporate governance. Pace the noble Lord, Lord Bilimoria, I suggest that its motto might be not “Back to basics” but “Forward to basics”.
It may be said that this Bill should be confined solely to the matter of regulation, but that will not wash as an excuse. This Government have made a practice of devising vast portmanteau Bills incorporating disparate provisions. Regulation from above must be complemented by better corporate governance from below and this Bill should be amended to secure that. Bailing out the banking system with unprecedented sums from the Exchequer—and more may yet be needed, as noble Lords have pointed out—gives a wholly different meaning to public-private partnerships. Both in the magnitude of the sums involved and the risk being assumed by the Government on behalf of taxpayers, the benefits have been privatised and the costs nationalised, in the words of Dr Vince Cable. For that reason alone, every effort must be made to minimise opportunities for further fraud and illegality so that we have a more transparent, ethically professional and accountable UK banking system.
My Lords, before I turn to the main body of my remarks on the Bill, I will comment on the position stated so forcefully by the noble Lord, Lord Bilimoria, who I regret is not in his place, and echoed by other noble Lords. That position is that returning regulatory powers to the Bank of England would, in some sense, create a more robust regulatory system. Noble Lords who take this view should recognise that, in the decade prior to the Bank of England Act 1998, the Bank of England had a lamentable regulatory record. Johnson Matthey, BCCI and Barings were all significant failures by the Bank of England. Indeed, the Bank of England’s Board of Banking Supervision commented with respect to Barings that the Bank of England did not understand the market that it was supposed to be regulating. I shall return to the Bank of England later in my remarks.
This Bill is one of the most important measures to come before us in this parliamentary Session. Everyone knows that the success of financial services is a vital component of this country’s economic future. The Bill seeks to create a new framework for the operation and protection of those services, at least as far as banking is concerned. Yet, while being important in itself, the Bill is surely, as many noble Lords have said, but a first step in the series of measures that are needed to transform the operation and regulation of financial services in this country and, indeed, internationally, as the Prime Minister noted following the G20 meeting in Washington in mid-November. Because this is but a partial measure—a first step—it is vital that the measures in the Bill are crafted from a coherent and consistent analysis that will carry over to the later legislation that will complete the pressing task of financial markets reform. This first step must not be a false step, jeopardising what follows.
In these difficult times, it is particularly important that the Bill should embody a thorough understanding of the lessons that should have been learnt from the bitter experiences of the past two years or so. To identify those lessons, there is no better place to start than Mr Alan Greenspan’s evidence before the US House of Representatives on 23 October. He stated:
“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief”.
He went on to say:
“This modern risk-management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year”.
Mr Greenspan was honest, almost painfully so, about the intellectual and practical failure of the policy stance that he had adopted for 10 years as chairman of the Federal Reserve board. But the actual content of his mea culpa is in fact wrong and betrays a serious lack of understanding of what has happened. The issue is not whether banks would manage their risks efficiently, but whether they could do so.
Greenspan has failed to take on board the fact that the financial risks taken by firms have significant externalities; that is, they impose costs and risks on society as a whole far greater than the costs and risks experienced by the originating firms. Just as it is impossible for a single energy user to manage the risks of climate change—that depends on the operation of the system as a whole—so it is impossible for an individual bank to manage the totality of risks to which it is exposed. That, too, depends on the operation of the system as a whole. It is this systemic risk that has been so brutally revealed in the disappearance of liquidity from financial markets.
Systemic risk is an ever present characteristic of financial markets; it is embedded in their DNA. It is, therefore, totally wrong to attribute what has happened to black swans or similar highly improbable events. Systemic risks are ubiquitous in markets of white swans. They are totally normal and have reappeared regularly, albeit in different guises, for the past 300 years. Financial regulation should focus on systemic risk, not that of individual firms. That is the first lesson that Mr Greenspan and we should by now have learnt. Regulation is essential because, in the presence of systemic risk, free, competitive markets are inefficient and prone to crisis.
The classic example of systemic risk is the bank run, which was well described by my noble friend Lord Peston. The failure of bank A, due to imprudent loans, provokes a run on bank B, even though bank B is solvent. However, because its lending is longer than its deposits, it is illiquid, and the run forces it to collapse. The second lesson that should have been learnt from recent events is that this classic example of systemic failure is hopelessly out of date. In the past 30 years, the structure of financial markets has changed fundamentally; it has shifted from a bank-based to a market-based system. Financial intermediation has moved from banks into markets—into long chains of securitised counterparty transactions—and financial crises are now manifest in financial markets in general rather than in banking markets in particular. Hence, crises no longer take the form of bank runs; instead, market gridlock is the source of systemic risk. Despite popular belief, the failure of Northern Rock was certainly not the result of a bank run. Northern Rock was brought down by gridlock in the commercial paper market long before the queues formed outside its branches.
I shall sum up the lessons that we ought to have learnt. First, systemic risks are endemic to the financial system as a whole and cannot be managed by individual firms. Secondly, systemic risks stem today from gridlock in financial markets, not from bank runs, and gridlock may originate anywhere in complex chains of counterparty transactions throughout the financial system. Thirdly, therefore, detailed knowledge of the operation and structure of firms and markets is essential to the effective regulation of systemic risk.
The question that we face is whether these lessons are embodied in the Bill or whether it has failed to reflect the lessons of recent events. One cannot this evening test all elements of the Bill, but I shall consider three parts of it. First, on the target of the special resolution regime, the main purpose of the Bill is, of course, to create a special resolution regime for banks and, to a certain extent, building societies and credit unions. A bank is defined in Clause 2 as,
“a UK institution which has permission ... to carry on the regulated activity of accepting deposits”.
The creation of special resolution regimes is well established in the US and is long overdue in the UK. The Government are to be applauded for bringing them forward.
However, in the light of our second fundamental lesson of recent events—that systemic risks stem from gridlock in financial markets—the clause defining the targets of the regime is unreasonably restrictive. It means, as the Government have just now recognised, that the special resolution regimes could not have been applied to Lehman Brothers, yet the collapse of that firm is probably the most serious financial policy failure of the post-war era. What should we learn from the Lehman failure? Systemic failure may not originate in banks; instead, it may originate anywhere in the complex structures of financial counterparties, whether they are investment banks, special purpose vehicles, hedge funds, or elsewhere. Confining the special resolution regime to banks is long out of date. I look forward to hearing the Government’s amendments in Committee, which should rescue the Bill from this archaic anomaly.
Secondly, let us look at Clauses 33 to 48 on the transfer of securities. It is important to note that the impact of these clauses is contrary to the Government’s objectives as set out in the G20 communiqué of 15 November, to which Her Majesty’s Government subscribed. The G20 communiqué placed considerable emphasis on the need to develop efficient clearing mechanisms for financial instruments. However, the passage into law of Clauses 33 to 48 would seriously compromise the attainment of that objective. Indeed, it would seriously compromise netting in general.
The reason for this is that the Bill grants sweeping powers of contractual override. This will mean that lawyers will not be able to issue “clean” legal opinions for netting exposures. This will in turn require parties to recharacterise their short-term lending transactions on a gross basis, rather than a net basis, hence increasing regulatory capital charges and market risks. Essentially, the broad stabilisation powers would drive up the costs for British banks engaging in netting, yet the Government have committed themselves to increased netting, not less. This contradiction is an unintended consequence of the Bill and I will be proposing ameliorating amendments in Committee.
Thirdly, on the roles of the FSA and the Bank of England, my final test of the Bill’s provisions against the lessons of recent events concerns two proposals at each end of the Bill. These are Clause 7, the trigger clause where it is proposed that a stabilisation power,
“may be exercised in respect of a bank only if the FSA is satisfied that the following conditions are met”,
and Clause 228, proposing the establishment of the Financial Stability Committee of the Bank of England. As I have argued, a fundamental characteristic of financial markets today is that systemic risk resides in the structure of markets and firms. In the current division of regulatory responsibility, the Bank of England has the main responsibility for managing systemic risk but has no direct knowledge of firms. That knowledge of markets and institutions, if it resides anywhere, resides in the Financial Services Authority. Hence it is indeed appropriate that the FSA should have its finger on the trigger. The Bank of England does not have the detailed supervisory knowledge of not just banks but the structure of financial institutions as a whole to perform this role.
There is a problem, however. The FSA has no direct responsibility for systemic risk; that responsibility rests with the Bank of England. The FSA knows about firms and markets and the Bank of England has the responsibility for managing systemic risk. This dangerous dichotomy, already too evident in recent events, could be overcome by making the new Financial Stability Committee, to be established by Clause 228, a combined committee of the Bank and the FSA, jointly and severally responsible for financial stability. This would have the dual advantage of informing the Bank’s stability analysis about the actual operations of firms in disintermediated markets and ensuring that systemic risk became a basic tenet of the FSA’s operational philosophy. In other words, the Financial Stability Committee could be an operational bridge between the FSA and the Bank of England—the bridge that has been so conspicuously lacking in recent months.
If a joint committee is to be an effective bridge, however, not just between the Bank and the FSA but between markets and systemic risk, it must be composed of and advised by the informed, the sceptical and the contrary. The last thing that we need is another committee of City grandees who are richly incentivised to spot the bursting of the bubble and notably fail to do so. In view of the remarks that he made in his maiden speech, I think that the noble Lord, Lord Smith of Kelvin, would agree with me. A contrary Financial Stability Committee should have behind it a well resourced research department. Experience of the past year has shown that it was only the lowly research teams that spotted well in advance the danger of sub-prime mortgages; they were ignored, but it is about time that they had a voice at the high table. A joint Bank/FSA Financial Stability Committee would be the perfect mouthpiece. I will be proposing amendments in Committee that would establish the Financial Stability Committee as a joint committee of the FSA and the Bank of England and would ensure that its membership extended far wider than the narrow extent currently envisaged in the Bill.
This is a good Bill, but it could be an even better Bill. Some of the lessons of the so-called credit crunch have emerged only in the past few months, after the Bill was drafted. We have the opportunity and the responsibility to bring it right up to date.
My Lords, the debate today has been on a higher level than much of the public comment in the press and news bulletins. I am glad to be able to take part in a debate which is beginning to identify some of the underlying difficulties that have arisen in these exceptional circumstances.
I have no current interests to declare but I have been involved with banks or banking throughout most of my working life. I worked in a merchant bank in the 1960s and 1970s. In the 1980s I was the Minister responsible for the then Banking Bill and the then Building Societies Bill. In the 1990s I became director of an international bank and chairman of its audit committee. I was also for a time on the boards of the Securities and Investment Board and of the FSA. I say this because I have been trying to look at the picture from many different angles. There is one thing that comes back to haunt me and which I cannot understand. This is what I would like to talk about this evening.
