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Regulatory and Banking Reform

Volume 728: debated on Thursday 16 June 2011


My Lords, I shall now repeat a Statement made in another place by my honourable friend the Financial Secretary to the Treasury. The Statement is as follows.

“It is now well known that the tripartite system set up by the previous Government failed spectacularly in its mission to maintain stability. The decision to divide responsibility for assessing systemic financial risks between three institutions meant that in reality no one took responsibility. The crisis dramatically exposed this flaw and cost the taxpayer a vast amount of money.

We cannot allow another crisis such as the one we have just witnessed. Shortly after taking office, we set in train a consultation on reforming our system of financial regulation. Today, after two extensive rounds of consultation, I am presenting to the House a White Paper, including draft legislation, setting out the blueprint for a completely new system of regulation. Let me summarise the main proposals.

A permanent financial policy committee will be established inside the Bank of England. Its job will be to monitor overall risks in the financial system, identify bubbles as they develop, spot dangerous interconnections and stop excessive levels of leverage before it is too late. It has already started operating on an interim basis and is having its first formal meeting today. Subject to legislative progress, the permanent body will be in place by the end of next year.

We will abolish the Financial Services Authority in its current form and transfer its significant prudential functions to a new prudential regulatory authority that will sit in the Bank of England. The prudential regulatory authority will focus on microprudential regulation. It will bring judgment to the vital task of regulating the soundness of individual firms that manage risk on their balance sheet, particularly banks and insurance companies. But we recognise, of course, that these types of firms engage in very different types of business, which is why we propose to provide the PRA with a specific statutory objective for its insurance responsibilities.

We are bringing a new approach to protecting consumers. A new financial conduct authority will oversee the conduct of financial services firms, the operation of markets and the protection of consumers, with new powers to ban the sale of toxic products. I can confirm that as an integral part of its mission to secure better outcomes for consumers and investors, this authority will also have a new duty to promote competition. Judgment, discretion and proactive intervention will be the hallmark of our new regulators.

We are bringing forward this draft Bill for pre-legislative scrutiny, for which a Joint Committee of both Houses will shortly be convened. We are seeking valuable input from Members on both sides of this House. It is in all our interests to get this right.

Last year we also established under Sir John Vickers an Independent Commission on Banking to resolve the debate around the structure of the banking sector in the UK. I am sure the whole House will join me in paying tribute to Sir John and his fellow commissioners for the excellent job they are doing.

The commission’s interim report put forward two particularly important proposals: bail in, not bail out, so that private investors, not taxpayers, bear the losses when things go wrong; and a ring-fence around better capitalised high street banks to make them safer and protect their vital services to the economy if things do go wrong. I can confirm that the Government agree in principle with both these proposals.

Of course, we will await the commission’s final report, but I can tell the House that any reforms will need to meet the following principles: all banks should be allowed to fail safely without affecting vital banking services, without imposing costs on the taxpayer, through reforms that are applicable across our whole banking industry and in a manner consistent with EU and international law. I can also confirm today that we welcome the commission’s recommendations on increasing competition in retail banking and we are working closely with it to achieve this aim.

We are also taking the first steps towards normalising the Government’s involvement in the financial sector. One legacy of the crisis is that today’s taxpayers have a direct interest in several banks through large-scale guarantees and shareholdings. We do not believe the Government should be a long-term investor in financial institutions. It will take some time, possibly several years, before we can make a complete exit from our investments in the banks.

Today I can confirm the start of that process. On the advice of UK Financial Investments, we have decided to launch a sale process for Northern Rock. This follows extensive work over the past three months to consider potential options for returning Northern Rock to the private sector, while generating the best possible taxpayer value. The sale process will be open and transparent and in line with state aid rules. I have already written to the chair of the all-party parliamentary group on mutuals to reassure him that any interested parties can bid for it, including mutuals. This reaffirms the Government’s commitment to actively promoting the mutuals sectors. This does not mean that other options to return Northern Rock plc to the private sector have been ruled out. However, I believe that at this point in time a sale process is most promising.

