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Reforming Financial Markets

Volume 712: debated on Thursday 9 July 2009


My Lords, with the leave of the House, I will now repeat a Statement made in another place yesterday by my right honourable friend the Chancellor of the Exchequer on government proposals for reforming financial markets. The Statement is as follows:

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

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

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

Our economy has a clear need for well managed, well functioning banks and financial institutions to perform a vital set of functions: channelling investment and helping people to save and plan for the future.

The financial services industry is also a major employer in this country of more than 1 million people, and it will continue to generate wealth for our country in the future.

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

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

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

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

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

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

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

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

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

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

There is, of course, a debate to be had about whether Governments should restrict the size of banks or separate different types of banking, as happened in the United States in the 1930s. I believe that this is a simplistic solution which fails to take account of the complexity of today's financial system. Small banks as well as large banks can threaten financial stability, as in the case of Northern Rock. Equally, both retail and investment banks in different parts of the world have failed in the past year. And it is not only banks that can affect stability, as we saw in the example of the American insurance company AIG.

In addition, the approach of one regulator for one category of institution deemed to be systemically important and another regulator for the rest seems to me to miss the point, because what is systemically important can change rapidly, as we have seen in the past two years. Instead, the new regulatory system has to recognise and respond to the complexities of individual institutions, and that is what we are doing.

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

The move in this country to a single regulator 12 years ago addressed problems with the previous regime of multiple self-regulators which did not reflect the changing nature of financial markets, and our approach has been adopted by many other countries. However, 10 years on, the world has moved on again. Some of the global problems of the past two years went beyond the scope of existing regulation, while others were simply not given sufficient attention by regulators and central banks. In this country, the authorities have been able over the past year to deal quickly and effectively with a number of financial stability issues, such as those relating to the Dunfermline Building Society and Bradford & Bingley. But further reform is now needed. We will therefore legislate to set up a council for financial stability which will bring together the Bank of England, the FSA and the Treasury. It will not only deal with immediate issues but will monitor system-wide financial stability and respond to long-term risks as they emerge. That needs to be done on a formal statutory basis.

The council will draw on the expertise of the FSA and the Bank, which are and will remain independent of government, by looking at their regular reports—the financial stability report and the financial risk outlook—and formally responding to their recommendations. In that way, when risks or threats to stability are identified they will be addressed. This body will do that in a way that is transparent and accountable so that people can see how and why decisions are made, with the regular publication of minutes. The council’s responsibilities will be set out in law, with published terms of reference. In discussion with the Treasury Committee and the House, we will consider how to increase accountability through greater parliamentary scrutiny.

We have already taken significant steps to improve the way in which we monitor and manage risks to the financial system as a whole—through more systemic use of stress testing of financial institutions, for example. The proposals that I am making today will further strengthen our ability to identify and deal with systemic risks and will ensure that the authorities can be held accountable for their actions.

We also need to consider what further countercyclical measures are needed in order to allow us to lean against the credit cycle and prevent the build-up of risks that could threaten the stability of the financial system. The principle of leaning against the cycle is easy to agree, but deciding what action to take and when to take it is far more complex. At the moment there is no clear consensus here or abroad, but I believe that central banks will have an important role to play in this area.

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

We intervened to stabilise the banking system while retaining a clear view that banks are best managed and owned commercially and not by the Government. We intend to return our stakes in the banks to the private sector in a way that brings best value to the taxpayer, promotes competition and maintains stability, and we will use the proceeds to cut government debt.

We are empowering consumers, supporting better corporate governance and strengthening regulation so that our financial sector can continue to be an engine of prosperity. I commend this Statement to the House”.

That concludes my right honourable friend’s Statement.

My Lords, I thank the Minister for repeating the Statement made yesterday in another place. We have had the overnight benefit of reading the reviews of those outside Parliament. I do not suppose that the Chancellor will be thrilled with the reception that his proposals have received, but he should not be surprised; the Statement is yet another sign of a Government who are running out of steam.

The Statement does not come close to acknowledging one central fact about the banking crisis: namely, that the regulatory arrangements that the Government set up failed. The Government put banking supervision into the vast experiment of the FSA. The Government believed that a memorandum of understanding would create effective tripartite working. All this failed.