I am amazed and appalled by the events in the financial markets, and banking in particular, which have occurred in the last year or two, especially in recent months. The question which does not seem to get much coverage is: how did it all come about? Connected to this is the question: how are we going to prevent it happening again? We read comments to the effect that no one foresaw what was coming and that there was no advance warning. That is not entirely true, however. There were big imbalances and tensions building up in the world economy, the difference between China’s surplus and the US deficit, overheated investment markets and housing in many countries, and overgeared instruments for leveraged buyouts. These were all signs of excess and they put some people on notice.
About two years before the Northern Rock affair exploded, the Governor of the Bank of England issued a statement that the market was mispricing risk. That was a crucial observation by one of the key players; it came from a source who knew what he was talking about. It seems, however, to have had little impact. It does not seem to have affected the way in which the FSA looked at individual institutions; it does not seem to have changed broad banking policy in any way. It all went on gloriously as before, as if there were no icebergs in the ocean.
Inevitably the crisis has led to suggestions that we need more regulation. We may do but we also need better regulation and we need much better supervision. Supervision is ultimately the ingredient that has failed and which set off this whole process. Regulation is a matter of setting rules and the nature of regulation may well change as result of current events. Supervision is the oversight of the actual business of institutions and therefore where in this case and others the damage will have begun.
How could the crisis have developed on such a scale, with nobody realising what was happening until the last moment? It has involved many banks in many countries and the puzzle is what caused everyone in key positions in or in relation to those institutions to have a complete mental block at the same time on the nature of these instruments. This must be the worst collective failure on a colossal scale in economic history. Too many of the important players seem to have suspended their critical faculties.
Within banks there are managers, traders and dealers at the coalface; there are risk departments and control systems; there is a head of risk who reports to the board and to the audit committee; there is an internal audit structure and beefed-up forms of audit committee, which not only look at figures and data but carry out stress testing. They think they are on top of things.
Of course, it was the banks’ fault in that they bought piles of what transpired to be toxic financial waste, but others should also have noticed. The first to have done so should have been the external auditors, but those who perhaps above all should have noticed were the rating agencies, which seem to be covered with a lack of glory in this whole story. The supervisors are critical in this. Sub-prime mortgages are a high-risk asset, no matter what wrappings you put round them. You can call them an SIV, a CDO or any other acronym, but basically they consist of dodgy risk, and those who entered into them on such a substantial scale seem not to have focused on that at all.
How can such a crisis be stopped from happening again? I think that supervision will have to be thought through from first principles. It is important, and I am glad, that the FSA is beginning to undertake this but I hope that it looks at the issue in a way that reveals why the institutions affected took on and built up such huge positions in instruments and types of business that they did not properly understand.
Of course, we will get new proposals on regulation. In some respects that may be a very good thing, but it will also probably be influenced by overseas interests, because co-ordination in an international market is very important. The right personnel must be employed, and the people who carry out an extended and, one hopes, more penetrating process of supervision must become a source of key information about the nature of the assets on the balance sheets of deposit-taking institutions. There is no getting away from that.
What about the future? We are in the middle of a storm at the moment but we have to think beyond that. When we get beyond it, I hope that the regulatory function, which is separate from the supervisory function—although they overlap—will apply in a form that enables the supervisors, in their turn, to make a proper and well informed judgment about the nature of the institution over which they have supervisory responsibility.
My Lords, Second Readings are an opportunity to debate what is in a Bill. However, they are also an opportunity to debate what should be in a Bill but is not. This Bill provides for pre-funding of the Financial Services Compensation Scheme—which has not been much talked about this afternoon—and that is something that may or may not turn out to be needed. However, it does not provide for the other changes that should be made to the Financial Services Compensation Scheme, and it is to those that I wish briefly to devote myself this evening.
I want to start with a positive note about the scheme. Two of the big problems are being solved. Paying back depositors if an institution went under used to be jolly slow, but Loretta Minghella and her team did a fantastic job with the Icelandic banks in speeding up that complicated process. It bodes very well for the future speed of compensation.
There is another major problem on which I am optimistic. The compensation scheme has a £50,000 limit and therefore does not cover someone who makes a short-term, very large deposit—for example, someone who sells his house and puts the money in the bank—and the next day the bank goes under. At the moment, that person is not protected beyond the £50,000 limit, and that will have been very scary for some people in the atmosphere that prevailed in the autumn. However, without going into detail, I think that that problem will be resolved by the FSA in the near future.
However, I am not so confident that the FSA will fix a much bigger defect in the scheme which has been referred to in the debate—that is, the problem of the £50,000 compensation limit applying not per brand but per authorised institution. A few weeks ago, Hector Sants spoke at an all-party meeting downstairs and suggested that it would be solved, but I think that the omens since have suggested a backing-away. Perhaps I may describe the problem, taking HBOS as an example. Let us suppose that you have £50,000 in an account with H and another £50,000 in an account with BOS. You think that you are covered by the compensation limit but if HBOS goes down, other than if the Government take special action, under the scheme you will get back only one lot of £50,000 and will be £50,000 down.
At present, the approach seems to be that information will be brought to bear on consumers so that they understand that HBOS is only one authorised institution and that two separate accounts will not be protected. However, I think that that expects an awful lot of consumers. When you open an account, there is enough small print without trying to find out what other banks are linked with the bank into which you are putting your money. So I believe that, if there is to be a limit—I shall come back to that in a minute—it should be per brand and not per authorised institution. I know that there are problems of legal definition in dealing with that, but I cannot believe that, with all the resources of the FSA’s legal department, those problems cannot be resolved if there is a genuine will to do so, and the FSA would alleviate much concern among investors if it did so.
I come to the kernel of what I want to say tonight. I referred to a limit on compensation for depositors, but why should there be a limit on retail depositors? I do not necessarily go as far as the noble Lord, Lord Blackwell, in wanting all depositors to have 100 per cent protection but I think that all retail depositors should be 100 per cent protected. I have puzzled over this question but I am afraid that it involves a journey into a very strange world—that of bank regulators.
I have known bank regulators for a while, including as an economic journalist. Those who do not know them can be assured that they are not like other people. There are many stories to illustrate this but I can do it most quickly by quoting one magnificent sentence from the regulators’ regulator, Alan Greenspan:
“If I have made myself clear, you must have misunderstood me”.
Banking regulators embrace paradox, ambiguity and contradiction. They persuade themselves that in this they have a higher wisdom and that, if it escapes the rest of humanity, that is not surprising. The argument against unlimited compensation that banking regulators come out with is that it would create moral hazard. Those two words in themselves do not mean very much, but never mind—noble Lords will know what they mean. In normal language, they mean that ordinary people must be at risk with their deposits if they put a lot of money into one bank, otherwise they would not have any incentive to check whether the bank was sound or unsound.
I find that a very bizarre argument, even coming from bank regulators. The truth is that there is a lot of moral hazard in banking, and there are two lots of people to whom it should apply. One is those who manage the banks because, if a bank collapses, they lose their jobs. I should not say that I am delighted but I cannot help but observe with a certain wry humour that a lot of them are losing their jobs now. They are paying the price of the moral hazard.
The second lot of people who suffer, for whom I have more sympathy, are shareholders, who will lose many, most or all of their investments. They are supposed to know what goes on in their banks; if they do not and things go wrong, it is right that they suffer. You have to feel sorry for small shareholders but, if you go into the stock exchange business, you have to be prepared to run the moral hazard of investing in bad companies and, if you get it wrong, losing money. However, the information that shareholders have is vastly better than that available to consumers, and their moral hazard is quite enough to protect against insanity, if indeed it does so. It was not a lack of moral hazard that caused the banks to collapse; as the noble Lord just said, it was a sort of collective insanity that came over the industry.
Furthermore, the other main protection against these kind of events is supposed to be the action of regulators. It seems tough to allow regulators to make the appalling mess that has allowed the collapse that is going on at the moment, and then say that depositors should know that bank A is safe and bank B is not safe and, in theory, lose money if they fail to distinguish between the two. It is most unfair on your average punter.
However, there is a further twist as we go through this fantasy world of banking regulation. The theory is that you only get £50,000 back, but, in practice, nothing of the kind applies. In practice, the Government have paid out in full for all depositors who lose their money. They have even paid out in full on people who put their money into Icelandic banks, which is pretty extraordinary. To call it generous understates it. When London Scottish went down only a few weeks ago, there was no question of any depositors losing their money. They all got the whole amount back from the Government.
So we are here in Alice in Wonderland territory. On one hand, Ministers insist—the Prime Minister himself has done it—that depositors will be compensated in full and simultaneously insist that they are only entitled to £50,000 per authorised institution. Jimmy Thomas, a working-class Minister in the MacDonald Government, once said that if you cannot ride two horses at once, you should not be in the circus. The Chancellor’s position on this is a bit like riding two horses galloping in different directions and this is a trifle demanding, even for a politician.
This strange world has practical consequences. Suppose you hear that a bank is rumoured to be in trouble. Maybe you have a deposit there. You start to wonder if you should go down and get your money out before everybody else does. If you believe the Alistair Darling who is riding one horse, there is no reason at all. You will be compensated in full if it does go under, so leave your money there. If you believe the Alistair Darling who is riding the other horse, you had better get down there fast if you have more than £50,000. I will just deal with one counterargument which is used. It is perfectly true that only 2 per cent of depositors have more than £50,000 in a bank, but it is also true that they account for one-third of the total deposits; that is to say that they have quite enough capacity to bring down any bank that may exist.
Different European countries have different compensation arrangements, from 100 per cent in Ireland on down. It would be much the best if there were one rule for the whole of Europe, so that deposits and depositors did not become the itinerants of our day, chasing hither and thither in pursuit of maximum safety. However, it would be better still if the one rule across Europe was 100 per cent compensation for all retail depositors. At a stroke, one possible source of instability, in these all too unstable days, would be eliminated.
My Lords, I have stood from these Baron Benches, as they are called, for many years and spoken on similar subjects. It always gives me really great pleasure when the professors and economists buzz off. If the accountants could only go as well, life would be much easier. Banking problems only began when economists arrived within government departments—237 within one year, over half from eastern Europe. It was only when people relied upon accountants that things began to go wrong. These Benches are where the Barons sit. Noble Viscounts such as my noble friend on my left should normally sit a bit nearer the front, and the Earls sit on the very front.
I am rather pleased that I have two speeches today. I was always told that I should have three.
The bankers are now here. There is the noble Lord, Lord James—Lloyds from 1959 to 1964—and the noble Lord, Lord Stewartby, then Ian Stewart, working for my cousin Giles Guthrie at Brown Shipley, a really great name. The noble Lord, Lord Oakeshott, was in Warburg Investment Management, known for being able to take a risk on absolutely anything and to give odds on any financial subject in the world. These were great people.