I also want to make the House aware that, following an application by the Bank of England to the High Court today, Southsea Mortgage and Investment Company Ltd, a very small bank, has been placed into the bank insolvency procedure. This follows a decision by the FSA that Southsea no longer satisfied the FSA’s threshold conditions for operating as a deposit-taker. As such, the Financial Services Compensation Scheme has been triggered and eligible depositors with balances up to the limit of £85,000 are safeguarded. Eligible depositors with amounts in excess of the insured limit of £85,000 may be entitled to receive a share of their savings above this limit as part of the insolvency process.

Finally, I would like to update the House on the ongoing negotiations on international financial regulation. When I was in Brussels yesterday, my message was clear. We must learn the lessons of the crisis and create the foundations for stable and sustainable growth without fragmenting global markets. That is why global standards are strongly in our national interest. Much of the debate has focused on the implementation of the Basel III accord and we have been busy making the case for implementing it in full right around the world, including here in Europe. Last week’s IMF assessment supported our arguments for minimum standards here in the EU, with discretion for national authorities to increase them where necessary.

When the coalition Government came into office, questions were asked about the future of banking and regulation, but they had not been answered. It has been our job to resolve them. Our goal should be a new settlement between our financial system and the British people—a new settlement where the banks support the people, instead of the people bailing out the banks. This Statement today sets out the progress we have made towards building this new settlement and the actions we are taking to complete it”.

My Lords, that concludes the Statement.

My Lords, I am most grateful to the noble Lord, Lord Sassoon, for repeating the Statement made by the Financial Secretary to the Treasury in another place. The Financial Secretary begins by commenting that the tripartite regulatory system failed. That is obviously true, and indeed a variety of other regulatory structures around the world also failed. In order to help us to establish a clear historical time line to understand what actually happened, will the noble Lord, Lord Sassoon, tell the House in which speeches prior to 2008 the Financial Secretary, the Chancellor or the noble Lord himself called for a tightening of regulation? Hindsight is a wonderful thing.

Continuing the theme of the rewriting of history, at the end of the Statement the Financial Secretary states that when the coalition Government came into office, questions were asked about the future of banking and regulation, but they had not been answered. I remind the noble Lord that domestically the most important road map for reform—the Turner review—was published in February 2009, and that the G20 conference that set the framework for international reform was held in September 2009. Far from there being no answers, most of the economic and financial analysis on which the Government’s proposals today are based was done before the election.

I turn to more substantial matters. The Statement fails to make it clear whether the financial policy committee will have any powers. What will it actually be able to do? Will it, for example, have the power to impose leverage collars or loan-to-value ratios to calm a bubble? Will it have the power to impose pro-cyclical levies on banks? Given that the committee will be the focus of macroprudential regulation, what will its relationship be to the more general formation of macroeconomic policy? It is now obvious to everyone that fiscal policy can be a source of macroprudential risk, so what role, if any, will the committee have in the formulation of fiscal policy, even, let us say, at an advisory level?

The Financial Secretary states very emphatically that the prudential regulatory authority will focus on microprudential regulation. Does not this division between microprudential and macroprudential issues repeat the institutional rigidities and errors of the past? Given that the regulation of individual firms will require macro issues to be taken into account, what exactly is the difference between the risks that create macroprudential problems and those that create microprudential problems, and how will anyone know in advance of a crisis which is which?

The Financial Secretary states that the financial conduct authority will have new powers to ban the sale of toxic products. This really is very odd. Since in the recent crisis the toxicity of products was related to the macroprudential risks they created, how is this power invested in the arm’s-length FCA to be related to the management of macro risk by the Bank of England?

I now turn to the future structure of the banking industry and the work programme of the Independent Commission on Banking, as covered in the Statement. First, we on this side heartily endorse the principles for reform set out in the Financial Secretary’s Statement. We would, however, add a further principle: that the failure of a bank should not destabilise the real economy.

Secondly, the Statement endorses in principle the ICB proposition that there should be a ring-fence around high street banks. That sounds sensible and clear until one asks: what exactly is a high street bank? Does the Financial Secretary refer to banks that base their business only on high street deposits—the deposits of households and firms? Or, would it be acceptable for high street banks to have interbank lending, repos and other wholesale funds on the liability side of their balance sheet, given that it was the failure of these markets in commercial paper that was a major factor in the financial crisis? Will that ring-fencing apply to all banks offering retail services in the UK, whether they are British companies, subsidiaries of foreign companies or branches of foreign companies? Will it also apply to banks passported into the UK from other EU jurisdictions?

