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Banking: Asset Protection Scheme

Volume 708: debated on Monday 9 March 2009


My Lords, with the leave of the House, I will now repeat a Statement made in another place by my right honourable friend the Financial Secretary to the Treasury on the asset protection scheme and the agreement, in principle, reached on Saturday between the Treasury and Lloyds Banking Group. The Statement is as follows:

“Mr Speaker, the Chancellor is travelling to Brussels, ahead of the meeting of the European Community Finance Ministers tomorrow, to discuss the G20 Finance Ministers’ meeting this weekend. He has therefore asked me to make this Statement.

The asset protection scheme was announced in January. In his Statement on 26 February, my right honourable friend gave details of the participation of the RBS Group, and he mentioned the negotiations under way with Lloyds. The approach we adopted with Lloyds is similar to that with RBS. Discussion involved a large amount of complex detail and it was important to take time to reach a satisfactory conclusion. An agreement, in principle, has now been reached which helps ensure financial stability, safeguards the interests of the taxpayer and supports the real economy by increasing lending.

Under the asset protection scheme, the Government will provide protection against certain credit losses on particular assets in exchange for a fee. A first loss, similar to the excess in insurance policies, remains with the institution. Lloyds will meet all of this. The protection provided by the Government will cover 90 per cent of the remaining loss. The other 10 per cent will remain with the institutions as an incentive to manage the assets prudently. The Government will accept applications to the scheme from other eligible institutions until 31 March.

Lloyds announced on Saturday its intention to place £260 billion of assets in the scheme, on which it has already taken impairments of some £10 billion, and through the first loss mechanism it will retain a further exposure of £25 billion. Any losses beyond this will be borne 90 per cent by the Treasury and 10 per cent by Lloyds. The protection will cover a range of assets, including mortgages, unsecured personal loans, corporate and commercial loans and Treasury assets.

Lloyds will pay a fee of £15.6 billion in new non-voting B shares. These will count as core tier 1 capital. The Treasury has also agreed to replace its existing £4 billion of preference shares. Current shareholders will be able to purchase these ordinary shares as part of an open offer. The Treasury will take up its pro-rata share of the open offer, so maintaining its minimum voting share at 43.5 per cent, and will subscribe for any additional shares not taken up by existing shareholders. If no other shareholders take up their entitlements, the Treasury’s ownership of ordinary shares will increase to 65 per cent. Taking into account B shares paid as a fee, its economic ownership will reach up to 77 per cent.

As my right honourable friend set out, the asset protection scheme is a key step to put banks on a stronger footing, insuring their balance sheets and boosting lending to businesses and individuals. As part of this deal, in return for access to the asset protection scheme, Lloyds has agreed to increase its lending by an additional £14 billion over the next 12 months: £3 billion for homebuyers and £11 billion for business lending. It has made a similar commitment for 2010. Consistent with RBS, Lloyds will also be required to present a detailed implementation plan to the Government and to report monthly on compliance with the lending agreements. The Government will publish an annual report on these arrangements, which will be made available to Parliament. The agreements are binding and will be reflected in the performance-related pay of bank staff involved.

Another condition for Lloyds—as for any bank participating in the scheme—is a requirement to develop a sustainable long-term remuneration policy. This means reviewing policies and implementing new policies consistent with the FSA’s new code of remuneration practice. We have agreed that no discretionary bonuses will be paid in 2009, except to junior staff earning on average £20,000, and that there will be no annual free award of shares at all.

At the heart of the current financial and economic problems around the world is a crisis of confidence about bank assets. Lack of confidence is having profound effects on UK companies and individuals who are not able to secure business loans or mortgages. The critical obstacle to expanding lending is uncertainty about the value of banks’ balance sheets, so we are acting now to enable the banks to clean up their balance sheets, making them more able to lend to individuals and businesses. Transformation will not happen overnight, but this is the essential starting point, and it must go hand in hand with broader reform of banking supervision and regulation.

Action must be taken, not only here but by Governments across the world. The alternative is a failure of the banking system, here and elsewhere, which would make the recession longer and more painful, and put more jobs at risk. Getting the banks to lend again is essential to our economic recovery and to our fight against the global recession.

The Government are clear that British banks are best owned and managed commercially, and not by the Government. The future of the UK as a financial centre, and the future of our economy and thousands of jobs, depends on being able to run banks commercially. All countries are having to deal with the same problem: how to isolate assets which are damaging confidence in the banking sector and preventing banks from lending more. Over the coming weeks, we will continue to discuss with other countries, including the US and the European Union, how best to co-ordinate our approach to the common challenges we face.