Me, my Lords? I was in industry—asbestos. I then went into economic forecasting. I was the only non-economist to be employed because I was meant to know about industry. Thereafter, I thought that everything I did went well, but it steadily collapsed. I joined Singer and Friedlander and yesterday the legislation came in effectively to abolish it. It was a great entrepreneurial bank set up by two arbitragists, Mr Singer and Mr Friedlander—one Austrian and one South African—at the start of the war. That was arbitrage, which gradually became acceptable. When it merged with the Bowring Group, it became an accepting house. The reason I felt confident to join was that CT Bowring was the only person to pay out in the San Francisco earthquake disaster, as a fund. You knew, therefore, that you were with someone who was undoubted. From there, I moved to Samuel Montagu, which was owned by Midland Bank.
I want to try and explain how a bank works. It does not need all these outside regulators. It needs supervision. When you really have a fear of the chief inspector coming to look in your fridge to make sure whether you have any wine illegally on the bank, you then start to get nervous. Midland Bank, for which I worked, was the biggest bank in the world. It was known as the farmer’s bank and was an industrial bank, but gradually it fell and fell. It trained every bank in the world and every banker. You could recognise one, because if he crossed his hand over his chest and seemed a bit deferential, you could ask if he was trained in the Midland Bank and if it was Sheffield or Haslemere and they would say yes.
Every single head of finance in the country had been trained in the Midland Bank. Unfortunately, things gradually went wrong. When we had a credit committee it was a nightmare. First, I was a director of international banking at Samuel Montagu. We wanted to get use of our parent company’s balance sheet and that needed craftiness beyond belief. We knew that if we worked with Warburg, it had that amazing ability to unlock money from any bank in the world—it was called placing power. It never put any of its own money in; it just wanted to use other people’s balance sheets, and it was clever. In Morgan Grenfell, where the noble Lord, Lord Smith of Kelvin, was, there was a wonderful man, probably the best investment merchant banker in the world, Bill Mackworth-Young. When he spoke to Luke Meinertzhagen at Cazenove’s—Luke was called the man with the golden telephone—they could place anything in the world and anything they placed never went wrong.
On the other hand, at Midland—if you were in Samuel Montagu—you had to go across the road to the international credit committee and present yourself, as a director, in front of 20 people, with someone standing with a brown telephone in the corner to say what the committee had done direct. It would go out by texted telex, wherever it was. I was quite nervous because I did not understand this. They were all slightly bureaucratic. In the merchant banking side you could be called an “esq”—I was known as “Lord Esq”—but you had to be a “mister” in the bank; you could not be an esquire because you were not landed. These people knew their job. You would be asked, “Have you been there?”. That meant that you could not lend to anybody unless you had been to the country in the last 90 days, or unless you or the manager had visited the client in the last day. You had to know thy customer. Then, if they were not sure about it, they would introduce a strange phrase. I thought I should know all these initials like SIVs, but they did not turn up. “Committee, I think we are not sure enough. I think it should be an FFW”. I did not know what an FFW was and I did not dare go and ask other people. Quietly, I asked how long we had been using the term “FFW”. “Oh, before my time, my dear chap, way before my time”.
I then found out that only Midland had it. It was a “fair following wind”. It meant that, if the project stacked up, the agreement, in principle, would follow. That FFW would read as Project MJ223B and so on, FFW-ed. The governor of the central bank of wherever it was in the world knew that he had got Midland on side. That was almost like the traditional handshake.
That was not the end of it. The proposals then had to go back to head office in Poultry, to the fourth floor where the gold was actually gilt, not gold paint as on the other floors. If you ever went before the Midland board—some of my noble friends have been directors—you were told to go into the office, wait and then take three steps before the board, and you had to describe the project, as a director.
Only once did I beat the system. The noble Lord, Lord Whitty, who is not here, would enjoy this. I dealt with the more difficult countries because I was not important enough to deal with the easy countries. I was asked to help Bhutan. Bhutan wanted a new aircraft. As our esteemed customer was Hawker Siddeley, where the noble Lord, Lord Whitty, worked, I suggested that it should have an HS125. When I put forward the proposal to the credit committee, I was asked whether we had been to Bhutan. We had not, but by chance, the night before I had met the Queen of Bhutan in Fulham and helped to push-start her MG. So I said, “I have met the Queen of Bhutan”. The committee said, “Hmm. Perhaps. FFW-ed”, and Bhutan got the plane.
The supervision was from within and you were so frightened of letting down your own colleagues that you did not need outsiders, but of course you constantly had to walk across the road to the Bank of England, particularly when you handled the exchange control.
Sadly, Midland Bank, with 333 branches, employing 33,000 people and getting 330 applications for charity, one from each branch, every day, thought it could expand. It owned Northern Bank and Clydesdale Bank and had a 20 per cent stake in Standard Chartered Bank and lots of joint ventures. It then decided it must move with the new world, open up another time zone and get involved in America. It bought a company called Crocker which was in the sub-prime mortgage market—all that time ago—and it was accused of red-lining. That cost Midland Bank $800 million, the same amount as the total budget of Afghanistan today.
I learnt very quickly that if an investment bank or any bank does not have a balance sheet, it is not allowed to lend more than 17 or 20 times the share capital in reserves. I thought, “How much can you lend?”. I did not think about what would happen if you lost $20 million and that you would have to reduce your lending by that much. Nor did I realise the pain when inflation came in. With interest rates so high, we found that big companies would not pay early and suppliers would pay late; you then found that the pressure was on lending.
That is the present situation. Every one of us needs Joe the plumber. I have lots of “Joe the plumber”s. This morning it was Steve the laundryman. He is a really good, right-wing chap who believes in his children being properly educated. He works his heart out and does the best shirts in London at the cheapest price. This morning, I said to Steve, “What shall I tell them today?”. He said, “Tell them to take over the banks, nationalise them all, and give us the money without interest until they bring down the amount of interest they are getting in from everyone else. It’s not fair. They’re coining it in”. I said, “They made a mistake. Do you need any money?”. He said, “No, except that you are not doing as many shirts”. For economic reasons, I thought I might wear one shirt for two days; for noble Lords sitting close to me, I should say that this is actually a new shirt today. Steve pointed out that many people are thinking of economising.
The banks and the Bank of England are the best people to supervise their business, provided they know what they are doing. Now we come to the problem: no one doubted the four clearing banks, but we have too many banks. I shall not bang on too long about the rating industry, but maybe we should introduce our own rating system. Let the Bank of England introduce a rating system for banks. There would be no triple A-rated banks at the moment; there may not be many double-A banks, but we could devise our own rating system which would give people confidence in banks. If the rating was sufficiently good, people would stand behind it.
I end on a slightly sad note. Everything is about trade and I was in trade. Lombard Street was about trade. Our worry today is that we are misrepresenting things. The noble Lord, Lord Myners, has heard me bang on about the balance of payments. We will have a balance of payments deficit of £100 billion on visibles this year. The surplus on invisibles will fall away naturally because the financial services market is down a bit. We have only 11 countries in the world where we have a surplus in trade. As our currency has gone down by 20 per cent, so the cost of our imports, which are many times more than our exports, will go up. We may have a currency crisis and we may, one day, think back to exchange control.
I am optimistic because we are still one of the most international countries in the world and the Bank of England is one of the most respected banks. We should not just count our blessings, but when there is a problem we should look at our future trading strategy and the advice we give to help it to trade out of it. We have some problems and the only way we can get out of them is to trade out of them.
My Lords, it is always a great pleasure to follow the noble Lord, Lord Selsdon, who introduces a personal note into our debates which is genuine and pleasant.
The noble Lord, Lord Stewartby, asked why we are here. This Bill has been pored over, as the Minister said, in consultation, in papers, in studies and in extensive debates in another place. That does not mean that the Bill is perfect. When dealing with the Financial Services Bill, which my noble friend Lord Peston will remember very well, I sat where the noble Baroness, Lady Noakes, sits now; it too had been studied endlessly, but it got a lot of things wrong, as I shall explain.
A further complication is the timetable. I understand that the Bill has to become an Act before the original Act lapses. That means that a 255-clause Bill will be debated in your Lordships’ House at a machine-gun pace in the first week after the recess. I will argue, and I hope that the Minister will accept, that in the light of that and all my other arguments, a review of the legislation after a period would be right, as the noble Baroness and the noble Lord, Lord Newby, have claimed. We cannot just let it go by without reviewing the legislation.
The noble Lord, Lord Stewartby, asked why we were here in the first place. It is commonly said that today’s bankers have forgotten how to be bankers. We have had a series of catastrophic misjudgments. One was revealed yesterday: the Royal Bank of Scotland and HSBC were involved in a fraudulent arrangement in New York. The Government have had to intervene on a massive scale. Bankers are very unpopular, as mentioned by my noble friends Lord Peston, Lord Lipsey and Lord Barnett. I have a slight caveat to that. Auditors, as my noble friend Lord Barnett said, seem to have escaped criticism. It is important to look at history to explain, in the words of the noble Lord, Lord Stewartby, what has happened and why we are here.
In 1890, Barings Bank, for which I had the privilege to work for a number of years, had to be bailed out by the Bank of England and a consortium of friendly banks because it was left holding a baggage of Argentine defaulted securities and had no liquidity. No lessons were learnt as in 1995 Barings collapsed completely, beyond salvation, because one of its traders in securities was arbitraging between the Singapore and Tokyo stock markets with such enthusiasm that he engaged the whole net worth of the parent bank. Directors in London were prepared to transfer the whole of the net worth of the parent bank to Singapore to support his position. The result was that Barings went bust. The Barings directors did not have a true understanding of the business being conducted in Singapore, because if they had they would not have allowed the entire net worth of an old merchant bank to be squandered away on some trader’s say-so. I remind noble Lords that the same thing happened in 1931 at the Creditanstalt bank in Vienna. It went bankrupt because it was left holding a lot of securities and had no idea that they were worthless. The failure of the Vienna bank led to the collapse of the entire financial system in 1931, which in turn resulted in legislation that I will come to in a moment.
All these banks—Lehman Brothers is another case—had securitised instruments which they did not understand. The collapse in 1931 led to what in my view was a very sensible development. It ended with the Glass-Steagall Act in the United States and a distinction being made between commercial banks and banks that traded in securities. All that broke down here in the 1980s and in the US, with the final repeal of the Glass-Steagall Act in 1999. In our case, the breakdown led to the infamous Big Bang in the City, when banks paid stockbrokers and jobbers ludicrous sums of money on the grounds that that was the way forward. They had no idea what they were buying, but they rushed into buying things because that was the fashion of the period. As a result, serious bankers forgot to be bankers and became, as they saw it, dealers. However, the business cultures of dealers and bankers are quite different. I am sure that I do not need to overemphasise the fact that a banker is someone who looks at a balance sheet and says, “I am a taker of deposits, I will lend them out on overdraft over a relatively short term, and I will not get involved in buying securities, let alone when I have no idea of their value”.
