Bank Resolution (Recapitalisation) Bill [HL]
Thursday 18th July 2024
(4 months ago)
Lords ChamberRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text
Bank Resolution (Recapitalisation) Bill [HL]
Tuesday 30th July 2024
(3 months, 3 weeks ago)
Lords ChamberRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text Watch Debate Read Debate Ministerial Extracts
The Financial Secretary to the Treasury (Lord Livermore) (Lab)
My Lords, I am sure that all noble Lords will be pleased to see the noble Baroness, Lady Penn, in her place today. I enjoyed working with her on the passage of the Financial Services and Markets Act in the last Parliament, when I was new in my role and she knew a great deal more about the Act than I did. Now I am new in my role again, and I am quite sure she still knows a great deal more about this Bill than I do; I am sure that I will enjoy working with her just as much. I am also pleased to see and work again with the noble Baroness, Lady Kramer, who probably knows more about this subject than the rest of us put together.
The Bank Resolution (Recapitalisation) Bill will enhance the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of banks. It ensures that, where failing banking institutions require intervention, in particular smaller banks, certain costs of managing their failure do not fall on taxpayers. It strengthens protections for public funds and promotes financial stability, while supporting economic growth and competitiveness by avoiding new upfront costs on the banking sector.
The resolution regime was introduced in the wake of the global financial crisis and implemented in the UK through the Banking Act 2009. It provides a number of additional tools to the Bank of England to manage the failure of financial institutions safely, helping to limit risks to financial stability, public funds and the economy. The regime was introduced in recognition of a global consensus that reforms were needed to end “too big to fail” and ensure financial institutions could wind up their operations in an orderly way. This regime has been developed and added to steadily over the past decade by a succession of Governments, giving the UK a robust regime and supporting its role as a leader in financial regulation, while also reflecting relevant international standards.
The regime was last used to resolve Silicon Valley Bank UK, the UK subsidiary of the US firm that collapsed in March 2023. The Bank of England used its powers under the Banking Act to facilitate the sale of Silicon Valley Bank UK to HSBC, delivering good outcomes for financial stability, customers and taxpayers. All the bank’s customers were able to continue accessing their bank accounts and other facilities, and all deposits remained safe, secure and accessible. In doing so, the Bank of England ensured the continuity of banking services and maintained public confidence in the stability of the UK financial system.
While the case of Silicon Valley Bank UK demonstrated the effectiveness and robustness of the resolution regime, the Bank of England, the Treasury and international counterparts have carefully considered the implications of this wider period of banking sector volatility. This builds on the proposals set out in consultation by the previous Government, following the work they did with the Bank of England after the Silicon Valley Bank case. This Government believe there is a case for a targeted enhancement to give the Bank of England greater flexibility to manage the failure of small banks effectively. I hope that, given the origin of these proposals, they will be welcomed by noble Lords from across the Chamber.
It is worth noting that small banks that fail are typically expected to be placed into insolvency under the bank insolvency procedure and are currently not expected to meet the conditions that must be satisfied for the Bank of England’s resolution powers to be used. These conditions include whether exercise of the powers is necessary to meet certain objectives of resolving a bank and is in the public interest.
Under the bank insolvency procedure, upon entering insolvency, the Financial Services Compensation Scheme compensates eligible depositors for account balances up to £85,000 per depositor within seven days, with higher limits for temporary high balances. This compensation is funded initially through a levy on industry and then, where possible, recovered from the estate of the failed firm.
Following the case of Silicon Valley Bank UK, the Government’s view is that in some cases of small bank failure, the public interest and resolution objectives may be better served by the use of resolution powers than insolvency. If, in future, a failing small bank were to require resolution, it may require additional capital. This may be needed for a range of reasons: for example, to meet minimum capital requirements for authorisation or to sustain market confidence. At present, these costs may initially have to be borne by taxpayers, as the Treasury would be the only available source of funds to meet these expenses. That is an undesirable status quo.
A key aim of the Bank Resolution (Recapitalisation) Bill, therefore, is to strengthen the protections for public funds where a small bank is placed into resolution instead of insolvency. Overall, this is a necessary and, I hope, uncontroversial set of reforms in order to ensure the regime effectively continues to limit risks to financial stability and to taxpayers.
It is important to note that the bank insolvency procedure will still have an important role in managing the failure of small banks. Relatedly, the Government do not intend to make widespread changes to a resolution regime that is already working well. Instead, this Bill reflects the view that there is merit in a targeted set of changes which ensure that, if needed, certain existing resolution tools can be applied to small banks in a way that achieves good outcomes for financial stability while also protecting taxpayers.
The Bill achieves this by introducing a new mechanism. This mechanism allows the Bank of England to use funds provided by the banking sector to cover certain costs associated with resolving a failing banking institution and achieving its sale, in whole or in part. The Bill does three things to create the new mechanism. First, it expands the statutory functions of the Financial Services Compensation Scheme, which will be required to provide funds to the Bank of England upon request, to be used where necessary to support the resolution of a failing bank.
Secondly, the Bill allows the Financial Services Compensation Scheme to recover the funds provided by charging levies on the banking sector. This is similar to the current arrangements for funding depositor payouts in insolvency, with the exception of the treatment of credit unions. In response to feedback from industry, the Government have decided to carve out credit unions from levy contributions in recognition of the fact that they cannot be put into resolution, and so the new mechanism cannot be used on them. It is important to note that this means the banking sector is levied only after the event of failure, not before, thereby avoiding new upfront costs on the sector.
Thirdly, the Bill gives the Bank of England an express ability to require a bank in resolution to issue new shares, facilitating the use of industry funds to meet a failing bank’s recapitalisation costs. Taken together, these measures give the Bank of England a more flexible toolkit to respond to small bank failures in a way that promotes financial and economic stability. Critically, they strengthen protections for taxpayers’ money, while avoiding new upfront costs on the banking sector.
The Bill consists of five clauses and is narrow in scope. I will now set out how each of them operates and the effect they produce. The first clause inserts into the Financial Services and Markets Act 2000 a new section which introduces the new mechanism. It allows the Bank of England to require the Financial Services Compensation Scheme to provide the Bank of England with funds when using its resolution powers to transfer a failing firm to a private sector purchaser or bridge bank. It sets out what these funds can be used for: namely, to cover the costs of recapitalising the firm and the expenses of the Bank of England and others in taking the resolution action. It also allows the Financial Services Compensation Scheme to recover the funds provided through levies.
The second clause sets out that the Bank of England must reimburse the Financial Services Compensation Scheme for any funds it provides that were not needed. The third clause primarily ensures that existing provisions relating to the Financial Services Compensation Scheme apply to the new mechanism in the same way. The most substantive change specifies that the Financial Services Compensation Scheme cannot levy credit unions to recoup funds provided under this mechanism. The most substantive change in the fourth clause gives the Bank of England the power to require a failing firm to issue new shares. This will make it easier for the Bank of England to use the funds provided by the Financial Services Compensation Scheme to recapitalise the firm by using the funds to buy the new shares. The fourth clause also makes several consequential changes to reflect the introduction of the new mechanism. The fifth and final clause sets out procedural matters, including that the Treasury may make regulations to commence the provisions in the Bill.
The key proposals in this Bill have been subject to consultation with industry, and the Government appreciate the feedback they have received and have reflected on it carefully. The Government note the concerns about the appropriateness of credit unions being liable to pay levies under the mechanism. The Government have taken this feedback on board, and the Bill therefore carves credit unions out of the scope of levies where the new mechanism is used. The Government also acknowledge the questions raised by industry about whether additional safeguards should be included to ensure the Bank of England calls on the Financial Services Compensation Scheme only where this is less costly than putting a bank into insolvency instead. The Government have reflected on this feedback carefully and consider that the safeguards in the existing resolution regime remain appropriate.
However, the Government do intend to update the special resolution regime code of practice in due course, in order to set out how we will ensure clarity on how the Bank of England will consider relative costs to industry in different scenarios. As part of this, the Government intend to set out in the code of practice their expectations around what the Bank of England would need to report on publicly following the exercise of its new powers. Finally, the Government stress that the banking sector as a whole stands to benefit from use of the mechanism set out in the Bill, in particular in its ability to reduce the potential risk of contagion arising from small bank failures where resolution is in the public interest.
I recognise that noble Lords have in the past raised concerns about the exemptions applied when SVB UK was transferred to HSBC and, although these are not within scope of the Bill, may wish to raise such concerns today. It is important to note that the resolution of SVB UK presented an exceptional set of circumstances which required an exceptional response, recognised by noble Lords across the House at the time. The House also supported the conditions that were applied to the exemption, in particular to limit the type of business that SVB UK—now HSBC Innovation Banking—is able to carry out. I am assured that the regulator is in a position to ensure these conditions are met.
I would also like to reassure noble Lords that there is no expectation that ring-fencing provisions would be disapplied in the event of resolution in future; as with many aspects of resolution, they would need to be considered on a case-by-case basis, based on the balance of risks and the public interest at the time. The Government would, though, caution against steps that would create significant new procedural barriers to the use of the transfer tools, given unpredictable situations and the need to act quickly and decisively.
Stability is at the heart of the Government’s agenda for economic growth, because when we do not have economic and financial stability, it is working people who pay the price. The resolution regime is a critical source of stability when banks fail, by ensuring that public funds and taxpayer money are protected. This Bill delivers a proportionate and targeted enhancement to the resolution regime to ensure it best continues to provide that important stability. I look forward to hearing your Lordships’ views on it during this debate. I beg to move.
Lord Moylan (Con)
My Lords, I welcome the noble Lord to his place on the Front Bench. In reviewing the short list of speakers in this Second Reading debate, I am very conscious that I probably know less about this topic than anybody else who is about to speak. So, I feel peculiarly exposed, coming immediately after the Minister and giving the opportunity to all subsequent speakers to point out where I have got things wrong. None the less, that is the luck of the draw. I will say at the outset that I do not object to the measure proposed in this Bill. What I want to raise is the question of whether we have quite the robust bank rescue system that the Minister thinks we have and said we have during his introductory speech.
Silicon Valley Bank is the starting point of this. In some ways, Silicon Valley Bank was not a bank failure; the parent bank failed in America but the UK subsidiary did not in itself fail, and was successfully sold to the private sector. It was sold, admittedly, for a nominal sum, and the shareholders lost their money, but none the less that is a good outcome, and those involved are to be congratulated on succeeding in doing that. The bank continues to operate and it is there in the private sector; no taxpayer money was thrown at it, and that was a successful outcome.
The Bill arises, therefore, not so much from Silicon Valley Bank as from officials thinking about what might have happened if it had all gone wrong and whether we would have needed an additional power had it worked out rather differently. That line of thinking is also to be welcomed; it is good that officials think about what might have happened if things had gone wrong, and whether they would need an additional power. So we might reach the conclusion that we have a very robust system, but what I am saying is that it was not really tested very well.
It is worth examining the players in this system, and how bureaucratic and inflexible the system has become as we have set it up. The responsibility for sorting out a bank failure rests with the resolution authority, which is a department of the Bank of England. Should it have to acquire ownership of a bank in the course of a rescue, the bank would become a subsidiary of the Bank of England, and as long as that continued it would be, in a sense, as safe as the Bank of England, as we used to say. However, further down the corridor is another department of the Bank of England, called the Prudential Regulation Authority, and it would not be having any of that at all. The Prudential Regulation Authority would say, “It may be a subsidiary of the Bank of England, just as we and you are a department of the Bank of England, but we are going to insist that it is separately capitalised”. Indeed, the Bill is addressed at finding a route and an additional tool whereby that capitalisation could be provided. So we have two departments here that are not entirely working together, and are treating each other as alien bodies. That is rather distressing.
We then have the FCA. One of the problems that arose in relation to Silicon Valley Bank, which was an unusual species of liquidity risk as opposed to insolvency risk, was that it had a high number of accounts that were accounts of technology companies—that is its specialist business. These were ordinary current accounts for paying the bills and things like that, as businesses have to do. Some of these were large technology companies and some were small technologies companies, but, as a man, they united in saying, “If we can’t actually run our current account on Monday morning when this all opens, there’s going to be the most unholy mess”.
One way of sorting this out in the old days would have been for the Governor of the Bank of England to ring up the chairman of a bank and say, “There are only about a thousand of these customers. Would you mind very much opening current accounts for them, so that we can release some of the funds and they can operate in an ordinary way on Monday morning—we’ll sort out all the details later?” But there is another player up the road, the Financial Conduct Authority, which is not part of the Bank of England, that would not allow any of that at all because there would not be time for the “know your customer” inquiries that have to be made. Another bureaucratic step that we have put in place would have prevented a very simple and obvious solution being put into effect.
I worry whether, when the system is tested properly—Silicon Valley Bank was not a real test of the system—it will be as robust as we would all want to believe it is. Obviously, there is no political point-scoring going on here; we all have the same objective when it comes to trying to ensure the systemic robustness of the banking system in the UK.
To move on from the question of the systemic robustness of the system, there is the question about the Financial Services Compensation Scheme, which is already creaking and is a major charge on the financial system. This will add further to it, in an unpredictable way. It appears that, at the moment, the FSCS operates by way of a levy, which is paid in advance based on the actuarial likelihood of default in particular areas. I assume—the Minister might be able to tell us this—that in this particular case, if recourse was had to the FSCS, it would not be by way of the levy but by a sudden demand presented for money to be supplied immediately: we want it now, out of your reserves. If I have got that wrong, and it is to be part of the levy, some estimate of how much it will increase the levy by would be helpful. It is not clear from the Bill itself which it will be.
In addition to the FSCS levy, which is paid by more or less everybody, banks with equity and liabilities in excess of £20 billion pay the bank levy. As I understand it, the bank levy does not go to the FSCS but straight into the Consolidated Fund and is never seen again. I fully accept the Minister’s contention that there should not be a charge on taxpayer funds. However, if the bank levy is there partly as an insurance premium to help ensure that there is a way of dealing with big banks if they go wrong, maybe that should be looked at before a further dip into the FSCS as a source of funding for the recapitalisation.
I end with three questions for the Minister. First, will he confirm that the bank insolvency process will remain the default, and that recourse to the FSCS as envisaged by the Bill will be the exception and not become routine? I think in his speech he half-confirmed that, but if he was able to reconfirm it for me, that would be helpful.
Secondly, could the Minister tell your Lordships about consequential costs, particularly legal ones? If the process is followed and a bank is recapitalised using FSCS money, but there is then some endless legal dispute that goes on for ever—as there might be, involving shareholders; nobody knows how people are going to respond to these things—will those legal costs be excluded from the FSCS levy so that they could not be recovered from the FSCS? They would be a liability of the Bank of England, because presumably the Bank of England’s conduct would be the subject of any legal action.
Finally, would the Minister like to consider the future of the bank levy and make an assessment, at least, of the effect of the bank levy and the FSCS levy on the competitiveness of banking and financial services in the UK after this further addition to it? I contend that it is becoming very burdensome, and a real charge on domestic banking in a way that is beginning to contribute to what we see on our high streets—which is, frankly, the disappearance of domestic banking and the services that we all so much rely on.
Baroness Bowles of Berkhamsted (LD)
My Lords, I welcome the Bill, as I do the recognition that resolution, rather than insolvency, can be a better public interest solution for smaller banks, or at least for some smaller banks. Smaller and specialist banks are providing banking services, in particular to growth companies and start-ups, which cannot easily get banked with big banks. Likewise, I continue to hope that we will have community banks. I believe that the resolution process, should it come to that, looks a more supportive outcome all round.
As Silicon Valley Bank showed, businesses have a harder time protecting their deposits when there is a need to have sizeable sums available for running the business, including paying salaries, and that resolution reaches a fairer solution for businesses and their employees. It is a pity that it is always a megabank that has to come to the rescue, but it has ever been so, and of course again they get more competitive. We had concerns at the time, which the Minister has already covered to some extent, that maybe the HSBC ring-fence was got around; my noble friend Lady Kramer may mention that as well.
Overall, though, I have no concerns about the principle and content of the Bill, but there are a few related points that I would like to raise. The cost-benefit analysis shows that resolution can be less expensive—in effect, just using funds that would have been paid out to insured depositors. I would say that even if it were a bit more costly, it has a public interest benefit.
I also wonder whether there can be double or hybrid dipping into the FSCS; for example, if the resolution included a haircut on deposits, bringing deposits under the £85,000 level and triggering individual payments so that there could be both recapitalisation and individual compensation drawn from the FSCS. These might seem strange proposals, but I saw some very strange proposals during the financial crisis in the EU. Double dipping for recapitalisation, or subsequent rounds of recapitalisation, is envisaged in Clause 2—or is it the case that loss of deposits will be done only as part of insolvency? Is there a bar to mixing the two?
One of the guiding principles is to stay within the overall levy affordability criteria for industry. Does this inevitably mean that timing plays a part? If there is more than one rescue in a short time, will depositors end up somehow getting a worse deal by going through the bankruptcy and insolvency route rather than the resolution route, or will there be a look at the sort of smoothing over time of the burden to the banking and finance sector?
The move in the Bill may also be a psychological one, as it cuts down the demarcation between those banks that have to hold MREL and will be resolved, and those that do not hold MREL and are expected to be allowed to fail. I do not want a consequence further down the track to be a call for small banks to hold MREL. MREL was intended for large banks posing systemic risk and engaging in riskier capital market operations, but it has already crept downwards to mid-sized banks, which do not have capital market operations and for which MREL is unduly expensive. MREL also makes the depositor the enemy, as the highest liability a bank can have is its depositors. This shows in the low rates of interest of those banks with lots of other types of business and in the flight of depositors to smaller banks seeking reasonable rates. MREL in itself is a driver as to where you put your deposits, because otherwise you will not get a decent return, but at the same time, by doing that you are perhaps going somewhere less safe.
Finally, as it must, the Bill amends Section 213 of FSMA 2000 in respect of the FSCS. I take this opportunity to voice again my dissatisfaction with how that scheme works on the FCA side, where the £85,000 guaranteed sum is not actually guaranteed because it suffers deductions to cover administration expenses, as has just been announced in the case of WealthTek, where there is a charge of some £23,000 deducted from the £85,000 guarantee. Once again, the FCA dallied for a year after a whistleblower contacted it about the culprit, John Dance, during which time the situation for investors declined substantially.
It is additionally galling for investors to find the FCA taking the costs of the administration out of what they thought was a guaranteed amount. It is quite easy not to know that this happens. I have asked a lot of the people I work with in the financial sector about whether they know it is not £85,000 on the FCA side, and that you might lose a big chunk of it to the administration. Even many people operating in fund management did not know this themselves. That is probably because it is such a big strapline, but it does not say: “Wahey—you might have expenses taken away from this”. Now, this does not happen on the banking side—at least not yet. I believe this is due to the provisions of the EU deposit guarantee scheme, which I may have had a hand in.
First, can the Minister assure me that, alongside the modifications for use of the Financial Services Compensation Scheme in small bank resolution, and in any domestication yet to come of the retained EU law deposit guarantee scheme, there will not start to be cost deductions from the £85,000 on the PRA side of things? Secondly, on the FCA side of things, I think that that guarantee should be a guarantee, and if costs have to be recouped, then it should be through another route. In the WealthTek case, it said that only 4% of investors fell into the trap of the unexpected deductions. The fact that that is thought to be a small number of investors is all the more reason not to have that trap and discriminate against a small number of investors. Is this something that the Government will look at? Overall, I am not happy that the FCA is in charge of the rules of the scheme that allow it to force the cost of its own dalliance on to the investor guarantee.
Lord Macpherson of Earl’s Court (CB)
My Lords, I declare my interest as chairman of C Hoare & Co, which would almost certainly be classified as a small bank for the purposes of the Bill.
I congratulate the Minister on becoming Financial Secretary to the Treasury. After the chancellorship of the Exchequer this is the oldest Treasury ministerial post, and I am pretty sure that it is the first time that it has been held by a Member of this House. I had the good fortune of working with the Minister for a decade around the turn of the century. He has huge Treasury experience and considerable ability and was a pleasure to work with. I wish him well in what will inevitably be difficult times ahead when no doubt he will come to this House on many occasions to make Ministerial Statements.
I speak in support of the Bill, which is a model of good legislative practice with a well-handled consultation and cross-party support. It is welcome that the new Government have seamlessly picked up where the previous Government left off. Politics is all about difference, but at least 90% of governing is about continuity.
Having been the Permanent Secretary and accounting officer when the Treasury had to nationalise Northern Rock and resolve the Icelandic banks in 2008, I am acutely aware that having the necessary powers in place makes it a whole lot easier. Of course, the Government can generally rely on common-law powers in such circumstances or, in the case of Northern Rock, pass an emergency Bill in 24 hours. I pay tribute to the late Lord Darling for managing the financial crisis so effectively with the limited powers then at his disposal, but I would not recommend a make-do-and-mend approach; it diverts finite resources from the job in hand, which is managing the crisis itself. It is better to have the right legislative and institutional framework in place, and to learn from each time the framework is tested in order to improve its functioning.
In 2008, it fell to the Treasury directly to resolve failing banks. I recall asking the Bank of England whether it would take on the role, thinking that the clue was in the name—it is a bank—and that a bank might be better at taking the necessary steps rather than a government department, but the Bank of England declined my request. Lord Darling put that right in his 2009 Act, which ensured that the resolution authority resides in the Bank of England. In my view, that is the right approach; the Bank of England is better placed to retain the necessary expertise and experience, not least because it can pay its staff more generously.
However, the Treasury needs to remain alert to one important point, which the noble Lord, Lord Moylan, touched on indirectly: the conflict of interest created by the abolition of the Financial Services Authority in 2013. The Bank of England is now the regulator and the resolution authority, and responsible for macro- prudential policy. It also in effect has the power to tax the industry through PRA fees and the wider Bank of England levy. The Bill extends its powers of taxation by allowing it to draw on the Financial Services Compensation Scheme to recapitalise a failing bank. There is nothing wrong with that in principle; it is much better that the industry finances its failures rather than the general taxpayer.
The Bank of England generally does its job well. All I am asking is that Treasury Ministers maintain adequate oversight. To this end, they need to be vigilant to three issues. First, apart from the brief period in 2007 when fear of moral hazard dominated its thinking, the Bank of England has a historical tendency to intervene. I recall Sir Douglas Wass, one of my predecessors at the Treasury, some 40 years after the event still expressing irritation at the Treasury being kept in the dark about the Bank’s intervention in the secondary banking crisis of 1973-74. I can foresee circumstances where the Bank will choose to recapitalise a small bank rather than put it into a bank insolvency process, less because it is in the national interest and more as a way of minimising the reputational damage of regulatory failure.
Secondly, because of the Bank’s power to tax the banking industry, I fear that it will pay insufficient attention to minimising the costs of resolution. I may be wrong, but my recollection is that the Bank of England incurred greater costs, with advisers and so on, in resolving the Dunfermline Building Society than the Treasury did in resolving the Icelandic banks. Unlike the Government, the Bank does not have to stand for re-election, so its incentive to contain costs is rather less.
Finally, it is important that small banks remain well capitalised. Challenger banks are adept at lobbying government and central banks for special treatment, arguing that this enhances competition. To some degree it does, but they are not slow to make political donations. I witnessed this at first hand a decade or so ago. It is important that the authorities ignore these blandishments. As my old friend the noble Lord, Lord King of Lothbury, used to observe, the best way to ensure that the banking system is safe is to ensure that it is adequately capitalised.
I should emphasise that these are minor points that are more about the spirit of Treasury oversight than the substance, and I am happy to support the Bill.
Lord Eatwell (Lab)
My Lords, the introduction of the resolution regime in the Banking Act 2009, and the subsequent development of living wills in which large banks are required to produce plans for how they could be wound up, are both designed to reduce the risk of the cost of failing banks falling on the taxpayer. This Bill seeks to add an additional protection for the taxpayer, by shifting the risk of funding the resolution of a bank from the Treasury to the Financial Services Compensation Scheme and therefore to the banking sector as a whole in subsequent levies—so far, so good. The Explanatory Notes provided by the Treasury suggest that the purpose of this legislation is to provide for the resolution of small banks, citing the resolution of Silicon Valley Bank UK as an example of where the successful resolution of a failing bank was clearly preferable to the alternative—namely, insolvency.
Maintaining the operations of a bank, particularly where the asset side of the balance sheet is strong, if illiquid, has obvious advantages. It avoids the disruption of banking services that occurs under formal insolvency procedures. Indeed, the sale of Silicon Valley Bank UK to HBSC for £1—I wonder if anyone knows whether that was actually paid; perhaps the noble Baroness, Lady Penn, knows—ensured that banking services were maintained by HSBC for an important segment of UK industry.