We welcome the possibility that Northern Rock may be returned to the private sector as a mutual. I echo the question asked by the noble Lord, Lord Lawson, on Monday: in the model chosen for the privatisation of Northern Rock what weight will be given to the implications for future financial stability? Would not mutualisation be an important buttress of stability?

In the Statement the Financial Secretary also voices his support for the Basel III accord. As the noble Lord will be aware, at the centre of that accord is the increase in the minimum capital that banks are required to hold relative to risk-weighted assets. Is the noble Lord aware that the capitalisation of the banks in Ireland prior to the crisis exceeded the new limits proposed in Basel III? Why are the Government supporting such a feeble standard?

We welcome the publication of the White Paper and the draft Bill, and indeed the Government’s agreement to pre-legislative scrutiny. We also note that many of the institutional structures to be given legal legitimacy by the Bill are already in place. There was a reference to the financial policy committee meeting today. Given that the Financial Services and Markets Bill, the predecessor of the Financial Services and Markets Act, underwent major changes, including institutional changes after the pre-legislative scrutiny by the committee chaired by the noble Lord, Lord Burns, is not the establishment of these structures, prior even to a Second Reading in another place, somewhat premature?

I am grateful to the noble Lord, Lord Eatwell, first, for making a clear admission that the tripartite system failed and therefore something needed to be done about it, and, secondly, for welcoming various of the other aspects of what we are doing, including our approach to bank failure and pre-legislative scrutiny. However, the fact that he starts with bracketing together a recognition of the failure of the tripartite system and then questioning the approach taken by my right honourable friend the Chancellor and others of us who are now in the Treasury and what we did in the past is remarkable. We got on to the case in opposition immediately the crisis hit and started to work practically on learning the lessons.

I completely agree with the noble Lord that fine work of analysis was done by the noble Lord, Lord Turner, particularly in his FSA report, and others, but the previous Government had a couple of years in which they signally failed. If they recognised the failure of the tripartite system, they certainly did not tell us then. They had two years in which they could have established an independent commission to look at banking. They could have done the work to analyse what would be a better system but they did none of that. Instead, my right honourable friend the Chancellor, when in opposition, commissioned work from people, including myself. We did a considerable amount of work that put us in a good position, so that when we got into office we launched the rounds of consultation that have led to today’s White Paper. It is not therefore a question of hindsight being a fine thing but of getting on, learning the lessons and starting down the track of implementing a better system.

The noble Lord, Lord Eatwell, went on to question the powers of the FPC. I appreciate that the White Paper is a long document to have absorbed in the past few hours and point to the discussion in it about the possible tools and powers that the FPC may have. In order to move forward on that, we have asked the FPC to come forward with proposals in the next few months—I expect them in the third quarter—for the tools and powers that it believes will be necessary and appropriate to enable it to carry out its function. For the avoidance of all doubt, I will confirm that the FPC will have no role in setting fiscal policy.

The noble Lord then raised the issue of macroprudential and microprudential risks. I thought that his analysis was interesting. Clearly there is a very difficult issue about where the micro and macro areas stop and start and how they relate to each other, which goes to the heart of the problem with the tripartite arrangement. The Bank of England was clearly responsible for analysis of the macro risks but was not given by the previous Government the tools to deal with the consequences of the problems that it found. On the other hand, the Financial Services Authority was responsible for the micro risks—and never the twain shall meet. I am surprised that the noble Lord does not give the Government credit for the fact that we have brought the macro and micro together under the umbrella of the Bank of England precisely to address the problem that he identifies.

The noble Lord mentioned toxic products. Some of these may have been related to macro factors, but one has only to look at the scandal of PPI—not to mention a string of other products wheeled out by the financial services sector over the past few years—to understand that toxic products are most often generated at firm level, and it is appropriate that the conduct authority should have powers to ban them.

The noble Lord went on to ask about the definition of the ring fence. The question of the ring fence should be left to the appropriate experts. The Independent Commission on Banking, chaired by Sir John Vickers, will in the second phase of its work focus on precisely how the ring fence will work; that is what it is doing at the moment. On the specific question of whether the ring fence will apply to EU-passported banks, the FSA’s and in future the PRA’s full rules will apply only to banks headquartered in the UK. EU bank branches that are passported into the UK have as their lead authority the EU home regulation, not the UK host regulation: therefore, any ICB proposals would be implemented consistent with EU law. That is one of the principles enshrined in my honourable friend's Statement.