That was not the case with Northern Rock and Bradford & Bingley, which involved a different clash of business cultures. I am afraid I was also Jeremiah on the opposition Front Bench during the passage of the 1986 Building Societies Bill. I said that it would be a disaster. It seems to me now, just as it did then, that a building society, whose business is lending on mortgage at long term on the back of a relatively stable retail deposit base, is asking for trouble if it develops ambitions as a bank to finance those long-term assets in the wholesale money market, particularly the interbank market. The danger is compounded if the building society in question loses its sense of social lending and goes recklessly in pursuit of profit maximisation. That is precisely what happened in the cases of both Northern Rock and Bradford & Bingley. The cultures of building societies and banks do not mix.
Although the Big Bang and the building societies legislation were under a Conservative Government and in my view underlie our present problems, I have to agree with noble Lords opposite in their criticism of the move some years ago by this Government to remove the regulation of banks from the Bank of England and place it under something called a tripartite framework of the Treasury, the Bank and the Financial Services Authority, a development also referred to by my noble friend Lord Eatwell. I could not understand then and I cannot understand now how the Bank can satisfactorily play the role of lender of last resort unless it also has a regulatory function—not, I hasten to add, that when I was a banker myself I was particularly happy with the banking supervision department of the Bank of England as it was then constituted. The department head had spent most of his career in public relations, which would mean beefing it up.
What do we have now? We have a system of universal banks that try to do everything but do not necessarily understand everything they are doing. However, they want to do everything because that is the nature of a universal bank. They are regulated by a tripartite system whose members seem to have difficulty in talking to one another. Under those circumstances, I find it difficult to see how the present Bill will prevent future disasters. As the noble Lord, Lord Stewartby, and the noble Viscount, Lord Eccles, observed, it might have been useful last year but perhaps not this year. It may be impossible to put the genie back in the bottle in terms of separating the business of underwriting and dealing in securities from the business of deposit taking and commercial banking without a collapse of 1931 proportions, which obviously we have to guard against. But I hope that someone, somewhere, is thinking about restoring the role of securities versus commercial banking and the financial integrity of mortgage lenders. Obviously I am ludicrously optimistic, but I remain so in the hope that someone will look at these issues seriously.
We are dealing with a Bill that will do little or nothing to address what I regard as the real problem. There is some evidence that the authorities are not entirely clear about the final shape of the legislation. For instance, in this Bill the Government propose to give themselves not just Henry VIII but truly Cromwellian powers to change the rules whenever they see fit. Clause 75 as it stands, even after negotiations, allows in subsection (8) the Treasury to make a series of orders amending the law without prior parliamentary approval. Cromwell would certainly have approved. Clause 155 allows the Treasury to amend primary legislation relating to building societies, but at least any proposal to do so requires prior parliamentary approval. All this reinforces the conclusion that we need a review of this legislation after a period to see how it is working.
I have a few small points to make. There is some doubt about the code of practice. The authorities are to “have regard” to the code. I could have regard to a code of practice but it does not mean very much. When he winds up the debate, I should like my noble friend to explain what “have regard” really means. As with many Bills, miscellaneous bits and pieces have been tacked on, such as the “financial stability objective” in Clause 228, which my noble friend Lord Eatwell talked about. Is it necessary to have this on the statute book? After all, I thought that the idea that the Bank of England,
“shall … contribute to protecting and enhancing the stability of the financial systems of the United Kingdom”,
was guaranteed because it is the job of the Bank of England and the Government. But, as my noble friend pointed out, there is the question of the Financial Stability Committee which is going to be set up under the Bill. Will my noble friend explain the status of this committee? Is it going to be transparent? Will we see how it operates and know what it says?
I have spent too long on my remarks. It is only right and fair to advise my noble friend that, if the parties opposite press to a Division the question of a sunset clause, post-legislative scrutiny or an independent review, either in Committee or on Report, I will be in their Lobby.
My Lords, coming this late into the debate one is always on the edge of one’s seat as to whether there is going to be anything left to say of the text one has brought in. I thought that I had got lucky until the noble Lord, Lord Williams of Elvel, summarised most of my main points. However, I shall try to elaborate on them a little.
I go back to the opening remarks of my noble friend Lady Noakes when she said that we are not opposed to the idea of the Bill; we want it to happen. Effectively, she was saying, “We are the Opposition and we want to help you”, if you will believe it. I can go along with that entirely but the Bill as it stands is seriously flawed in practicalities. If we are to have a speedy process of resolution following the recess, the Minister could do a great deal to assist by addressing a number of critical points which are wrong in the Bill and by bringing forward amendments or clarification at that time.
I shall use my time to run through the six points that I wish to make. Before I do so, I repeat the warning given by my noble friend Lady Noakes at the outset which did not get the reaction that I expected. Your Lordships will be aware that Section VI of the Bank Charter Act 1844 lays down a strict requirement that the Bank of England shall deliver each week to the Government a precise account of the total value of all notes and coinage of the realm currently in circulation. Remove that control and there is nothing to stop an unreported and unmonitored flooding of the money market by the undisciplined use of the printing presses. If we went down that path we would be following a road which starts in Weimar, goes on through Harare and must not end in Westminster and London. That is the great fear that the abolition of that section will bring about—but the Bill abolishes it. What on earth that provision is doing in the Bill I have no idea; it does not belong there and has nothing to do with the rest of it. If it is left in, it will be the biggest single threat to the Bill and will undo all the good work that it might otherwise do. Let us get rid of it.
My six specific points refer to the practicalities of implementing the Bill. It is, let us say, three o’clock in the morning at Freshfields or Simmons & Simmons and one is trying, with this Bill in hand, to work through the implementation of an acquisition—this might be in three years’ time, three months’ time or whenever. I refer your Lordships to Clause 48(1)(c), which deals with the arrangements for close-out and offset—netting off. It appears to imply that at the time of the execution of a bank rescue under the Bill there should be an entitlement to net off the value of any debtor of the bank against any liability which that same debtor has as a creditor. This might be a highly desirable arrangement but, as it stands, it is wholly in conflict with the Insolvency Act 1986. Effectively, it would create an illegality in the Bill. It would become a fraudulent preference, and that is strictly not allowed. We need clarification of the circumstances under which this could be done.
I can only conclude that this remarkable document, the Explanatory Notes, must have been written by a student anarchist collective from about 1968. Perhaps they have now become Treasury solicitors or Treasury officials—presumably they have to earn a living somehow when they have qualified and finished being anarchists. They say, “Do not worry about this because we will pass a statutory instrument and that will make it all right”. They give that answer as the standard resolution to every problem that arises. If they are listened to, the air will be thick with a shower of statutory instruments flooding through the House; they will be flying around like confetti at a spring wedding on a windy day. We cannot do it.
They are also saying that there is to be no referral to either House; that there will be no debate on any of them. This is not the language of mature, democratic government; it is the language of totalitarianism seeking to obtain control of a process; it is not a democratic procedure. Will the Minister address seriously the question of the fraudulent preference? It is a serious crime; it must not be committed and yet the Bill is saying that we should do it.
My second question is of a similar nature. It relates to Clause 71, which deals with the arrangements governing a pension scheme. When I read it, I thought it was the joke that had been written into the Bill in order to keep us amused while reading through this vast amount of legislation. It is only about two months ago that we debated the Pensions Bill in this House, when the Government were strongly resistant to any suggestion that a solvent company could have a failed pension scheme and could go into the PPF. Amendments were brought forward and defeated, the Government got their way and that is how it stands. The Bill does not say that there is any obligation to fill the deficit in an underfunded, insolvent pension scheme but it does say that where a bank is acquired and there is a pension scheme, the pension scheme should be hived off and should float away to take care of itself. If that were the case, it would have no access to the Pension Protection Fund. Effectively, the Government have opened up the hazard of a totally unfunded pension scheme being adrift in the market because they would not recognise that the scheme could not go into the PPF if its parent was solvent, which of course it would be if the bank is rescued first. It is nonsense; it is the funniest joke in the whole document, and there are not many.
My third concern relates to the recurring use of the phrase “financial assistance”. It swarms through the Bill. Another mildly funny joke is that sometimes it is used correctly in the sense that the law requires, but I do not think the people who drafted it realised that they were using it correctly. To a quoted company, financial assistance means, quite specifically, that if you are going to be acquired by another company you cannot give any assistance to the person who is acquiring you to buy you. As the Bill stands, financial assistance is referred to recurringly as though it is permissible for the bank to assist the Government to purchase it. A situation could easily be created by the Bill in which the Government want the bank to be acquired in order to rescue it and therefore come to an arrangement with the bank under which the assets of the bank are rearranged, packaged or parcelled up to a third party, who then participates in the acquisition to support the Government’s action. That would create a financial assistance which would be illegal under the Companies Act. No recognition of that appears in the notes or in the Bill. That is a serious concern.
Again, the unhelpful descriptive memorandum says, “It is not a problem; we will just issue another statutory instrument and put it right”. Clause 7 and paragraph 32 of the Explanatory Notes acknowledge this point but then go on to say that the accepted interpretation can be ignored for the purposes of the Bill, thus overturning a long-established and sensible law.
This cavalier attitude to the established laws of finance carries on into Clauses 17 and 34, which both separately and together appear to suggest that where anything required by the Bill runs counter to an existing law, that can simply be set aside and ignored in the greater quest for the acquisition of more banks on behalf of government. Worse still, Clause 75 provides for the “Power to change law”. This has already been referred to but the noble Lord who mentioned it omitted one hugely important point. There is a power to change the law simply on the issue of another statutory instrument by the Treasury but, unbelievably, the same clause goes on to say that the power to modify the provisions will include the power to modify common law and both primary and secondary legislation simply by the use of statutory instruments which will not be referred for the consent of either House. I should love to know what a Law Lord might think about the intention to alter common law in that way and I am sorry that none of them is here to stand up and talk to us on the subject today.
Throughout the Bill there is an undisciplined and completely erratic use of the word “asset”. You might think that that is a quibble in this context, but I put it to your Lordships that it is fundamental to understanding how the Government are going to interrelate any bank they take control of. They will do so by an acquisition of assets. I suggest that there are three categories of asset that would each react very differently in terms of what the Government could do with them.
The traditional way for a bank to acquire a distressed company is for it to acquire the balance sheet of the company concerned. That is a whole assets and liabilities acquisition. If that is how the Government intend to proceed in this case, that is fine, but we must understand that by acquiring the balance sheet the Government would be acquiring all the undertakings and investments on that balance sheet as well. Let us suppose that the bank being acquired had a significant interbank relationship with another bank and that the Government, as the new owner, then sought to interfere with that arrangement by creating an act of default on the third-party bank, giving them the opportunity to move for the immediate nationalisation and acquisition of each other bank reflected in the original balance sheet of the first bank acquired. I do not really believe that that is the devious process in the Government’s mind but they might want to consider injecting here, and in several other places, a negative pledge not to do what might be raised as a possibility in this case. That might speed up the eventual process of moving the Bill forward.