As part of our presidency of the G20, the Chancellor recently wrote to Finance Ministers setting out a set of shared principles for dealing with asset protection and insurance. It is essential to restore confidence in the banks, allow them to clean up and rebuild, and get lending going again. The economic recovery and thousands of jobs depend on it”.

That concludes the Statement.

My Lords, I thank the Minister for introducing the Statement to the House, although, to my mind, it poses more questions than it answers. I declare that I have banking arrangements with Lloyds bank.

The Statement said:

“The Treasury has also agreed to replace its existing £4 billion of preference shares”.

It does not say what with. It goes on to say:

“Current shareholders will be able to purchase these ordinary shares as part of an open offer”.

What shares, and what open offer? Are there to be two offers, one to the Treasury and another to shareholders, or is there to be one offer only? If it is to the shareholders, they had probably better watch out. They are a pretty sad collection, who have had their savings almost completely wiped out through the merger with HBOS—a merger brokered by the Prime Minister which has proved to be as disastrous as his sale of gold. I know that it was not opposed by my party, but that was on the assumption that the Government would have taken appropriate steps to ensure that they knew what they were doing with the step that they were promoting.

The Statement says that the Government will not be interfering in the running of the bank. How can that be reconciled with specifying lending levels and dictating salary particulars? Lloyds is to lend £14 billion in the next year and another £14 billion the following year. What will happen if it fails to meet these targets? Will it be forced into making loans that it might otherwise not make, or which it deems to be imprudent? Is another banking bubble being created? We are where we are today because of inappropriate and imprudent lending. Pressure on banks must inevitably mean pressure to make marginal loans.

If bonuses are to be forbidden in the current year, will this result in constructive dismissal for some senior executives? If so, have they had to be compensated with higher basic salaries, which are, after all, the other side of the remuneration package? Or have all the senior executives voluntarily surrendered any bonuses to which they may have been entitled? Mr Daniels of Lloyds bank said that he was not able to do proper and due diligence before Lloyds bank purchased HBOS. Can the Minister say whether there has been a proper look at the enlarged bank before committing so much more money on this occasion?

Each time that a new injection is made to the banking sector, fresh assurances are given. How many more times will fresh capital, fresh guarantees or other forms of financing be needed? Perhaps the Minister could tell us. Where the Government are a shareholder, are they capable of permitting a good commercial decision if it is a bad political decision? Or will the difficulty of doing this make it impossible for the Government to leave banks to be run on a commercial basis, as they have said that they will?

My Lords, this is another depressing announcement and another step in the creeping nationalisation of the banks, yet the Government seem to want to pretend that that is not what is happening. The Statement says:

“The Government are clear that British banks are best owned and managed commercially and not by the Government”.

The truth is that both RBS and now Lloyds Banking Group are effectively owned by the Government. The big issue with which we are still grappling—and the Government certainly are—is what this means in terms of the management of the bank and whether, having put such huge amounts of public money into it, the bank will now be run in the public interest.

The Government have said they are not going to be involved in the running of the bank. We might be less concerned about this, given that they have set out some general principles, if Mr Daniels had not described taxpayers’ shareholding as just another name on the share register. For the British public, that attitude is not acceptable. Does the Minister believe that Mr Daniels, if that is his view, is the right person to continue in his position at the bank? Can the Minister also tell us what the consequences of today’s announcement are in terms of the composition of the board of the bank? Will additional government directors now be appointed?

What happened to the October agreement on lending and what were the consequences of that in terms of any increased lending over the past few months? The Government say that Lloyds has agreed to increase its lending by an additional £14 billion over the next 12 months. What is not clear to me is what that is additional to. Is it additional to the amount of lending that Lloyds was undertaking a year ago or additional to some unspecified level of lending that the board agreed but of which we are ignorant? Given the high amount of government involvement, additional expenditure and commitment to the bank, we need greater clarity on what this alleged additional expenditure is going to consist of.