The focus on small banks is important. It is a recognition of the important role—referred to just now by the noble Baroness, Lady Bowles, yet so often unrecognised—that small banks are playing in the UK economy today. I will give the House just one example: a bank called Unity Trust Bank. It has a balance sheet of a little over £1 billion. To give an idea of scale, the balance sheet of Barclays Bank is 1,500 times larger. Last year, 87% of Unity’s quarter of a billion in new lending supported projects in health and well-being, community spaces and services, education, skills and employment, and financial inclusion. Around half of that lending went to parts of Britain defined as areas of high deprivation, as measured by the Index of Multiple Deprivation. It achieved all this while earning a very healthy return on equity and maintaining a tier 1 capital ratio of 20%. If Barclays’ numbers were the same as that, Britain would be a very different and a very much better place. This is just one example of the excellent work done by small and medium-sized banks.
That is why it is particularly welcome that the Bill makes no provision for increased funding burdens on small banks such as MREL provisions. Britain already suffers from the fact that necessary prudential regulation creates an anti-competitive environment in banking, making it particularly difficult for small banks to cover compliance costs. We should not make the task of small and challenger banks even more difficult.
All this adds up to a valuable and proportionate piece of legislation. Unfortunately, the documentation provided in support of the legislation contains a number of disturbing propositions that take some of the shine off the Bill. For example, in the Treasury document replying to the consultation on the Bill we find the following proposition:
“Noting that the expectation is that the mechanism would generally be used to support the resolution of small banks, the government considers it appropriate for the mechanism to be, in principle, applicable to any banking institution within scope of the resolution regime”.
So, this procedure is not deemed to be targeted solely at small banks but might apply to banks of any size. Perhaps the Minister could enlighten us as to what the Treasury has in mind?
Most disturbing of all is the evident belief, held by both the Treasury and the Bank of England, that this new resolution mechanism can deal not just with idiosyncratic risk—that is, failures in just one or two banks at a time—but also with systemic risk: failure impacting the system as a whole. Consider this statement in the Bank of England’s guide to resolution entitled The Bank of England’s Approach to Resolution:
“The need for a financial system to have an effective resolution framework was a key lesson from the global financial crisis of 2007-09. During the crisis, governments had to resort to ‘bailouts’ as some banks had become too big, complex, and interconnected to be put into insolvency like other types of firms. Without a resolution regime, letting them fail would have meant that people or businesses would have been unable to access their money or make payments. The potential risks to the financial system and the economy meant they had become ‘too big to fail’”.
Now it goes on:
“Resolution changes this by providing powers to impose losses on investors in failed banks while ensuring the critical functions of the bank continue”.
Well, I hope and pray that the Bank of England does not believe this nonsense. The ability of a resolution regime to protect the taxpayer depends on the proposition that the banking services can be maintained by sale of the failing bank to a competent and well-funded counter- part. But, in a systemic crisis such as 2007-09, this is impossible because there are no buyers. Everyone is in trouble. In these circumstances, there are only two answers: bailouts by the taxpayer or insolvency.
Size matters, too. When Credit Suisse failed, the Swiss authorities immediately abandoned any pretence at resolution; only public funds could handle the job. This is not just true in the case of a large bank failing. As the Treasury consultation document notes,
“while an individual institution may not be considered systemic, if a risk is common—or perceived to be common—among similar institutions, the collective impact can pose a systemic risk”.
In other words, the failure of many small banks all at once can be as devastating as the failure of a large bank. But, having made this very sensible point, the Treasury goes on to suggest that somehow “targeted resolution” will sort things out. It would seem that both the Treasury and the Bank of England are prone to wishful thinking.
It is also worth noting that, in the face of a systemic crisis, the levy proposed in the Bill, which is designed to fund the demands on the FSCS, would be a powerful source of crisis contagion. I note that the Treasury is taking steps to limit such contagion.
There is one small irritation with the documentation that is important for later stages of the Bill. The cost- benefit analysis presented by the Treasury has little relevance to the Bill’s subject matter. It compares costs and benefits of the resolution regime with the alternative of insolvency, but that is not the issue here, which is the comparison of the costs and benefits of the new funding mechanism as an addition to the old resolution regime, as set out in the Banking Act 2009. I suspect that the benefits, predominantly of flexibility, are small and that the changes in costs are negligible, even though the allocation of costs is now different. Could we please have a relevant cost-benefit calculation for later stages of the Bill?
This is a very useful measure to deal with the failure of small banks in circumstances in which the rest of the banking system is in rude health. Please let us not pretend that it is anything else.
Lord Vaux of Harrowden (CB)
My Lords, it is always a pleasure to follow the noble Lord, Lord Eatwell, with his in-depth analysis and huge knowledge of this area. I feel I will probably fall short after that, but I will give it my best go.
This Bill provides the Bank of England with slightly greater flexibility to find a resolution to a bank failure other than insolvency, at a cost to the rest of the banking industry. As we have heard, it follows on from the lessons learned from the insolvency of Silicon Valley Bank. As such, I think that, like everybody else, I am generally supportive of it. But it does beg some questions, so, rather than making points about its merits or demerits, I will ask the Minister a number of questions about how it will operate in practice and some of the potential impacts.
First, the Special Resolution Regime effectively splits the banking industry into two tiers: those larger banks whose failure might create systemic risk, which are required to maintain excess debt and equity over the minimum capital requirements, known as MREL, and smaller banks whose failure would not be expected to create systemic risk, which do not hold MREL. SVB was a small bank whose failure was none the less considered to create some systemic risk because of the nature and concentration of its customer base. The Bank of England therefore decided to follow a resolution procedure, which it felt was better than allowing SVB to go into insolvency, which would have restricted its customers’ access to their funds, which I think the noble Lord, Lord Moylan, referred to. SVB was then rapidly transferred to HSBC for £1—a good result all round, I think. Customers retained continuity of access to funds and did not lose any of their deposits and HSBC gained a subsidiary that it said would accelerate its strategic plan by two or three years.
However, this begs the question as to whether we have the classification right for which banks are required to hold MREL. It is currently based primarily on size. Should the PRA be required to do more to ensure systemic risk has been identified before failure? SVB seems to have come as something of a surprise, and its risk profile does not seem to have been recognised in advance, so it appears to me that the current classification should be reviewed and that we should at least consider extending the MREL regime to small banks whose failure would none the less create some systemic risk. I would welcome the Minister’s thoughts on that.
Secondly, and this goes to a point that the noble Lord, Lord Eatwell, raised, the letter that the Minister kindly sent explaining the Bill states in the first paragraph:
“The Bill enhances the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of small banks”.
The Minister said that in his opening words as well, so could he explain why the Bill applies to all banks, including those inside the MREL regime?
Under the Bill, any costs of putting a bank into a resolution procedure, either by transferring it to a private sector purchaser, as happened with SVB, or by transferring it to a bridge bank with a view to ultimately transferring to a private sector purchaser or insolvency, will be met by funds provided by the industry via the FSCS. The Government indicate that in most cases they expect the costs to be lower than putting the bank into insolvency because it should avoid compensating depositors up to £85,000 each. The costs that the FSCS would cover would include the costs of recapitalising the failed bank, the operating costs of the bridge bank, and any costs in relation to the resolution, including legal and other professional expenses, costs of valuation and other associated costs incurred by both the Treasury and the Bank of England.
That raises a number of questions. What cap or limitation is there on the costs? While the Government say that they expect costs generally to be lower than insolvency, and they are probably right, that is not guaranteed. The bridge bank could be run for up to two years, and that is extendable in certain circumstances, so this could become quite a large, open-ended cost. Who controls the level of costs during the period? I think the noble Lord, Lord Macpherson, talked about this. It is not those who are going to be paying for it, so there is no direct incentive to keep the costs as low as possible. How is that going to be scrutinised? What input will those who ultimately pick up the costs have?
Under an insolvency process, there is a de facto cap on the liability to the FSCS, and therefore the industry, which is the amount of the deposit protection. Is it right that the wider industry will potentially be on the hook for paying more than that de facto cap? As I understand it, this process will be used only—and I think the Minister mentioned this—if it is in the public interest to do so, where a small bank failure turns out to create systemic risk. That would reflect a failure by the PRA to identify a systemic risk, as I mentioned earlier. If the resolution decision is driven by a public interest test, surely it should be the public purse that pays the excess rather than the banks which have no part in this. As a matter of principle, it is shareholders, lenders and other creditors who should bear the primary risk before the industry is asked to contribute. The industry should not be underwriting any debt or equity or even supplier risk. What is the mechanism for ensuring that the resolution process will not unfairly benefit share- holders or other creditors?
Related to that, if a bank is transferred to a bridge bank and two or even more years later goes into insolvency, where will the FSCS money that has been poured into the bank in the meantime rank in the hierarchy of debts? It should presumably rank above all debts that existed on the day the bank was transferred to the bridge. Is there a mechanism for returning money to the FSCS and to industry if it can be recovered either in insolvency or a sale? To go further than that, any sale to a private sector purchaser in these circumstances is typically under fire sale conditions, so they usually happen at below market price. SVB UK was transferred to HSBC for £1, as I mentioned, and HSBC is widely seen as having got rather a bargain because the failure of SVB was not caused by the UK entity; there was nothing wrong with the UK entity. SVB UK had loans of around £5.5 billion and deposits of around £6.7 billion and in the previous financial year had recorded a profit before tax of £88 million. Its tangible equity was around £1.4 billion, so quite a bargain at £1.
Will there be or should there be a mechanism for clawing back any excess profits made by the private sector purchaser to be refunded to the FSCS if the FSCS has provided the resolution financing? What happens if the failed bank is a subsidiary of an overseas entity? What mechanisms do we have for ensuring that the parent company pays for the costs of such a failure and not the FSCS? Why should the UK banking industry pick up the costs if there is a viable overseas entity? I realise that was not the case with SVB, but there could be a situation where an overseas bank sets up a UK subsidiary that does not go very well so it just walks away from it. It should pick up those costs. Is there a process for clawing back management bonuses and dividends paid prior to the failure?
As a general principle, bad or failing businesses should be allowed to fail, and that may mean that creditors, including depositors beyond the protection cap, lose money. There is a risk that this mechanism could be used to avoid negative headlines or for political or reputational expediency. After all, as was said before, the costs of taking the action will not fall on those making the decisions. Ultimately, the costs will be borne by consumers as the banks pass them on in low savings rates, higher lending rates or higher charges. What safeguards are in place to ensure that the mechanism is used only in appropriate circumstances? I am broadly supportive, but I have a lot of questions and look forward to hearing from the Minister.
Lord Sikka (Lab)
My Lords, when you are the last speaker in the queue, you find that all the good points have already been made and you have to rewrite your speech rapidly. I have a number of questions for the Minister. First, this Bill suspends the iron law of capitalism, which is that the inefficient and incompetent go to the wall. Somehow that is not to be applied to the banking sector. If the Minister considers the provisions of the Bill to be good enough for a flourishing finance industry, why not apply them to other sectors where we have many essential businesses?
Looking at the Bill, it seems to assume that the Financial Services Compensation Scheme—the FSCS— has significant reserves from which the Bank of England could immediately obtain benefits. Will the Minister explain what kind of reserves the FSCS is required to maintain and how their adequacy is judged? Its accounts for the year to 31 March 2023 show it had a surplus of just £5 million, which was then taken to cover the deficit of the pension scheme. In other words, there was a zero surplus for that year, but the cumulative cash balances were £510 million. Is that enough to rescue one or more banks or do these buffers need to be beefed up? I hope the Minister will be able to tell.
Bank failures could be localised or they could have a domino effect, in which case the FSCS would not have adequate resources. Will the Minister explain what would happen then? As I understand the Bill, insolvency would be the only option left. What have we learned about the insolvency of banks? The biggest insolvency was in July 1991 when the Bank of Credit and Commerce International was shut down, but to this day there has been no investigation, no report, nothing. What have we learned about insolvency of banks? Would the Minister like to reopen that probe and tell us why there has been no investigation, why there has been a complete cover-up and what we could have learned from it to devise better regulations?
Under the Bill, the cost of reckless practices at one bank would be borne by others, as the FSCS would raise levies on other banks. There are clear moral hazard issues here, especially as the boards of the failing banks do not face personal consequences and shareholders have only a short-term interest. Will the Minister explain how these moral hazards would be checked by the regime proposed?
We all know from history that rescue and recapitalisation is not the only way that the Bank of England and the Government rescue banks; they also engage in deceit, skulduggery and cover-up. The classic case relates to HSBC, which in 2012 was fined $1.9 billion by the US regulators for money laundering. At that time, it was the largest ever fine on a corporation. According to the US Department of Justice, HSBC
“accepted responsibility for its criminal conduct and that of its employees”.
The bank was regulated by the UK authorities, which took absolutely no action. In March 2013, the US House of Representatives Financial Services Committee began a review of the US Department of Justice’s decision not to prosecute HSBC or any of its employees or executives for admitted criminal activities. Its July 2016 report titled Too Big to Jail contained a two-page letter from the then Chancellor, George Osborne, and extracts of correspondence with the Financial Services Authority and the Bank of England. The Chancellor’s letter, dated 10 September 2012, urged the US authorities to go easy on HSBC as it was too big to fail. It also urged the US authorities to go easy on Standard Chartered Bank, which was fined £330 million for money laundering and for sanctions busting. Despite requests, which I have made in this House, no statement has ever been made to Parliament.
No documents have been placed on public record to show why banks are being rescued by deceit and cover-up, and this inevitably emboldens banks. In 2019, Standard Chartered was again fined for money laundering and sanctions busting—this time for $1.1 billion—and HSBC has been a habitual offender. Can the Minister explain why these matters are not being looked at? The institutionalised corruption increases the likelihood of banking failures. It would be helpful to know what steps the Government will take to cleanse the City of London. Simply saying “We will recapitalise banks” will not do.
The Bill rests on very shaky regulatory foundations. After the 2007-08 crash, the regulators’ duty to promote the industry was abolished and they were primarily required to be what I call watchdogs and guide dogs. The last Government changed that legislation and now regulators are required to promote competitiveness and growth of the industry. The regulators have effectively become puppies and lapdogs of the industry. Regulatory actions requiring stringent oversight or lower gearing ratios could be interpreted as a tax on competitiveness and the potential growth of the industry. Such conflicts were considered to be contributory factors in the 2007-08 crash, but they are now back on the statute books.
Lehman Brothers had a leverage of 30.7:1 when it crashed and Bear Stearns had a leverage of 36.1. On the one hand, the Bank of England and regulators tell the banks that they must be well capitalised; on the other hand, tax relief is offered on interest payments on the debt. Government incentivise taking on leverage. How can that create stability? Why do the Government not abolish the tax relief on interest payments by corporations? That would certainly reduce their financial risks and vulnerability. Again, I look forward to hearing from the Minister.
The current regulatory environment is much weaker than the pre-crash environment. Shadow banks are the new elephant in the room. Shadow banks include hedge funds and private equity, and all are unregulated. They are meshed with the retail and investment banks, insurance companies and pension funds but remain unregulated and totally opaque. Some parts of this industry are located in offshore tax havens, and it is impossible to see their financial statements and make any meaningful assessment of the risks and dangers that they pose to the banking system.
Private equity and hedge funds function as banks, but they are not subject to any minimum capital requirements, control on leverage or stress tests, even though the collapse of one firm can destabilise the whole sector. The collapse of the US-based Archegos Capital Management showed how rapidly the domino effects occur and had immediate negative effects on the capital buffers of Goldman Sachs, Morgan Stanley, UBS and Credit Suisse. Banks that are regulated in the UK now have multiple connections with shadow banks, including lending to buyout companies and the funds that acquire them, the firms that manage them and the investors that back them. There is a complex web that is impossible to penetrate, and that will ultimately bring forward a crash. In April this year, a Bank of England official responsible for financial stability, strategy and risk said that there were serious
“questions about the risks of these financing arrangements, and the growth in kinds and quantity of leverage, or ‘leverage on leverage’, throughout the ecosystem”.
Successive Governments have failed to bring shadow banks within the scope of regulation. A deeper crisis is being incubated, just as it was before the last crash. When the next crash comes—and it will come—it will engulf every sector of the economy, as private equity is into supermarkets, hospitals, GP surgeries, water, care homes, cosmetics, housing, property, hotels, insurance and everything else. There will not be enough money to rescue, so we need to strengthen the regulatory system now. The recapitalisation regime of this Bill will not be able to cope.
Of course, Ministers can dismiss the kinds of concerns that I have expressed, but it would be most unfortunate if the next crash was to come during the term of the Labour Government in office. Does the Minister know how many entities regulated by the FCA are enmeshed with shadow banks and what their risk exposure is? I have been unable to work that out by looking at the accounts of these organisations, but the Minister may have superior information. If he does have it, can I ask him to publish that data?
Shadow banking is now a major danger to the stability of the financial system and its practices can undermine the regulated banks, but shadow banks are not required to contribute to the recapitalisation fund. Why is it that they can create risks for the entire system but do not bear the cost? Can the Minister explain how much they will contribute to this recapitalisation fund and whether he considers their contribution to be adequate?
Baroness Kramer (LD)
My Lords, as the first of the winding speakers, I can repeat all the good points. This has been an exceptionally strong debate. I have welcomed the Minister on previous occasions and I welcome him again to his role. I can very much support this piece of legislation, picking up on the points made by the noble Lord, Lord Macpherson. It seems to me to be one of the first sensible approaches to dealing with the failure of small banks and, I hope, minimising the exposure of the taxpayer. However, I very much pick up the points made by the noble Lord, Lord Eatwell. If this happens on a mass or systemic basis, essentially the taxpayer is always going to be the body in play, and we should not fool ourselves that, in a really mass crisis, the banking sector as a whole will be able to pick up the problems of a large part of banking in the UK. We have to be realistic on this issue.
In fact, I have always thought that it was pretty unrealistic that most small banks could be allowed to fail, with depositors protected only up to £85,000 by the Financial Services Compensation Scheme. Therein lies the potential for a sudden run on many other banks, with flight based on rumour and social media. I suspect that, if the Government or the regulators attempt to allow failure to be a significant part of the programme for dealing with problematic banks, they are going to find once again that they are facing the impossible. Sometimes, we have to be realistic. Often, schemes which look good on paper just do not work out in the practices of real life.
The Treasury and the regulator found this out the hard way when Silicon Valley Bank UK effectively failed thanks to the troubles of its US parent. As others, including the noble Lords, Lord Vaux and Lord Eatwell, have said, SVB had to be saved through its forced sale to HSBC for £1. Perhaps this new, more realistic process could be done with an individual bank. Is that unrealistic? Can the Minister elaborate on this? Could we not just be much more open and say that we are looking for resolution? Failure would then come only in the most extreme and rare of circumstances. Picking up on the point made by my noble friend Lady Bowles, resolution is the path to go down if we are to have a banking system in which the general public at large continue to have real trust.
I want also to pick up the point raised by the noble Lord, Lord Moylan. If there is to be trouble on a large scale and, as a consequence, the FSCS is turning to the banking system as a whole and asking for very large payments, does anybody within this chain have the ability to waive that and just say, “No, this demand is excessive. We are going to ask for a smaller portion from the banking system, or we are simply going to say, ‘This crisis is sufficiently large that we are going to turn to the taxpayer’”? To me, it is not realistic to suggest that, under every circumstance, the FSCS could turn to the banking system and be fully reimbursed. I would be grateful if the Minister enlarged on that. I am glad that he said that credit unions have been exempted from the levy. It would have been entirely improper to include them.
I have some related questions. The Minister knows that I was troubled by the sale of SVB UK. As the noble Lord, Lord Vaux, said, HSBC buying it for £1 was a real giveaway. HSBC played hardball, as it would, so the Government did not have a lot of choice. As the Minister knows—I have raised this before, and he referred to it in his speech—I still regard the terms of that sale as a mechanism which provided HSBC with a route to evading the ring-fencing rules that would normally apply to its retail banking, in order to separate it from investment banking activity.
When I raised this issue in Grand Committee, the Minister of the day was unable to give any kind of satisfactory answer. As far as I could tell, there was nothing to stop HSBC transferring those assets over to its Silicon Valley Bank entity, where it could engage in derivatives and securitisation on any scale it wished. If this final solution is now different, would he mind writing to me? It is probably impossible to answer that question now, but perhaps he would put a letter in the Library that makes it clear why busting the ring-fence was not a consequence of the way that sale was structured. That would be exceedingly helpful. As my noble friend Lady Bowles asked, could we get some assurances that, if the resolution pattern established for Silicon Valley Bank is going to be repeated, there will be measures in place to make sure that it does not become a backdoor to evading ring-fencing constraints? Following the 2008 crash, most of us—both in this House and in the other place—recognise that ring-fencing is a critical part of the defence against a repeat of the kind of crisis we saw back then.
As I say, I have long been sceptical of all schemes to resolve small banks, but, frankly, I am also somewhat sceptical of the plans to resolve large and medium-sized ones—those identified as systemic. As others and the Minister said, large and medium-sized banks are required to hold MREL—basically, bail-in bonds, to put it in English—to protect or provide a route to resolution. But, as the noble Lord, Lord Eatwell, said, when Credit Suisse collapsed in 2023, the Swiss regulators immediately realised that the consequences of implementing its resolution plan would lead to lasting damage to the Swiss economy. Swiss regulators are not fools or softies; they were facing the absolute reality that, with a failure of a bank of that size, they could not allow the backstop of wiping out shareholders or owners of convertible bonds. In effect, they organised a takeover of Credit Suisse by UBS. So does the Minister really expect that our regulators will implement the current bail-in resolution schemes, or will we also find that “too big to fail” still rules the day? It is time to be honest about this—with a new Government, perhaps it is time to look at this again much more directly.
Will the Minister also pick up an issue raised by my noble friend Lady Bowles: MREL and medium-sized banks? As she said, the market for bail-in bonds for medium-sized banks is so small that it is almost non-existent, so the bonds are exceedingly expensive. The consequence is that UK banks are now choosing not to grow from small into big because they see no way to put in place the MREL layer that would be required under current PRA regulations. Even if they did, because of the price they would have to pay for those bail-in bonds, they would face a competitive disadvantage compared to the big banks, which access a much more liquid bail-in regime. Is now not the time to take another look at the medium-sized banks and see whether a better scheme could be devised for their resolution, rather than assuming that MREL will be an adequate way for them to put in place that kind of protection?
I draw the Minister’s attention to the other issues raised by my noble friend Lady Bowles and ask for a full response. We are supportive of the Bill. We will look at it in Committee to see whether any amendments could improve it, but, as I say, this is the first time I have looked at a piece of banking resolution legislation and thought, “Actually, that could work in practice, not just on paper”.
Baroness Penn (Con)
My Lords, as has been the case with certain previous Treasury Bills, we have had a small but expert group of contributions today, and we have heard some common themes. From the Opposition Front Bench, I say first and foremost that we support the Bill. That should come as no surprise, given that it draws on proposals that were consulted on when we were in government.
As we heard, the genesis was the response to the period of banking stress in spring 2023, particularly the failure of Silicon Valley Bank. It is worth recalling that, at the time, Silicon Valley Bank was successfully sold to HSBC—I do not know whether the pound was actually paid—customers were able to access normal banking services and their deposits were protected in full, at no cost to the taxpayer. This was a significant success.
However, those events raised several questions, one of which is being addressed today: the potential risk to public funds of any resolution action for a small bank, given that, unlike larger banks, they are not required to hold a portion of their own equity and debt above minimum capital requirements to support their resolution. The solution put forward in the Bill is the use of the Financial Services Compensation Scheme levy to meet the costs of recapitalisation that may be needed to support the operation of a bridging bank or facilitate a sale to a private sector buyer.
As I have said, we are supportive of the Bill, but it would be helpful to our scrutiny of it if the Minister were able to give further detail on three areas. The first, which we have had some debate on today, is the approach to resolution versus insolvency. The PRA has set out that it does not seek to operate a zero-failure regime, but rather to work with the Bank of England to ensure that any firms that do fail do so in an orderly way. Prior to the failure of SVB, for smaller banks this was assumed to involve insolvency. With resolution now a viable alternative for smaller banks, it would be useful to understand the extent to which the Government expect resolution to be used, as opposed to insolvency.
The second area is the question of costs. A number of concerns were raised in response to the Government’s consultation with regard to the costs of the new FSCS levy. In particular, reassurance was sought that the most cost-effective mechanism would be used by the Bank of England in considering what course to take. Of course, those two questions are related. I was pleased to see the Government publish a cost-benefit analysis alongside their consultation response—although, as the noble Lord, Lord Eatwell, has noted, it is not without its limitations. That analysis seeks to provide reassurance that resolution, rather than insolvency, will often be the less costly option, both in terms of direct costs and the wider benefits of customer continuity and public confidence in the banking system. Although that may be welcome, it is hard not to conclude that resolution may become the default option when it comes to managing the failure of a small bank; indeed, the noble Baronesses, Lady Bowles and Lady Kramer, have said they would welcome such a move. If that is the case then the proposals we are debating amount to more than just a minor modification of the resolution regime—as is contended by the Government.
This is also an important point as the Government put forward the alternative of insolvency as a check against the inappropriate use of resolution in the case of small banks. For example, in addressing concerns around recapitalisation being used alongside the private purchaser tool, where it may otherwise be reasonable for the purchaser to recapitalise the bank, the Government point to insolvency as an alternative option, providing
“an important safeguard against any inappropriate use of the new mechanism alongside the Private Sector Purchaser stabilisation option.”