Of course there were many other factors at work in the banking crisis; it was not just a story of regulatory failure, nor was such failure confined to the UK. The inescapable truth, though, is that before 1997 we had a system of banking regulation that by and large worked, and the Government created one that, when put to the test, by and large did not. The Government cannot escape blame for that.

If we had a Prime Minister who could take responsibility for his failings, we might have had a different set of proposals this week, but the Prime Minister cannot admit fault so his Chancellor is equally unable to do so on the Government’s behalf. If my party is elected at the next general election, we will not have that inhibition. As my honourable friend George Osborne announced yesterday in another place, we will restore the responsibility for microprudential supervision of banks to the Bank of England, together with other systemically important businesses and activities.

In doing so, the other responsibilities of the FSA will be more focused. There are crucial tasks of consumer protection and oversight of markets, and we need an organisation which is built around the cultures that are needed for those tasks. Leaving the very different microprudential supervision to fight for attention alongside these issues in a large and unwieldy organisation is not the right answer, and we reject the Government’s defence of the status quo.

By locating microprudential supervision within the Bank, we can reunite macro and microprudential supervision, which were torn asunder by the Prime Minister in 1997. It is theoretically possible that the 1997 ideas on tripartite authorities could have worked, but the Prime Minister’s design simply did not fly.

This set of proposals from the Government pretends that, by renaming an imperfect arrangement and adding a tiny bit of transparency, it will fly. The proposed council for financial stability is just the tripartite arrangements in fancy dress. It may be less harmful than the existing tripartite arrangements, but it does not address the need for macroprudential supervision to have proper tools and linkages to microprudential supervision to work effectively.

The Government are rather late converts to the notion that the FSA has to have a defined role in financial stability if the current structure is maintained. The Government rejected this during the passage of the Banking Act earlier this year. But we now need to move beyond sticking plasters to hold together arrangements which are broken. We do not need the FSA involved in financial stability; we need a fresh start. The Conservatives’ proposals would provide this.

There are of course some aspects of the Government’s proposals which we can support, even though much in the documentation is still very vague. We have called for a long time for countercyclical regulatory capital and for effective liquidity supervision and regulation. We support increasing the regulatory focus on high-risk firms and activities. We look forward to seeing Sir David Walker’s proposals on governance. We support the elimination of unacceptable remuneration practices. We have also long argued for industry-financed support for financial capability. We also support greater powers to deal with market abuse and the conduct of individuals.

However, we must sound a note of caution in all these areas. Financial services are global businesses and there is little natural loyalty to any country. If the UK runs ahead of the international community, as these proposals seem to suggest in some areas, we could be cutting off our nose to spite our face.

Of course, we all feel let down by the banks and want to impose tighter controls over them, but if the result is that the international competitiveness of the UK is harmed or if firms feel driven to leave the UK, then government action will be counted a failure, possibly of massive proportions. Whether we like it or not, financial services are a major part of the UK’s GDP and we must act proportionately and carefully.

I do not know whether the paper that came out yesterday is a White Paper or a Green Paper. The Statement is studiously vague. Is this is a statement of intent from the Government which will result in action, or it is merely a statement of views which might result in action? The annexes to the document are much more tentative than the front part, and even where a firm intention is signalled, there is little on the timetable.

I hope that the Minister can today set out exactly what the Government intend to do over the next nine months or so. Will he set out for the House what the Government intend to include in legislation and when? The White/Green Paper states that a Bill will be brought forward in the next legislative Session. Precisely what will it cover? Do the Government intend to give it priority in the next Session, because, without priority, it has little or no chance of reaching the statute book? I am sure I do not have to say that, unlike the case of the last Banking Act, the Government cannot rely on these Benches to smooth the passage of the next Bill if its content diverges from our own policies. In the mean time, there are more urgent things for the Government to deal with. These are barely touched on in yesterday's proposals, though referred to tangentially in the Statement.

In Europe, our negotiating position is at best weak. The protections achieved in the proposed European regulatory arrangements do not go anything like far enough to protect our financial services industry from those parts of Europe which have long resented the success of the City of London. We may not even have the protection of qualified majority voting if the Government do not get their act together fairly soon. The Minister has been forthright in this country on the appalling alternative investment funds management draft directive, but how in practice are the Government going to stop this particular juggernaut given that it is being powered and steered by France and Germany?