Remuneration is clearly going to be looked at by the Government. A number of issues will no doubt arise about existing members of staff. Will Sir James Crosby still be entitled to his pay-off and pension pot and will the same apply to Mr Cummings, whose disastrous commercial property loans helped destroy HBOS but who still has a £6 million pension pot? The Government say there will not be bonuses to the extent previously planned. Can the Minister confirm that £80 million is still being planned as bonuses for the coming year? We accept that the bank’s staff may be unhappy to have their bonuses removed, even low-paid bonuses; that may not be good for morale, which is the reason given for retaining bonuses. But can the Minister accept that the decisions that the Government have had to make in respect of the banks are bad for the morale of the British public when it sees billions of pounds going into institutions which would otherwise be bust? Given his long-standing commercial experience and understanding, can the Minister tell us whether any other company in this circumstance would still be offering bonuses to staff for any reason whatsoever?

Finally, can the Minister accept—I am sure that he does—that private shareholders feel deeply aggrieved about what has happened to them and are unclear about the options which were explored by the Government when the merger between Lloyds TSB and HBOS went ahead? The Government have published part of their evidence in respect of this to the Office of Fair Trading. That evidence explains that they were looking at alternatives to the merger at that point but not why they rejected them. Can the Minster explain that now?

My Lords, in answer to the first question asked by the noble Lord, Lord Howard of Rising, about whether there are one or two offers of shares, there is one conversion from preference shares to ordinary shares and one offer to existing shareholders of Lloyds Banking Group. If existing shareholders take up their shares and the Government take up only their pro-rata ownership, the Government’s ownership shareholding will be maintained but private shareholders will also maintain their shareholding. If private shareholders do not take up the shares consequent on the conversion, the Government’s shareholding will increase.

The Government are not involved in the day-to-day running of the banks. They do not intend to be and should not be. The noble Lord, Lord Howard of Rising, asked about the lending conditions and whether these were not evidence of the fact that the Government were engaging in the management of the banks. It is necessary to see those lending conditions—on which I will say more in a moment in response to a question from the noble Lord, Lord Newby—as being an integral part of the transaction, the exchange of value. The Government are providing additional support for Lloyds Banking Group in exchange for Lloyds Banking Group entering into lending commitments. Lloyds believes that it can meet those commitments in accordance with its existing credit criteria. There would be no sense at all in the Government encouraging banks to lend irresponsibly.

No one is being constructively dismissed from Lloyds Banking Group by virtue of the decision on bonuses. A number of members of the board of Lloyds Banking Group have voluntarily surrendered their rights and entitlement in respect of bonuses, and for that I commend them. They set an example which others should have followed.

The noble Lord, Lord Howard of Rising, mentioned questions concerning due diligence and the observations made by Mr Eric Daniels to the Treasury Select Committee that he had insufficient time to carry out due diligence on behalf of Lloyds TSB before proposing the acquisition of HBOS. The Treasury has carried out considerable due diligence on the loans which Lloyds is putting into the asset protection scheme but there is still a great deal more work to be done. That is why these asset protection agreements will not be completed until early summer.

The noble Lord, Lord Howard of Rising, asked whether I believe that the board of Lloyds and Government will be able to make the distinction between a good commercial decision and a bad political one. The fact that the Government wish to keep the Royal Bank of Scotland and Lloyds Banking Group in the listed company sector, accountable and responsible to all shareholders, is clear evidence of the fact that we recognise that these banks must be run in a commercial manner, accountable to all shareholders rather than treating one shareholder as being more influential than another. That also answers the first of the points made by the noble Lord, Lord Newby, about these two banks being nationalised. They are not nationalised; they are public companies in which the Government are a large shareholder, but only temporarily.

The noble Lord, Lord Newby, asked whether Mr Eric Daniels was the right person to continue in his position at the bank. I would encourage noble Lords to take account of the excellent record of Lloyds TSB under the leadership of Mr Eric Daniels when seeking to form a view on his competence as the chief executive of a banking group. His capacity to manage in an effective way the day-to-day affairs of a major bank was very evident in the way he performed those duties at Lloyds TSB. However, it must obviously be a matter for shareholders whether they regard Mr Daniels and his colleagues as the right people to be leading the enlarged group.

In making that observation, I also draw attention to the fact that some 80 per cent of the assets that Lloyds Banking Group is placing into the asset protection programme come from the old HBOS business as opposed to the Lloyds business, which provides some further verification of the skills of the Lloyds banking team. Noble Lords will no doubt be aware that the senior management of the new Lloyds Banking Group is drawn almost solely from previous employees of Lloyds TSB, with very few of those senior positions being held by former executives of HBOS. Lloyds Banking Group is able to make these lending commitments, which are in addition to the loans that it had already intended to extend—they truly are additional loans—in the light of the fact that it now has, at a 14 per cent level, one of the strongest core tier one capital ratios of any bank in the world. In the steps that we have taken with the Royal Bank of Scotland and Lloyds Banking Group, we have put the capital levels to levels that compare very favourably with those in many other jurisdictions.