That argument is also deployed with respect to any impact of the proposals on market discipline. The Government
“considers this to be a manageable risk when set in wider context, given that insolvency remains an important part of the toolkit.”
Therefore, when the Minister responds, it would be useful for him to set out whether resolution will be the preferred approach to failure over insolvency for small banks. If not, can he give an example of a scenario where insolvency may be used over resolution?
I expect the Minister will likely refer me to the framework in which the Bank of England can deploy its resolution powers in order to answer that question. It will be for the Bank to determine the appropriate response within the resolution conditions and objectives set out in the Banking Act 2009, and in particular the use of the public interest test, which seems to bear significant weight for guiding the operation of the resolution process and providing safeguards to the Government and the banking industry in providing value for money. Again, that may be wholly appropriate, given the need for flexibility in response to scenarios that can be planned for but which invariably play out in unexpected ways. However, we have already heard from the noble Lord, Lord Macpherson, about some of the risks, or misalignment of incentives, with so much of the decision-making lying with the Bank of England.
That brings me to the third area where further detail from the Minister may be of help: the scrutiny of and accountability for the use of these powers—a favourite theme from our discussions on the then Financial Services and Markets Bill. The consultation response acknowledges the importance of this, and points to Sections 79A and 80 of the Banking Act 2009, which require the Bank to report to the Chancellor of the Exchequer where it has used resolution powers to transfer a bank to a private sector purchaser or a bridge bank. The report must comply with any requirements specified by His Majesty’s Treasury, which could include requiring the Bank to disclose the estimated costs to industry of the options that were considered.
I am pleased that the Government have said they intend to update the Special Resolution Regime code of practice to reflect the introduction of this new mechanism, and expect that they will confirm that His Majesty’s Treasury will stipulate that reports produced on the use of this new mechanism would require the Bank to disclose the estimated costs to industry of the options considered. I also welcome the expectation that the Treasury will expect to make such reports publicly available, including laying them before Parliament where required to do so under the Banking Act.
However, given the importance of this, it would be useful to see proposed updates to the SRR code of practice alongside this legislation, rather than once it is complete. Could the Minister commit to publishing the proposed updates ahead of the Bill reaching Committee? There is an expectation that such reports would be made public, including laying them before Parliament, but would Minister commit to strengthening this expectation to a commitment? Could he elaborate on where the Banking Act requires such reports to be laid before Parliament and, crucially, where it does not?
The Government have also committed that the update to the Special Resolution Regime code of practice will address the fact that, for larger banks, the new FSCS levy could be seen as charging them twice for the same risk, given that revenues from the existing banking levy can already be drawn upon to support resolution, if needed. One could argue that larger banks are paying for the same risk not twice but three times, as they meet their own MREL requirements to support their resolution. While I understand the Government’s desire to spread the cost of this mechanism across the whole sector to avoid disproportionately burdening smaller banks, as the noble Baroness, Lady Kramer, asked, what consideration have the Government given to the impact on medium-sized banks that are required both to meet their own MREL requirements and contribute to this new levy?
Finally, I share the concern of many noble Lords that the Bill does not limit the use of this mechanism to the resolution of small banks. Can the Minister confirm that the Government remain of the view that MREL remains the appropriate route for the resolution of larger banks? Is the intention that this mechanism cannot be used for that purpose but is reserved only for smaller banks without MREL in place? This is important to understand whether the scope of the Bill is just a minor adjustment to the resolution regime or a more fundamental shift in how we are approaching failing banks.
These Benches support action taken to update the resolution regime. We acknowledge the need to have a flexible system in place that allows for action to be taken swiftly in response to rapid changes in circumstances, but it is also important that the costs and benefits of such action are properly understood, and that there is transparency and accountability in place for when such powers are deployed. I look forward to the Minister’s response.
Lord Livermore (Lab)
I thank all noble Lords for their contributions to this debate. As noted in my opening speech, this is intended to be a targeted and proportionate enhancement to the resolution regime. It will provide the Bank of England with additional flexibility to manage bank failures in a way that strengthens protections for financial stability and taxpayers. Therefore, it supports the Government’s ambitions to promote economic stability and growth.
Without the Bill, a gap would remain in the resolution framework, meaning there would be a potentially significant risk to public funds in the event of a small bank requiring intervention. In certain circumstances, there could also be a greater risk of contagion from the failure of one small bank spreading to others. The bank insolvency procedure and other forms of modified insolvency remain an important part of the toolkit for dealing with the failure of small banks.
A key principle underlying the Prudential Regulation Authority’s approach to banking supervision is that it does not operate a zero-failure regime. Rather, it works with the Bank of England, as the UK’s resolution authority, to ensure that any firms that fail do so in an orderly manner. Any resolution action, including action involving the new mechanism, would continue to be subject to all four resolution conditions being met. The Bank of England must also have regard to a number of resolution objectives to ensure that the action taken is in the public interest. Not every small bank failure would meet those conditions to justify taking resolution action. However, in the event that a small bank failure does meet these conditions, it is right that the Bank of England has the appropriate flexibility to manage the failure effectively.
To address the key point made by the noble Lord, Lord Moylan, since the global financial crisis there have been international efforts to address the risks that crystallised during the crisis and to reform and strengthen financial supervision and regulation, making the financial system stronger and more stable. Financial stability is a priority for this Government, at the heart of our vision to support economic stability and growth. The Bill supports that priority by ensuring that there continues to be a robust regime for managing the failures of banks in a way that limits risks to financial stability and taxpayers.
The noble Lord also asked about the funding for the FSCS. The Financial Services Compensation Scheme is funded by levies on the financial services industry, as he knows. For deposit-taking firms, if a bank or a building society were to enter insolvency, the FSCS would have to pay out compensation and then raise its levy on the banking sector to recover the funds. To cover the gap between paying out compensation and recovering the funds through the levy, the Financial Services Compensation Scheme would use its overdraft as well as its commercial credit facility. Combined, these can provide up to £1.5 billion.
The noble Lord asked about the speed of providing the money. The Financial Services Compensation Scheme will provide the money as soon as it is able. Given that resolutions generally happen very quickly, in a matter of days, the Financial Services Compensation Scheme may be required to provide the money very quickly.
The noble Lord asked about the vehicle for the funds. Under the Bill, the Financial Services Compensation Scheme would provide the funds at the Bank of England’s request and recoup them from the banking sector. The Financial Services Compensation Scheme is well placed to perform both functions, as it already has the infra- structure and expertise to source funds at short notice, handle large sums of money appropriately and levy the banking sector.
The noble Lord also asked about the bank levy. The Government believe that their proposal to fund costs through the Financial Services Compensation Scheme is a targeted and proportionate approach, ensuring that the banking sector pays only when it needs to. Meanwhile, the bank levy continues to ensure that banks make a fair and sustainable tax contribution that reflects their importance to the financial system and wider economy. However, the Government believe that the mechanism provided for under the Bill should be funded by the wider banking sector. The bank levy would therefore not be an appropriate funding mechanism and is not paid by small banks, for which the new mechanism is primarily intended.
The noble Lord asked too about the regime being insufficiently robust and not yet tested. The resolution regime is designed to ensure that the Bank of England has the full suite of powers needed. The Bank of England and the Treasury regularly contingency plan to test the regime.
Coming to the points raised by the noble Baroness, Lady Bowles, I am very grateful to her for her support for the Bill. She asked about WealthTek and MREL in substance and raised concerns about the recent failure of WealthTek and the implications of that failure for consumers. It will not be possible for me to comment in detail on the case of an individual firm failure. However, I will respond to her on her general concern that costs due to an administrator can be deducted from compensation that is due to consumers when their firm fails. In the case of depositors of banks, I reassure the noble Baroness that PRA rules are clear that no insolvency or administration costs can be deducted from payouts due to covered depositors when their bank enters insolvency.
The investment bank special administration regime is a bespoke insolvency regime for investment firms that hold client assets. It is designed to offer better outcomes for customers by ensuring that the special administrators prioritise the return of client assets.
The noble Baroness also asked about requesting money more than once in a single resolution. The Bank of England is not limited in the number of times it can request money from the Financial Services Compensation Scheme. This provides appropriate flexibility in case further unanticipated costs arise following the initial intervention, for example in relation to subsequent litigation or compensation. This in turn reduces the risk to public funds.
On the question of small banks holding MREL, the Bank of England is ultimately responsible for MREL policy. The Government note that setting MREL for small banks would be very expensive for this cohort of firms.
The noble Baroness also asked about raising new taxes on the banking sector. The Bill avoids imposing any new upfront costs on the banking sector. Crucially, all costs are contingent and would crystallise only in the event of a firm failure. The counterfactual to using resolution powers alongside industry funds would be insolvency, in which scenario the banking sector would in any case be liable to pay levies to fund depositor compensation.
I am very grateful to my noble friend Lord Macpherson for his very kind words. The noble Lord asked about the banking insolvency procedure, as did the noble Lord, Lord Sikka. A key principle underlying the Prudential Regulation Authority’s approach to banking supervision is that it does not operate a zero-failure regime. Rather, it works with the Bank of England as the UK’s resolution authority to ensure that any firms that fail do so in an orderly manner. It is important to note that any resolution action, including action involving the new mechanism, will continue to be subject to all four resolution conditions, including the public interest test being met, just as it is now. Not every small bank failure would meet those conditions to justify taking resolution action.
My noble friend Lord Macpherson also asked about the Treasury’s ongoing role in authorising the new mechanism. As now, the Treasury will be consulted on any use of resolution powers. However, its consent is required only if the use of those powers would have implications for public funds.
My noble friend also asked about the Bank of England not being incentivised to keep costs down. It is right that Bank of England expenses can be recovered by levies. The alternative, of course, would be to use public funds.
My noble friend Lord Eatwell and the noble Lord, Lord Vaux of Harrowden, also asked about the scope of the Bill not being limited to small banks. The expectation is that the mechanism would generally be used to support the resolution of small banks. However, the Government consider it appropriate for the mechanism, in principle, to be applicable to any banking institution within scope of the resolution regime. This would give the Bank of England, in consultation with the relevant authorities, the flexibility to respond as circumstances required.
My noble friend also suggested that the regime does not protect against systemic risk and is dependent on a buyer to work. It is worth noting that the resolution regime includes an expansive set of powers designed to equip the Bank of England with the tools to manage systemic risks and to limit contagion across the financial system. As well as the powers to transfer a failing firm to a buyer, this toolkit also includes the bail-in power. As part of this power, the largest and most systemic banks are required to hold additional equity and debt to absorb losses and self-insure against their own failure.
In the event that these banks fail, the Bank of England can use these additional resources to recapitalise the firm, including by converting the additional debt into equity and turning those creditors into shareholders. This would allow the failed bank to continue as a going concern without necessarily relying on a buyer, thereby stabilising it sufficiently to give it time to restructure and address the issues that led to its failure.
Equally, the Bill will ensure the Bank of England’s toolkit to manage systemic risk is robust by ensuring that the Bank of England is able to mitigate risks of contagion that may arise from the failure of a smaller bank, including in situations where a buyer is not forthcoming.
My noble friend also queried the point of comparison in the cost-benefit analysis published by the Government on 19 July. One principle of the resolution regime, as it has operated to date, is a presumption that shareholders and creditors will be required to meet the costs of bank failure. This is why the largest and most systemic banks are now required to hold additional equity in debt: to absorb losses and self-insure against their own failure. For banks that are not required to hold additional equity and debt, the Bank of England’s preferred strategy for managing their failure is insolvency. The Bill would make an alternative source of funds available, such that resolution powers may be considered for small banks that would otherwise be expected to be placed into insolvency. I will look further into the points that he raises, but the Government therefore maintain that insolvency is the correct counterfactual and the right point of comparison with the new mechanism, and they stand behind the analysis that they have published.
The noble Lord, Lord Vaux of Harrowden, asked about costs of the industry being taken into account. There are a number of important safeguards in the regime. The Bank of England must consult with the PRA when considering resolution action. The PRA, in turn, sets a cap on what is considered affordable for the sector to be levied per year. The PRA will continue to have this role under the new mechanism. In addition, the Government intend to update the special resolution regime code of practice to provide greater clarity about how the Bank of England will take account of the costs to the Financial Services Compensation Scheme when considering whether to use the new mechanism in its assessment of the resolution, conditions and objectives.
The noble Lord, Lord Vaux of Harrowden, asked about the deal for buyers coming on the back of industry. The Bank of England will be responsible for determining whether resolution is in the public interest, including transfer to another firm. The new mechanism introduced by the Bill ensures that where there is no willing buyer, absent recapitalisation the taxpayer is not responsible for meeting the costs of recapitalisation. As now, the expectation is that usually any sale will be achieved by an auction process.
The noble Lord also asked about subsidiaries. It is possible that the parent company may be able to recapitalise its subsidiary outside of resolution, but there may be circumstances in which this is not possible, as was the case with SVB UK. It is important that the Bank of England has the necessary tools to deal with a failing firm, regardless of its home jurisdiction.
The noble Lord, Lord Vaux of Harrowden, also asked about levy affordability. In line with its safety and soundness objective, the PRA carefully considers the affordability of the Financial Services Compensation Scheme levy for firms. The Government are therefore confident that any levies imposed as a result of this mechanism will be set at a level that is affordable for firms.
On the noble Lord’s point about letting shareholders and creditors of the failed bank off the hook vis-à-vis other, larger banks that have to meet these rules in resolution, Sections 6A and 6B of the Banking Act 2009 require the Bank of England to ensure that shareholders and creditors bear losses when a banking institution fails. This is an important principle that will continue to apply when the new mechanism is used. This involves cancelling, diluting or transferring common shares so that shareholders are the first to bear losses.
The noble Lord, Lord Vaux, also asked about the flowback to the Financial Services Compensation Scheme. Any money requested by the Bank of England but not expended would be returned to the FSCS. Any money that the Bank of England recovers through the sale of the firm in resolution, or through its winding up, would also be returned to the FSCS up to the amount of the original payment.
Finally, the noble Lord asked whether taxpayers should pay. It is not right to presume that government should pay for resolution. The Bill rightly follows the approach taken in insolvency: the costs fall to industry. I hope I have covered all his points. If not, I shall write to him.
The noble Lord, Lord Sikka, asked about letting firms fail to impose market discipline. The failure of Silicon Valley Bank UK showed there may be some cases where it is in the public interest for the Bank of England to intervene in a small bank failure if doing so mitigates the risk of systemic impacts. However, insolvency remains an important part of the toolkit. It is important to know that any use of the transfer tools in their resolution regime would entail the writedown of regulatory capital. This would impose losses on shareholders and creditors of the firm and is an important means of maintaining market discipline.
The noble Lord, Lord Sikka, also asked about interaction with the corporation tax cap. This Government have been clear about their mission to boost growth; it is vital that the tax system support this. The Chancellor’s commitment on tax was set out in the manifesto. We keep all tax under review, and the Chancellor makes tax policy announcements only at fiscal events in the context of the public finances.
I am grateful to the noble Baroness, Lady Kramer, for her support for the Bill. She raised a number of questions about the ring-fencing exemptions. She specifically raised points about the circumstances surrounding the failure of SVB UK and the decision to provide HSBC with an exemption to the ring-fencing rules. As I alluded to in my opening remarks, this exemption was deemed crucial to ensuring that the sale of SVB UK could proceed. The success of the transaction was necessary to protect SVB UK depositors and the taxpayers, but it did not set a precedent. As I stated earlier, the resolution of SVB UK presented an exceptional set of circumstances that required an exceptional response, recognised by noble Lords across this House at the time.
I recognise the noble Baroness’s important point about ensuring that any resolution action is subject to appropriate scrutiny. That is why the Government have committed in their consultation response to updating their code of practice regarding reports. The Bank of England is already required to submit to the Chancellor to lay before Parliament in the event that this new mechanism is used. We will develop those amendments to the code of practice in due course and consult with the Treasury’s banking liaison panel, which advises on the resolution regime on the precise scope of its content. The noble Baroness invited me to write to her, so if I have not covered all her questions here, I absolutely will in a letter.
The noble Baroness also asked whether the Government are committed to the bail-in procedure. Bail-in is a crucial part of the toolkit for resolving the largest, most systemic banks. There is international consensus behind this.
The noble Baronesses, Lady Kramer and Lady Penn, asked about the impact on medium-sized MREL banks and what consideration the Government have given to the impact on medium-sized banks, which are required to meet their own requirements to hold equity and for debt to be bailed in, known otherwise as MREL, as well as to contribute to the costs of this new mechanism.
The Government recognise the important contribution made by challenger banks and note concerns raised during consultation about the broader policy surrounding MREL. MREL policy is set by the Bank of England, as set out in the Government’s consultation response. The Bank of England will reflect on the feedback raised during consultation and consider whether changes are warranted to its approach to setting MREL policy.
Notwithstanding that, I emphasise the Government’s belief that the funding approach set out in the Bill is targeted and proportionate, ensuring that the banking sector pays only when it needs to, avoiding a new set of upfront costs. The Government have concluded that the entire banking sector, including medium-sized banks, stands to benefit from the new mechanism through the protection of financial stability and the reduced risk of contagion. It will also contribute to ensuring that the UK retains a robust and world-leading resolution regime.
The noble Baroness, Lady Kramer, asked about the new mechanism applying only to small banks without MREL. I think I covered that in my previous answer.
I am grateful to the noble Baroness, Lady Penn, for her support for the Bill. As she says, its origins were cross-party, and I am grateful for her continued support. She raised the issue of using resolution procedure versus insolvency, which the noble Baroness, Lady Kramer, also asked about. Both noble Baronesses asked about the extent to which resolution will be used instead of insolvency, and for an example of where insolvency will be preferred over the new mechanism. I should reiterate that the bank insolvency procedure will remain a vital part of the toolkit and a preferred strategy in the event of many firm failures, and I stress that the Bill is not designed to replace the bank insolvency procedure; it is designed instead to expand the Bank of England’s options when faced with a small bank failure.
Whether to put a failing firm into a resolution is ultimately a decision for the Bank of England in its capacity as resolution authority. It will decide this based on an assessment of the resolution conditions, and in particular on the basis of whether it is in the public interest at the time. It will make this judgment in advancement of the statutory resolution objectives, including to protect financial stability and public funds. Therefore, if the Bank of England judges that the resolution conditions and public interest test for resolution would not be met for a specific bank, it would seek to place that bank into insolvency. That might be for a range of reasons but could include, as an example, a judgment by the Bank of England that the bank’s failure would not have systemic implications for the financial system or create significant disruption for customers.
The noble Baroness, Lady Penn, also asked about the accountability and for an update to the code of practice, and she asked to see the proposed updates to the special resolution regime code of practice alongside this legislation. I am happy to share a draft of the proposed updates with your Lordships at the earliest opportunity, and I can write to the noble Baroness once they are available. I note that the final wording of any proposed updates would be subject to review by a cross-section of representatives from the authorities and industry on the statutory Banking Liaison Panel, which advises the Treasury on the resolution regime, and of course on the final content of the Bill.
The Government’s consultation response noted that the Government anticipate that any reports required under the Banking Act to ensure ex-post scrutiny of the Bank of England’s actions when using the new mechanism would be made public and laid before Parliament as required. I am happy to state that the strong expectation is that such reports required under the Banking Act would be made public and laid before Parliament, and in many cases this is already required by statute.
The noble Baroness asked me to elaborate on where the Banking Act requires such reports to be laid before Parliament and where it does not. Section 80 of the Banking Act requires the Bank of England to report to the Chancellor of the Exchequer on the activities of a bridge bank as soon as reasonably practicable after each year of its existence, and for any such reports to be laid before Parliament. That reflects the fact that use of the bridge bank tool can have a wide range of implications that will likely be of interest and of concern to Parliament, notably the risks that using the tool could carry to public funds.
Section 80A imposes the same requirement to report to Parliament when the Bank of England exercises the bail-in tool. Section 79A of the Banking Act imposes a similar requirement on the Bank of England in relation to the use of the private sector purchaser tool, although there is no requirement for a report under this section to be laid before Parliament.
As I said in my earlier remarks, I can reassure your Lordships that in any event where the new mechanism was used the Treasury would intend to ensure that any such reports were made available to Parliament and the public unless there were clear public interest grounds for not doing so, such as issues of commercial confidentiality.
Since the global financial crisis, resolution policy has been developed as a key means of managing the risks that arise when banks fail. Although that regime has worked well in practice, it is important to learn the lessons from last year’s period of banking sector volatility. This targeted set of enhancements is a key part of the policy response and provides the Bank of England with a more flexible toolkit to respond to the failure of small banks. The Bill recognises that there should be protections for public funds and taxpayers’ money when a banking institution fails. It is a narrow and uncontroversial Bill and has been drafted with the aim of achieving its primary objectives while minimising financial and regulatory burdens on the sector.
The Government have listened to feedback from industry and designed their policy accordingly, ensuring that there is a carve-out for credit unions from the requirement to contribute towards levies for these purposes. The Bill is an important component in ensuring the economic and financial stability that will deliver economic growth.
Bank failures are highly unpredictable and can come about at short notice without warning, so it is right that the Government introduce this Bill now to enhance the resolution toolkit and protect public funds. I hope that your Lordships will recognise the merits of this Bill and are able to support it.
Lord Moylan (Con)
Before the noble Lord sits down, unless I missed it, I did not hear him give an answer to my question about whether the Bank of England will be able to recoup legal costs from the funds charged to the Financial Services Compensation Scheme or merely the reimbursement of the recapitalisation costs that would of course go into the bank. If he is not able to answer today, he may wish to write.
Lord Livermore (Lab)
I did endeavour to answer quite a lot of the noble Lord’s questions. On that one, I will write to him.
Bank Resolution (Recapitalisation) Bill [HL]
Thursday 5th September 2024
(2 months, 2 weeks ago)
Grand CommitteeRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text Read Debate Ministerial Extracts Amendment Paper: HL Bill 2-I Marshalled list for Grand Committee - (3 Sep 2024)
Member’s explanatory statement
This amendment seeks to ensure that the bill applies primarily to smaller banks, using Minimum Requirement for Own Funds and Eligible Liabilities (MREL) as a definition.
Baroness Bowles of Berkhamsted (LD)
My Lords, I am pleased to open the Committee stage of this Bill. I expect this to be the only longish speech that I will make, so noble Lords should not worry about getting six of this length.
I have two amendments in this group but, first, for the benefit of anybody following these discussions either now or later, I shall mention the scope issue that has reared its head for several noble Lords in trying to formulate amendments. The Long Title, which defines scope, is:
“A Bill to make provision about recapitalisation costs in relation to the special resolution regime under the Banking Act 2009”.
The Bill’s provisions have effects that reach into resolution decisions, bail-in and capital structures, but various amendments’ attempts to take that into account in other relevant ways have been ruled out of scope. Indeed, in the light of this amendment-drafting experience, I wonder whether all the bits of the Bill pass the scope test; that may become clearer as we work through the amendments, in particular my Amendment 22 in this group and Amendment 23 in the final group.
I turn to my Amendment 1 and the similar amendments in the rest of the group. They have a common theme: making sure that the provisions really are limited in application to small or smaller banks, which is what we have been told they are about following on from the actions taken for Silicon Valley Bank. However, there is no such small bank limitation in the Bill. Clearly, the question arises: how small is “small or smaller”? Like other noble Lords, I have taken the view that the only clear distinction is for non-systemic banks—that is, those required to hold MREL, bail-in bonds or whatever you wish to call them, which represent the only regulatory division we have.
Of course, as raised by me and others at Second Reading, we then have the issue that the PRA has extended the MREL requirements far lower down the bank size range than systemic banks, well into the “smaller bank” range. This may well be the reason that there is no differentiation in the Bill: so that, in theory, the Bill applies to any bank and everything rests on the Bank of England’s decision. It seems that the majority of us here disagree with that and think that it should be limited by a defined measure; the obvious one is the level at which MREL is required. If the PRA causes the resolution provisions to be impeded by its MREL choices, that will be something for it and the Bank of England to consider and live with.
My Amendment 1 has another little tweak, in which I suggest that the cutoff is linked to the index-linked value of the net assets at which MREL was originally set in 2016: £15 billion. In numbers, that would mean the size now would be £22 billion if it were index linked, not £15 billion, and it would not continue to dwindle, relatively speaking, as is happening with the PRA MREL threshold. My amendment therefore overlaps with regimes that can do bail-in, although my real hope, as I have already suggested, is to make the PRA see that, for various good reasons, it should increase the MREL threshold at least by indexation, and ideally to the level where it applies only to banks that have full capital market access, so that bail-in instruments are not disproportionately expensive for them. However, if we want to coalesce around MREL as the dividing line, I am not going to rock the boat. Indeed, I tabled an amendment to that effect, but it got lost somewhere. I think the Bill Office thought that my other amendment was an amendment to my amendment.