The Government need to ensure that there is effective co-operation and decisive working at international level, not just within Europe. We cannot go it alone on regulatory changes and the Government in particular need to ensure that the United States is bound into international action. The history of the United States, which did not even implement Basel 2, is not encouraging here. How will the Government ensure that the G8 and G20 move beyond mere words? These are issues that should be pre-occupying the Government, not rearranging the deckchairs of the tripartite authorities.

My Lords, after the 1992 general election, my noble friend Lord Ashdown, who was then leader of the Liberal Democrats, made a speech in the small town in his constituency called Chard. The late Lord Russell-Johnston did not like it, saying that the Chard speech sounded more like a burnt offering. Whether this is a burnt offering or a damp squib, or whatever the most appropriate analogy, in our view this White Paper fails completely to offer a decisive response to the extraordinary banking crisis through which we have come.

I shall deal with some of the issues in the order that the Minister dealt with them. We agree that there needs to be better consumer advice, but the model that the Government have adopted is fatally flawed. To give the FSA, even before the crisis, responsibility for managing consumer advice rather than going to people like the citizens advice bureau, was nonsense. Now to enshrine that in legislation makes it worse. Secondly, why, if the Government are so keen that consumers should be protected from unnecessary risk, have they instructed RBS to give a proportion of its mortgages at at least 90 per cent loan to value during a period of continuing falling house prices? Is that not just supporting unnecessary risk?

The Government want to see greater competition in the banking sector and we agree, but these proposals will do nothing to bring that about. Why do they not forestall a decision that is likely to be made by the EU, and break up RBS or the Lloyds Banking Group? The Government want to promote mutuals and so do we, but the White Paper suggests that they will set up a working group to look at it. That is just pathetic. Why not, if they are going to break up some of the banking groups, turn parts of them into a mutual? Halifax has a nice ring to it, and so does Northern Rock, but the White Paper contains nothing of any substance in that respect.

We agree with proposals that capital adequacy rules should be tightened up, but the whole question, which the noble Baroness concentrated on, of the management of macroprudential risk and financial stability as a whole is made a greater muddle by the White Paper. We thought when the Banking Bill was going through that the establishment of a financial stability committee in the Bank of England meant that it would be responsible for overall financial stability. We argued that it should in fact be a joint committee with the FSA, but the Government propose that the FSA has its own committee looking at financial stability. In addition to that, they want the Treasury to have its own committee looking at financial stability, called the council for financial stability, chaired by the Chancellor—in effect, a third financial stability committee. That is a greater recipe for disaster than the existing tripartite arrangements.

We on these Benches do not agree with the noble Baroness that simply ripping the heart out of the FSA in terms of its supervision of major financial institutions and returning that to the Bank of England makes best sense. The Bank of England's reputation and track record in dealing with financial and banking crises is not unblemished. But while we do not agree with that, we believe that these proposals setting up three financial stability bodies will lead to greater rather than less muddle.

The Government have turned their face against even a modified version of the Glass-Steagall Act and hope that they can avoid the problems that that Act sought to deal with by better capital adequacy rules. Given that the major banks are, in effect, underwritten in all their activities at present by the Government, will the Minister give the House a convincing reason why the Government should underwrite the casino banking activities of the major banks, and why a firewall cannot be established between them and the deposit-taking activities, which one can see, at the end of the day, will always require government underwriting? The Statement says that the House, by which no doubt the Chancellor means the House of Commons, would consider how to increase accountability through greater parliamentary scrutiny. Will that include consideration of your Lordships’ Economic Affairs Committee having a greater role in this area?

We agree that we need greater international co-operation and we are glad that the Government promote it. We agree that the Minister should take the kind of tough stance he is taking in the EU in respect of the proposed legislation on hedge funds. But when one talks to anyone in the City or any financial institution about the Treasury's activities in Europe, we are always told that they are woefully understaffed and come to the issue late. Despite impressive speeches by the Minister, what is required is a bigger, long-term, intensive staff input at European level to ensure that we do not get into the mess we are now in, with badly prepared proposals coming forward, and that, if we do, we have the resources to lobby effectively. Will he assure the House that those resources will be forthcoming, as they appear not to be in place now?