Questions were also asked by the noble Lord, Lord Newby, about the pensions and other entitlements of Sir James Crosby and Mr Peter Cummings. Noble Lords will no doubt be aware that the executives of UK Financial Investments, the body that holds these shares on behalf of the Treasury, has asked Sir Victor Blank and Sir Philip Hampton, respectively chairmen of Lloyds Banking Group and Royal Bank of Scotland, to carry out investigations into the conduct of directors in the Royal Bank of Scotland and in HBOS. Those investigations are being carried out with the support of external legal advisers, and no doubt reports will be made back to those boards. I emphasise to noble Lords that the decisions taken will be for the boards of the new RBS and the new Lloyds Banking Group, rather than for individual shareholders.

There was a final question from the noble Lord, Lord Newby, as to the circumstances in which a loss-making group can pay bonuses. The answer lies in good schemes that attempt to localise performance objectives and tie them up within an overall corporate objective. For example, you can have a branch that has performed exceedingly well. You can have a counter clerk who, through her performance, engagement with customers and helpfulness has achieved individual performance goals. Many of these schemes attempt to ensure that there can be that localised identification of an exceptional contribution by an individual, notwithstanding that the group as a whole may not achieve its targets. From my experience, we had similar challenges at Marks and Spencer during a difficult time, and this is not an easy issue to get right. I believe that is why the directors of Lloyds Banking Group, if they were here rather than me, would explain that they are attempting to pay modest bonuses, notwithstanding the very large losses that the newly combined group has reported.

My Lords, I strongly, in principle, support what the Government are doing. Indeed, I have not heard a serious alternative, although we have had lots of questions. My noble friend talked of other eligible institutions that could be brought into the scheme. Would that include large insurance companies that possibly had substantial toxic assets? From what he was saying about the further due diligence that I am delighted to hear the Treasury is doing before the deal is completed, the deal will not be completed for Lloyds to be included in the scheme until that due diligence is completed in the summer, as he put it.

I have another question. As the Treasury is effectively underwriting the rights issue and the share price that will be in that rights issue, does that mean that the Treasury has approved a particular price in advance of the due diligence that it is now doing?

My Lords, to answer my noble friend’s first question, the asset protection scheme is open to eligible institutions, which are defined for the time being as UK-authorised deposit-takers with a minimum of £25 billion of eligible assets. It is a scheme that is designed for banks; it is not designed for organisations whose primary activity is in another line of business.

The agreements reached with the boards of the Royal Bank of Scotland and the Lloyds Banking Group are sufficiently detailed for those boards and the Treasury to enter into commitments, while recognising that much further work needs to be done to be assured that we understand the toxicity of the assets and to ensure that we are putting a sufficiently strong and robust ring fence around the most at-risk assets. The structure of the scheme is designed to ensure that the first loss arising from the normal course of business will continue to be held by the shareholders of the banks, whereas extreme loss, or high-stress loss, will fall into the asset protection scheme in respect of 90 per cent of that loss.

Finally, my noble friend asked whether we are underwriting. We are not underwriting a public offer in the sense that we have already committed £4 billion of equity to the Lloyds Banking Group, which is currently held in the form of preference shares. Those are tier one capital, but not core tier one. By converting them to ordinary shares, they become core tier one, and it is those shares on which we are offering a claw-back facility to the other shareholders of Lloyds Banking Group. If those shareholders do not take up those shares, the Government will continue to have a £4 billion exposure, albeit now in the form of ordinary shares rather than preference shares.

My Lords, given that we are where we are, I support the measures that the Minister has just announced; but given that we are where we are, does he not think, at least with hindsight, that to promote or, at the very least, to allow the deal to go through that has led to the HBOS contamination of the previously relatively healthy Lloyds TSB was a great mistake?

My Lords, the noble Lord, Lord Tugendhat, brings to his question considerable knowledge and experience in banking, but I fear that he is incorrect in suggesting that the Government promoted the merger of Lloyds TSB and HBOS. The merger was promoted by the board of directors of Lloyds TSB, agreed by the directors of HBOS and agreed with alacrity and a very huge majority by the shareholders of both banks. The Government subserviated the interests of competition to the need for financial stability in the context of enabling the merger to take place but did not in any circumstances promote such a transaction.