I turn to my Amendment 22. This deletes Clause 4(3), which is not needed in the event that there is limitation to application only to non-MREL banks. I will explain how I came to that conclusion. The subsection references Section 12AA of the Banking Act 2009, which in turn references Article 47.3(b) and (c) of the EU’s Resolution and Recovery directive. Most compliance with EU directives has been put into the 2009 Act.
I happen to think, especially nowadays, that it would be much better to say more clearly what we actually meant in Clause 4(3) than to have to pedal all the way back to a European directive. I have another amendment on it, Amendment 23, right at the end of our considerations next week. I will let noble Lords know what it is all about. Article 47.3(b) of BRRD is the amount by which the authorities assess that common equity tier 1 items must be reduced to the relevant capital instruments written down or converted, pursuant to Article 61. The latter gives the order of writing down priority. Article 47.3(c) is the aggregate amount assessed by the resolution authority, pursuant to Article 46. To save noble Lords the misery of me reading out Article 46, it is the sum of write-down and recapitalisation.
To cut this long story short, the subsection refers to things that happen only when you are in a bail-in situation. So, if we limit it to non-MREL banks, it would seem to be superfluous, because there cannot be any bail-in as they are not required to hold MREL. Of course, if we use my Amendment 1 with the index threshold of MREL, we might need it or need to rewrite it.
However, thinking about it further, I also query whether this subsection is properly in scope as it seems to relate to changing bail-in requirements and not to recapitalisation. That is made clear in the Explanatory Notes, which state that Clause 4(3) basically amends the bail-in sequence and conversion of capital instruments to allow adjustment to the contribution of shareholders and creditors when exercising the bail-in write-down tool. We should bear in mind that there are other parts of legislation that tell you the sequence in which you must do one, and how you exhaust the first before you move on to the next, and all those kinds of measures.
The end result that it has a knock-on effect of increasing recapitalisation costs that are then to be met by the FSCS. As I said, that seems to depart from what I envisaged was the purpose of the Bill. I did not have in my mind that it was about levying banks to help rescue shareholders or bail-in bond holders of another bank. I understood that it would be more like the Silicon Valley Bank rescue, where the point would be to rescue unprotected depositors.
Overall, we can do without this clause in all circumstances and I wait to hear the Minister’s explanation. It would be useful, before we get to Report, if we could have some kind of laid-out worked examples of where this might come in and what might happen. I understand why the Government wish for flexibility but it is a flexibility that goes way beyond what I have understood to be the intents of the Bill. I beg to move.
Baroness Noakes (Con)
My Lords, I have Amendment 5 in this group, to which I will speak. I regret that I was unable to take part at Second Reading in July, but I have read the Hansard report of the debate and I can see that there is a lot of common ground on the Bill between those of us not on the Government Benches.
As this is the first time that I have spoken in Committee, I draw attention to my interests as recorded in the register of interests, in particular that I hold shares in banks which, under the terms of the Bill, will end up footing the bill if the bank recapitalisation power is used.
My Amendment 5 is slightly different from Amendment 1 in the name of the noble Baroness, Lady Bowles, and slightly different from Amendments 8, 10, 12 and 18 in the names of other noble Lords. Those amendments basically seek to confine the use of this power to small banks—typically using MREL as the deciding point. Mine does not rule out using the power for larger banks but instead inserts the requirement for Treasury consent.
The Government clearly sold this legislation, as the noble Baroness, Lady Bowles, explained, as being about smaller banks, referring to it as being a better route for a better outcome compared to using the bank insolvency procedure, which is the current default assumption for smaller banks. As is often the case with legislation, however, the stated aim then gets converted into a very broad power. This power is so broad that if the RBS failure happened again it could cover the recapitalisation of RBS, which, I remind noble Lords, cost £45.5 billion in 2008. The Bank would have that power with nothing in the Bill to prevent it.
There is a constraint on the amount of annual FSCS payments set by the PRA, which I think is £1.5 billion a year, but that can be changed by the PRA at any time, and the PRA is not, of course, independent of the Bank of England; it is fully part of it.
I am not surprised that the Treasury does not want to narrow the drafting of the Bill to cover only those banks that do not have MREL. The Government have themselves talked about wanting to cover the case where MREL has been set but the banks are on a glide path and have not yet achieved the full amount of their MREL. It seems reasonable for the power to be used in those circumstances, but the Government have not even offered to amend the Bill to confine it in that way.
I broadly accept that there may be a good case for using recapitalisation schemes beyond non-MREL banks or those that have not yet raised their full amount of MREL, because it is genuinely difficult to predict circumstances where such a power would be extremely useful. However, when the Government draft broad and unconstrained powers, they have a duty to put checks and balances in place, and there are none in the Bill. If they do not put checks and balances in place, we must take that on as part of our duties in scrutinising legislation. My amendment has opted for Treasury consent, but there could well be better ways of putting guard rails in place. Treasury consent is not an onerous requirement when the Bank of England is handling a potential bank failure. It inevitably works closely with the Treasury; the Treasury has to be consulted whenever a stabilisation power is used, and we should be in no doubt that when, for example, SVB UK was in trouble, the Treasury was intimately involved in the arrangements to deal with HSBC very rapidly. Therefore, obtaining Treasury consent need not cause a delay or any other real problems.
Lord Vaux of Harrowden (CB)
My Lords, as we have heard, this group of amendments, including my Amendment 10, probes the reasons for including all banks in the scope of the Bill, rather than just the smaller banks, as originally envisaged in the consultation that started in January. The first sentence of the consultation was very clear:
“This consultation sets out the government’s intention to enhance and keep up to date the UK’s Special Resolution Regime … providing a new mechanism to facilitate use of certain existing stabilisation powers to manage the failure of small banks”.
But, as we have heard, it is not restricted to small banks. Most of the amendments in this group would remove from the scope of the Bill those banks that are required to hold MREL and would be subject to bail-in procedures using those MREL resources. I think the number of separate but similar amendments that we seem to have is probably down to the fact that this all happened in recess, and we did not have the opportunity to get together. I am sure that if the Minister is not able to satisfy us, we will be able to coalesce around something in common.
It is worth quoting from paragraph 7 of the Explanatory Notes:
“This means taxpayers are exposed if a small bank failure is judged to require resolution action but the firm in question does not possess sufficient MREL resources to provide for recapitalisation, unlike larger banks that do possess these resources”.
If larger banks possess those resources, as they are required to do, why do we need them to be subject to the process envisaged by the Bill? The noble Baroness, Lady Noakes, talked about the glide path situation where a bank has not quite got there—yes, I see that point—but for those that are there, does this not imply that we are not confident that the existing MREL scheme is sufficient? If there is a problem with the MREL scheme, surely it would be better to fix that rather than adding a new process on top of it.
So could the noble Lord please clarify under exactly which circumstances he sees the recapitalisation process in the Bill being used for a failing MREL bank? Is there a concern that the MREL resources are insufficient? Other than glide path situations, that is the only logical reason I can see to include big banks in the scope of the Bill.
Secondly, not having the expertise of the noble Baroness, Lady Bowles, I do not really understand how the two processes would work together. Is this an either/or situation; is it either a bail-in using MREL resources or a recapitalisation? If that is the case, surely there is a risk that the industry would be required to fund the recapitalisation of banks with large balance sheets instead of the costs being borne by the failed bank’s shareholders and subordinated debt holders. That would create a potential moral hazard. Or is it a combined process where the MREL resources would be used first and, if insufficient, the recapitalisation would follow on top? If that is the case, it implies that there is a concern that the MREL funds are insufficient. The best way forward would be to fix that problem rather than add another process, as I said before.
So could the noble Lord please clearly explain how he sees the two processes working together? I am drawn to the suggestion by the noble Baroness, Lady Bowles, of a worked example between now and Report to help us see how that could work. In particular, can he clearly confirm that the recapitalisation process can never be used to reduce the losses of a failing bank’s shareholders or creditors?
In the absence of a strong explanation of why, contrary to the originally stated intention, the scope of the Bill has been extended to larger banks, I would be minded to support amendments on Report that restrict its scope to exclude MREL banks.
Lord Eatwell (Lab)
My Lords, my Amendment 11 also—I think rather neatly—confines the Bill to what are defined as small banks. However, my concern is somewhat different from those voiced by noble Lords until now. It is that the whole approach to the resolution regime suggests that banks fail one at a time and not all together. Anyone who went through the experience of 2007 to 2009 knows that, in a systemic crisis, it is possible for all the banks in the country to be suffering major problems at the same time. In the circumstances of a systemic crisis, I fear that the mechanism proposed in the Bill could be a source of contagion, in the sense that the cost of the collapse of a bank, or of many banks together, would be seen by the market as imposing costs, which are now unbearable, on other parts of the banking sector.
This comes down to two issues—that of contagion and, I am afraid, that of persistent complacency. The Treasury and the Bank of England refuse to face up to the fact that, in the end, it is the taxpayer who will pay in a systemic crisis.
I will deal first with contagion. The levy links the financial failure of a bank or number of banks to the banking sector as a whole. Does this create a contagion effect? It must be remembered that much of contagion is created by the expectation of a cost, not just the reality. Expectation then becomes the parent of reality. It can reasonably be expected that the failure of a small bank would be manageable under the resolution regimes set out by the Bank of England and discussed in this Bill and its explanatory documents.
However, there are two fundamental problems where one could have significant contagion. One would be multiple failures, an issue I will address in a moment. The other is the potential failure of a big bank, because the Bill and the Explanatory Notes explicitly refer these mechanisms to big banks as well as small ones.
I will take the issue of the failure of multiple banks or a big bank. I wrote to the Financial Secretary about this and he very kindly wrote back a very valuable explanation. I presume that his letter has been circulated to the people who took part—no, I see that it has not. Well, I will quote a bit of it, because it seems to reveal the problem that I am identifying. He refers to multiple bank failures, but I would apply the same thing to a big bank failure. He says that there will be levies when the bank fails and adds:
“These levies are subject to an affordability cap”—
I did not know that—
“by the Prudential Regulation Authority based on how much the sector can safely be levied in a given year. This cap is currently set at £1.5 billion. If multiple firm failures resulting in a recapitalisation requirement is under £1.5 billion, the Government would expect the FSCS to borrow from its commercial borrowing facility and be able to safely levy from the banking sector and repay that commercial borrowing within 12 months. However, if the amount exceeds £1.5 billion, or if it is below £1.5 billion and the PRA has determined that the FSCS is unable to raise the levy on affordability grounds, the Government would expect levies to repay any borrowing from the National Loans Fund to be spread out over multiple years”.
But, no, you do not have multiple years in a systemic banking crisis; you have to operate now.
The cap of £1.5 billion is worth comparing with the measures that the Government had to take in 2007-08—Lloyds Bank, £20 billion and NatWest, £45 billion. So the failure of one of those banks could be somewhat above the affordability cap, as set out in the Financial Secretary’s letter to me. Indeed, today, those numbers could be multiplied by a factor of roughly five.
Even when MREL is taken into account, the £1.5 billion cap seems to me to expose the fact that this scheme is not applicable to large banks. For example, if we look at the largest MREL plus required capital, it is that of Barclays, which is 30% of risk weighted assets—the largest of all the major banks. That leaves 70% of risk weighted assets to which the taxpayer is exposed. There would not be a collapse of all of those, but there can be very large numbers very quickly. So the idea that with an affordability cap of £1.5 billion, one could handle the Lloyds Bank situation or the NatWest situation as the Government confronted them in 2007-08 is, it seems to me, fanciful.
This brings me to my final related point. There is a persistent reluctance in all the documents concerning the resolution regime to admit that the resolution of a large bank will always fall on the taxpayer. Given the need for the maintenance of confidence in the banking sector, this persistent reluctance and the pretence that MREL has eliminated the taxpayer from exposure is damaging to confidence. It would be valuable for the Purple Book to make clear that, in extremis, Bagehot’s rule comes into effect, the Bank lends without limit and the Treasury will step in to resolve those banks that are “too big to fail”. My amendment clears away a dangerous ambiguity in the Bill. The threat of multiple small failure will continue to exist, but it takes away the ambiguity that this could be involved in the resolution of a big bank in the circumstances of a systemic crisis similar to that which we have faced in the past.
Baroness Vere of Norbiton (Con)
My Lords, it is a great pleasure to be back in this Room—sadly, standing on this side. Nevertheless, it is an interesting experience being in opposition and doing my first Committee—a learning experience. I am grateful to all noble Lords who have participated in scrutinising the Bill. I recognise that we are at the beginning of the Session and sometimes it takes a while for things to get into place. There has been quite a lot of work done and I think we have made some very good progress. I, too, did not speak on Second Reading, and I blame that entirely on the Prime Minister, because he extended Parliament and I was already on holiday, so therefore I could not do that. I am very grateful and put on record my thanks to my colleague, my noble friend Lady Penn, who did it in my stead.
The Bill was originally developed by the previous Government and was waiting for parliamentary time, so I think my role today is to test the thinking of the new Government to make sure that they are still on the same page. I am very grateful to the noble Baroness, Lady Bowles, for kicking off this debate so eloquently and knowledgeably. I note her concerns about the scope of the Bill. I would love to say that she did not slightly lose me, but she did, so I will come back to that if it seems to be a problem that we need to look at.
I want to go back—to be helpful, possibly to me—to first principles on this. Having listened to the contributions that have gone before me, I think I have got it right that there are three groups of financial institutions. I am going to call them “banks”, because “financial institutions” is long and it takes a while to get my tongue around.
The first group are the MREL—the big eight banks. These are the ones that have been directed by the Bank of England to hold MREL, and they must also submit a resolvability assessment framework, or RAF, to regulators. The RAF is structured so that these firms can think about how their business works and what capabilities they need to achieve the three resolvability outcomes: having adequate financial resources; being able to continue business through resolution restructuring; and effective communication and co-ordination.
I read somewhere that the 2024 assessment of these documents was due to be published in September, and I should like an update as to whether it has been published. Can the Minister comment on the outcomes of this scrutiny: is the system working? I understand that one bank was not quite there yet. Let us see whether we are going to try to exclude the largest banks from the scheme or whether we follow the suggestion of my noble friend Lady Noakes of getting the involvement of the Treasury. We need to test whether those banks which are deemed too big to fail have a coherent and funded plan in place should they get into financial difficulty. If that were the case, there would be some argument for potentially excluding them from the Bill, but there should at least be some safeguards in place.
Then there is the second group. This was raised with me by UK Finance, and this is why my amendment is slightly different to those of other people. There are those banks in the second group that are on the glide path to full MREL status. These institutions will get there, but it would be helpful to get an update from the Minister as to how many institutions make up this second group so that we can consider further whether there is a substantial risk and where that risk might reasonably lie—and so how long they will take to reach their destination.
Finally, there is the third group. These are the important ones. They are the ones that the Bill should be focused on. These are the smaller banks, and they are often innovative, they are often very high growth and sometimes that in itself can lead to challenges. It is these banks that the Bill seeks to target. Indeed, it was my understanding, as it was that of the noble Lord, Lord Vaux, that they would exclusively benefit from this scheme.
If things start to go awry, due to either a business-specific issue or wider market turmoil, these proposed powers would create this mechanism where the banking sector itself, in its entirety—all three groups—would fund the recapitalisation of the relevant bank or banks, and the taxpayer would be relieved of that burden. So that all makes perfect sense to me.
Then we come to the reasonable worst-case scenario, which I think is what the noble Lord, Lord Eatwell, was referring to. It is not beyond our imagination that things could get very bad very quickly, with a number of small or even medium-sized banks getting into trouble at the same time. The first group would, I hope, have their MREL in place; they would have their plan, which has been approved by the regulators to make sure that they continue.
I am slightly less clear what would happen to the second group—those on the glide path to MREL—were there to be a market-wide event. These are significant institutions and if they are to be included in this mechanism, we get into issues of how the banking sector then repays that through the levy, which I will come on to. There might well be a situation where one, two or more quite substantial institutions need recapitalisation from the FSCS in the same financial year. Have the Minister’s officials done any sort of assessment of how bad that could possibly get and any thinking about what the plan would be if it were to get that bad? Also, what would the hurdle be for declaring this sort of state of emergency?
While the FSCS might have a looming potential liability from the second group, there is also the third group to be considered. These ones are the potential future lifeblood of our financial sector in the United Kingdom and they would most likely need a relatively small amount of recapitalisation funding to get them through the turmoil. This is why parity is needed around the applicability of the scheme proposed in the Bill, but also the circumstances in which the scheme would reasonably and rationally be used—and, frankly, the circumstances in which it would not be, because it would just not work. In a reasonable worst-case scenario, how is anyone going to decide which ones get saved and which do not? One has to rely upon the amount of funding that could be affordable over several years of a levy applied to the UK banking sector, but that is not going to be enough money. How would that resolve itself and what would that process look like?
As mentioned by the noble Lord, Lord Eatwell, which I picked up in one of the briefings as well, the FSCS will have significant powers to apply the levy, not only in the financial year when the event or events take place but in subsequent financial years. If I am in the UK banking sector and things have gone pretty bad, and I suddenly have this massive weight of a levy going over several years to repay the events of one financial year, that to me is concerning.
It is also concerning because, of course, things are done differently in the EU, so you would get a slight mismatch from a competitiveness perspective. I would be worried about that. Has the Minister done an assessment of the impact of this potential multiyear hit, once we have an idea of the reasonable size and then the potential maximum size? Has he assessed the competitiveness of the UK banking sector, should this multiyear levy suddenly be required? How much could the UK’s system cost our banking sector and over what period of time? Are there circumstances, and in which circumstances, when rationally there is a systemic failure and the only person who could step in would be the taxpayer? I do not want the taxpayer to step in, trust me, but that would prevent permanent damage to one of our most important sectors.
The other key consideration is the impact on the FSCS and its ability to meet its obligations under the deposit guarantee insurance scheme, because if that has all gone to recapitalisation funding, there will be nothing left. I believe we will come on to that later in Committee.
This is a range of thoughtful amendments tabled by noble Lords and I am grateful for them. As many noble Lords pointed out, they very much go along the same sorts of lines. I look forward to hearing the Minister’s response to them. I will not go into a great amount of detail on them, but I note that my Amendment 8 takes into account those on the glide path, which we need to recognise. I am grateful to the noble Baroness, Lady Bowles, for the fine case she made for Amendment 22; I will move quickly on from that.
That brings me to the remaining amendment in the group: Amendment 18, which is in my name. Here, in essence, I am probing whether the Minister is content with the current imbalance between the banks liable to pay the levy versus the ones that, realistically, will make use of the new powers. Does he feel it is fair that the entire banking sector pays to recapitalise what, I feel, the Committee hopes will be smaller banks only? Does he accept and is he comfortable with the largest banks paying twice, in essence—particularly as they will have to have limited or no input in or influence on many of the events that might cause a resolution event or events? These largest banks will pay twice: once for their MREL and associated requirements, and again in the event of a resolution event or events of which they would not be able to take advantage.
Context is important here. We will come back to costs again but banks already pay a plethora of taxes, levies and charges, both to regulators and directly to Treasury funds. There is the bank levy, the bank corporation tax surcharge, the economic crime levy, the FSCS levy and the FCA/PRA fees. That is a lot—and let us recall that these costs are never borne by the banks themselves; they will always be borne by the businesses and consumers who use them.
The Financial Secretary to the Treasury (Lord Livermore) (Lab)
My Lords, I am grateful to all noble Lords for taking part in this debate on the first group of amendments. I note that the scope of the mechanism is a key and central issue, both for noble Lords and for the wider banking sector. I hope to offer some reassurance to the noble Baroness, Lady Bowles, and other noble Lords regarding this concern.
I start by addressing Amendment 1, tabled by the noble Baroness, Lady Bowles, which would prevent a recapitalisation payment involving a bank that has issued minimum requirements for own funds and eligible liabilities, otherwise known as MREL. I stress that the Government’s strong policy intention is for the mechanism provided by the Bill to be used primarily to support the resolution of small banks. The Government therefore do not generally expect the mechanism set out in this Bill to be used on the type of firms that these amendments would seek to exclude.
The principal issue here is whether that intention should be set out in the Bill. The Government’s considered view is that it is right for the Bill to contain some flexibility for the Bank of England to be able to use the mechanism more broadly in some circumstances. That is because firm failures can be unpredictable and there could be circumstances in which it would be appropriate to use the mechanism on such firms.
For example, this may be relevant in situations where a small bank has grown but is still in the process of reaching its end-state MREL requirements. Firms in this position would have at least some MREL resources to support recapitalisation but the new mechanism could be used to meet any remaining shortfall if judged necessary. Without the proposed mechanism, there would be a potential gap in this scenario, creating risks to public funds and financial stability.
Ultimately, the decision to use the mechanism would rest with the Bank of England, having assessed the resolution conditions. The Bank of England is required by statute to consult the Treasury before any use of resolution tools, providing an effective and legally binding window for the Treasury to raise concerns if it had any.
I also point out that, during the Government’s consultation period, more respondents were in favour of the scope set out in the Bill than opposed. I appreciate noble Lords’ concerns about this issue and am happy to commit to exploring how to provide further reassurance on the Government’s intent via the code of practice.
The noble Baroness, Lady Bowles, asked whether the Bank of England should reduce MREL requirements in the knowledge that it could instead use FSCS funds. The Bank of England sets MREL requirements independently of government but within a framework set out in legislation. Any changes to firms’ MREL requirements would therefore be a decision for the Bank of England. The Bank of England will consider, in the light of this Bill and wider developments, whether any changes to its approach to MREL would be appropriate.
I turn briefly to Amendment 8, tabled by the noble Baroness, Lady Vere, which similarly aims to exclude from the new mechanism those firms that are required to hold MREL. I hope that I have already fully responded to her concerns in that regard; the Government are clear that this Bill is primarily intended for small banks, but that it is right to retain flexibility.
Lord Vaux of Harrowden (CB)
Just to clarify, is there anything in the Bill that changes the effect on shareholders and creditors compared with if it had been done by just the bail-in approach?
Baroness Bowles of Berkhamsted (LD)
I know that the notes have no effect, but those regarding Clause 4(3) say that it
“amends section 12AA … to allow the Bank to take into account the funds provided by the FSCS when they are calculating the contribution of shareholders and creditors required when exercising the bail-in write-down tool”.
That says that you will be able, and consider it positive, to adjust the contribution of shareholders. That is because you are using incoming capital. I think that the shareholders and bail-inable creditors should be written down as they are supposed to be, then, when you still do not have enough money for capitalisation, there is the money from the Financial Services Compensation Scheme. I understood that and have no problem with it, apart from the size issues. Saying no to the question just put by the noble Lord, Lord Vaux, contradicts what is written in paragraph 26 of the Explanatory Notes.
Lord Livermore (Lab)
It may be best if I write to noble Lords to clarify this point.
Amendment 11, tabled by the noble Lord, Lord Eatwell, would exclude from the scope of the new mechanism those firms whose MREL requirement exceeds their minimum capital requirement. This would include both firms expected to be transferred to a private sector purchaser and those bailed in when they fail.
I stress to the noble Lord, as I have to others, that the Government’s intention is for the mechanism to be used primarily for small banks. That is ultimately central to the Bill’s purpose, but I emphasise the importance of having flexibility in the legislation for the Bank of England’s ability to respond effectively in a crisis. As I have noted, this may, for example, be relevant if a firm is still in the process of building up its MREL requirements to be able to fully implement a bail-in strategy.
I also note the amendment from the noble Baroness, Lady Noakes, which intends to ensure that, if the Bank of England seeks to use the new mechanism on a bank required to hold bail-in liabilities, it must first get the consent of the Treasury.
I am conscious that there are other amendments related to the subject of Treasury approval for the use of the Bank of England’s powers and that we will turn to this matter more substantively later. What I will say now to the noble Baroness is that the Government consider it important for the Bank of England to be able to take decisions in a resolution independently and decisively.
I will mention two important safeguards. First, as required by statute, the Treasury will always be consulted as part of the Bank of England’s formal assessment of the resolution conditions. Secondly, if using the mechanism on larger banks had implications for public funds, such as requiring the use of the National Loans Fund, this would be subject to Treasury consent. But I repeat that the Government’s strong policy intention is ultimately for the mechanism to be used primarily on small banks.
Amendment 18 was tabled by the noble Baroness, Lady Vere. It seeks to clarify the rationale for the scope of financial institutions liable to pay the levy for the new mechanism delivered by the Bill, given the expectation that the new mechanism would apply primarily to small banks. The Government believe there to be benefits to mirroring the existing process for recouping the costs of paying out depositors in insolvency and maintaining a broad-based levy. In particular, as noted in the Government’s cost-benefit analysis, the exclusion of larger banks would raise concerns about the affordability of the levy for other banks, which would in turn increase risks to public funds and the overall viability of the new mechanism.
In addition, in cases where the new mechanism may be used, the counterfactual would be for the failed bank to enter insolvency. As a result, the sector would already be liable to contribute to the costs of a small bank failure. As set out in the Government’s cost-benefit analysis, while highly case-specific, the upfront costs of an insolvency are generally expected to be greater than those under the new mechanism delivered by the Bill. The Government therefore feel it is right to mirror the arrangements in place for an insolvency and to maintain a broad-based levy.