The second category of definition for an asset is that it is solely related to the acquisition of the shareholders’ funds, which implies participation in the equity by some form of instrument that is issued. My noble friend Lord Eccles has been raising this matter since we had the Bradford & Bingley debate about the lack of concern for and identification with the interest of shareholders and other investors. This is a huge omission from the Bill. Shareholders and investors are pretty well ignored as second-class citizens and are not dealt with adequately. They need to be better addressed in the Bill if it is to satisfy all parties.
The third category of asset that might be here is the simple acquisition of the backing assets that back every loan in the name of the bank; you just transfer the ownership of the title deeds into the Government’s control. That is workable at one level, but I tried to think of an example of how it might go wrong. This is deliberately intended to be a ridiculous example, but let us suppose that the Government decided that they wanted to nationalise the major football clubs in the country. They could do so by easily tapping into the assets that would be secured to the banks in the name of the loans that had been given to those clubs. Football clubs are only an example; it could be any form of commercial activity going. By just getting the asset level, the Government would have the means of moving their policy of nationalisation forward into any industry they chose, where loans had been made to the companies in that industry. Again, some form of negative pledge that that is not the Government’s intention would solve that problem, but it is a risk. This all comes from the lack of an adequate identification of what is meant by “assets” in the Bill.
The Minister will know—we have had some private conversations about this—that I have been critical of the instrument by which the money is being injected into the banks being rescued. I continue to have that concern because the instrument he is using at the moment is oversimplistic and does not give him a reasonable opportunity to realise the value by using the shareholdings concerned in the form of some bond that either might be used for a back-to-back loan or might itself be floated separately, in order to recover the taxpayers’ money and so deduct something from the £118 billion of national debt that we have at this time. Some £37 billion is outstanding in this category at the moment, and I shall continue in the view that much of it could be recovered quickly as a deduction against the £118 billion if the Minister had selected a more flexible instrument. The Bill does not have enough to say about the process of acquisition and investment. I have said previously to the Minister that he should be looking more closely at the traditional bank method of a convertible, redeemable, cumulative loan stock, which would give him all the advantages and a marketable commodity in the international finance sector, and would probably get him his money back very quickly. This needs a lot more thought, which is absent from any comment in the report as it stands.
The Explanatory Memorandum is a complete disaster and should be rewritten from beginning to end, preferably without its emphasis on the idea of, “Don’t worry about breaking the law; we’ll pass a statutory instrument”, which I think is a disgrace. There is also an unfortunate and, I am sure, unintended element of sneaky secrecy in it. There are two elements to which that applies. First, the memorandum says that the Government do not want the 1844 section to continue because they do not want the Bank of England to publish the borrowing figures as that might frighten people. Secondly, they use a similar phrase in the Explanatory Memorandum when they say that there is to be no registration by the Government of any assets that they take to secure a loan in rescue to a bank, because they do not want the world outside to know that they are rescuing that bank. However, I should have thought that this was essential information, with regard to both taxpayers’ money and to the sanctity of the arrangements regarding taxpayers’ money and how it is being accounted for.
Those are my main concerns. I wish the Minister a thoughtful and happy Christmas and I hope that he comes back with some amendments that address these various points.
My Lords, to follow the intervention of the noble Lord, Lord Selsdon, we have had the economists, the accountants, the lawyers and the bankers, and now I am intervening on behalf of the customers and consumers. I declare my interest as chair of the new organisation Consumer Focus.
I support the Bill, but we all have to recognise that although it looks quite chunky—as the noble Lord, Lord James, has just said, it has some pretty far-reaching powers in it, which no doubt we will look at in Committee—it is a limited Bill, which relates to the problems that face us right now. I welcome the references to consumer protection in the Bill, although the aspects of the compensation scheme that were mentioned by my noble friend Lord Lipsey could do with some improvement. These references deal with protection for depositors in the event of a bank failure or when a bank looks to be in danger of failing. Indeed, the bulk of the Bill is about bank failures or, to a lesser extent, reducing the likelihood of a bank failure.
It is right and of immediate importance that the Bill should address those issues, but the fact is that, as the average consumer looks at it, we did not have a high street bank failure for 100 years. The noble Lord, Lord Eatwell, reminded us about BCCI, but that was not a high street bank. In the past 18 months, though, the average user of bank services has been completely appalled, as has every citizen, at what has happened here and in the United States. Much of the financial turmoil, as we euphemistically term it, has been on the basis of recklessness and misjudgments in the banking sector here and across the Atlantic. That has caused serious anger and confusion among consumers, whether businesses or individuals.
When consumers look at what has happened in the banking sector and its effects, they are not only appalled and dismayed but uncomprehending and baffled, as well as to a large extent unprotected from the knock-on effects of the disaster. As a business, you now find it difficult to get credit. As a mortgage holder, you see the value of your property plummeting. As a home seeker, you are pretty hard put to get a mortgage at all on the terms that you wanted. As a shareholder in a bank, or in almost anything, the value of your shareholding has gone down. As a saver, the return on your life savings is going south towards zero as we speak. As an actual or future pensioner, the value of your pension scheme has plummeted. So there is real cause for concern and anger out there.
In the whole of this area, it is really only the depositor who is protected. It is right that a banking Bill should protect the depositor, but you also have to recognise that there is a much wider range of anxiety and loss of confidence in the system. As the noble Lord, Lord Bilimoria, said, that lack of confidence is the main thing that the Government nationally, and Governments internationally, have to address right now.
The banks are not victims of this crisis; they are, in large part, the cause. Only this morning, we had the news that some of our most respected banks had invested huge sums of money—$700 million, in one case—with a particular operator in New York, which turns out to be pretty much a one-man operator who does his own financial controls and has an accountant; he appears to be basically a country accountant who does the auditing off his kitchen table in upstate New York. You would have thought that with due diligence the banks could have worked that out.
Banks are always urging on us, if we go for a loan or want to change our investment or transfer our savings, that we should observe due diligence. In all the fine print that regulators require and all the banking documents that we receive as consumers and customers of banks, there is a caveat emptor clause. But if banks are urging due diligence on us, where was the due diligence on the part of many aspects of the banks? Most of us do not get a personal touch with a bank any more. If we go for a loan, it is a computer that gives us the answer, and the computer usually says no. But if it says no to us, how come it has not said no to all these traders with the banks’ assets—that is, our assets—in the past 18 months? We are not talking about fly-by-night operators; respected, long-established household names and globally successful companies have brought down the system. They are not spivs or speculators; they are not the gnomes of Zurich; they are not even the private equity companies or the hedge funds. They are organisations that we and most citizens of this country regard—in the United States it is the same—as our friendly local bank.
In the real economy, we were probably facing a recession, although a relatively minor one. However, the fact that that recession was preceded and hugely aggravated by this crisis of confidence, and is likely to be prolonged by the collapse of confidence, means that we are probably in the most difficult economic situation that many of us can remember.
There is another victim here which is not the banks or even the average customer. Because of where this started and because of how we are viewing sub-prime borrowers, there is a real danger that the net result in distribution terms will be that people will stop lending money to relatively poor people and that the sub-prime borrowers will be seen as the cause, rather than those who failed to exercise due diligence in extending sub-prime loans. The public and small businesses that are suffering at this time also see that hardly anybody in the banking sector or among the regulators has suffered as a result of this. I have to say that, on this rare occasion, I agree with the remarks made by the Leader of the Opposition the other day on this subject.
The regulators have failed to prevent this happening. They were probably never in a position to second-guess the range of decisions that the banks were making, but they could have seen the tendency and could have intervened earlier. Therefore, there are questions to be raised about the long-term role of the regulators in this respect.
I have a small personal story to tell about this. I was the chair of the previous consumer organisation when the Northern Rock crisis first came on our television screens and the queues were outside the banking branches. We mildly suggested that the underwriting compensation should extend from 90 per cent to 100 per cent of the first £34,000 in depositors’ accounts. It was, I thought, a rather tentative exercise in that area, but a senior official in the Financial Services Authority rang us and told us that this would prejudice the whole aspect of moral hazard that had to operate within this market. He became very insistent. I happened to be at the Liberal Democrats’ party conference, for my sins, at that point. After the third phone call, in which he tried to persuade us not to send out that press release, which in my view would have taken the majority of the people in the queues back home and off our television screens, thereby reducing the degree to which panic was induced by the Northern Rock crisis, I had to say to that senior gentleman that he was getting so boring with his requests that I was actually going to go in and listen to Ming Campbell.
The regulators must seriously face up to some questions. But what do we do now? The reason why this Bill is limited is that it deals with this immediate crisis. It is not exactly emergency legislation, but it deals with an emergency. Most of the provisions in the Bill are important levers and instruments for a Government to have in that kind of emergency situation. I have no doubt that in Committee noble Lords will raise a number of problems about how they are operated and their knock-on effects, but it is vital that in this immediate period we have such provisions.
What I find difficult about this immediate period is that the Government, who have taken a shareholding or recapitalised a number of the banks and are therefore in a position of influence and leverage in those banks, are choosing not to exercise that leverage. I go back to the point made by my noble friend Lord Barnett. We have government-appointed directors on the boards of those banks. The Government clearly have a policy in relation to the extension of credit and other banking objectives, but we have taken the self-denying ordinance that those directors and that influence will not be exerted in any way other than in the narrow commercial interests of the bank and that the arm’s-length body that will be set up to invest will quietly stand back and not exercise that influence. In this crisis situation, I do not think that we should operate with that degree of coyness and I do not believe that the punters out there will understand why we are denying ourselves that influence. The Government—that is, the taxpayer—have put a lot of money in. They have policy objectives that, by and large, the population supports in this context, so surely in this period we should use that leverage to help to secure those objectives.
If we are successful—and, one hopes, we will be successful in getting through this difficult period—a whole range of other issues arises. We must distinguish between this Bill’s provisions for the crisis that we must get out of and its steady-state provisions; indeed, noble Lords have made various suggestions about changes to the regulatory framework under which we operate. A number of areas need to be urgently addressed in that context, but they also need a period of serious, in-depth consideration. I welcome the fact that the noble Lord, Lord Turner, as chair of the FSA, has undertaken a review of the role of that agency, which I hope is broadened to the totality of the regulatory framework.
A number of steady-state issues exist, to which some noble Lords have referred, including the structure and number of regulators. The tripartite system is well known; it is also a tripartite system for consumers, who, depending on the nature of their ordinary transactions with their banks—whether it is for credit, a mortgage, a loan or a retail banking account—have to deal with the OFT, the Banking Code or the FSA. That is confusing to consumers and quite expensive to the industry and it needs looking at. The issue of due diligence of banks and their internal and external audit provisions also needs looking at, as does the corporate governance of banks, as other noble Lords have said. The governance of banks has a huge, economy-wide implication. The role of banks’ non-executive directors is different from the role of non-executive directors in other sectors.