Finally, we agree that the Government should return our stake in the banks to the private sector in a way that brings best value to the taxpayer, promotes competition and maintains stability, but will he assure the House that the Government will not rush to get these banks back into the private sector? Does he accept that in most places where banks have been brought under public ownership such as Sweden, the States and elsewhere, it has tended to be 10 years before they returned to the private sector? Will he assure us that they will not be sold on the cheap in order to deal with any short-term financial problems of the Government instead of ensuring that the taxpayer gets a long-term benefit rather than a disbenefit from their period in public ownership?

My Lords, I welcome the contributions from the noble Baroness, Lady Noakes, and the noble Lord, Lord Newby. The framework set out by my right honourable friend the Chancellor of the Exchequer yesterday in his speech in the other place and in the document that we published yesterday afternoon is a strong one, which draws on the competencies and strengths of the Bank of England, the Financial Services Authority and the Treasury. In its development, we consulted extensively over a long period of time with a broad group of stakeholders, including practitioners, trade associations, the Bank of England and the Financial Services Authority.

The noble Baroness refers us back to the structure before 1997. Let me respond to that, and let me also respond in a moment on the structure before 1986. Before 1997, we had a proliferation of largely self-regulating entities. I was in the financial services sector myself at the time. The company which I led was a member of or regulated by more than four separate bodies in the United Kingdom: the SIB, the FSA, the PIA, IMRO, the DTI, the Bank of England and many others. That surely cannot be an appropriate model to which we should aspire to return. Indeed, it is clear that the world is moving towards increased consolidation of financial supervision into a single body, reflective of the fact that businesses are increasingly organising themselves across multiple business lines.

The noble Lord, Lord Newby, reminds us that the history of banking supervision prior to 1997 was not without its blemishes. One remembers BCCI and Barings. The noble Lord, Lord Lawson, whom I see in his place today, reminded us earlier this week about Johnson Matthey. Before that, in the early 1970s, when I first came to work in the City, we had the secondary banking crisis. There is no evidence that we should, as the noble Baroness suggests, go back to a system that was somehow perfect and which would address current failures in supervision, which are not isolated to the United Kingdom. We have seen significant banking failures in the United States of America, Switzerland and Germany and many other jurisdictions where there are radically different structures.

At the heart of my right honourable friend's proposal yesterday is a clear message about judgments and behaviours. The solution to severely reducing any possibility of a repeat of the experience of the past two years must lie in behaviours, judgments and social factors, rather than architecture. The noble Baroness has failed to appreciate the importance of the council for financial stability. The heart of this radical and powerful proposal will be in transparency and accountability. This will bring together the complementary skills of the Bank of England, in macroeconomic analysis, and the Financial Services Authority, in its familiarity with the institutions that it supervises—a familiarity which, as we know, will now be tested against far higher standards as a consequence of the enhanced supervisory programme introduced by the noble Lord, Lord Turner, and the board of the Financial Services Authority.

At the heart of that will be clear and open reporting of the views expressed. The governor has talked about giving sermons to an empty church. His sermons, his encyclicals, will now be widely reported. In particular, to address comments from some observers, the Bank of England will in future make it very clear what actions it believes should be taken in the light of its analysis of the macroeconomic situation. So that will be not only a sermon that tells us about sins, failings, and shortcomings, but one which gives us hope and guidance, by pointing out the actions that should be taken. In the event that the FSA does not respond constructively and positively, that will be a matter of record. That is of considerable importance.

I wrestle with the noble Baroness's comment—I believe that I cite her correctly—that we do not need the FSA involved in financial stability. That is an extraordinary statement, if that reflects the view of the party opposite. I said that I would take us back to 1986. I do so in part because of the debate about Glass-Steagall, which I fully anticipate that the noble Lord, Lord Lawson, will speak to shortly. Prior to 1986, we had a form of Glass-Steagall in this country, but we brought that to an end with what is colloquially known as big bang. Big bang removed the barriers that existed, separating much of the activity that takes place under the heading of investment banking from retail and commercial banking. From recollection, the party opposite was in power at that time.