The noble Baroness asked about the Bank’s resolvability assessment framework. I am told that the latest update was published in August. She asked how many firms were on the glide path. I will write to her with specific details, and if any of her other questions are not answered in my speech today, I will write to her also on those points.
Baroness Vere of Norbiton (Con)
One concern was raised in the document that has been published, so I would be grateful for the Minister’s comments on that.
Lord Livermore (Lab)
I will write to the noble Baroness on that point.
I turn finally to Amendment 22 in this group, tabled by the noble Baroness, Lady Bowles, which concerns the use of the bail-in resolution tool. Section 12AA of the Banking Act 2009 sets out the principles by which the Bank of England calculates the shortfall amount when the bail-in tool is used and, as a consequence of that calculation, how much of a failed firm’s resources needs to be bailed in. The addition to Section 12AA in Clause 4, which this amendment seeks to prevent, ensures that any available funds from the Financial Services Compensation Scheme via the new mechanism could be taken into account when calculating the shortfall amount and, as a consequence, how much of a firm’s resources would need to be bailed in when the new mechanism is used alongside the bail-in tool.
This change to Section 12AA is important as there are some circumstances where bail-in may be the preferred tool for the Bank of England to use as a precursor to transfer of the firm to a bridge bank or private sector purchaser, even if the bank is small. This is because the bail-in tool permits the writing down of subordinated debt or other liabilities, to which mandatory reduction under the bridge bank or private sector purchaser tools does not apply. There may be circumstances in which it is appropriate to write down the subordinated debt or other liabilities of a small bank. The intention is therefore for the bail-in tool to be available alongside use of the new mechanism.
In such circumstances, this amendment would preclude the Bank of England, when calculating the shortfall amount, from being able to take into account any funds that were available from the Financial Services Compensation Scheme under the new mechanism. As a consequence, when determining how much of the firm’s subordinated debt and other liabilities should be bailed in, the Bank of England would be obliged not to factor in those external funds and would have to write down more of the firm’s resources than it needed to. In certain circumstances this would be undesirable and could undermine the wider goals of a resolution process. The noble Baroness, Lady Bowles, and the noble Lord, Lord Vaux, suggested worked examples. We will of course take that idea away for further consideration ahead of Report.
I hope that these explanations have been helpful and that I have provided some reassurance on these points. I will of course write where I have indicated that I will do so. In the circumstances, I hope that the noble Baroness will withdraw her amendment.
Baroness Noakes (Con)
My Lords, before the noble Baroness decides what to do with her lead amendment, I will raise two points. The first is that the noble Lord referred fairly briefly to the code of practice. Could he explain, first, how he sees the code of practice being used for the issues that we have identified in this group of amendments? Secondly, will he update the Committee on when we expect to see a revision to the code of practice? At Second Reading, my noble friend Lady Penn asked whether she could have sight of the draft updates. The noble Lord responded very positively to that, but clearly no draft updates have yet appeared. My additional question is: are we likely to get those draft updates? Clearly they have not arrived before Committee; will we get them ahead of Report? Seeing codes of practice, or updates of codes of practice, helps us to understand exactly what the Government are doing.
The second point I wish to address is a mechanical one. The noble Lord has already said he will write on a number of things; I expect he will say that quite a lot as we go through Committee. It would be very helpful if those letters were copied to all the Members who are taking part in Committee, or that the mechanism of “will write” letters on the publications page of the Parliament website is used promptly so that all noble Lords who have an interest in the areas get an opportunity to see the correspondence.
Lord Livermore (Lab)
On the noble Baroness’s first point, we are committed to updating the code of conduct, to doing so swiftly and to consulting with industry thoroughly on it. I cannot give her a timescale today. On the commitment to write letters, of course I will make sure those letters are copied to all noble Lords.
Baroness Bowles of Berkhamsted (LD)
I thank everybody who has spoken in this debate. Not surprisingly, we have had quite a lot of good points. I am still not reassured that the Bill’s scope is right. I understand entirely wanting to give the Bank of England flexibility. Ultimately, it is in the best place to judge what is the best thing to do, taking into account public interest, not setting off a systemic failure and all those kinds of things. At the same time, I have this instinctive dislike of something that enables the Bank to do something that I think it definitely should not be allowed to do, which I have said is in paragraph 26 of the Explanatory Notes. I will not repeat it.
I noticed, as the Minister spoke, that he very carefully said “primarily small banks” the whole time. There is this issue of “primarily” and where it stops. There could be other ways to include up to medium-sized banks. The code of practice could be one way of doing it, or a strategy, as the noble Lord, Lord Vaux, had as part of one of his amendments. I do not think it can be passed in this case which, as was said by the noble Lord, Lord Eatwell, could start a whole systemic issue. It is really built for the idiosyncratic case, or maybe for a couple of small banks, but that is it. It is basically about saving the uninsured depositors and people like that, in the public interest, rather than, as unfortunately it says, saving the shareholders and creditors. We have to look carefully at which creditors and at the definitions. I would like to see that laid out, because my reading is that, when we looked at the sections I quoted that date back to the BRRD, we looked at the bail-in things that happen in big banks, not at the other liabilities generally held by small banks. I might have got that wrong, but I would really like to see this properly laid out.
So I still have some issues. There needs to be something in the Bill that takes account of the concerns raised, however that is done. I can be flexible about it, but I think that my Amendment 23, when we get to it, would be one way to do it.
I am afraid that I will withdraw my amendment at this stage, but I expect to return afresh on Report. We have all been hampered by the fact that this has been a first-up Bill after vacations—and this will happen again on Report, when we will have been back for only one week. That makes it very difficult to have communications and meetings with the Minister.
The Deputy Speaker (Lord Haskel) (Lab)
My Lords, I have to inform the Committee that the annunciator will not be repaired until this evening. Apparently, there is a fault with a cable and the carpet has to be taken up to get to it. We will have to manage without the annunciator this afternoon.
Amendment 2
Baroness Noakes
Member’s explanatory statement
This amendment probes the nature of “other expenses” and the persons other than the Bank which could incur expenses.
Baroness Noakes (Con)
My Lords, Amendment 2 is a probing amendment. It would delete new Section 214E(2)(b) of FSMA. Under new subsection (2), a “recapitalisation payment” includes the cost of recapitalisation; that is at new paragraph (a). There is clearly no issue there because that is what the Bill is about. However, new paragraph (b) would allow the Bank to include
“any other expenses that the Bank or another person has incurred or might incur in connection with the recapitalisation of the institution or the exercise of the stabilisation power”.
This raises a number of questions.
First, who are these other persons who can incur expenditure in connection with the recapitalisation? The Government’s consultation referred to the Treasury, the Bank of England and a bridge bank. If that is the case, it seems that the paragraph ought to be confined to those persons, as I could not think of any other person who could make a case for receiving money under the auspices of the recapitalisation payments power.
Secondly, why is there not more precision about exactly which costs could be covered? Again, the response to the Treasury’s consultation gives the sorts of expenses that could be covered—legal fees, consultancy fees and the like—but is virtually silent on what should not be covered. The only example cited for what is not covered is the cost of preparing in parallel for an insolvency process, but that leaves a huge swathe of costs that could well be brought within the ambit of the recapitalisation payments. As drafted, it could certainly include many expenses that no one could reasonably label as being related to recapitalisation.
The Minister will be aware that UK Finance has expressed very real concerns that the banking sector will be left exposed to litigation or regulatory costs that emerge once a failed bank is in a bridge bank. In a bank insolvency procedure, such litigation or regulatory action would lead nowhere, as there would almost certainly not be any spare funds to cover any costs arising in that way. However, once the possibility of financing via the recapitalisation power arises, a new deep pocket appears, which could act as a magnet for litigation. Does this legislation mean that the banking sector is writing a blank cheque for whatever litigation emerges and which the Bank then chooses to engage in? Can there be any constraints on the Bank’s decision to fight or concede litigation? What are the incentives for the Bank to seek the optimal outcome, which may or may not be to concede a case in litigation? How is the banking sector to be protected in these circumstances?
Costs arising from regulatory action is even trickier. Let us assume that, following a small bank failure, the FCA decides to take regulatory action in relation to non-compliance with the consumer duty prior to the failure. As anybody who has been involved in one of the regulatory actions taken by the FCA, or indeed the PRA, will know, these are long, drawn-out and very expensive processes. Who should decide whether to fight regulatory action or concede and pay fines or redress? These could end up being funded by the recapitalisation payments. If the PRA were involved in regulatory action, rather than the FCA, how can the conflict of interest within the Bank be dealt with so that the costs falling on the banking sector are seen to be fair?
Lastly, new paragraph (b) allows the Bank to include costs that “might” be incurred. I completely understand why, when the recapitalisation calculations are made at the outset, that will involve an element of forecasting, because the formulation is not confined to, say, costs that are reasonably expected to be incurred. Instead, the Bank is allowed to include any costs that “might” be incurred, however improbable that might be. An overly conversative approach to working out what costs might be incurred will result in the banking sector bearing too much cost up front. It is not good enough to just say that, if there is a surplus left at the end of the day, it will be returned via the FSCS.
To sum up, the formulation in new subsection (2)(b) is simply too wide. As I said at the outset, this is a probing amendment and I shall listen carefully to what the Minister says, but my instinct is that new subsection (2) needs some guard-rails drafted into it. I beg to move.
Baroness Bowles of Berkhamsted (LD)
I only need to say briefly that I am in agreement with the noble Baroness. This is drafted too widely. Part of me thinks that some of this should be covered by the ordinary banking levy, and that the PRA and the Bank of England have to manage their budget, as anybody else would have to, in expectation of sometimes having adverse effects, rather than there being some bottomless pit, or pool, of money into which they always have access. The truth of the matter might need to be somewhere half way in between, but it is too open at the moment.
Lord Vaux of Harrowden (CB)
My Lords, I briefly add my support to what the noble Baronesses have said. This is drafted extraordinarily widely. The words
“another person has incurred or might incur in connection with the recapitalisation”
could theoretically include the legal costs of the shareholders of the bank that is going bust, for example. We have to find some way of reducing that scope. I had attempted to deal with this in Amendment 12 on reporting, but having heard what the noble Baroness said I do not think that does it. We need to find some way of narrowing it.
Baroness Vere of Norbiton (Con)
I am grateful to my noble friend for tabling this amendment and I added my name to it. I am also grateful for the comments made by my noble friend Lord Moylan. He is not in his place but he raised this issue during Second Reading and set people thinking about it.
I do not have a huge amount to add. I agree with the comments made by my noble friend Lady Noakes, the noble Baroness, Lady Bowles, and the noble Lord, Lord Vaux, but I would also say that this will have to be a double-edged attack. Not only must we potentially do something on this but the reporting of it will have to be clear and go into great detail.
When it comes to expenses, all noble Lords will be aware that the costs of financial lawyers and other professional financial advisers are not de minimis. The total cost of expenses may well exceed the cost of the recapitalisation of the bank, so it is important that we ensure that there are some guard-rails around this, recognising as ever that these costs will end up falling not on the banks but on the people who bank with the banks.
Does the Minister have any view as to roughly how large an expense bill might be? I do not even want to guess, because I hope that he will be able to give me some idea of what we are looking at.
The noble Lord, Lord Vaux, mentioned the expenses incurred by another person. I think that all noble Lords who have spoken so far agree that that is extraordinarily broad, and we will need to consider what we might do about that. Potentially, one could put something in the code of practice but, again, is that sufficient? We might also protect ourselves by requiring Treasury consent—who knows? Again, we might want to think about that. Going back to the point raised by the noble Lord, Lord Eatwell, it is tempting to think about these things as a single event, and we might be talking about £10 million-worth of expenses, but if a whole bunch of such events happened at the same time, we could very soon be talking about real money. We need to get to the bottom of this. I look forward to the comments from the Minister.
Lord Livermore (Lab)
My Lords, in response to the amendment from the noble Baroness, Lady Noakes, I hope to explain and provide some clarification around the expenses within scope of the mechanism under the Bill, as well as clarify the Government’s rationale for our approach.
The key purpose of the Bill is to ensure that there is a source of funding for recapitalisation of a bank in resolution, where that bank does not hold the necessary resources to allow it to be bailed in. In addition to the core expense of the recapitalisation payment, other expenses are likely to be incurred. There are two in particular.
First, there are likely to be a number of ongoing expenses incurred by the Bank of England, or by a Bank of England-owned holding company or operating company, when running a bridge bank, beyond those concerned with simply injecting new capital into the failed firm. This could, for example, include additional staffing costs and advisory fees incurred by the Bank of England to support its ability to operate a commercial bank.
Secondly, there will likely be a set of ancillary expenses incurred by both the Bank and the Treasury in undertaking a resolution of this type. As set out in the Government’s consultation response, this could include, for example, the costs of receiving professional advice, such as on legal or accountancy matters. It may also include the costs of appointing an independent valuer, as required under the Banking Act. As such, the persons other than the Bank of England referred to in the legislation whose expenses could be met using the new mechanism are expected to be the Treasury and any other Bank of England-owned legal entities that are not the Bank of England itself. The noble Baroness asked why the full set of costs are not specified. It is important that the Bill is not overly prescriptive, allowing the Bank to respond flexibly when costs arise.
The noble Baroness, Lady Noakes, also raised concerns about the treatment of litigation costs. As the noble Baroness, Lady Vere, noted, this arose at Second Reading as well. Depending on the circumstances, these again may be covered by the relevant part of Clause 1 addressed by this amendment—for instance, where the Bank of England is subject to litigation concerning the resolution and recapitalisation process. Given the fast-moving and unpredictable nature of bank failures, the Government believe that it is prudent to ensure that there is broad provision to cover these potential additional expenses incurred by both the Bank of England and other persons such as the Treasury. Ultimately, the alternative is that the cost of such expenses may need to be met by the taxpayer.
I wish to reassure noble Lords that in determining whether to include certain ancillary expenses in its request for funding to the Financial Services Compensation Scheme, the Bank of England is subject to the usual obligations under public law to act in a way that is reasonable and it will need to factor this into any assessment of what is in the public interest. In addition, the legislation does not allow the Bank of England or any other person to claim expenses that arise exclusively for preparing for bank insolvency.
I hope this provides the noble Baroness with a helpful explanation of the Government’s approach, and I respectfully ask her to withdraw her amendment.
Baroness Noakes (Con)
My Lords, first, many thanks go to the noble Lords who supported my amendment. I thank the Minister for his response but, with the greatest respect, he did not go much beyond what is in the Treasury’s response to the consultation document. He reiterated that the Bank and the Treasury, or the Bank and its entities, are likely to be the ones that have their costs covered. I have no real problem with that—put it in the Bill.
Similarly, the Minister talked about the Bank needing to be reasonable but I am not sure that being reasonable about the kinds of expenses that could occur via litigation is going to satisfy the banking sector, which fears that judgments working significantly to its disadvantage are going to be made and that it will have no way of influencing those decisions. There is not even the kind of protection that you get in insolvency, where you get, for example, creditors’ committees that act as a constraint on what liquidators can do. So I do not think that the Minister has really given a proper response on how the sector, which is going to pick up the tab—ultimately borne, as my noble friend Lady Vere pointed out, by the customers of banks—can be satisfied about the judgments made about the huge range of costs that could emerge during the course of handling a failed bank using the recapitalisation power; and how those costs can be seen to be properly incurred and not acting against the interests of the banks.
The Minister also did not engage with the issue of whether, in estimating future costs, you should constrain the costs to those that are reasonably foreseen, which is a natural formulation in legislation. Frankly, “any costs that might be incurred” is too big a definition to be used reasonably. I think that that formulation needs to be used again.
I will read carefully what the Minister has said in Hansard but my instinct is that he has not added to anything that is already in existence via the Treasury’s response to the consultation. I suspect that we will want to return to this on Report but obviously, for now, I beg leave to withdraw.
Baroness Noakes
“(2A) The Bank may not exercise the power in subsection (1) more than once in respect of the same financial institution without the consent of the Treasury.”Member’s explanatory statement
This amendment requires the Bank to obtain Treasury consent before it can require the FSCS to make a second (or subsequent) recapitalisation payment in respect of an individual bank.
Baroness Noakes (Con)
My Lords, it is me again, I am afraid. That is the trouble with getting enthusiastic about amendments during recess—you pay for it when you get back.
Amendment 3 is a probing amendment to find out the Government’s approach to using the recapitalisation power on more than one occasion. The amendment uses the technique of requiring the Treasury’s consent to the use of the recapitalisation power more than once in respect of the same financial institutions. My purpose in this amendment is not to debate the formal involvement of the Treasury, as I will return to that broader topic in a later group. I am using the amendment as a technique to find out whether there are any constraints at all on the use of the recapitalisation power on multiple occasions.
When the Bank of England decides to use the recapitalisation power, it works out what sum of money it needs to put the bank in a position where it can be sold on. We discussed in our debate on the previous amendment the kinds of expense that can count as recapitalisation costs for the purposes of the power. My own view is that the Bank must try at the outset to reach as clear a view as possible on the amount of the whole that the recapitalisation payment is designed to fill because, if the Bank does not do that properly at the outset—making a good, honest assessment of what the total cost will be—it cannot reach a realistic judgment about whether to proceed with a bridge bank or to initiate an insolvency process.
So I find it disturbing that the drafting of new Section 214E seems to allow the Bank to double-dip into the FSCS without any other process or consideration. If the Bank runs out of recapitalisation cover, it probably means that it did its sums wrong in the first place or that additional facts have emerged, increasing the costs in ways that were not anticipated at the outset. In either event, that can call into question whether the initial decision to use the bridge bank instead of the bank insolvency procedure was the correct one. It may also raise the question of whether the bridge bank strategy should be continued or replaced with the bank insolvency procedure.
It also brings into question the nature of the additional hole in the finances of the failed bank, which is covered in part in the previous amendment. It may not be clear that the incentives are in the right place for the correct judgments to be made about whether any additional costs arising from regulatory action or litigation should be accepted or challenged. If the costs are down to PRA action, there are clear conflicts of interest involved.
I completely understand the need for flexibility in legislation. I hope that the Minister will also appreciate that the open-ended nature of the Bank’s powers in the use of the recapitalisation payment technique carries particular problems when a second or subsequent attempt is made to obtain a recapitalisation payment. I hope that the Minister can explain how the Government see this power being used, if it is to be used more than once, and whether—including to what extent—there are mechanisms in place to ensure that the way in which the Bank uses that power is fair to the banking sector.
The Bill makes the banking sector pick up the costs. The sector itself will probably have had no involvement whatever in the failure of a bank yet it has to pick up the tab, ultimately borne by its own customers; that is whenever the Bank decides to use the recapitalisation powers. So it is only fair and reasonable that there should be some checks and balances in return. I hope the Minister can reassure the Committee that there are checks and balances and that, when the Bank uses the power in what has to be quite an unusual situation—for example, it has got the sums wrong or something else has caused a requirement for more to be put in—it raises the need for additional safeguards in order to satisfy the banking sector that the costs that will be loaded on to it are reasonable.
I beg to move.
Lord Vaux of Harrowden (CB)
My Lords, I rise again briefly. The noble Baroness has made some really important points. Once again, I have attempted to deal with this as a reporting question in Amendment 12, which states that a report would be required each time a recapitalisation payment was made; that should stand anyway.
This can become quite significant if, for example, there is a situation where the Bank of England expects to be able to sell a bank immediately but that falls over and then goes into a bridge bank for two years—or, indeed, more—and picks up all those costs along the way. One can see a situation where you could have, for example, an annual payment covering the costs of the bank until the Bank eventually decides to put it into insolvency. The critical factor must be that, any time a recapitalisation payment is being considered, whether it is the first one or a subsequent one, the insolvency route is reconsidered at each point and this does not become an open-ended default drag on costs—but the reporting point, which we will come on to later, stands as well.
Baroness Bowles of Berkhamsted (LD)
The noble Baroness, Lady Noakes, made a good point. I agree entirely with what the noble Lord, Lord Vaux, said.
I raised double-dipping at Second Reading and got the answer, “Well, yes, you could double-dip”. Of course, if you go from thinking that you are going to do the bridge bank or whatever to having to move into insolvency, there will be another dip if there are deposits to cover; I have a later amendment on that but it is all part of the same conversation. I am sure that the noble Lord, Lord Vaux, knows a lot more about this than I do because he is an accountant, but things always get worse than you expect. How is the Bank going to deal with that? Initially, it is probably going to have to ask for more than it thinks it could possibly ever need.
Some kind of structure around this, with points at which it is revisited and good reporting, appears to be the only solution. I initially thought, “Yes, maybe HMT intervention is the solution”, but I take the point that the Minister made earlier on about HMT intervention and independence. The fact is that, really, they are all in it as a club taking the decisions together already, so I am not sure that that would necessarily be the decisive factor one would want. It is about what the procedures are; the way things are being done and being understood; and how the reviews and reporting happen so that, when the worst happens and another dip comes along, one is not totally taken by surprise.
Baroness Vere of Norbiton (Con)
I rise only to celebrate the fact that my noble friend Lady Noakes had so much time during recess in which to draft all these marvellous amendments because they certainly get the little grey cells going. I appreciate her eloquent explanation of her amendment and the very practical example of what could happen that was provided by the noble Lord, Lord Vaux. This goes back to a topic that was raised earlier about there being a certain feeling of a blank cheque in terms of certain elements of the scheme and wanting to ensure that there are appropriate guard-rails.
I will not go much further; I will come on to my observations about the sharing of powers and responsibilities between Ministers and regulators in due course. I look forward to hearing from the Minister.
Lord Livermore (Lab)
My Lords, I note that this amendment from the noble Baroness, Lady Noakes, is one of several concerning whether Treasury consent is needed when the Bank of England is exercising its powers—in this case, when the mechanism is used more than once for a particular institution.
Addressing the specific case of the amendment, although I think we can agree that it would usually be desirable to have to use the mechanism only once in respect of a particular institution, this may not always be the case. As an example, if a failed bank is transferred to a bridge bank, there is a risk of further deterioration in its balance sheet over time. It is foreseeable that, if that were the case, the Bank of England may need to use the mechanism again in order to recapitalise the institution; this would allow the Bank of England to maintain confidence in the firm, promoting financial stability.
The Government believe that it is important for the Bank of England to have reasonable flexibility to do so, reflecting that the full implications of a bank failure are hard to anticipate in advance. In addition, if further approvals are required, this may undermine market confidence in the original resolution action given that such approvals cannot be presumed in advance.
However, I note a few important pieces of context to this broader position. First, as required by statute, the Treasury is always consulted as part of the Bank of England’s formal assessment of the resolution conditions assessment. In practice, there is also frequent and ongoing dialogue between the authorities. Therefore, the Government are confident that there are proper and robust channels by which it could raise concerns if it had any.
Secondly, given that the new mechanism is ultimately funded by industry, we would expect the Bank of England to consult the Prudential Regulation Authority on any additional request to use the new mechanism. This is important as the Prudential Regulation Authority determines what is considered affordable to be levied on the sector in any given year.
Finally, if additional use of the mechanism had implications for public funds, such as requiring use of the National Loans Fund, provision of this additional funding would be subject to Treasury consent. Overall, the Government believe that this strikes the right balance in preserving the Bank of England’s freedom of action while ensuring the appropriate level of Treasury input into decision-making.
I hope that this provides some comfort to the noble Baroness and respectfully ask that she withdraw her amendment.
Lord Vaux of Harrowden (CB)
The one thing the Minister did not cover there was the question of whether, on a second or subsequent recapitalisation payment, the Bank would have to look again at whether the insolvency route is the one it should go down, rather than a secondary payment.
Lord Livermore (Lab)
It would always look at the situation at the time and make each individual decision on that basis.
Lord Vaux of Harrowden (CB)
It would always do so or it would always have to do so?
Baroness Noakes (Con)
Okay. We understand that the Bank has to make these decisions. The issue is what there is to provide a check or balance on the Bank. That has not been addressed by the Minister.
I thank noble Lords who supported this amendment. I agree with the noble Lord, Lord Vaux, that there has to be something that allows a proper judgment to be made if there is a second go. It is also important to consider at each stage whether the bank insolvency procedure should be the right route. It is not clear that that is written into the legislation. It appears not to be very transparent after the initial use of the powers. I think the Bank is required to consult the Treasury on the initial use of the powers, but it is not required to consult the Treasury on any subsequent use of the stabilisation powers or of the bank recapitalisation power itself. I think the Minister referred to the fact that there was a lot of contact between officials. I know that, but the issue is what is formally required.
The Minister’s response in respect of guarding the finances of the industry seemed to be that the PRA has to be consulted, but the PRA is not overinterested in the finances of individual institutions. Indeed, a big conflict of interest exists between the Bank of England and its component part of the PRA. The governor chairs both the Bank of England and the PRA and the deputy governor sits on the Court of the Bank of England. This is all very intertwined, so consulting the PRA does not provide a mechanism that gives comfort to the banking industry that its interests are being dealt with. This is another bit of unfinished business.