There are wider issues, which the Government have been good at dealing with—for example, their policies on financial exclusion, bringing more people into the banking system and how they are brought in. Mention has been made of regulating credit rating organisations. That, too, is vital. More fundamentally, we should look, as we have done in other sectors, at the unbundling of some of the services that banks provide so that they are no longer both horizontally and vertically integrated organisations. Those are all legitimate areas for review and for this House to debate and they are important areas for the Government, the regulators and the industry to address. However, they are not the business of this Bill.
This Bill gives the Government and the regulators the basis to deal with the immediate emergency crisis—as I still call it—which it might take us two years to get out of. Other issues that I and others have raised at Second Reading are probably outside the scope of the subsequent stages of the Bill. That does not mean that there cannot be improvements to the Bill as it stands, but it is important that the House should recognise that distinction in subsequent proceedings.
My Lords, I support legislation that enables the Bank of England to rescue failing banks; therefore, I give overall approval to this Bill, as do the British Bankers’ Association and my opposition Front Bench. In particular, I applaud the increase by the FSA of the deposit protection limit of the Financial Services Compensation Scheme to £50,000.
I wish to focus on five areas of concern. Other speakers have covered them, but I think that it does no harm to emphasise them again. These concerns and suggested remedies are not especially political, but are expressed with the view of improving the Bill. After this, I wish to make some general comments on the banking crisis.
My first area of concern, as many speakers have mentioned, is Clause 4. I, like others, am concerned that the tripartite regime has still not appreciated that for any but the smallest institutions the main objective must be to put into place arrangements by which customers would have continued access to their banking facilities. As my honourable friend Mark Hoban said in another place, the priority should be “financial stability”, which would be achieved by “continuity of service”. I agree with his view that it would be vital to have amendments that help to ensure that a failing bank is,
“open for business the next day, even if it is rebranded, renamed or whatever”
because this will,
“provide more reassurance than payments made through a deposit guarantee scheme”.—[Official Report, Commons, 26/11/08; col. 813.]
Bradford & Bingley, for example, comes with a £14 billion interest liability for the industry, but the use of the special resolution regime to enable the transfer of the deposit base was much preferable to insolvency and paying out compensation cheques to millions of depositors. The continuity of banking services is vital to the maintenance of consumer confidence and financial stability, as opposed to an assurance of compensation payment, even in seven days, and I believe, like the BBA, that this ranking should be expressed in the Bill.
To justify my argument for the continuity of banking services, I cite the impact assessment of the Bill, which states that in the UK 90 per cent of wages are paid directly into a bank account, approximately 98 per cent of benefits are paid into a bank account or Post Office card account, and that over 75 per cent of adults have at least one direct debit.
My next area of concern is Clause 7, in particular subsection (3), which proposes that the second condition should be that it is “not reasonably likely” that action will be taken by or in respect of a bank that will enable it to meet its Financial Services and Markets Act threshold conditions. I believe that a higher test should be set and that the second condition should be premised on it being “highly unlikely” that the threshold conditions will be satisfied.
My next areas of concern are Clauses 47 and 48, as mentioned by many other speakers, which involve the safeguards for partial transfers. The details here are not for today’s debate; they involve the protection of counterparty creditor rights in the event of a partial transfer under the special resolution regime.
The banking industry has raised with Ministers concern that the significance of these issues has still not been grasped and that there is the potential for a real detrimental effect on the willingness of banks to transact in the UK. This could have a hugely significant bearing on the competitiveness of the UK financial services and the capital position of UK banks. In addition, it believes that, as matters stand, lawyers will not be able to give clean legal opinions in support of set-off and netting arrangements and that, as a result, there could be a dramatic shift in the willingness of businesses to transact with UK banks. I believe, therefore, as many noble Lords have said, that rather than having a non-statutory code of practice, safeguards should be included in the Bill itself.
One cannot overemphasise the extent to which institutions are currently contemplating the need to unwind positions in the event of the requisite legal certainty not being delivered in advance of the Bill receiving Royal Assent. This would result in huge extra costs for the banks and would bring with it the very real prospect of international banks moving operations out of the UK and UK banks closing large parts of their business activities and being obliged to reduce their balance sheets on a large scale. What is the Government’s view on this whole area, and do they plan to introduce necessary and important amendments to these clauses?
My next area of concern is Clauses 63 to 67, which would give the authorities powers in the event of a partial transfer to require the residual bank and all other group companies to provide services and facilities to the entity to which there had been a partial transfer. I believe the clauses are too open-ended and have the potential to expose other group companies to major risks. It is also important, in my view, to establish a time limit for the provision of such services—for, say, between one and three years, with a 12-month notice period after that.
My next area of concern is Clause 75. The Government have taken on board that this clause was too broad in scope and that it was unwise to build into a Bill powers to revise any aspect of the legislation with retrospective effect. However, Clause 75(3) still provides the power by which this part of the legislation can be amended retrospectively to facilitate a special resolution. This power needs, however, further limitation and the setting of better parameters for its use. I understand that it would still be possible to overturn the safeguarded arrangements by amending contract law. In addition, as has been mentioned by other speakers, we await the report of the Delegated Powers Committee on this clause.
My next area of concern comes in Clause 167. As the noble Baroness, Lady Noakes, said, the idea of a pre-funded compensation scheme is not suited to the UK market. It simply takes away funds that could be lent to stimulate the economy. I do not believe that it would contribute substantially to UK confidence. On the other hand, Clause 170, which permits the Treasury to make loans to the Financial Services Compensation Scheme from the National Loans Fund, seems much more sensible. The recent transfer of Bradford & Bingley’s retail deposit business demonstrated the value of such a facility and that prompt effective action to safeguard the interests of depositors can be taken without the existence of a pre-funded deposit protection scheme.
I go on to look at the impact assessment. The document signed by the Chancellor of the Exchequer in October 2008 claims total costs arising from the Banking Bill of only £2.2 million to £4.5 million. However, the costs of the FSA proposals for banks to marshal their customer base into a “single customer view” could be as much as £1 billion, according to an independent study to be published by Ernst & Young in January on behalf of the FSA, FSCS and the BBA. Can the Minister confirm these figures?
There also must be a cost to the FSCS of making contingency plans to issue cheques to several million customers, which would be very different in scale from making contingency arrangements to make payments to several thousand.
Furthermore, I agree that the legislation should be reviewed independently after four years, to consider its impact on the UK banking and financial system. I understand that a similar provision was included in the Financial Services and Markets Act and the Terrorism Act. All secondary legislation should be subject to an affirmative resolution and preceded by a full consultative process.
I wish to make a few general comments about the banking crisis. To blame the crisis entirely on world events is wrong. In the UK, the tripartite regime has failed to do its job properly. It replaced the previous scheme, which, as the noble Lord, Lord Bilimoria, said, worked perfectly satisfactorily. I am sorry that the noble Lord, Lord Turner, is not here to update us on what the FSA is planning to do to improve regulation.
If the tripartite regime had done its job properly, banks would have been better regulated and the banking crisis could possibly have been avoided. All this legislation would not have been necessary. As important as the banking Bill is the need to get the global and the UK financial regulatory system in better order—on that note, I wish to repeat the remarks made by the noble Lord, Lord Bilimoria, on the weaknesses of the Financial Stability Committee. This means having financial regulators who understand the subject, who may be on secondment from banks or legal firms and who are well paid.
If we do not pay the regulators well, people who might have joined them will go and join the banks instead. The regulators must understand how bank balance sheets work, and ensure that sensible ratios are kept to and off-balance-sheet vehicles are carefully monitored. The regulators also need to consider whether a Glass-Steagall type law should be reintroduced in the UK and the US, which separates investment banks from clearing banks.
Realistic levels of bank lending must take place. The Government should not have stated that they wish the banks to return to the levels of 2007. In some way the Banking Bill addresses none of the issues I have just mentioned. It is a Bill to tackle crises when they arrive and entirely fails to address major regulatory issues. As the noble Lord, Lord Williams of Elvel, said, I cannot see how this Bill could prevent future disasters.
My Lords, as my noble friend Lord Newby said—and as both the opening speakers summed up pretty well—we support the purposes of this Bill. However, as the noble Baroness, Lady Noakes, said, there is some way for this Bill to travel. We are concerned about the wide regulation-making powers in Clause 75 and will be addressing that in more detail in Committee.
This is a timely Bill. I had a stark reminder of that earlier in this debate, while popping out to the Peers’ lavatory, when a highly respected Peer came up to me, because he had heard me speaking the other day during the Queen’s Speech debate—I will not say who he was or the name of the bank—and asked whether the £100,000 or so he had in a leading British bank was safe. I checked to make sure that he was talking about a deposit, rather than a shareholding, and said that it was and that I was sure of that. I can understand why he asked, particularly as this was one of the banks which are all over the newspapers today, being one of the mugs taken for a ride by Mr Madoff. It is an extraordinary state of affairs—the noble Lord, Lord Whitty, put it pungently and well—that banks have let themselves get into this sort of situation with this sort of shyster.
Let me declare my interests as I should, not just as a pension fund manager for the past 30 years but, in this context, as a director of a subsidiary of Close Brothers Plc, which is a British bank. I thank the noble Lord, Lord Selsdon, for declaring some more of my past—that I was previously a director of Warburg Investment Management, where, I like to think in those far-off days, we more or less invented spread betting. However, at least there, we used to do it with our own money, knew the risks that we were running and paid out with a smile. I was lucky enough to be recruited to Warburg’s by Sir Siegmund Warburg. Working for Roy Jenkins, he gave me an introduction to Lord Rothschild and to Siegmund Warburg. It may well be, had I taken the job at Lord Rothschild’s, that later I would have been competing with the noble Lord, Lord Myners.
It has been an interesting debate. I was most struck by the speech of the noble Lord, Lord Whitty, who spoke up for the consumer or the punter, if I can put it that way. The problem we have is that banks are effectively on strike. Whatever they say, almost all of them are closed to new business lending. I say this, not just having heard the anecdotal stories that we all hear from banks, but also from a good deal of knowledge from inside those banks. The people who are in those banks—decent people, in the lending teams—are finding it heartbreaking that they have to cut back all the time. They are under extreme pressure to cut back their loans.
We are not just talking here about small or shaky companies. Mainstream, large British companies are under pressure the whole time to reduce the risk-weighted assets and claw money back. Frankly, the recapitalisation of the banks is not working. Following on from the noble Lord, Lord Whitty, I ask the Minister if he will respond on the narrow way in which the Treasury seems to be regarding the function of UK Financial Investments Limited. I looked up, and have here, a role specification for the position of a non-executive director with UK Financial Investments Limited, which describes the overarching objective as being,
“to protect and create value for the taxpayer as shareholder with due regard to the maintenance and financial stability and to act in a way that promotes competition”.