The question of Northern Rock was raised. As I said, we want to see a competition and are required under state aid rules to have one that is fair and open to all parties. We would welcome mutuals participating in that bidding process. As to whether a mutual outcome would be a greater buttress of stability, that is open to question. Any bidder for Northern Rock or participant in our banking system needs to demonstrate a level of financial stability that meets the regulatory requirements. I think one should not draw a distinction between different categories of institution on that basis.

The last point raised by the noble Lord was about Basel III and the Government’s support for the higher capital requirements under it, I think pointing out that the capitalisation of the Irish banks exceeded the Basel III limits. That enables me to confirm that the Government’s position on this is that for too-big-to-fail banks a capital buffer above Basel III is appropriate to ensure their resilience.

My Lords, I must congratulate the Government on their courage in recognising not just the need to reform regulation and the regulatory system, which certainly was not fit for purpose, but to go beyond that to recognise the need to restructure the banking industry in the teeth of a lot of opposition from the industry itself, although a stronger case certainly needs to be made fully to convince all of us that ring fencing is a better strategy than division of the banks.

I shall ask the Minister two questions arising out of today. He talked a moment ago about a new regulatory system bringing together micro and macro, which is what we all wish to see, but he will be aware of the remarks made today by the Governor of the Bank of England, which were quoted in the Daily Telegraph, about reducing the burden of routine collection and focusing on the major risks to the system. He will know that the system collapsed in large part because securitisation and derivatives were piled on top of mortgage loans that were faulty and very often fraudulent. It was the failure to see the link between the micro and the macrosystemic that led to the crisis that we saw. Will he make sure that we do not now have a swing back in the other direction in regulation to systemic ignoring the relevance of the micro?

On the return of banks to private ownership, which is something we all wish to see, will he give some assurances that serious consideration will be given to schemes such as that proposed by my colleague Stephen Williams, MP for Bristol West, which would involve a distribution of shares in part to the public in order that they may gain some of the upside? The Treasury would still receive its funding, but on a deferred basis. Would he agree that UK Financial Investments, being a very silo organisation, is not likely to appreciate the potential benefits of that much wider engagement with the public, sharing upside reward with people who have suffered from the crisis?

I am grateful to my noble friend Lady Kramer for her general support for what we are doing and her recognition of how far the Government have already gone in pushing forward with the structural and regulatory reforms. On the micro/macro link, I refer noble Lords to the full, and very interesting, remarks by the Governor last night at the Mansion House because he talked with great coherence and good sense about what the failure of the previous regulatory regime was, which was to collect a huge amount of detailed data that it was unable to analyse to draw out the conclusions.

However, in the new world, experienced bank supervisors are needed who are able to analyse and draw out the picture, which was never difficult—whether it was on securitisation or on a lot of other matters or funding models—before the crisis. There should be meaningful discussions with the banks in terms of the individual banks that they supervise about what this translates to in terms of the exposure of the individual bank’s business model. If my noble friend were to read the Governor’s full remarks, she would see that the Bank is absolutely where she would like it to be on its thinking on this. I got no sense of swing-back in it.

On ownership of the banks, we are well aware of the proposals that have come in, including that from Stephen Williams on mass retail participation. We and UKFI are actively considering mass retail participation as we think ahead to returning the banks into the private sector, which of course is not the same thing. A subset of it would be distributing the banks’ shares for free or on some other basis, which raises value-for-money considerations and quite a lot of technical market considerations. But I can reassure my noble friend that all these proposals will be given due consideration.

My Lords, I have here a letter from Unite, the union representing the workforce at Northern Rock. As can well be imagined, the workforce is extremely concerned about its future. It points out that at its height Northern Rock had 6,500 employees. It also ran the Northern Rock Foundation with £200 million of investment in the area. Those in the workforce are concerned not only about their own jobs but about the general impact on the situation in the north-east, where there is a very high level of unemployment and where people have great difficulty in getting alternative work. In any situation in regard to restructurings and so on, it should be a major concern for the Government to ensure that whatever decisions are taken do not worsen the unemployment situation in the area. Everything possible should be done to ensure that employment is kept at a reasonable level. As regards Northern Rock, that does not seem to be the situation.