I have one question for the Minister: is any of this territory, such as using the mechanism more than once, likely to be covered in the code of practice?
Lord Livermore (Lab)
We can certainly take that away and look into doing so.
Baroness Noakes (Con)
That means you were not thinking about it, but you might think about it, so I will leave that for the time being.
I remain uncomfortable at the scale of the powers that the Bank has without any real practical constraints on how they are used. Given that we are using the banking industry to avoid amounts falling on taxpayers, which is reasonable and accepted by the industry up to a point, I think we need to make sure that it is protected in that, and I cannot see where the protections are.
I need to think about this further. I will certainly read what the Minister has said, but I suspect we will return to this in some way when we get to Report. I beg leave to withdraw the amendment.
Baroness Noakes
“(2A) The Bank may not exercise the power in subsection (1) in respect of a financial institution which meets the condition in subsection (2B) without the consent of the Treasury.(2B) The condition is that the financial institution is a subsidiary of a company based outside the United Kingdom.”Member’s explanatory statement
This amendment requires the Bank of England to obtain Treasury consent before it can require the FSCS to make a capitalisation payment in respect of a bank which is a subsidiary of an overseas body.
Baroness Noakes (Con)
My Lords, this is another probing amendment. In this, I want to probe the circumstances in which the Treasury believes it would be appropriate for the UK banking industry to stump up for the recapitalisation of a foreign-owned bank. This amendment uses the technique of Treasury consent, as some of my other amendments do, but this is not what I am trying to talk about in this amendment. I am trying to probe the substance of using the recapitalisation power for the subsidiary of a foreign company.
Of course, I know that SVB UK was a foreign-owned bank and the simple answer to my question might be that this gives the Bank another way of avoiding what happened in that case: SVB was gifted to HSBC with the additional present of permanent exemptions from the ring-fencing regime. If we accept that we should avoid being held over a barrel by HSBC in future, this would be a good use of the power. So can the Minister say whether, if presented with the same facts as those relating to SVB UK, the Bank would have preferred to recapitalise SVB via a bridge bank and then sell it on a timescale consistent with achieving better value for money from the UK? The heavens are opening as we are discussing these important things.
More broadly, is it not the case that the Bank should satisfy itself that the foreign subsidiary banks are either adequately capitalised in their own right or parts of groups that are expected to be resolvable via bail-in-able capital, in line with international expectations? In general, the regulatory system for banks following a financial crash is designed to ensure that they hold capital or bail-in liabilities, which avoids the need for extraordinary support. When a UK bank subsidiary of a foreign company fails and requires money to keep it going, there has been at least a prima facie case that there has been some element of regulatory failure, either in the UK or elsewhere. There should not be an expectation that the failure of a foreign bank would impose costs on the UK banking sector—nor, indeed, the UK taxpayer, if that is the alternative.
It would be helpful if the Minister could explain in what circumstances the Government would consider it appropriate for the Bank to use the recapitalisation power in relation to foreign-owned banks and, perhaps more importantly, when the Government would not consider it appropriate to use the power. Can he also say whether any of this is likely to be covered in the code of practice? I beg to move.
Lord Vaux of Harrowden (CB)
My Lords, this weather sounds like the reason I ended up tabling a load of amendments in south-west Scotland: I had nothing better to do for a few days.
Again, the noble Baroness, Lady Noakes, raises a really important point. I have tried to attack it in a different way in Amendment 16, where I look at the recovery of money from shareholders. I will be interested to hear what the Minister has to say. I had in mind the sort of scenario where a foreign company sets up a bank in the UK, it does not go very well and it decides just to walk away from it, having perhaps removed all the assets in the meantime. Clearly, it does not seem fair that the costs of sorting that out should fall on the industry or, indeed, the British taxpayer. It would be really interesting to understand how we can ensure that foreign shareholders behave properly and how, when it does go wrong, we can recoup the money from them.
Lord Eatwell (Lab)
My Lords, I am somewhat puzzled by the amendment in the name of the noble Baroness, Lady Noakes, in this case. Surely, under the Basel accord, the UK regulator is responsible for the regulation of a subsidiary that is legally established in the UK. If “subsidiary” were changed to “branch”, the foreign regulator would indeed be responsible for regulation in that case. It seems to me that this particular amendment would violate the Basel accord to which His Majesty’s Government are committed.
Baroness Bowles of Berkhamsted (LD)
I will just comment that we have seen capital being sucked out of subsidiaries and taken back to the States and have been left with the collapse here. Basel accord or not, there ought to be some kind of mechanism of group support. I wonder whether there has been any international progress on that. What other mechanisms could be used to ensure that those kinds of things do not happen? Ultimately, it is going to be quite difficult to do this unless you somehow put on some extra capital requirements–and then you then start to get into all kinds of international difficulty. Perhaps the Minister could say something about what levers, if any, are available.
Baroness Vere of Norbiton (Con)
I rise briefly to build on the comments made by previous speakers. This is an important issue. Again, it is worth recalling that this will not just be the recapitalisation funding; there might also be associated expenses. I note the point made by the noble Lord, Lord Eatwell, about the Basel accord and it being a subsidiary et cetera, but it strikes me that this is of a different level of political salience than a purely domestic collapse might be, where one has established structures. It could get incredibly uncomfortable for the Government if we do not have a better and fuller understanding of what safeguards exist already to make sure that banks are appropriately capitalised by their parents abroad and of how we avoid the perception of the Bank of England acting in interests which are not necessarily aligned with those of Daily Mail readers—let us put it that way. It is not that they have to align with Daily Mail readers, but one might imagine that this could be very problematic.
I would like some reassurance about what we would do if it were to be a significant amount rather than the very small amount for Silicon Valley Bank and how we would seek to address the concerns that would inevitably arise from the general public.
Lord Livermore (Lab)
My Lords, in response to the amendment tabled by the noble Baroness, Lady Noakes, I hope I can provide some clarification on how the resolution regime operates currently with respect to subsidiaries of international banks, and therefore how the Government have approached the design of the new mechanism with respect to those banks.
One of the strengths of the UK’s banking sector is that a number of international banks seek to operate within the UK, including by setting up subsidiaries. These are often providers of critical banking services, such as current accounts, business accounts and sources of working capital to businesses. It is therefore important that a robust system of regulation is in place to ensure that such subsidiaries can operate safely within the UK. This includes ensuring that in the event of their failure they can be managed in an orderly way. The resolution regime does not currently make a distinction between domestic UK banks and subsidiaries of international banks in terms of which authority is responsible for taking resolution action in the UK. In all cases, this responsibility falls to the Bank of England, except where there are implications for public funds. The Government continue to believe this is appropriate.
While the failure of banks is rare, the most recent example, and the genesis of this Bill, was Silicon Valley Bank UK, itself a subsidiary of an international bank. The Government consider that there were two key lessons from that event. First, it is critical that the Bank of England has the flexibility to move decisively during a crisis. Secondly, it is important to introduce the new mechanism delivered by the Bill in those cases where there is not a willing buyer. The Government do not therefore believe that there is a strong justification for treating subsidiaries differently from domestic UK banks and requiring a further set of approvals. To do so would create additional obstacles to efficient resolution decisions, which recent experience suggests can be necessary.
The noble Baroness asked whether the Bank would have used the mechanism on SVB. I cannot comment on an individual case or decision that it may have taken, but the case showed the usefulness of the option of having a mechanism provided to the Bank.
The noble Baroness also asked whether this issue will be covered in the code. The code updates will cover a broad range of issues following the Bill’s passage. We will progress and publish that code swiftly.
The noble Baroness further asked whether a parent company should be able to support the failure of a subsidiary. While the parent company may be able to recapitalise its subsidiary outside of resolution, there may be circumstances where that is not possible, as was the case with SVB UK. It is important that the Bank of England has the necessary tools to deal with a failing firm regardless of its home jurisdiction. In practice, the mechanism uses the Bank of England’s transfer and writedown powers, so the parent company would suffer losses on its investment in a subsidiary.
I therefore respectfully ask the noble Baroness to withdraw her amendment.
Baroness Noakes (Con)
I thank noble Lords who have taken part in this debate. I found what the Minister said very helpful. What the noble Lord, Lord Eatwell, said, was also helpful, although I had understood that, where there are large groups, the group parent will be responsible for ensuring the capitalisation of the subsidiaries, in particular by holding MREL at the top level, but I may need to check my facts on that. I thought colleges of regulators would be working among themselves towards the health of the group overall, so I did not I think it was entirely located in the UK, but I will check that out.
What the Minister said is very helpful and I will reflect carefully on it. If the case is that there is no difference between a UK-owned and a foreign-owned bank, no issue arises. But if there are any differences in the way that a foreign-owned bank is treated in the UK, then that would be a case. I will go away and think about that further and I beg leave to withdraw the amendment.
Baroness Noakes
“(2A) The Bank may not exercise the power in subsection (1) without the consent of the Treasury.”Member's explanatory statement
This amendment requires the Bank of England to obtain Treasury consent before it can require the FSCS to make a capitalisation payment.
Baroness Noakes (Con)
I rise to move Amendment 6. Noble Lords will be pleased to know that I get a bit of a break after this one.
This amendment would require the Bank of England to obtain Treasury consent before it uses the recapitalisation power. When I introduced my last two amendments, which contained a requirement for Treasury consent, I explained that they were a device to probe issues about the use of the recapitalisation payment power. In this amendment, my use of Treasury consent is not a probing device and I am focusing on the role of the Treasury in the broader context of accountability.
The Minister is a newcomer as far as the passage of financial services legislation in your Lordships’ House is concerned; some of us are older hands at it. When the Financial Services and Markets Act 2023 went through this House, accountability was one of the key themes which was debated on and off throughout its passage. This amendment and a later amendment return to that theme of accountability.
The Bank of England has been given huge powers by successive Governments, which we debated at length in passing the 2023 Act, but, like many other bodies which have accumulated in the public sector, it has relatively weak accountability. The governor may need to turn up to the Treasury Select Committee for an uncomfortable couple of hours from time to time, but that is just about it. One great outcome from the 2023 Act has been the creation of the Financial Services Regulation Committee in your Lordships’ House, which is chaired by my noble friend Lord Forsyth of Drumlean and on which several noble Lords on this Committee sit. I hope that our new committee will add significantly to parliamentary scrutiny of financial services quangos, but neither House of Parliament has any real powers in relation to these public sector bodies that have been given very significant powers.
This problem is not confined to the Bank of England or to financial services. The Industry and Regulators Committee of your Lordships’ House produced a report earlier this year, Who Watches the Watchdogs?, which will be debated in this House next week. One of its findings was that regulators, as a particular kind of public sector body
“exercise substantial powers on behalf of Parliament and the public, but are not subject to the same forms of accountability as ministers; to quote one witness, ‘the people can replace their elected representatives, but they can’t vote out bad regulators’”.
That applies, mutatis mutandis, to many other forms of public sector body.
The report noted that there was a
“widespread perception … that regulators’ accountability to Parliament is insufficient”.
It went on to recommend that there should be a new independent statutory body to support Parliament in holding regulators to account. All of this will sound familiar to those of us who took part in debates on the 2023 financial services Bill, because my noble friend Lord Bridges of Headley tabled amendments trying to set up something similar for the main public sector bodies in financial services—the PRA, the Bank of England, the FCA and so on. I hardly ever support setting up new public sector bodies, so I did not support my noble friend last year, and I would not support the Industry and Regulators Committee’s recommendation either. It does not form an approach that I think is the right one, but I wholeheartedly agree with the analysis that accountability is a real issue for these public sector bodies.
By enjoining the Treasury in any decisions as to the use of the recapitalisation power, Parliament gains the additional ability to question Treasury Ministers about the use of the power and the circumstances that surround the use of it. At the moment, it is easy for the Treasury Minister to say, “Nothing to do with me; it’s all down to that lot up in Threadneedle Street”. We have had many frustrating exchanges with Treasury Ministers along these lines, including when SVB UK was given away to HSBC. Treasury consent would be an important enhancement of the process of parliamentary accountability.
As I said in the earlier group, I do not believe that getting Treasury consent is necessarily an onerous part of the process, but it would be a small price to pay for an increase in accountability, so I regard this as a modest addition to the framework created by the Bill. Obviously, I have drafted this in connection with a specific power in the Bill, but it is a principle which could be applied to many uses of significant powers by the Bank of England, the PRA and the FCA.
The use of the power by the Bank of England could be entirely straightforward, in which case it is unlikely to engage the interest of Parliament, but there are likely to be some cases where the use of the power is controversial or where there are questions to be asked about whether bank failure is associated with some form of regulatory failure. Parliament should be very much engaged in cases of this nature, and my amendment would provide the platform for such engagement.
I know that the Minister will be briefed by his officials to resist this amendment, and I am sure that it suits the Treasury to be able to operate behind the scenes with the Bank of England but in a largely deniable way. I appeal to the Minister’s instincts, which I am sure are sound, about the need for effective parliamentary accountability. I beg to move.
Baroness Vere of Norbiton (Con)
My Lords, I am incredibly grateful for all the amendments from my noble friend Lady Noakes, but particularly this one. It gives the Committee the opportunity to consider the overarching balance of power and I think it is right that we start to do so—or continue to do so, as my noble friend pointed out.
I am the poacher turned gamekeeper. I am no longer a Treasury Minister. I have just spent many glorious months at the Treasury and prior to that I spent eight years as a Minister in government. I was in the Department for Transport for a long time and a Lords Whip, which many noble Lords will know puts one in touch with all sorts of government departments and various people giving you briefings and all sorts of things. One learns quite a lot about things and it is all very interesting. I am grateful for the opportunity to touch on the bigger picture, which my noble friend has allowed us to do.
The scrutiny and accountability of regulators is somewhat lacking. It was possibly the biggest surprise that I had as a Minister over the years. Having said that, each regulator is very different, and I have worked with a wide variety of them. Each wears the independence cloak in a different manner: some regulators, despite claiming independence, will actually work very closely with and listen to the Minister; other regulators, when I tried to ask them a question, literally slammed the door. It is really not on. Something needs to change.
It is entirely natural that operational decisions, based on a set of detailed regulations, should sit with regulators. Of course they should; that is unarguable. Ministers do not really have the time or the knowledge. They could do it, because they could have the knowledge as Ministers can be briefed, but they would not have the time to do it and it would gum up the system. That is fine. However, the balance between who takes the operational decisions and the broader operations of regulators is somewhat awry, in my view.
We have handed over a large amount of policy-development, policy-making, regulation-drafting, code of practice-drafting and consultation-issuing activities to regulators, over which Ministers have no insight. I know that officials from the Treasury will recall some issues that happened under the last Government fairly recently, when one of the regulators just took off on a path. I asked, “Why are you going down that path? That’s not a path you should be on. Come back”. They replied, “But we’re independent”.
How are we going to fix this? I have a niggling feeling that the Bill continues a trend to which I see no end. Fairly broad-brush powers are being given to a regulator or regulators that are then subject to interpretation and implementation. Often that interpretation and implementation cause the problems. There is mission creep. The regulators add another team of officials; the Minister never sees these officials and does not know what they do. They interpret the policy slightly differently, because they were not involved in its original development and so on. All this happens with little or no oversight.
I used to sit on the other side and would happily stand up to say—my goodness—the best thing that a Minister can say: “I’m sorry; I cannot comment on that. Regulators are independent”. It is really easy. The second thing I would say, if that did not wash, is that, “Ministers are accountable to Select Committees in Parliament”. Are they really? No, they are not really. I have appeared before Select Committees and it can be a bit uncomfortable for a while. They might ask you a couple of difficult questions, but it is not going to cause you to lose more than a couple of nights’ sleep.
Quite often, by the time you get to a Select Committee appearance by AN Other head of a regulator, it is too little, too late. The policies have already been devised, developed and put in place. The damage has already been done.
Furthermore, there seems to be no mechanism by which recommendations from these accountability sessions in Parliament are mandated for action by the relevant regulator. Many regulators can be told or asked by the Select Committee, “Please can you do X, Y and Z”, but they can basically take no insight from that at all.
I feel this quite personally, having recently lived through it, because throughout my time as a Minister I had the fear that if things go horribly wrong—sadly, sometimes they do—it is not the regulator that feels the heat. It is the Minister. One cannot go to the media and say, “The regulator is independent. I had nothing to do with it”. That does not wash with the public. Now that we have broken the connection between Ministers and regulators, we are in a very difficult situation. The Minister has no power—and that is why the fear exists—to make sure that things cannot go horribly wrong, even if they spot things that need to be improved.
This is but one amendment in a whole series. Yes, it was a useful device for getting amendments down for other elements for debate, but this is serious. My noble friend Lady Noakes is trying to take back control from the regulators and rebalance the system to enable Ministers to input at an appropriate point. She has a point.
Lord Livermore (Lab)
My Lords, I note that a number of other amendments have touched on the topic of Treasury consent before the Bank of England exercises its powers. I hope to fully address the Government’s position on that matter now.
I start by addressing the amendment laid by the noble Baroness, Lady Noakes; I will touch briefly on some points that I have made previously. The Government believe that the existing division of responsibility between the relevant authorities in resolution works well. It is important to maintain the position that the Bank of England can take decisions on the appropriate resolution action independently, guided by the objectives given to it by Parliament under the Banking Act and in line with relevant international standards.
There would be two key risks if that system were to change. First, it would confuse the lines of accountability for resolution decision-making, in effect making the Treasury the de facto resolution authority in the case of certain banks that may be subject to the new mechanism. This would undermine the Bank’s role as the resolution authority and may be seen as out of step with the intent of the relevant international standards. Secondly, a resolution is more likely to succeed when it is conducted by a single decision-maker backed by the right resources and expertise. The Bank of England is ultimately best placed to make those judgments and, therefore, to ensure that there is market confidence in resolution action.
However, there are safeguards to ensure that the Treasury can engage with the Bank of England’s decision over resolution matters, including any use of the new mechanism. As I have noted before, the Bank of England must consult the Treasury during any resolution action as part of its assessment of the resolution conditions, which are required by statute. This is an important legal requirement and ensures that the Treasury is meaningfully engaged in the Bank of England’s decision-making process. The Treasury and the Bank also maintain a productive ongoing dialogue.
Finally, the Treasury retains absolute approval in any resolution with implications for public funds, ensuring that the interests of taxpayers are appropriately reflected in resolution decisions and the Chancellor’s ultimate accountability for public funds to Parliament. The Government view this as an appropriate and proportionate framework in the context of the new mechanism.
The noble Baroness, Lady Noakes, asked about the Bank’s accountability to Parliament. I note that the Bank must inform the Treasury and share copies of legal instruments when taking resolution action. The Treasury must lay those in Parliament. The Bank must also report to the Treasury on the use of those powers; in some cases, the report must also be laid in Parliament.
I turn to the amendment in the name of the noble Baroness, Lady Vere—I note what we might describe as a slight change of heart from her position in government over the past 14 years. Her amendment would require the Financial Services Compensation Scheme to seek the approval of the Treasury in circumstances where it has to levy in subsequent financial years after the mechanism under the Bill has been used. I should clarify that, in principle, the mechanism provided by the Bill could be used to manage multiple firm failures at once; of course, the Bank of England would carefully consider the implications of doing this when assessing the resolution conditions, having regard to the special resolution objectives.
Moreover, any levies would be subject to the affordability cap set by the Prudential Regulation Authority, based on how much the sector can be safely levied in a given year; currently, that is £1.5 billion. In the event that multiple failures resulted in a recapitalisation requirement under that cap, the expectation is for the Financial Services Compensation Scheme to be able to levy safely for the funds within 12 months. It would not do that only if the Prudential Regulation Authority considered that it would carry issues of affordability, in which case the levies could be spread over a longer timeframe. In the event that the amount exceeded the £1.5 billion cap, the Government would expect the Financial Services Compensation Scheme to levy over multiple years, ensuring that it remains affordable for the sector.
It is important also to note that, in these circumstances, the Financial Services Compensation Scheme would be able to turn to the Treasury and request a loan under the National Loans Fund. The levies charged over multiple years would then be used to repay such a loan. Of course, borrowing from the National Loans Fund remains at the sole discretion of the Treasury.
I hope that I have been able to provide noble Lords with some reassurance on these points, and that the noble Baroness is able to withdraw her amendment as a result.
Baroness Bowles of Berkhamsted (LD)
I did not speak earlier because all the points I wanted to make were picked up, but there are two things on which I wish to comment. We have a change now in that, before, the Treasury would be more involved when the matter involved use of public funds; now, that has been transferred to the industry, so the Treasury is less involved and perhaps less concerned. Yet the Treasury remains the only possible constraint around and is far from perfect.
For the PRA and the FCA, there are plenty of powers to instigate reviews by government. The big mistake, apart from us not having proper oversight of regulators in general—there are various mistakes—is that those reviews have not been used a lot more often. They should be done almost on a rolling regular basis, not just when there has been a big disaster.
The other thing we have done differently is that we have made the central bank the resolution authority. Therefore, you cannot hold the central bank to account, because of its independence, in the same way that you could if you had constructed an independent resolution authority. That is, as you might suppose, the subject of a big debate that went on in Europe when I was ECON chair. There is an independent resolution authority there; it is not the central bank. That was one of the big considerations, because you cannot really hold a central bank to account. Ultimately, the sort of change that is envisaged in this Bill may move us further towards considering whether we need to do that.
Baroness Noakes (Con)
My Lords, I thank all noble Lords who have taken part. The predictions made by my noble friend Lady Vere on the content of the noble Lord’s response were pretty accurate in places. The noble Lord has not really engaged with the weak accountability that exists. The noble Baroness, Lady Bowles, is absolutely right about the use of the Bank of England as the resolution authority and giving it all those powers with almost no constraints whatever, other than consultation. Whoever chose to do that back in 2009—whichever Government were in power then—did not set up the right accountability environment for the use of those powers to exist. Once you put something inside the Bank of England, it is very difficult to engage in those issues, because it guards its independence on practically everything.
This is one of the big issues that will need to be addressed at some stage. There may not have been an instance yet that has caused people generally to realise how dangerous it is to have large, unaccountable bodies in the public sector with huge powers but relatively weak accountability. That is because we are still muddling through, and it is frustrating to some people who are dealing with these regulators, including Ministers, that they cannot fully engage. We have not had one of those big instances where everybody says that we have the wrong model. In a sense, I know that my pleas for a greater level of accountability to be included in statute are not really being heard, but that will not stop me raising them at every single opportunity I can. Indeed, I have some more amendments through which to talk about accountability further.
This has been a useful exchange. I will think about it further, having read the Minister’s response in Hansard. I will think further about whether I take this forward again on Report. For now, I beg leave to withdraw the amendment.
“(2A) The Bank of England may only exercise the power in subsection (1) if it assesses that the use of the power would support the public interest, which may include but need not be limited by—(a) supporting market competitiveness, or(b) retaining or growing smaller banks.”
Baroness Bowles of Berkhamsted (LD)
The point that I am trying to get to with Amendment 7 is, again, more transparency around what the public interest issues are. It is fairly reasonable to say that, of course, the Bank will do things that are broadly what it considers to be in the public interest, but there are quite a range of factors involved. They include the specific ones that were utilised in the Silicon Valley Bank case because of the potential loss of the float that companies had for paying their workforce and all those kinds of things. I did not object to that; I thought it was jolly good.
We also have the issue of wanting to encourage market competitiveness while retaining and growing smaller banks, which is always trumpeted as an issue, so I put those in as possible factors. But my real call is to say, again, that we need more things to be put into the documentation, whether that is a strategy, a code of conduct or even discussion documents, about the types of things that can be contributory factors to this public interest. Something may always happen that is a surprise. Maybe the Silicon Valley Bank and the large amounts of payroll in a particular sector of the economy was a surprise.
We need some kind of expectation and oversight of how these things are to be weighed up. That is the main force behind me putting this particular amendment in. Can we specifically mention, somewhere in the Bill, that it is in the public interest? As I said, it is accepted but I do not think that it is written down. I beg to move.
Lord Livermore (Lab)
My Lords, before I turn to the specific amendment from the noble Baroness, Lady Bowles, I note that the Government fully recognise the importance of market competitiveness and the critical role played by small and growing banks in serving customers across the UK.
On the specifics of this amendment, I note that, before undertaking resolution, including when using the new mechanism, the Bank must be satisfied that the resolution conditions in the Banking Act have been met. The third resolution condition is that resolution is necessary having regard to the public interest in the advancement of one or more of the special resolution objectives. Those objectives are set out in detail in the Banking Act and are intended to reflect the key objectives of the resolution regime across all in-scope firms. For instance, this includes maintaining financial stability, protecting public funds and enhancing confidence in the stability of the financial system.
The objectives do not explicitly reference market competitiveness or supporting small banks. This reflects how, in undertaking resolution, the Bank of England should be appropriately focused on managing the significant risks to financial stability that can arise in a highly unpredictable scenario. As set out in their consultation response, this has informed why the Government believe that the broader resolution framework works well, including the existing balance of special resolution regime objectives, and why we have not proposed to change them.