I welcome the noble Baroness’s strong endorsements for the proposals made in connection with capital, liquidity, strengthening governance and addressing issues about remuneration, and her support—support reiterated by the noble Lord, Lord Newby—for education and steps to improve consumer information. She said that there would be dangers if we ran ahead of other countries in the steps that we were taking. My right honourable friend was clear that we are working at the heart of the G20 and EU to ensure that we take other countries with us. We will run ahead of other countries if that is defined as leading the debate, setting the standards and insisting on change, but we will not become detached from other countries to a point where it would disadvantage British businesses and British retail customers of our banks.

The noble Baroness asked what we would do over the next nine months. We will consult, engage, lead the debate and take forward programmes to set higher standards around issues such as accounting, derivatives and central clearing parties, and to participate fully in the debate about macroprudential supervision. The legislation we propose to bring forward is detailed clearly in annexe A of the paper; it will focus on the establishment of the council, and we will give it priority in our legislative programme. In parallel, we will work hard to help our partners in Europe understand the flaws and misunderstandings in the current draft directive on the alternative investment management industry. We are already working to make progress on that. I assure the noble Lord, Lord Newby, that in my judgment the FSA has appropriate support and resource in place here.

I welcome the strong statements of the noble Lord, Lord Newby, in support of consumer empowerment. I assure him that we have not given any instruction to the RBS about making loans in respect of 90 per cent of loan to value. We leave that matter in the hands of those at the Royal Bank of Scotland. They are the competent people, under Sir Philip Hampton and Mr Stephen Hester, to make those decisions.

I have already spoken about Glass-Steagall. The noble Lord, Lord Newby, said that it was assumed that reference to “the House” was to the other place; in that, he is of course correct because I was reading my right honourable friend’s Statement. However, I certainly expect the appropriate committees of this House to take an active interest in the reports and minutes of the council for financial stability.

I assure the noble Lord, Lord Newby, that it is not the Government’s intention to rush to sell shares in the Lloyds Banking Group and the royal bank. We are clear that the taxpayer has taken significant risk, made a large investment and expects to be appropriately rewarded for that. I have no doubt that it will be. At the time that we made those investments, I said that I was confident that the taxpayer would make a large profit. My confidence in that is greater now than when I made that statement. We will make the sales when we think it is appropriate to do so; when we get a fair reward; and when it contributes to competition and sustaining the significant improvement in financial stability, which my right honourable friend has already achieved with his strong and confident actions.

My Lords, the Chancellor’s Statement, which the Minister kindly repeated, represents an inadequate, complacent and muddled response to what is undoubtedly a very complex, but also very important, problem. I do not want to dwell on the past, but since this has come up I have to say that the Minister inadvertently misled the House. Conduct of business regulation and prudential supervision of the banking system are two quite separate activities. Both have their place and both are very important. It was the conduct of business regulation of the financial sector that was divided pre-1997. Prudential supervision of the banking system, which is at the heart of the matter, was greatly strengthened by the Banking Act 1987, which I put through. It was not divided at all. It was weakened by the present Prime Minister in 1997, and that is one of the reasons for all the subsequent problems.

The noble Lord expected me to say something about Glass-Steagall and I will not disappoint him. Does he recall that on 24 June the Governor of the Bank of England, giving evidence to the Treasury Committee in another place, revealed that, culpably, the Government had not consulted him on the proposals that they were working on? He also explicitly drew the committee’s attention to, and agreed with, the remarks of Paul Volcker, the former chairman of the United States Federal Reserve system and now an adviser to President Obama, who said that commercial banks,

“funded in substantial part by taxpayer-protected deposits”

should not

“be engaged in substantial risk-prone proprietary trading and speculative activities that may also raise questions of virtually unmanageable conflicts of interest”.

In the Statement repeated by the noble Lord, he described this separation as “simplistic”. Is he really saying that the views of the highly experienced Mr Volcker and the Governor of the Bank of England are simplistic?

My Lords, whether I inadvertently misled the House is a matter of judgment. For the avoidance of doubt, I make my view clear that legislation taken through Parliament when the noble Lord, Lord Lawson, was Chancellor of the Exchequer delivered a significant improvement in the prudential supervision of a more broadly defined banking sector than had previously been the case. The views of the governor are best expressed by the governor himself. I can assure the House that both the FSA and the Bank of England were consulted and actively involved in framing the thinking behind the paper that we produced yesterday. Whether the FSA and the Bank of England would agree with each and every aspect of the paper is not necessarily assured, but we absolutely took their views into consideration.