I am very glad that my noble friend on the Front Bench raised mutualisation because it seemed to me that that is a way in which it might be possible to maintain a much higher level of employment in the area. It is very important to bear in mind concern not just about the financial stability, important though that is, but about what happens to employment in the area and the general standing in the area of not only the financial situation but the economic situation generally.

I am grateful to the noble Baroness, Lady Turner of Camden, because these considerations will be ones which prospective bidders for Northern Rock will be asked to address in their bids. Of course, the Government are very mindful of the situation in the north-east and its dependence on the public sector in particular. I am sorry that my noble friend Lord Bates is not here today because I am always refreshed by his reminder to the House that a lot of vibrant new business is being generated in the north-east. But I very much recognise, as do the Government, the problems, and the bidders will be asked to make a lot of these things clear when they come forward with proposals.

My Lords, I welcome overall this Statement and the speech last night made by the Chancellor on related matters. In many ways, the Chancellor’s speech spelt out what he intended rather more clearly than was done in the Statement today. However, I am very glad that he is sticking to his plan A for the economy, which was so clearly endorsed by the IMF recently. In response to the question of whether it was time to adjust macroeconomic policies, it gave the clearest possible answer—no.

As to regulation, it must be right that the Chancellor is scrapping the tripartite agreement, which had such disastrous consequences. The position was not quite clear from my noble friend’s reading of the earlier Statement. My understanding is that what is being proposed is what the IMF calls a triple peak arrangement; that is, a new prudential regulator, a new financial conduct authority and a new macroprudential authority. Am I right in thinking that there are three bodies rather than two?

I turn to the other question in relation to regulation and to the question of ring-fencing. Personally, I would have preferred the more radical solution of complete separation. I realise the arguments about cost of capital, competition and so on but, after all, American banks did survive quite successfully for a long time under the Glass-Steagall arrangements. But when we come to the question of ring-fencing between the investment part of a bank and its retail part, I am not clear whether it is intended that the ring fence should have holes in it or whether there is to be a complete ban on capital flowing from one side of the ring fence to the other. There seems to be some discussion at the moment which suggests that the ring fence would not be as solid as perhaps some of us would wish it to be.

The other thing that is not clear about whether something is too big to fail is whether, following the establishment of the ring fence, the part of the bank concerned with investment banking, no matter how large, would be allowed to fail but the retail side would not. In other words, there would be an absolute guarantee that the retail part of a bank would be protected by the Government. If that is so, it raises very serious questions of moral hazard. The extent to which the retail banking section has not been devoid of the recent problems arising from risk-taking creates a real problem. Obviously, we will be much clearer about this when we see the White Paper and the pre-legislative scrutiny which takes place. But perhaps my noble friend would clarify precisely what is meant by ring-fencing in this context.

My noble friend’s first question was about whether this is twin peaks, triple peaks or whatever. I have always found that a somewhat stale way to analyse the issue because over the past decade constant comparisons were being made between single peaks, twin peaks and so on, so I am reluctant to be drawn into characterising what we are now proposing as any number of peaks. All I can say is that it is emphatically not a triple-peak solution in that the macroprudential and the micro in the PRA are going to be in one body in the Bank of England. So although characterising it as twin peaks is closer to the models that have been analysed by academics and others over the last few years, it gets us back to language that I am not sure is entirely helpful. However, it is certainly not a triple-peak solution.

On the questions around separation and permeability of the ring-fence, the Government will be guided by the independent commission’s final report. But it is also important to recognise what the ICB’s interim report did and did not say. To put it simply, it certainly was not a division between retail and investment banking. The commission acknowledged that a balance has to be struck between imposing very high costs on an important sector and the degree of safety. The point of firewalling is not to eliminate all risk, but to minimise the risk and cost to the taxpayer should a bank fail. The ICB is now focused on these issues between now and September. The principal issues to be looked at by the Government and the Bank of England will be the powers to manage the collapse of any investment bank, were that to happen in the future. As I hope was clear from my honourable friend’s Statement, one of the principles in establishing the ring-fence is to make sure that the taxpayer is not exposed on either side of it. Therefore, getting rid of the risk of moral hazard is at the centre of the construct that we are looking to put in place.