I note, however, that the Government actively considered both the role of small banks and market competitiveness when developing the policy approach for this Bill. In particular, market competitiveness is a key reason the Government chose to pursue a solution whereby banks must contribute to the costs of recapitalisation only after a failure has occurred. Crucially, this means that the new mechanism does not create any upfront costs for the banking sector.
As noted at Second Reading, the Government have also committed to updating the code of practice to ensure there is a clear process by which the Bank of England calculates the costs that could arise for industry if the new mechanism is used. In addition, the Government believe that the new mechanism supports the UK’s small banks. It ensures that there is a robust system in place for resolving them and maintaining continuity, when that is judged to be in the public interest. This should help support wider confidence in the regulation of the sector.
The mechanism in the Bill is also designed to be proportionate. This is why any levies associated with recapitalisation will be spread across the entire banking sector, ensuring that it is affordable for small banks. Overall, the Government believe this strikes the right balance in that these wider policy issues have influenced the design of the Bill, but that in using the mechanism the Bank of England is ultimately guided by the existing special resolution objectives. I therefore respectfully ask the noble Baroness to withdraw her amendment.
Baroness Bowles of Berkhamsted (LD)
I thank the Minister for that response. Again, I make the point that, through the Bill, we are changing from an inherent public interest in public money into using private money to do the rescue. I am not sure that the Banking Act was drafted with that in mind and I doubt that we could amend relevant sections through the Bill. It is just worth having another look with those eyes, maybe after a period of time, to see whether some kind of adjustment is needed because this safeguard check that exists around the use of public money has been taken away. It has not been replaced by anything; it has not even necessarily been replaced by more transparency. With those comments I beg leave to withdraw my amendment.
Lord Sikka
“(3A) Before exercising the power in subsection (1), the Bank and the scheme manager must assess whether they consider that there should be a clawback of executive pay and bonuses from the previous 12 months.”Member’s explanatory statement
This amendment seeks to address potential moral hazards through requiring the Bank and scheme manager to take directors’ pay and bonuses into consideration when a recapitalisation payment is made.
Lord Sikka (Lab)
My Lords, Amendment 9 deals with moral hazards, which, if anything, are multiplying. The amendment seeks to restrain excessive risk-taking by imposing possible personal penalties on bank directors.
The recent legal developments have actually multiplied financial moral hazards and the related risks. For example, the Financial Services and Markets Act 2023 reintroduced the secondary regulatory objective to promote the growth and international competitiveness of the finance industry. In effect, it dilutes the regulator’s remit to protect customers. On 12 August, the Chancellor said that she and the Economic Secretary to the Treasury were constantly asking regulators, “What are you doing in practice to meet that secondary objective?” The meeting of that secondary objective will necessarily increase moral hazards.
Secondly, further deregulation is coming in—reforms of Solvency II, for example—with the claim that this will somehow conjure up an additional £100 billion of investment by reducing capital requirements. There is no pot of gold sitting in a corner in any bank boardroom that people can simply empty and get £100 billion out of. All of that is underpinning bank resilience and insurance company resilience. All of that is invested in some safety buffers. All of that will have to be liquidated. Yet the consequences for how the directors might behave have not really been outlined.
The cap on bankers’ bonuses has been lifted, so there are now economic incentives for bank directors to be reckless and take excessive risks, as that would maximise executive pay and bonuses—all done in the full knowledge that the bank would be rescued, restructured, recapitalised or bailed out, be it through the mechanism of the Financial Services Compensation Scheme or, eventually, some reconstruction. There are no great pressure points on bank directors to be risk-averse and prudent or to act in a responsible manner.
The risk-boosting effects of moral hazards are ignored by this Bill, yet they are highly relevant to any form of stability. We have a whole history showing how this happens. In the 2007-08 banking crash, attention was drawn to moral hazards or conflicts of interest between the interests of shareholders and managers, debt holders and the public purse. Bank directors took on excessive leverage because the state incentivised them to do so. It continues to incentivise them to do so, for example by giving tax relief on interest payments, which reduces both the cost of debt and the weighted average cost of capital while increasing shareholder returns, providing a justification for greater executive bonuses and remuneration.
Numerous studies have shown that shareholders were, and remain, focused on short-term returns. In any case, they still do not get good-enough information to invigilate directors; perhaps at some point, when we are discussing the world of accounting, I will point out how almost useless company accounts are in enabling shareholders or anybody else to invigilate directors. Back at the time of the last crash, directors accepted excessive risks from not only financing the organisation but risky investments. For example, numerous varieties of derivatives and complex financial bets were made because of explicit guarantees about depositor protection, central banks providing liquidity and support, and, ultimately, publicly funded bailouts.
If the bets made with other people’s money paid off, directors got mega payoffs; if they did not, somebody else picked up the loss, leading ultimately to rescue bailouts—now we are using the term “recapitalisation”. This Bill adds another string to publicly funded bailouts—though it likes to use different language. Yes, the cost of the FSCS levies is borne ultimately by the people, as has already been pointed out, and not necessarily by other banks.
If the Government succeed in persuading the banks to lend more to facilitate additional investment, as they are trying to do, that will add to the risks and strain the capital adequacy requirements of those banks. In boom times, banks tend to lend more freely, because they do not want to miss out on the opportunity to make more profits, and they relax credit standards, but there are inevitably consequences, as we saw with the last crash. Directors are rarely held personally liable, and that remains the position today.
Amendment 9 would address this gap by requiring the Bank of England and the scheme managers to consider a clawback of directors’ pay and bonuses paid during the previous 12 months. In case the Minister might refer to other clawback arrangements, let me pre-empt those. Paragraph 37 of the UK Corporate Governance Code states:
“Remuneration schemes … should include … provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so”.
That is of no help whatever, because such codes do not apply to large private companies, of which Wyelands Bank, which came to an end recently, is a good example. The codes are also voluntary and cannot be enforced in the courts. They do not empower stakeholders in any way; they do not require the clawed-back amounts to be handed to regulators or to be used for recapitalisation of banks.
The FCA handbook also has a section on possible clawback, but it applies to what it calls “variable remuneration”, which is generally taken to mean bonuses. It states that in certain circumstances the clawed-back funds need to be handed back to the institution. This does not cover entire remuneration; it does not require that the clawed-back amounts be used for the recapitalisation and reconstitution of banks. So, in the interests of clarity and certainty, a statutory approach to clawbacks is needed, not a mishmash of voluntary arrangements. I beg to move.
Lord Vaux of Harrowden (CB)
My Lords, I shall speak to Amendment 16, which would do a certain amount of what the amendment from the noble Lord, Lord Sikka, would do, but in a slightly different way. It is intended as a probing amendment to obtain clarification on what ability there would be to recover all or some of the costs of failure from either management or shareholders of the failed entity when it is recapitalised rather than being put into insolvency—there seem to be two different things there.
It is possible to imagine a situation where members of the management team responsible for the failure are paid large bonuses or dividends prior to that failure. As the noble Lord, Lord Sikka, pointed out, that is more possible now that the cap on bonuses has—rightly, in my view—been lifted. Can the Minister clarify in what circumstances it would be possible to recoup those bonuses or dividends to offset the recapitalisation costs? In an insolvency situation, where there is fault—for example, in cases of wrongful trading—it may be possible to recoup those payments, but I cannot see how that would work if the bank was recapitalised. To me, it must make sense that management should not see the risk of having to repay bonuses or dividends as being lower than it would have been if the bank had been put into insolvency just because the bank has been recapitalised.
Lord Livermore (Lab)
My Lords, I turn first to the amendment tabled by the noble Lord, Lord Sikka, which seeks to ensure consideration is given to a clawback of executive pay and bonuses from a failed firm before using the new mechanism. I note that while the bank resolution regime does not set out powers allowing the Bank of England to claw back money from shareholders or management, it does provide an extensive and proportionate set of powers to the Bank of England to impose consequences on the shareholders and management of a failed firm in resolution.
First, on placing a firm in resolution, we expect that any existing shareholder equity would be cancelled or transferred. This is an important principle that ensures the firm’s owners must bear losses in the case of failure. In many circumstances, this will affect directors and management who hold shares or other instruments of the failed firm.
In addition, the Bank of England has the power to remove or vary the contract of service of its directors or senior managers. The Bank of England exercises its discretion in deciding whether to use this power. However, as set out in the Government’s code of practice, the Bank of England generally expects to remove senior management considered responsible for the failure of the firm and to appoint new senior management as necessary.
Finally, as reflected in the code of practice, it is a key principle of the resolution regime that natural and legal persons should be made liable under the civil or criminal law in the UK for their responsibility for the failure of the institution. This is delivered by Section 36 of the Financial Services (Banking Reform) Act 2013, which provides for a criminal offence where a senior manager of a bank has taken a decision which caused the failure of a financial institution, if the conduct of the senior manager
“falls far below what could reasonably be expected of”
someone in their position. Overall, this ensures that, as appropriate in the circumstances, there are material consequences for shareholders and senior management when a firm goes into resolution.
More broadly, I can further reassure the noble Lord that the Government recognise the importance of high standards in financial services regulation. The senior managers and certification regime supports high standards by ensuring individual accountability for senior individuals within firms, and by promoting high standards of conduct and governance. The Prudential Regulation Authority sets rules on remuneration and applies these to medium-sized and large banks, ensuring they are proportionate, and there are clear requirements in the PRA’s rules for firms to ensure they have policies on malus and clawback in place to align management incentives with that of the bank.
I should also note the intention of the amendment of the noble Lord, Lord Vaux, to ascertain under what circumstances the Bank of England may be able to recover all or part of remuneration to management and shareholders, or require a shareholder to cover all or part of the recapitalisation costs. If recoveries were made from management or shareholders of the failed firm, the amendment would make it clear that these types of remuneration could count towards these recoveries.
I hope I have addressed the broader point about the treatment of shareholders and former management in my earlier remarks. As a point of detail, I would add that the Government expect any recoveries not otherwise specified in the clause to be covered already by the catch-all phrase “or otherwise” at the end of proposed new subsection (2)(a). I hope that addresses the points raised and I respectfully ask the noble Lord to withdraw his amendment.
Lord Vaux of Harrowden (CB)
I think the Minister has answered the point about management, and I recognise that the words “or otherwise” are at the end of the new subsection. Where I am not sure that he has answered the point is on the inappropriate dividends paid to shareholders beforehand—the Thames Water situation, and how that would be dealt with. Just saying that the equity would be written down makes no difference; in this situation, the equity is already worthless. We are talking about recouping the costs of the recapitalisation rather than the fact that the worthless company is worthless.
Lord Livermore (Lab)
I have managed to get through several groups without promising to write, but on this occasion I will write to the noble Lord.
Lord Sikka (Lab)
I thank the Minister for his reply. I will divert slightly to the point made about dividends. The legislation is a complete mess on distributable dividends. The previous Government were going to table legislation about some disclosures of distributable reserves, then just a day before—without any notice to Parliament—they withdrew that, because most companies do not have a clue what their distributable reserves are. This raises all sorts of questions about what are realised or unrealised profits. I will not go into the technicalities at the moment. Any time I hear a Minister talk about dividends or say, “We are going to control dividends”, whether it is about water companies or any others, that is just a no-go area at the moment. It cannot be sorted out without major primary legislation.
The Minister said that there is already legislation in place for civil criminal prosecution. I am afraid that legislation delivered hardly anything after the last banking crash. Countries such as Iceland and even Vietnam prosecuted far more bankers for their negligence than the UK did, though we managed to elevate some afterwards to some very senior political positions, so that legislation is not really effective. I take it from the Minister’s reply that he is not prepared to consider legislation specifically saying that there will be a clawback of executive remuneration. That is the point—in the absence of it, who knows whether the management concerned will bear any personal cost at all? Is my interpretation of the Minister’s reply correct?
Lord Sikka (Lab)
I thank the Minister. I withdraw my amendment for the time being, though I may bring it back at the next stage.
Lord Vaux of Harrowden
“(6) When the Bank of England exercises its power in subsection (1), the Bank must make a report to the Chancellor of the Exchequer within 28 days of the date of any recapitalisation payment being made.(7) The report must comply with any requirements as requested by the Treasury, but must include—(a) the reasons why the Bank decided to make a recapitalisation payment in preference to allowing the financial institution to go into insolvency;(b) a breakdown of the costs referred to in subsection (2);(c) a comparison of the expected recapitalisation payment or payments that will be paid by the Financial Services Compensation Scheme, compared with the expected costs to the Scheme in an insolvency process.(8) The Bank must make further reports to the Chancellor of the Exchequer within three months of the date of the sale of the institution to a private sector purchaser, or the sale, closure or winding up of the bridge bank, providing such information as the Treasury may require, including the breakdown of the actual recapitalisation payment or payments and the reasons for any differences to the expected costs referred to in subsection (7)(b). (9) The Chancellor of the Exchequer must lay a copy of each report under subsection (7) or (8) before Parliament.”Member’s explanatory statement
This amendment is intended to ensure that the reasons for decisions of the Bank to follow a resolution process in preference to an insolvency process are explained and the explanation laid before Parliament, both at the time of the decision and once the resolution process has been completed, and that the costs can be compared to what would have been expected if the institution had been placed into insolvency.
Lord Vaux of Harrowden (CB)
My Lords, as we have heard several times already, the area of accountability around financial services Bills seems to always come to the fore, as the noble Baroness, Lady Noakes, pointed out. She referred in a recent group to the weak accountability that exists in the Bill. My Amendments 12 and 24 in this group aim to improve that.
One of the main concerns raised at Second Reading was to ensure that the Bank of England explains why it has decided to follow a recapitalisation process rather than allowing a failing bank to fail and go into insolvency, which was the previous default. In particular, several respondents to the consultation raised concerns that the costs of the recapitalisation should not be greater than those that the FSCS would face under an insolvency process. Concerns were raised, not least by the noble Baroness, Lady Penn, that recapitalisation might become the default approach to a failing bank, rather than insolvency. At Second Reading, the Minister then referred to the strong expectation that
“any reports required under the Banking Act to ensure ex-post scrutiny of the Bank of England’s actions when using the new mechanism would be made public and laid before Parliament ”. —[Official Report, 30/7/24; col. 933.]
My Amendments 12 and 24 aim to strengthen the required reporting and to make it a requirement that those reports will be made public and laid before Parliament. Amendment 12 adds some detail around the contents of the report. In particular, it would require the Bank to explain why it chose recapitalisation over insolvency; to provide a breakdown of the expected costs, which we talked about in an earlier group; and to provide a comparison of the expected recapitalisation cost with what would have been expected to have been the cost under an insolvency situation. It allows the Treasury to stipulate other matters but, importantly, it also sets a shortish timetable for that report of 28 days. This really does have to be done on a timely basis.
Also, importantly, the requirement to report—again, we discussed this earlier—will apply to any subsequent recapitalisation payments made to the same failing institution. Again, this overlaps with Amendment 3 in the name of the noble Baroness, Lady Noakes, which we have already debated. As I said at the time, it is critical that, any time we further recapitalise, we look again at whether that is the appropriate thing to do or whether insolvency is the appropriate option.
To cover the ex-post scrutiny that the Minister referred to at Second Reading, the amendment also requires further reports to be issued and laid before Parliament once the resolution process comes to an end, whether that is through a sale or through an insolvency process. The whole process could be two years after the resolution process starts—indeed, it can be extended beyond two years—so it is important that what actually happens is scrutinised after the event and that any differences to what we were originally told was going to happen are explained.
Amendment 14 laid by the noble Baroness, Lady Noakes, does something similar but leaves the detail of what must be included in the report up to the Treasury. I would be keen to provide the Treasury with some minimum requirements for the report; what I have laid out are the important aspects.
Amendment 24 in my name simply tries to fix an anomaly, as I see it, in the Banking Act 2009. Under Section 80 of that Act, if a failing bank is transferred to a resolution company, the Bank of England must make a report to the Chancellor of the Exchequer and that report must be laid before Parliament. However, rather oddly—the Minister referred to this previously—according to Section 79A of the Banking Act, if all or part of the failing bank is sold to a private sector purchaser, the Bank of England must still report to the Chancellor but that report does not have to be laid before Parliament.
The eagle-eyed among you in this Committee may have noticed that my initial version of this amendment simply stated that the report had to be laid before Parliament. We are getting to the point of the scope issues that the noble Baroness, Lady Bowles, referred to in her opening of the debate. That amendment was, at the last minute, ruled as being out of scope of this Bill. I find that hard to understand, particularly given that I felt that the Minister rather firmly put it in scope in his Second Reading speech, but it was decided that it was too broad to be in scope. I had to change it so that it refers only to the situation where a recapitalisation payment has been made. I ask the Minister to consider seriously whether he can use his influence to change that. It seems mad to do it only in this circumstance and not in the wider circumstance of a bank being sold to a private sector player. The officials have perhaps been a little overzealous with their interpretation of scope in this case—and in this Bill, more generally.
As I said, in his Second Reading speech, the Minister pointed out the importance of Section 79A for scrutiny of the Bank of England’s actions. He also referred to the fact that there is no requirement for reports under Section 79A to be laid before Parliament. However, he went on to say that he could
“reassure your Lordships that in any event where the new mechanism was used the Treasury would intend to ensure that any such reports were made available to Parliament and the public”.—[Official Report, 30/7/24; col. 933.]
My amendment simply makes that intention a requirement; I hope that I am not pushing at a closed door and that it is not seen as controversial.
However we go forward, it is essential that the actions of the Bank of England are subject to full scrutiny and transparency. At Second Reading, the noble Lord, Lord Macpherson, eloquently described the potential for a conflict of interest in the position of the Bank of England, pointing out that the Bank might choose to recapitalise rather than put a bank into an insolvency process
“less because it is in the national interest and more as a way of minimising the reputational damage of regulatory failure”.—[Official Report, 30/7/24; col. 914.]
Any decision to recapitalise should be explained to avoid possible creep to this process becoming the default. The noble Lord also raised his concerns that there is little incentive for the Bank to minimise the costs of resolution—after all, the industry, not the Bank, will pay. He gave the example of the Dunfermline Building Society incurring greater costs than the Treasury incurred in resolving the Icelandic banks.
So I think it is essential that we strengthen the scrutiny of the Bank when it exercises these new powers, to ensure that any decisions it takes are clearly justified at the time and examined publicly once the resolution is complete so that any lessons can be learned. These amendments, or amendments like them, would achieve that. The Minister has said he expects all reports to be made public and laid before Parliament, so I hope he will simply accept them.
Finally, I add my support to Amendment 25 from the noble Baroness, Lady Bowles, which is also in this group. We discussed in the first group the concerns around the MREL regime that are raised by the Bill, so it seems entirely appropriate that an assessment should be made of the impact of the Bill on the MREL regime. I beg to move.
Baroness Noakes (Con)
My Lords, as the noble Lord, Lord Vaux, has said, I have Amendment 14 in this group. In substance, it is the same as the noble Lord’s amendment. The only real difference, as he pointed out, is that mine is less prescriptive. I am entirely happy with either version, but it is important that we deal with the specific reporting requirements, because the existing provisions are simply not adequate. At Second Reading, the Minister basically said that the Government would use the existing reporting requirements in the Banking Act, but the time involved is simply too long. It could take at least a year after the powers have been exercised. When the recapitalisation powers are used, that deserves more immediate scrutiny and, unless there is awareness of it by way of a report, that is simply not going to happen. So I stand completely behind whichever of these amendments the Minister cares to choose.
I also completely support what the noble Lord, Lord Vaux, has tried to do with his Amendment 24. It is a pity he cannot do it more generally in relation to Section 79A, but at least it rectifies what is clearly an anomaly that Parliament should not have allowed through when the Act was brought in. When the recapitalisation power has been used, it should be a requirement to lay a report before Parliament. This is in line with what the Minister said at Second Reading would happen, so I expect the Minister to accept the amendment with alacrity.
I am not quite sure why the noble Baroness, Lady Bowles, allowed her amendment to be brought into this group. That said, I do think it is an important opportunity to look again at MREL, in particular because those banks that do not have MREL now become potentially subject to the use of the bank recapitalisation power. There ought to be more transparency about how banks can be categorised in that way and more understanding by those in the banking sector of which institutions they might have to pick up the tab for in due course.
It is generally a contentious issue in the banking sector, and the way in which banks trip from no MREL to MREL can be a deciding factor in whether they can scale up, because the cost of raising MREL when you are a very small bank, if you trip over into needing to raise it, can have a very significant impact. I have certainly heard smaller start-up institutions say that they deliberately do not grow above a certain size in order to avoid coming within the MREL provisions, and that cannot be good for the UK. So I am not quite sure about the wording of the noble Baroness’s amendment, but I completely support the principle.
Baroness Bowles of Berkhamsted (LD)
The noble Baroness, Lady Noakes, asked why I allowed my amendment to be grouped in this way. I was simply trying to expedite matters for us and I thought we did not need another whole group, which would get the Minister up and down again. I agree with the other amendments and everything that has been said on this group. They deal with issues around conflicts and so on, and transparency is one of the best weapons we have that presumably will be allowed or in scope.
My amendment is one of those that do not read as I originally wrote it, because again we came into scope issues. I could not get the exact amendment that I wanted, so this was the best that I could do. Obviously, it is a companion to the amendments in the first group, which were saying that the majority of us want to limit to a threshold equal to MREL. If you therefore want to resolve banks that are a little bigger, you would have to shift MREL. I am not going to cry over that; I will cheer.
That may be an improper tactic but we do not have any other tactics to try to focus the PRA on the damage being done to the growth of smaller banks by putting MREL where it was not intended to be. We are out of line internationally and we do not really have any good justification for that. If there is a division between those banks that can be resolved and those that cannot, I still think that it goes there and the Bank will therefore have to give its view as to why. Perhaps it wants an extension in some way, so that it can get at bigger banks. What do we get back from that? That is the thought process that lies behind my amendment.
I support all these amendments. If they are knocked into a format that is suitable for Report, they would be very good additions to the Bill.
Baroness Vere of Norbiton (Con)
My Lords, I am particularly grateful to the noble Lord, Lord Vaux, and to my noble friend Lady Noakes for thinking carefully about reporting and tabling amendments accordingly. I had to support one of these amendments and I am afraid that I picked the noble Lord’s on this occasion. This is not favouritism; I was purely trying to spread the love a little. But as we approach Report, we might want to go back and check that whatever we end up putting into the Bill is future-proofed.
Sometimes one can put in too much detail, then people can slide round the edges by saying, “Oh, you didn’t tell us to do that”. Alternatively, there is being too broad, when people slide round another edge by not putting in the detail that you want to see. There is a balance, but this is certainly worth taking forward and looking at. Obviously, the accountability element is key here.
Another thought I had around this was on timing. Again, sometimes one can go too far and have a report too far in the distance, so by the time it comes out no one remembers what the problem was in the first place. The amendment tabled by the noble Lord, Lord Vaux, says “three months”; I was thinking “as soon as practical” or, in any event, within six months. I do not know, but in very complicated and complex circumstances there might still be issues and context to resolve to produce a report that is relevant in timing terms, but also incorporates everything that stakeholders wish to see.
When I was a Minister, my heart would sink when an amendment was put down about producing a report. I would think, “Another report—are we really going to read it?” To me, the question is: we might produce a timely report in a good fashion and with the right amount of detail, et cetera, but how do we then ensure the scrutiny of that report? It goes back to the issue of expenses which, as we agreed, could be quite significant. But who is going to look at those expenses and suck their teeth? Will they look at the legal fees of firm XYZ and say, “Do you know what? That’s too much”. Who is going to do that? Is there any body at all—not anybody—which would be able to look at it and do that? It has been suggested to me that the National Audit Office might occasionally pay attention to this sort of thing. This is about trying to get us beyond “Just produce a report”. Well, just produce a report and then somebody can look at it. I am sure that these are going to be great reports, but even so it is a concern.
I am looking forward to the response of the Minister. I believe that this should be our last group today, fingers crossed, but I am not sure that many of us want to go outside, given the weather.
Lord Livermore (Lab)
My Lords, I fully understand the substantial focus on the reporting requirements that will apply when the new mechanism is used. I shall start by addressing Amendment 12 on this point, tabled by the noble Lord, Lord Vaux.
The Government agree that, should the new mechanism be used, it is right for there to be a reporting mechanism to hold the Bank of England to account for its decisions, and that this should encompass estimates of the costs of different options. However, the Government intend to achieve the principles of scrutiny and transparency in a different way; namely, through the existing requirements placed on the Bank of England under the Banking Act 2009. As set out in their response to the consultation, it is the Government’s intention to use these existing reporting mechanisms to ensure that the Bank of England is subject to appropriate scrutiny when using the mechanism. The Government have committed to updating their code of practice to provide further details on how these reporting requirements will apply when the mechanism is used; I can re-confirm that the Government intend to include in the code confirmation that, after the new mechanism has been used, the Bank of England will be required to disclose the estimated costs that were considered as part of these reports.