My Lords, the Minister referred in his Statement to the broader reform of banking supervision and regulation. May I ask him for further and better particulars about that? What does he have in mind about banking supervision? Surely it will take place immediately. Is that right? Is Parliament to be consulted about the regulations? When will they be made, if at all?

My Lords, my noble friend is absolutely correct to draw the distinction between regulation and supervision. I have spoken in the past at this Dispatch Box about the inadequacies of supervision. Boards clearly failed in their supervision, management and direction of these major banking institutions and they were enabled in that failure by institutional shareholders who inadequately engaged with them and in many cases approved the strategies which proved to be seriously value-destructive. Sir David Walker is carrying out a review of the governance of banks and I will be making a speech on this subject at the National Association of Pension Funds in Edinburgh later this week. I wish I could share what I am going to say but, as I have not decided what to say, I cannot do that. No doubt some junior Treasury official will give me some words which I will either use or not use, depending on whether I find them appealing. I will try to maintain my own freedom of thought, despite the oppressive powers of the Civil Service to constrain a Minister from expressing his views on anything. I say that in the knowledge that they cannot get to me when I am standing at the Dispatch Box.

There are areas where supervision, government and engagement need to improve. The noble Lord, Lord Turner, will on 18 March be producing his report on regulation. I believe that will produce a number of important themes around capitalisation, macro-prudential regulation, liquidity management and the responsibility of directors. There is also a global context which we need to pursue as part of the G20 and revisiting the role of the Financial Stablity Forum and the IMF. There is much work to be done, therefore, and no doubt this House will be informed as progress is made.

My Lords, I should first of all declare that I am in possession of a pension from Lloyds Bank. Before the House thinks it has discovered a new scandal, I should hasten to add it is only £32 per month and I did not have the benefit of the intercession of the noble Lord, Lord Myners, in its negotiation.

I am concerned about the constant use of the word “toxic”, which is misleading and extremely dangerous in this context. “Toxic” implies that it is beyond recovery; it is a death process that is going to go to the fulfilment of complete death, which is not how we should regard this. The Minister and I have shared the experience of what was once the R&R, the reconstruction and renewal programme of Lloyd’s of London. You could have said that every syndicate in Lloyd’s was toxic but most of them survived that process and came to a very big fulfilment. The only way to approach the so-called toxic fund is to regard it as another reconstruction and renewal fund. For that purpose there is one thing the Minister could do which would bring huge benefit to the process. I have already written to the Minister on this subject and I should like to raise it again, particularly as he has already made reference to Sir David Walker, who was the author of this idea at its first manifestation some 30 years ago.

My Lords, a question is coming. I should like the Minister to give urgent consideration to the restitution of London Rules, which would provide an easy and rapid solution to the problem. The businesses in this toxic fund are not sole-banked with Lloyds Bank or the Royal Bank of Scotland. They are often syndicated among many other banks and you have to prevent the virus from spreading to the destruction of the banks around them. If the Minister brings in the principle of London Rules, he will have the means of regulating the multi-bank process now and giving an enormous advantage to the rescue process. Will the Minister give urgent consideration to bringing back London Rules?

My Lords, first, let me apologise. I did use the word “toxic” and it probably is an incorrect word. I have no difficulty in saying sorry. The issue around these assets is partly to do with the fact that they are poisonous, in that correct definition of toxic, but also that they are currently suffering from illiquidity. One of the virtues of the type of scheme that we have offered the banks is that it provides an opportunity for time and patience to see values recover. As the noble Lord, Lord James of Blackheath, knows, the London Rules worked rather well in a different environment. I am not sure they would work as well now in an environment in which loans are so widely distributed and where the lenders are based all over the world and the asset is now often in the hands of a hedge fund rather than in the hands of a bank. The London Rules operated in a previous environment in which most lending was domestic and mostly under the supervision of the Bank of England.

I first came to work in the City in 1972 or 1973 during the secondary banking crisis. The London Rules worked then but I do not think they would work as well now. That said, talks are going on at the moment which seek to promote codes and practices which are very similar to those which we associate with the London Rules.

My Lords, pursuant to the earlier question of the noble Lord, Lord Newby, about transparency, does the Minister participate in signing off the Statement which is going to be made first in another place and repeated by himself here? If he does, does he apply to it the test of whether the Statement contains the information that he would want if he was in opposition in your Lordships’ House as against being in government?

My Lords, I am entirely satisfied with the completeness of the Statement made by my colleague in the other place.