We strongly believe that an artificial division between simple and complex banks is simply unworkable. There is no sign anywhere in the world of any Government or regulator moving in that direction. Where there is scale and complexity, we need to ensure that there is competent management, effective regulation, adequate capital and high-quality liquidity. As a consequence of that, our large and complex banks such as HSBC and Standard Chartered will continue to be a source of great national pride and economic contribution.

My Lords, I would like to ask a couple of questions that arise from the Statement, which I welcome. First, does my noble friend agree that it is quite extraordinary to hear the representative on earth in this House of the financial services industry—namely, the Front-Bench spokesman for the Conservative Party—say that everything that has happened was the Government’s fault and that nothing was the fault of the accountants or of anybody in the financial services industry? Given the Conservatives’ approach to this matter, some of us conclude that they are all living on a different planet. Only a year ago, the accountancy profession signed off the accounts of all the major banks and said that they were fine—in other words, “It’s nothing to do with me, guv”—yet there are serious questions about the cosy relationship with the banks and all the fat fees that the accountants sitting over there get from them. I was very pleased to hear my noble friend say that the accountancy profession would be looked at. Secondly, even if it were not the case that the financial services industry—

My Lords, we are now in the sixth minute. I am emulating the speech of the noble Lord, Lord Lawson. Secondly, the question arises of the relationship between this country and the rest of the European Union. Does my noble friend also agree that, far from France and Germany stitching things up against our interests, as the noble Baroness, Lady Noakes, said, and far from their resenting the City of London, the truth is that this country has been very reluctant to accept what has now been accepted for the first time, which is that Britain needs to stand alongside France and Germany as regards European regulation? We now have a body chaired by the European Central Bank to do that. Does my noble friend further agree that the different planet that is being lived on by noble Lords in other parts of this House cannot last?

My Lords, I read with interest the Oral Question on auditors. I am sorry that I could not be in the House then, as I was being cross-examined by the Treasury Select Committee. During that cross- examination I came to the conclusion that I should have voted in favour of the amendment on assisted suicide that was proposed in your Lordships’ House.

The clear and primary culpability for the problems that the banking industry faces lies with the boards of directors, management and shareholders of banks; of that I have no doubt. Regulatory deficiencies across the world and shortcomings in supervision will need to be addressed and will lead to improvement, as will enhanced macroprudential supervision, but the core of the problem lies with the management and boards of directors of the banks. I think that we will find that Sir David Walker has some very interesting proposals in that respect.

Like my noble friend, I found myself believing that the party opposite was living on a different planet as regards some of the comments that were made. I find it quite extraordinary that it appears to want to foist on the Bank of England responsibilities and a role that the Bank is not seeking. The governor has at no point indicated that he wants to have microsupervisory responsibility for banks, building societies and systemic institutions.

Finally, I endorse many of the comments that were made in this House yesterday on the responsibility that the accounting profession, in its accounting principles, must accept and respond to in respect of its part in this global financial crisis. The accounting system, through mark to market, contributed in part to the crisis.

My Lords, will the Government ensure that as much emphasis is given to looking at the problems in supervision as to looking at those in regulation? In the Chancellor’s Statement, there was barely a passing reference to supervision, yet that, from an authority’s point of view, is where the trouble started. We do not yet have any account of how things developed so badly and the whole arrangement for supervision seems to have gone off the rails in this area. Can it seriously be the case that, when banks and others were stuffing their balance sheets with high-risk assets, the supervisors simply failed to notice? I find that difficult to accept, yet it happened across the board. Before you can put things right, you need to know how they went wrong. I hope that some investigation of the specific failings of the supervisory system can be carried out as a matter of priority.

My Lords, the noble Lord, Lord Stewartby, brings a considerable degree of relevant experience to this subject and the House always listens to his views with great interest. I draw his attention to the Turner report, which, coming after the audit of the FSA’s supervision of Northern Rock, built up a strong case for strengthening supervision. That, in particular, is captured by the FSA’s enhanced supervision programme. Shortcomings in supervision were apparent here, as in other countries, but there has been a step change. The FSA is talking about being more intrusive and about close and continuous supervision. It is talking about a more strategic engagement with supervised bodies than was previously the case. We have seen that issue being addressed.