However, this aim seems to be focused on trying to get the taxpayers’ money back as soon as possible, which is not the reason why £37 billion is being put into these banks by the taxpayer. Would the noble Lord, Lord Myners, look at that again?
The first appointment I believe to have been made to this body is a former investment banker from Merrill Lynch. It seems to me and many others that the people representing the Government on this body—and indeed we believe that there should be directors on the boards of the nationalised banks—should have a proper spread of business and consumer public experience. It should not be such a narrowly drawn remit.
There were a number of themes in the debate. One, in particular, was mentioned by four speakers: the noble Lords, Lord Blackwell, Lord Williams of Elvel, Lord Whitty and Lord Northbrook, all referred to the Glass-Steagall Act and whether banks should have been allowed to be involved in such gambling and active investment banking. Barclays Capital would be the most obvious and extreme example. We on these Benches think that that should be considered very seriously by the Government and the country. It is a very worth while and important point.
I pay tribute to my former colleague in the investment management industry, the noble Lord, Lord Smith of Kelvin, who made a very thoughtful and penetrating contribution from his great experience and recent knowledge. As other noble Lords have said, we greatly look forward to his contributions to our debates.
As always, the noble Lord, Lord Bilimoria, made a very interesting speech, highlighting the conflicts of interest faced by credit rating agencies and how we can deal with that. I agree that the business model is fundamentally flawed in the way that they are remunerated by the wrong side of the bargain, as it were.
As so often happens, my noble friend Lord Smith of Clifton made a powerful and hard-hitting speech, saying more in eight minutes than some other speakers did in 15 or 16. He said that there should be a sunset clause and made a powerful point about the proper representation of women on the boards of our banks. I look forward to the Minister’s reply.
The noble Lord, Lord Eatwell, made a speech with which we on these Benches strongly agree. We were struck by his suggestion of a joint financial stability committee acting as a bridge between the Bank and the Financial Services Authority. We support that suggestion and hope that he will press it in Committee; if he does, he will have our support. In his wide-ranging speech, the point about systemic risk being ubiquitous in markets was particularly well taken. Given the chains of transactions that are taking place, and following on from Lehmans, there are still many worries in the market about whether transactions will settle. We are far from being out of the woods yet.
The noble Lord, Lord Peston, made a very wise speech, focusing, rightly, on greed. We all know that greed and fear are what move markets, and there has been a great deal too much greed recently. To sum up how he started, it was a case of truth being stranger than fiction. If any of us had ever written a novel about what has happened, it would have been thrown straight into the trash can.
This has been a good debate, with some interesting contributions which we have greatly enjoyed. The noble Lord, Lord Lipsey, talked about ambiguity, paradox and contradiction, but there was nothing like that in his remarks. We were very taken with what he said about the Financial Services Compensation Scheme.
I have already thanked the noble Lord, Lord Selsdon, for revealing some of my misspent youth, and it was interesting to share his reminiscences. The noble Lord, Lord Northbrook, made good points about set-off arrangements, which we shall deal with in detail in Committee. We have had representations from the British Bankers’ Association and from banks.
It has been an interesting and productive debate to some extent. We have talked more about general banking matters, which the Bill cannot address, but there are detailed points of amendment. To get the banks lending again is vital and we must do anything we can in the Bill and bring pressure to bear to achieve that. Let us be under no illusion: if the banks do not start lending—as much to big and medium-sized businesses, particularly those which are backed by private equity, many of which are in grave difficulties—millions and millions more people will become unemployed. There will be a real black hole of failure. Individually, each bank may, from its own point of view, be taking decisions that are understandable but collectively they are doing completely the wrong thing. Only the Government can get the banks to lend again together; if they do not, the country faces a very bleak future.
My Lords, I, too, congratulate the noble Lord, Lord Smith of Kelvin, on his maiden speech. His experience and the insight that it brings will be a welcome addition to this House.
As my noble friend Lady Noakes said, we on these Benches have offered our assistance and support to ensure that the Bill is enacted in a timely fashion. I very much hope that the Minster will respond in a similar spirit of co-operation and good will by listening carefully to the comments made during this debate.
It is almost inevitable that enacting a complex piece of legislation against a deadline will result in alterations being needed as the Bill progresses through Parliament and quite possibly after it has become law. Indeed, Her Majesty’s Government have already proposed changes since the Bill was first introduced. Many of the comments made today have been of a technical nature with the aim of ensuring that the legislation works properly and that future problems arising from unforeseen consequences are avoided. Therefore, it is important that the Government fully consider these points.
My noble friend Lady Noakes has, as usual, made many sensible suggestions. They all merit the Minister’s attention, but in particular I draw his attention to the remarks on set-off and netting arrangements, a subject also referred to by the noble Lord, Lord Eatwell, and others.
It is essential that the banking and financial services industries operate against a background of absolute certainty where the legality of their arrangements is concerned, as my noble friend Lord Northbrook mentioned. In a litigious world, it is impossible to cope with the vast amounts of money involved without there being cast-iron certainty for all legal arrangements. Without that certainty, large parts of banking business carried on in London will go elsewhere. Parliament should be assisting the proper management of the industry rather than creating difficulties. As we have all seen in the past few months, banking is difficult enough without introducing laws that cast doubt over the conduct of normal everyday banking business.
That leads on to what has been referred to as the Henry VIII clause, which other noble Lords have mentioned. It is appreciated that changes to what is now Clause 75 have already taken place. The need for Her Majesty’s Government to have the necessary flexibility to cope with unforeseen emergencies is also recognised, but for Parliament to allow the Executive to make retrospective alterations to the law is bad both in principle and in practice. There should always be certainty in the law. As I have commented, banks need certainty to manage their business. To change the law at the whim of the Executive without recourse to Parliament is the act of a totalitarian state. While I recognise that a mechanism is needed to cope with difficult situations, such draconian measures are inappropriate in a free society. I also point out that Northern Rock and Bradford & Bingley were handled without this proposed legislation being in place. I will return to this point in detail in Committee.
Continuity of service to bank customers is important, as my noble friend Lord Eccles said. As he and my noble friends Lady Noakes and Lord Northbrook pointed out, banking services are a vital component of many people’s lives. It is to be hoped that the Minister will recognise the importance of continuity as regards people’s bank accounts. The failings of the tripartite authority need to be addressed, as my noble friend Lord Eccles and the noble Lord, Lord Bilimoria, pointed out.
The speech of my noble friend Lord James demonstrated yet again his knowledge and expertise. He raised a number of interesting points. His comments on relinquishing the requirement for the Bank of England to account for money in circulation were striking. If this discipline has been successfully carried out by the Bank for more than 150 years, why should it be stopped now when in these uncertain times it is more important than ever that this sort of information should be available?
I am sure that the House particularly looks forward to the Minister’s response to the remarks of my noble friend Lord Saatchi, which were as serious as they were entertaining. My noble friend Lady Noakes and the noble Lord, Lord Williams of Elvel, referred to the need for post-legislative scrutiny. Some aspects of the Bill may not be seen for many years, as they relate to powers that will be used only in what it is hoped will be exceptional circumstances. However, their use is significant. As such, it is only right and proper that whenever the stabilisation powers are used a full explanation should be given of why they were used and how the decision to use them was arrived at.
Parts of the legislation will have immediate effects on how banking business is conducted. Given the complexity of this Bill, the speed with which it is being introduced and its massive potential impact, there will almost certainly be some unforeseen consequences. It would be irresponsible not to have a post-legislative review reasonably soon after the Bill becomes law. I am sure that, with his experience in commerce, the Minister will appreciate this point.
Before sitting down, I repeat my exhortation to the Minister to give full consideration to the many constructive points that have been made during this debate.
My Lords, first, I join in welcoming the noble Lord, Lord Smith of Kelvin, to this House and in congratulating him on an excellent maiden speech. It spoke to his experience and wisdom, to the great benefit he will bring to this House and to a subtle sense of humour that we will all, no doubt, come to enjoy and appreciate. He is truly welcome.
This Second Reading has shown this House at its finest. The range and quality of the contributions were exceptional. They were of a standard of which the other place can truly be envious. The competence and understanding of those in this Chamber has thrown great light on the importance of this legislation and on the issues to which we will have to give careful consideration in Committee.
I welcome the spirit of the opening comments made by the noble Baroness, Lady Noakes. We will not abuse the good will that the opposition Benches have shown towards this legislation. I confirm to her and to the noble Lord, Lord Howard of Rising, that we will listen with great care to comments made in Committee. We will not be disrespectful. We will provide reasoned responses and will give consideration to the points that noble Lords make in Committee.
The noble Baroness, Lady Noakes, made a number of excellent interventions that spoke powerfully of the experience she gained in her professional life and in her time on the court of the Bank of England. The time that this House customarily expects a winding-up speech to take does not permit me to reply to the richness of her contributions or to those of other noble Lords. However, at one stage I thought that, in a possible act of hubris, the noble Lord, Lord Oakeshott, was practising doing a summing up and that it might not be necessary for me to do anything other than sum up the speech made by the noble Lord, Lord Howard of Rising, who came after him. However, I fear that the noble Lord, Lord Oakeshott, may have to wait some time before he has an opportunity to sum up from the government Benches.
The noble Baroness, Lady Noakes, spoke about the need for the Bank to monitor debt levels. I completely agree. Indeed, one reason why we have put a statutory duty for financial stability on the Bank of England is because although it was aware of the growth of credit and referred to it regularly in its commendable financial stability reports, somehow those reports were not listened to. That is an important issue that we need to reflect on to ensure that we do not repeat the mistakes or failures that led to the banking industry globally being in such a difficult situation.
Several noble Lords referred to the use of secondary legislation. We await with interest the report from the Delegated Powers and Regulatory Reform Committee. We hold that committee in the highest regard, and we will take due and proper consideration of its report. The noble Baroness, Lady Noakes, referred to EEA branches operating in this country. She will no doubt be aware that the Chancellor of the Exchequer has raised this with our colleagues in the European Union.
Much was said about Clause 7, and I shall come to that in a moment. The noble Lord, Lord Newby, observed that the banking crisis came upon us with few people forecasting it. It is worth making the point that that was true of other jurisdictions as well. Very few observers in France, Germany, the United States of America or Australia, where similar problems have been experienced, foresaw the true scale of the difficulties that the banking sector was going to experience. The noble Lord made a number of interesting and valuable observations relating to governance and cyclicality of capital. Those are worthy and important and they should not be lost, although their relevance to the Bill is rather limited. I was pleased that the noble Lord, Lord Newby, welcomed and supported the expert liaison group, which would appear to be a valuable utility available to us in developing complex legislation; I say that as someone new to the House.