My Lords, I, too, welcome the Government’s endorsement of the requirement for high-street banks to be better capitalised. However, I share the concerns of the noble Lord, Lord Higgins, about the efficacy and efficiency of ring-fencing, as opposed to total separation. As the Minister will know from his time in the City, banking groups are funded and the Treasury is run on a group basis. To separate the groups and deal with permeability will be extremely difficult. A legal separation would reduce, if not eliminate, the risk of inter-group contagion. It would also allow the risks of the high-street bank and the investment bank—or whatever the Minister chooses to call it—to be properly priced. This would benefit the ordinary consumer. The lower cost of borrowing that a better capitalised high-street bank paid could then be passed on to the borrower.

The second issue that arises on this is, again, a welcome commitment to apply this right across the banking industry. However, many of our banks are headquartered in other countries. Have the Government had any discussions with the Governments of, for instance, the United States and Spain? Do they share the Government’s enthusiasm for this approach? Will the Government also ensure that the lead regulator—whether in the United States or in Spain—will follow the same path?

My Lords, there are many questions wrapped up in all that. I am conscious that we have four minutes to go. I repeat myself, but we have set up the independent commission with a suitable group of experts and resourced with a secretariat that is now grappling with precisely these questions. Legal separation has, in the history of the US and Glass-Steagall, proved itself to be an incomplete answer to this. We have to find the best answer. We have set out the Government’s perspective, which is to endorse the principle, and set down the standards by which we shall judge the solution that the commission comes up with. I am sure it will listen to the ideas that are put forward here this afternoon, as well as to all the other submissions that it receives. It is not an easy challenge for the commission, but it is made up of the best people to carry it out.

On the international side, one of the standards by which the Government will judge the solution and decide whether to endorse it is compatibility with the international rules. That is the minimum. That is not what the noble Lord went on to say. As to whether other people will come with us, all I can say is that there has been a high degree of interest in what the commission has come up with in its interim report. People around the world are studying it. We shall see in time whether they will follow it. All I know is that the eyes of the world are very much on the continuing work of the commission.

My Lords, I draw attention to a confusing passage in the Statement, which makes the text about micro and macro more difficult to understand. It says:

“The Prudential Regulatory Authority will focus on microprudential regulation. It will bring judgment to the vital task of regulating the soundness of individual firms”.

However, that is not a task for regulation; it is a task for supervision, which is not mentioned in the Statement and caused some confusion in earlier business on these matters. I shall not say this at any length but supervision is a separate process, which got slightly lost under the old system. We need to be careful that these are two separate things, which are complementary and sometimes overlap, but nevertheless are not the same. The text on that needs another look.

I am grateful to my noble friend because this is a technical but very important area. He is completely right that there is a fundamental distinction between supervision and regulation and often texts can be loose on this. I hope that when he has a chance to read the White Paper he will see that there is extensive discussion of these areas. I refer him to the interesting remarks of the governor last night about the approach to supervision which he intends the Bank and the PRA under it to adopt in the new world, and that that should be a very different approach to supervision from what we have seen recently with the FSA. I take my noble friend’s points to heart, but the short text of the announcement does not give the full flavour that lies behind it.

I have a couple of quick points on the ring-fencing proposal. Does what the Chancellor said last night mean that we have finally ruled out the idea of a complete split between investment banking and commercial banking? Secondly, does the Minister agree that for ring-fencing to work, the ring-fenced commercial or high-street bank will need a strong degree of independence on its board of directors to enable it to stand up to the banking group of which it is a part?

Thirdly, the Minister’s point about how many holes there are or how permeable the ring-fence is is important because presumably the purpose of the ring-fencing is to stop the investment banks’ liabilities appearing on the commercial banks’ balance sheets as assets, or for that matter the liability of any other investment bank. If that permeability is there at all, investment bankers will find some way of using the commercial banks’ balance sheets to their advantage.

My noble friend makes some important points, which the independent commission has in the forefront of its thinking to resolve over the next few months. It is not that we have ruled out everything but that we have set up an independent commission. It came up with the ring-fencing proposal in its interim report and that is what my right honourable friend the Chancellor has endorsed, subject to the caveats included in the Statement. My noble friend’s points about how this is worked out in detail are some of the absolute correct ones.