My Lords, does my noble friend welcome the fact that the noble Baroness, Lady Noakes, on the opposite side, did not on this occasion commit the Conservatives to splitting up major banks into investment and retail banks? Such actions could only be a threat to the position of London and the importance of the major institutions. Does he agree that, up to March, there had been 46 bail-outs of banks—I am sure that since then there has been an increase—across the European Union in 16 countries, with central banks and financial regulators in charge? It is absolutely bogus to make the case that this is an issue of the central bank versus other methods of supervision. Finally, does my noble friend agree that the Bank of England and those advocating the involvement of the Bank in detailed microfinancial supervision of a very complex and ever changing financial system will eventually come to regret that course of action?

My Lords, I agree with much that has been said by my noble friend. I repeat that I have seen nothing to suggest that the Bank of England believes that it is the right body to carry out microsupervision of building societies, banks and systemically important institutions. What the governor has been very clear about is that, to deliver the Bank’s responsibilities for systemic financial stability, he needs access to information and the ability to influence outcomes. The council for financial stability and the proposals that we are making for improving the capture and delivery of information to the supervisory and regulatory bodies will address those concerns.

My Lords, may I press the Minister on one thing that he said in the Statement, which is that the Government will retain,

“the crucial link between national regulators and Governments”?

I ask him about that against the background of the letter written to me and placed in the Library on 1 July by the Leader of the House. She said that,

“measures are needed to ensure that rules are enforced, and therefore that the new authorities should review supervisors”—

that is, national supervisors—

“to ensure rules are implemented”.

She also said that,

“there cannot be binding powers or EU supervision where a fiscal consequence for national governments could result”.

That seems very similar to the remarks made in the Statement. Can the noble Lord explain those two things? Who will be in charge at the end of all this—Her Majesty’s Government or the powers of Brussels?

My Lords, the letter from the Leader of the House to which the noble Lord, Lord Pearson, refers is entirely consistent with the views expressed by my right honourable friend. Responsibility for the supervision of UK banks will remain vested with the Financial Services Authority. However, we cannot be isolated on an island. We need to acknowledge the reality of a global financial system and a global financial market, in which we have a strong interest in improved regulation and supervision of banks worldwide, because our banks and our companies transact business with them. We must work with our partners in Europe and elsewhere in the world to make mutual progress. The proposals set out by Mr de Larosière, as endorsed by ECOFIN and the European Council, on the creation of a European systemic risk committee, in particular, will be very helpful in that respect. I see no inconsistency.

My Lords, how can we have any confidence whatever in grandiose statements about regulatory authorities being held to account in the future when the Government, and the Treasury in particular, over the years have resisted attempts to make them responsible for their failure of regulation with regard to Equitable Life, despite the recommendations of various committees and the ombudsman? While that remains a blot on the record of the Government, how can we expect that they will act responsibly in the future?

My Lords, the Government made a clear statement of apology for certain actions taken in connection with Equitable Life by various Governments, including those before 1997. We have established a facility under a judge to take forward necessary payments consequent on the ombudsman’s report. Actions are being taken to address this issue and that will continue to inspire confidence in the Government’s commitment to good regulation.

My Lords, is there any connection between the capital requirements provision and the ability of the institutions to lend?

My Lords, the noble and learned Lord asks a very interesting question. First, capital is a core component of banking strategy because it absorbs loss and protects the interests of depositors. A feature of my right honourable friend’s Statement yesterday, which was not raised earlier either in this House or in the other place, is the intention that in future capital requirements should be much more sensitive to the risks of individual banking institutions. To put it simply, we will not have a one-size-fits-all approach, and banks with substantial investment banking proprietary trading and casino-like activities will need to carry more capital against those risks. That capital will provide support and confidence for depositors and, as a result of that, funding. Strongly capitalised banks will be able to support the borrowing requirements of their customers. Therefore, I believe that a strongly capitalised banking system is entirely consistent with the proper and correct extension of credit at a sensible price to meet the needs of customers.