My noble friend Lord Barnett made what could be described as an expansive speech. He came to my support, and although it was late in the day, I am grateful for his support for this legislation. He referred to the £100 billion that I mentioned in my opening speech, which we have given in insurance support for medium-term lending to our banks. I advise my noble friend that there has not been an issue about the price of insurance. In the discussions that I have held with the banks, they have been much more interested in currency and in the maturity of the scheme than they were in price. Noble Lords will know that we announced some modifications and improvements to that scheme yesterday. We judge that the insurance premium that banks are paying to have their liabilities guaranteed by the Government is appropriate. My noble friend asked about the £37 billion that has been invested in ordinary and preference shares of a number of banks. It is important to recognise that these are investments, and there is a matching asset.
The noble Lord, Lord Oakeshott, deduced from the specification for non-executive directors for UK Financial Investments that there was some urgency about disposing of these investments. I advise noble Lords that that is not the case. We are committed to ensuring that we get appropriate value, and judicious and careful decisions will be made as and when it is appropriate to seek to sell all or part of the investments that we have made. I confirm to my noble friend Lord Barnett that the price we pay to acquire shares in Royal Bank of Scotland and, in due course in Lloyds TSB and HBOS, will be appropriate, based on the circumstances prevailing when that commitment is made. I have previously advised the House that we should become accustomed to further losses in banks, both here and overseas. The reality of the situation in which the world finds itself, and the previous excesses, mean that we will see continued reported losses from our banks. I have previously said as much to this House, but I did not speculate on the amounts of such losses, as I am not in a position to do so. I am simply making an observation as a businessman.
Several noble Lords made observations about UK Financial Investments, the entity which is going to hold, at arm’s length, the shares that have been acquired on behalf of the taxpayer. I refer noble Lords to the letter from the Chancellor of the Exchequer to Mr John McFall, who sits in another place, which spells out why we believe that it is appropriate that these shares should be regarded as an investment, rather than an instrument for management direction. We must have regard to, and respect, the fact that these banks have other shareholders. They expect these banks to be managed in a competent and professional way, some might say in a more competent and professional way than has been the case in the past. However, there are agreements in place with the banks to which we have subscribed capital, which relate to making available and marketing credit, to providing advice to those who need it, and strengthening their boards.
I should like to make it clear that we are not appointing government directors to these boards. In so doing, I can also answer some of the questions about governance raised by the noble Lord, Lord Smith of Clifton. We are working with the boards of banks in which we have invested public funds to strengthen those boards, so that they are able to perform the duties and functions that a reasonable person might expect of them. To the extent that we support the appointment of additional directors, those directors will not absent themselves from board discussion when the independent directors—as one noble Lord referred to them—discuss matters related to the Government’s investment. They will be part of a unitary board with full and equal responsibilities as other directors.
The noble Lord, Lord Smith of Clifton, said that he did not expect to get an answer on the question of gender equality. I assured the House at the close of the debate on the economy that I would answer questions. It was only on reading Hansard that my team discovered how huge this commitment was, given the number of questions that had been asked during a seven-hour debate. I assure the noble Lord, Lord Smith of Clifton, that an answer will be forthcoming. In the mean time, I would say, on the issue of gender, that I once sat on the board of Marks & Spencer, which I think had more female directors than any FTSE company at that time and, conceivably, in the history of the UK stock market. When I stood down as chairman of Land Securities to accept my ministerial appointment, I was delighted that my successor was female. She thereby became, I think, the second female chairman of a FTSE 100 company.
My own experience is that female directors bring an added dimension to boards. Importantly, they do not bring as much ego as men. They are less keen to speak and more willing to listen. That is a commendable quality. That said, I fear I will disappoint the noble Lord, Lord Smith of Clifton, having possibly raised his hopes, by pointing out that it is not for this or any other Bill to specify some gender obligation. I think that all our boards will have more female directors in due course because they prove to be better. Enlightened self-interest will see that trend continue. It is not for Parliament to direct private companies on the make-up of their boards.
I should add that gender is just one aspect of diversity. I speak also to the noble Lord, Lord Oakeshott, in that respect and to my noble friend Lord Whitty regarding his comments about the consumer perspective of boards of directors. My belief is that it is for the boards of banks, not the board of UKFI which has a more limited function, to ensure that they have breadth of experience. Quite frankly, regardless of whether someone is male or female, if they were brought up in the same way, they went to the same schools and universities and read the same newspapers, they would be unlikely to bring a diversity of experience and look at the demands of the company through a separate set of lenses. The noble Lord, Lord Smith of Clifton, will find that I am a powerful supporter of the concept of more diversity on boards.
The noble Lord, Lord Saatchi, made a number of important observations. He entertained us with the acronyms of banking. I might accept his invitation to dinner; I am a competitive soul and I think that I might do reasonably well, but I clearly would not qualify in the noble Lord’s social class if we really were to believe that anything outside 64th Street in New York constituted sub-prime. I understand that, in Committee and during proceedings on his Bill to which the House gave a First Reading today, the noble Lord will raise the issue of the current terms of the Monetary Policy Committee.
Many people did know of some of the problems building up in the banking system, but few took any action. The noble Lord, Lord Blackwell, with whom I have worked in the banking industry and for whom I have the highest respect, also referred to the growth of leverage in the banking sector, which I believe went unnoticed by a number of bodies. It possibly went unnoticed by regulators, but, more importantly, it seemed to go unnoticed by boards of directors and institutional shareholders. When we talk about regulation and supervision, we should not lose sight of the fact that banks did not fail because of regulatory shortcomings; they failed because of the decisions that were taken by their boards of directors and senior managers. There is no evidence that any British bank or, as far as I am aware, any bank in any other jurisdiction, failed for reasons of regulatory shortcoming alone.
The heart of this must be to promote a greater culture of self-supervision. Banks, as a number of noble Lords have said, are inherently prone to risk; the very nature of banking, the taking of short-term deposits and their advance as longer-term loans, even if we do not use the markets, as my noble friend Lord Peston said, has involved risk which is quite different from that of other industries. That risk from a societal point of view is compounded by how important banks are to the effective running of our economy. We cannot lose sight of the fact that it is not possible for this Bill or for any other form of regulation to produce for this House and this country a no-failure regime. That simply is not possible.
We must seek to minimise the risk of failure and, when it occurs, to ensure that we have appropriate arrangements in place through a resolution regime, appropriate oversight by the various authorities and by a method—I respond here to a further question by the noble Lord, Lord Howard, about continuity of accounts—which is at the core of the arrangements that we are making to strengthen the speed and efficiency of the Financial Services Compensation Scheme. We are sensitive to the fact that failures will occur. When they do, we must be able to manage them rapidly, which is why the Bill seeks a considerable degree of flexibility in terms of the options open to us. This Bill is not just for today; it will not solve today’s problems. Perish the thought that this may sound presumptuous, but the Bill should anticipate and set in place solutions for problems that might emerge in the future.
I cannot do justice to the contribution from the noble Lord, Lord Blackwell, except to ponder the inconsistency between on the one hand suggesting that all bank deposits should be guaranteed while on the other seeking an assurance that competition would not be limited. I am happy to confirm to the noble Lord, Lord Blackwell, and to the House that competition continues to be at the core of our belief about an effective banking system. Other legislation is designed to ensure that that is in place.
The noble Lord, Lord Bilimoria, was one of a number of noble Lords to speak about the Bank of England. I have had the benefit, like the noble Baroness, Lady Noakes, of being a member of the court of the Bank of England. The proposals in this Bill will significantly strengthen the Bank of England. The court will be smaller. The court at the moment is too large and unwieldy to be as effective as it could be if it were smaller. The creation of a committee with responsibility for financial stability is a further significant improvement, although the existence of that committee will not alleviate or reduce the responsibilities of the governor and of the full court. The role of the Bank in monetary stability is different from its role in financial stability; the structure for the MPC, in which people vote individually, is not an appropriate structure for dealing with issues of financial stability.
I am grateful to the noble Lord, Lord Eatwell, for reminding us that, while we are proud of the Bank of England, it has had moments when it has not performed as well as it would have liked. I came into the City of London in the secondary banking crisis in 1973-74. That was not the Bank of England’s finest moment—nor was Johnson Matthey, Barings or BCCI. I urge noble Lords to recognise that the competency in the Bank of England in bank regulation moved to the FSA. It was not just dropped; it was not converted to working in the staff canteen or in public relations. It moved under Mr Michael Foot—the other Michael Foot—to the FSA. From my perspective, the tripartite system is architecturally sound because it provides a forum in which different points of expertise and responsibility come together to address issues.
The noble Lord, Lord Eatwell, made a number of important observations about the change in the nature of banking. I cannot do justice to those in the time available for my response. My noble friend Lord Williams of Elvel referred to the heavy workload that we face. The quality of this House, however, as admirably displayed today, and the efficiency with which people go about their business, means that there should be time to give the Bill appropriate scrutiny.
My noble friend Lord Whitty spoke to the need to take into account the interests of the consumer. In my experience, all successful businesses are distinguished by customer focus. He also referred to the role of the regulators. We have had clear messages from the noble Lord, Lord Turner, that the style of regulation from the FSA will be different in the future.
The noble Lord, Lord Northbrook, spoke about regulation, off-balance sheet items and Glass-Steagall, as indeed did the noble Lord, Lord Oakeshott. I am sure that the noble Lord, Lord Turner, would appreciate any views from noble Lords to inform the review that he is currently carrying out. I think that, in going forward, it will provide a very good opportunity to stand back and look at the challenges of defining an appropriate regulatory style and structure.
The noble Lord, Lord James of Blackheath, alerted me to a number of highly technical points, with which we will no doubt grapple in Committee. He mentioned financial assistance, fraudulent preference and an issue relating to pension scheme eligibility for the PPF. I simply say from my own experience at the Treasury that I have found no one whom I would describe as either an anarchist or a totalitarianist. Furthermore, I found the information memorandum produced by my officials to be of a very high quality. However, we will no doubt learn more when we reach Committee.
In conclusion, this is an important piece of legislation. I believe that, going forward, it sets a framework for strengthening bank regulation and that, importantly, it establishes a special resolution regime—a feature of other jurisdictions. That is something which we did not have when we needed it but we will have should we ever need it again in the future. Significantly, it also strengthens the functionality of the Bank of England and gives it additional responsibilities, which I think will only be of benefit to the performance of its duties. It addresses a number of technical issues surrounding the payments system and the issuance of notes from Scotland and Northern Ireland. That has been very carefully thought through and will no doubt be debated at some length in Committee.
I look forward to the Committee stage. I believe we will have ample opportunity to discuss the Bill, and we will listen with care and consideration to amendments from your Lordships. With that, I beg to move that the Bill be read a second time.
Bill read a second time.
House adjourned at 8.57 pm.