The Government consider that using the code of practice is an appropriate approach to hold the Bank of England to account for its actions, rather than putting these requirements in the Bill. The Bank of England is legally required to have regard to the code and the Government are required to consult the Banking Liaison Panel, made up of regulatory and industry stakeholders, when updating it. Using the code will therefore ensure that a full and thorough consultation is taken on the approach. Given the complex and potentially fast-moving nature of bank failures, this is important to ensure that any approach is sufficiently nuanced to account for the range of possible outcomes under insolvency or through the use of other resolution tools. The Government believe that amendments to the code of practice are more likely to be successful in achieving this outcome. As I committed at Second Reading, the Government will share drafts of these updates to the code of practice as soon as is practicable and will provide sufficient opportunity for industry stakeholders to be consulted on them.
I acknowledge the further amendment from the noble Lord, Lord Vaux—Amendment 24—which would make such reports available to Parliament when the new mechanism was used to facilitate a transfer to another buyer. It is the Government’s clear intention that any such reports required under the Banking Act, following the use of the mechanism, will be made public and laid before Parliament. The Government would not make reports public only if there were clear public interest grounds not to do so, such as commercial confidentiality reasons. This may particularly be the case when exercising the power to sell a failing bank to a commercial buyer. While such cases would hopefully be limited, it is important that they are allowed for.
I appreciate the intent of Amendment 14 in the name of the noble Baroness, Lady Noakes, which would require the Bank of England to report to the Treasury more swiftly than under the current requirements. The use of resolution powers is complex; in some cases, the Bank of England may be executing a resolution over a long period, particularly when placing a firm into a bridge bank. It is therefore sensible for the Bank of England to report a reasonable period of time after exercising its powers, ensuring that its report provides a full and meaningful assessment. On reporting more broadly, I repeat the points made in response to the amendment tabled by the noble Lord, Lord Vaux.
Finally, Amendment 25 in the name of the noble Baroness, Lady Bowles, would require the Chancellor to assess in the light of the Bill the appropriateness of the thresholds used by the Bank of England to determine which firms are required to hold additional loss-absorbing resources, known as MREL. As before, I should start by noting that the Government recognise the important role played by smaller and specialist banks in supporting the UK economy. I appreciate the concerns raised by the noble Baroness at Second Reading.
The Government have carefully considered the perspective of such banks in developing the mechanism in the Bill, which is intended to be a proportionate solution. On MREL, the Bank of England is responsible for determining MREL requirements for individual firms within a framework set out in legislation; that is an important principle, as the resolution authority, the Bank of England, is ultimately best placed to judge what resources banks should hold so that they can fail safely. I point out to the noble Baroness that, as set out in the Government’s consultation response, the Bank of England has committed to consider the potential case for changes to its indicative thresholds. Specifically, it has noted that it will consider whether any changes are appropriate in light of this Bill and other wider developments.
I hope that these points provide reassurance to noble Lords. On that basis, I respectfully ask the noble Lord to withdraw his amendment.
Lord Vaux of Harrowden (CB)
I will ask the Minister for one point of clarification. He referred to the reports under the Banking Act that will be provided as covering the costs and expenses. I do not think that he talked about the comparison with the counterfactual of the costs of insolvency, which is a critical aspect of this. Would those reports cover that?
Lord Livermore (Lab)
If the noble Lord does not mind, I shall add that to the letter to him.
Lord Vaux of Harrowden (CB)
My Lords, I thank all noble Lords who have spoken in this short debate and apologise to the noble Baroness, Lady Vere, for failing to thank her beforehand for signing her name to my amendment.
A number of points were raised. The noble Baroness was right when she discussed the timings. They were put in as a starting point; I would be very happy to look at what is appropriate. I still think that we need to beef up the reporting clauses in the Bill. I am encouraged by what the Minister said about the reports that exist being laid before Parliament, but, as the noble Baroness, Lady Noakes, referred to, there is more to do on the timings.
There is some merit in trying to put in the Bill at least some minimum requirements on what those reports should include. That will be important because, although I acknowledge what the Minister said about the code, we will not see it before Report. If we were able to see the proposed changes to the code before Report we might be able to take a different view. It happens quite regularly that we are told that something will be in a code of conduct, a future statutory instrument or whatever else, but we do not see it before we have to make the decisions on the amendments themselves. In the absence of that, I feel that we will probably want to come back to this on Report. In the meantime, I beg leave to withdraw my amendment.
Bank Resolution (Recapitalisation) Bill [HL]
Tuesday 10th September 2024
(2 months, 1 week ago)
Grand CommitteeRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text Read Debate Ministerial Extracts Amendment Paper: HL Bill 2-II Second marshalled list for Grand Committee - (6 Sep 2024)
“(6) Use of the Financial Services Compensation Scheme for bank recapitalisation and associated costs must not reduce bank depositors’ entitlement to the full amount of Deposit Guarantee Insurance.”
Baroness Bowles of Berkhamsted (LD)
My Lords, it falls to me to open proceedings again. This is very much a “what it says on the tin” amendment. If it were phrased as the question “Will the deposit guarantee always be honoured?”, I would expect the answer to be yes.
Last week, we discussed that there may be more than one recapitalisation dip. For a moment, let us imagine a worst-case scenario where there is more than one but things are worse than expected due to market circumstances—maybe contagion or other unforeseen circumstances—and the insolvency route has to be taken. Can we be certain that there would be no change to bank depositors’ entitlement—I do not think that is intended in any way, but I would like to hear the Minister say it—and that the system would have the capacity for whatever is thrown at it, if not cash capacity then some form of underwriting in addition to whatever borrowing is available? Does the overall capacity extend beyond the borrowing that is already set up or is it fundamentally underwritten by the Government? As they will get it back, I do not object to that; I am just inquiring as to what the mechanism is, although maybe one does not want to think about that until we get there, if we do.
Are the state of the Financial Services Compensation Scheme and the affordability of the levy, if there had already been recent large calls, for example, a factor in the analysis of whether to mount a recapitalisation rather than allowing the insolvency? There could be public interest factors that relate not merely to the bank under consideration per se. Does the public interest consideration also extend to the state of the compensation scheme? I beg to move.
Baroness Vere of Norbiton (Con)
My Lords, I rise to make a few comments about this, many of which have already been made by the noble Baroness, Lady Bowles. I am determined to make my comments none the less, so I shall use different words in a different order. The amendment does what it says on the tin—that is absolutely right—and I am confident that the Minister will state that there will be no diminution in the benefit of the deposit guarantee scheme, but is that in and of itself sufficient comfort? The framing of this Bill and the Minister’s exposition of it are shaped by a mindset that there will be a single resolution event; it will be an isolated occurrence; it will clearly be in the public interest, and it will be a single financial institution following specific issues relating only to that bank. That seems to be the vibe that I get when I read the information, particularly that which accompanies the Bill, and I remain concerned that there are insufficient checks and balances in place to enable Treasury input when the measures are used as envisaged, but also where there are multiple failures during a wider systemic event—a reasonable worst-case scenario.
A reasonable worst-case scenario can develop quickly, or it may become apparent only over time. In a slow burn and developing situation, decisions relating to banks facing challenges early on in a prolonged event will be made in a very different context from those whose challenges perhaps developed over a longer period. In essence, decisions will be made, but in very different environments, given what might have happened in the intervening period. It may well be that there is significantly less money left with which to play, so to speak, to ensure financial sustainability.
Whether a reasonable worst-case scenario is a one-off event or a slow burn, FSCS resources are going to come under significant pressure should two or more banks face insolvency or resolution, and choices will surely have to be made. Who makes those choices and based on what guidance? Will the FSCS prioritise DGI entitlements over the resolution of a bank or banks? What would happen in circumstances where the public interest test is at best marginal? There will be many circumstances when it is very clear, black and white, but there will be some when it is not quite so clear. On one hand, one might have a bank which needs to go through the insolvency procedure and therefore one set of obligations fall on the FSCS and, on another, a bank could go through resolution and it is a bit marginal whether the public interest test has been met. How are all those decisions going to be worked through, given the lack of direct oversight from the Treasury?
We have been told that the FSCS will be unfettered when it comes to decisions relating to the allocation of existing resources and borrowing from sources other than the Treasury for DGI or recapitalisation. Therefore, it seems that until the FSCS needs to go cap in hand to the Treasury to get more money over and above what it can already borrow, there is an obligation on the FSCS only to consult the Treasury and others and the decision-making essentially remains beyond the reach of Ministers. I will be interested in the Minister’s response.
The Financial Secretary to the Treasury (Lord Livermore) (Lab)
My Lords, I hope I can address the concerns of the noble Baronesses, Lady Bowles and Lady Vere, and provide them with reassurances about the protections in place for depositors as a result of the mechanism under this Bill. I can assure the noble Baroness, Lady Bowles, that in the event that the mechanism under the Bill is used, it would not reduce a covered depositor’s entitlement to a payout in the event of a subsequent bank insolvency. In this situation, eligible depositors would continue to be paid out up to the coverage limit set by the Prudential Regulation Authority, which is currently £85,000. That protection is enshrined in the rules set by the Prudential Regulation Authority. If the mechanism under the Bill is used and a bank subsequently enters insolvency, the Financial Services Compensation Scheme will continue to have access to the same resources as it does now. This means that it would first seek to use any existing funds or its commercial borrowing facility to meet its costs. If that is not sufficient, the Financial Services Compensation Scheme is able to turn to the Treasury and request a loan under the National Loans Fund. Any borrowing under the National Loans Fund would then be repaid by future levies. That is an important backstop that means that the Financial Services Compensation Scheme can continue to access the funding it needs.
The noble Baroness, Lady Bowles, asked a specific question about affordability being taken into account when deciding to recapitalise using the payout in insolvency. The answer to that is yes. The bank would consult the PRA when deciding to use its powers to consider affordability in levies. I hope this provides the reassurance that the noble Baroness is seeking that covered depositors will not face a reduction in what they are entitled to in insolvency if the new mechanism is used. On that basis, I hope she will be able to withdraw her amendment.
Baroness Noakes (Con)
Can I just clarify what happens when the FSCS has gone to the Treasury, because there does not appear to be a limit on the amount of money that it could draw down to meet its obligations to protected depositors? As the noble Lord, Lord Eatwell, pointed out on our first Committee day, there might be several financial institutions—my noble friend also raised this—in play at one time. It cannot be the case that an infinite amount of money can be funnelled through the FSCS and ultimately funded by loans from the National Loan Fund with the expectation that that will always then be met by subsequent years’ levies on the institution. Is there is there no break in the system which says, “No, this is too much for the FSCS to deal with”, especially as it is now potentially being loaded with a different kind of expense to process through its mechanisms?
Lord Livermore (Lab)
As the noble Baroness said, we touched on this briefly in the first day of Committee. If it is okay with her, I will write to set out the precise way in which the mechanism would work in that instance.
Baroness Bowles of Berkhamsted (LD)
I thank the noble Lord for his reply, which was broadly as I expected. We can draw from it that, in a situation in which the scheme will be used for recapitalisation, it will not set any precedents, because we do not know how much money will be in the pot if there have been other events. It will be considered case by case.
On the one hand, that has to be so, otherwise you might fall into the sort of trap perceived by the noble Baroness, Lady Noakes: that it is a perpetual pot, which the banks will have to fill, no matter what. That is not satisfactory but, at the same time, it is nice to have as much clarity as possible about the expected outcomes. We come back to the same point about what goes into the code of practice or other versions of it, whatever they may be.
My final point—I do not need to labour points that we have been around before—is that, in his answer about eligible depositors, the Minister said that this is enshrined in PRA rules. I just wish that it was enshrined in primary legislation, as it used to be. I had not absorbed how that was in the rules and was therefore changeable by the PRA. I thought that it would be fixed in primary legislation, but that is something else to think about. With those comments, I beg leave to withdraw my amendment.
Baroness Noakes
“214F Engagement with Parliamentary Committees(1) If the Bank of England exercises the power under section 214E it must, as soon as reasonably practicable, notify in writing the chair of each relevant Parliamentary Committee that the power has been exercised.(2) Relevant Parliamentary Committees are—(a) the Treasury Committee in the House of Commons, and(b) the Financial Services Regulation Committee in the House of Lords.(3) References to the committees referred to in subsection (2)—(a) if the name of the Committee is changed, are references to that Committee by its new name, and(b) if the functions of that Committee (or substantially corresponding functions) become functions of a different Committee of the House of Commons or the House of Lords, are to be treated as references to the Committee by which the functions are exercisable.(4) Any question arising under subsection (3) is to be determined by the Speaker of the House of Commons in relation to committees of the House of Commons and by the Senior Deputy Speaker of the House of Lords in relation to committees of the House of Lords.”Member's explanatory statement
This amendment provides that the Bank of England must notify the Treasury Committee of the House of Commons and the Financial Services Regulation Committee in the House of Lords if the recapitalisation power is used.
Baroness Noakes (Con)
My Lords, Amendment 15 would add a new section to FSMA. This would create a requirement for the Bank of England to notify the Treasury Select Committee in the other place and the Financial Services Regulation Committee of your Lordships’ House of the use of the recapitalisation power.
On our last Committee day, I tried to add a requirement for Treasury consent when the recapitalisation payment power was used in order to improve parliamentary accountability around the use of the power. That would, in effect, have tied Ministers into the decision, thus allowing Parliament—in particular, the other place—to hold Ministers to account. As I have said many times, the accountability of the Bank of England is weak. Unsurprisingly, because Ministers have never been known to be in love with ministerial responsibility or accountability, the Minister turned this down.
However, in response to my amendment, the Minister said, as if it was a self-evident truth, that:
“It is important to maintain the position that the Bank of England can take decisions on the appropriate resolution action independently”.—[Official Report, 5/9/24; col. GC 33.]
I am not sure that that is correct. The independence of the Bank of England certainly exists in relation to monetary policy, but it does not extend to the totality of its functions.
I invite the Minister to look at Section 4 of the Bank of England Act 1946, which was when the Bank of England was nationalised. Section 4 allows the Treasury to issue directions to the Bank of England—it has in fact never issued a direction, but the power exists. There are carve-outs from that power of direction to cover monetary policy, the activities and functions of the PRA, and something to do with central counterparties. It does not carve out the Bank as a resolution authority, so a power exists for the Treasury to direct the Bank on resolution functions. We should not therefore get hung up on the so-called independence of the Bank in considering amendments to this Bill, though we may well return to the topic on Report.
Lord Vaux of Harrowden (CB)
My Lords, very briefly, I support the noble Baroness’s amendments. Perhaps I would say that as a member of the Financial Services Regulation Committee—as one of the majority of us in this Room, I should say, who are members of that committee.
I see this as working closely alongside the reporting amendments that we discussed on Thursday. When we were talking about the reporting requirements the noble Baroness, Lady Vere, mentioned that it is all very well issuing reports, but not if there is no one to read them. This gives us somebody to read them. It is a fairly light-touch requirement: it is an obligation to notify but does not give any obligation on anybody to do anything with it, unless they feel they need to and that it is important. I hope that this simple measure, alongside the reporting discussions we had last week, will be something that the Minister is minded to accept.
Lord Eatwell (Lab)
My Lords, perhaps I might suggest that it would be wise of the Minister, if I may be so bold, to look warmly on the amendment. Discussions around the accountability issue were a persistent theme in the debates on what is now the Financial Services and Markets Act 2023, and led as the noble Baroness, Lady Noakes, pointed out, to the creation of the Financial Services Regulation Committee of your Lordships’ House, charged with the responsibility for maintaining parliamentary accountability of financial services regulators. I can assure him that if the Treasury does not accept this amendment, he will become weary of the number of times that it will come back again and again—the reason being simply that the committee feels strongly that its role is now a crucial part of the regulatory framework in the UK and that the reports to the committee effectively establish the groundwork of its role in pursuing the accountability agenda.
Baroness Bowles of Berkhamsted (LD)
Not surprisingly, I too support this amendment. I congratulate the noble Baroness, Lady Noakes, on her exposition of the genesis of the terms of Section 38 of the 2023 Act. Of course, I am a member of the committee that came as a consequence of that. In her presentation, although not in the amendment—wisely so—she suggested that maybe there would be some hearings and questions, and the possibility that they would be in camera.
I urge the Minister, the Treasury and, indeed, the Bank not to shy away from such suggestions, because it would not be the first time that I have heard mutterings about things being confidential and not wanting to talk about them to parliamentary committees. In Germany, its parliamentary committees can look into the books of the banks and get all kinds of confidential information and—do you know?—it does not leak out. It is quite possible for committees of this House to behave just as well. I put that in as some impetus for how you can get better accountability, oversight and, I suggest, help from the committees, where everybody, ultimately, is pulling in the same direction.
Baroness Vere of Norbiton (Con)
My Lords, there is not an awful lot more to say. This is a very elegant amendment from my noble friend Lady Noakes, and it was very elegantly explained. I am the sole member of this Committee today who is not a member of the Financial Services Regulation Committee—no, neither is the Minister—and I am sorry about that. All noble Lords involved in getting the committee set up have an enormous amount of experience in the field of financial services regulation and, looking at the inquiries that it is already doing, I think it will be a very valuable part of our regulatory infrastructure. I look on this amendment with warmth and favourability and I should imagine that the Minister will do so, too.
Lord Livermore (Lab)
My Lords, the amendment tabled by the noble Baroness, Lady Noakes, focuses on the important theme of how the Bank of England is accountable to Parliament. As I have said in response to other amendments, the Government agree that it is right that the Bank of England is held to account for the actions it takes in resolution. That includes being accountable, as appropriate, to Parliament, so I do look warmly, in the words of my noble friend Lord Eatwell, at the intent of this amendment. I also stress that it is right that the Bank of England can act quickly and decisively when exercising its powers. That is particularly important in a crisis situation.
That said, the Government expect that the Bank of England would engage with Parliament after taking resolution action, including when the mechanism under the Bill is used. Specifically, under the existing provisions of the Banking Act, when the Bank of England exercises its resolution powers it must provide a copy of the relevant legal instrument to the Treasury. The Treasury must then lay that instrument in Parliament and the Bank of England must also publish it. This will continue to apply under the new mechanism and ensure that Parliament is notified when resolution action is undertaken. I shall give one specific example. In the case of SVB, the Bank sent to the Treasury the copy of the legal instrument the same morning as it exercised its power. The Treasury then laid the relevant document in Parliament on the very same day.
I also reiterate points I have made elsewhere about the Government’s commitment to require the Bank of England to produce reports in the event that the mechanism is used. The Government strongly expect such reports to be made public and laid in Parliament unless there are clear public interest grounds for not doing so, such as issues of commercial confidentiality. I hope this provides some comfort to the noble Baroness and, on that basis, I respectfully ask her to withdraw her amendment.
Baroness Noakes (Con)
Just to clarify something with the Minister, I understand that the resolution instruments are notified to the Treasury and laid before Parliament but they, of course, do not refer to the use of the mechanism in the Bill. That is what I was focusing on, rather than the resolution action itself. They may be separated, so it is not quite satisfactory to say that the law already provides for the resolution instruments to be relaid, unless that bit of the legislation, from the 2009 Act, were amended to cover the use of the Bank’s payment capitalisation power. I was trying to fill in a gap that I thought existed.
Lord Livermore (Lab)
I do not know whether this goes far enough for the noble Baroness but we absolutely intend, and would be clear, that we expect the same exact procedure to apply for this new mechanism.
Baroness Noakes (Con)
I am very glad that the Minister has said that.
First, I thank my fellow members of the Financial Services Regulation Committee for their support on this amendment—I was never in any doubt that I would get it—and I thank my noble friend, the shadow Minister, for her support.
I think this will come down to whether the Treasury’s expectations should be backed up somewhere in the legislation or whether we can allow it to exist on the basis that Treasury expectations will always somehow work out in practice. I favour the former: we need to be clear in the legislation about the trail of information that needs to go and when it needs to go.
Lord Vaux of Harrowden
“(aa) on a winding up of the institution, any recapitalisation payment is to be treated as a debt of the institution and paid out of the institution’s assets in preference to all other claims except any prescribed fees or expenses of the official receiver;”Member’s explanatory statement
Because the recapitalisation payment is not paid by the FSCS to the institution, but is paid to the Bank of England, it is not clear how it would be treated on a winding up of the institution. This probing amendment aims to ensure that it is treated as a debt of the institution and to ensure that recapitalisation payments are recovered first in any insolvency process, in preference to other creditors or shareholders, other than the expenses of the receiver.
Lord Vaux of Harrowden (CB)
My Lords, this amendment is simply intended to try to obtain some clarification on how a recapitalisation payment that has been made by the FSCS to the Bank of England will be treated if the failing bank eventually gets into insolvency. This could occur if the bank is transferred to a bridge bank, the buyer is not found and the bank’s financial situation does not improve. There is a two-year deadline for the bridge bank although that can be extended in certain circumstances but, eventually, the process can end up with the bank being wound up.
If that happens, the recapitalisation payments should be treated as a debt of the bank and should rank ahead of all other liabilities, debts or other claims other than the fees of the official receiver when it comes to distributing any value that might be left in an insolvency situation. This is related to other discussions that we have already had and partially to Amendment 23, tabled by the noble Baroness, Lady Bowles, which we will debate later.
The principle should be that the shareholders, lenders and other creditors should not be put in a better position as a result of the recapitalisation. To put it another way, the industry-funded compensation scheme should not, in effect, be bailing out the losses of shareholders and creditors other than the depositors who will be compensated under the scheme should their deposits be lost in the insolvency. However, that is not clear in the proposed Bill, although it is entirely possible that I have missed something in the interplay between the various Acts that apply here. I would therefore be most grateful if the Minister could explain exactly how the amount provided by the FSCS would be treated in such a situation. It might most easily and clearly be dealt with by including it in the worked example that the Minister agreed to consider providing during our discussions on Amendment 1 on Thursday.
I should say that I suspect that my amendment as it is currently drafted probably does not work, and that it may require some changes to be made to insolvency legislation to work properly if there is an issue. Rather than worrying about the specifics of the amendment, I hope that the noble Lord will concentrate on the principle and explain how the recapitalisation payment would be treated in an insolvency process, as it stands, in particular in making sure that it does not advantage shareholders and lenders, and ideally point me to the relevant clauses of the relevant legislation. If I am right that the situation is unclear, we can sort the details out on Report. I beg to move.
Baroness Noakes (Con)
I support the amendment that the noble Lord, Lord Vaux, has put forward, and in particular the request for worked examples, preferably with numbers in, because the noble Lord, Lord Vaux, and I are accountants and we like looking at numbers rather than words. Having read the proceedings of the first Committee day in Hansard, I realised that I did not know how some of these things work in practice, so I think that it is important to have those worked examples.
Baroness Bowles of Berkhamsted (LD)
I support this amendment as well, or something like it, and I would be very pleased if the Minister was prepared to try to work out something that might go in the Bill, because we need to have some clarity around these issues. We come back, as has been suggested, to our shareholders being advantaged at the end of the day. I find who is getting what in insolvency remarkably difficult to follow anyway; I certainly defer to the noble Lord, Lord Vaux, who is an accountant and a lot better at it than I am. I suggest that, if the noble Lords present cannot get their heads around it or are wondering, it needs laying out somewhere for clarity, ideally in legislation.
Lord Livermore (Lab)
My Lords, I am about to write to the noble Lord, Lord Vaux, on the matter that he raises in his Amendment 17, following a commitment that I gave on the first day in Committee. I will also happily reflect any points raised in this debate in that letter, if helpful. In the meantime, I will set out some of the content of that letter, while providing some additional clarity on the points he raises. Again, I hear the request for worked examples that we discussed on day one.
The Bill extends the role of the Financial Services Compensation Scheme to include providing funds at the Bank of England’s request, which the Bank of England could then use to recapitalise the firm in question. As I have set out previously, the intention would be to achieve that recapitalisation by injecting equity into the failed firm, helping to restore it to viability. In the event that the Bank of England places the failed firm into a bridge bank, the Bank of England would become the sole shareholder for that bridge bank.
It is therefore possible that the Bank of England would receive recoveries in a subsequent winding-up of the bridge bank if all other claims were met, reflecting its position in the creditor hierarchy as a shareholder. The Bill provides for any such recoveries to be returned to the Financial Services Compensation Scheme. The Government consider this to be an appropriate method for dealing with funds used in a resolution and in keeping with the existing principles of the creditor hierarchy. I note four further important points.
First, by ensuring an injection of equity, it achieves the core purpose of the new mechanism, which is to restore the firm to solvency. By contrast, if such a payment were classified as debt—even if that had a more favourable ranking in the creditor hierarchy— there is a risk that it would not restore the firm to the necessary level of balance-sheet health.
Secondly, I note that the primary intention in deploying resolution tools using the new mechanism would be to sell the firm. It is therefore the Government’s expectation that a sale should be the outcome in the majority of cases, rather than placing the firm into insolvency and winding it up from a bridge bank.
Thirdly, I point out that, if the firm entered insolvency from a bridge bank and there were still eligible depositors, the Financial Services Compensation Scheme would pay compensation to those depositors and take on their position in the creditor hierarchy, as it usually does. That of course is the right approach, ensuring depositors maintain their super-preferred status in an insolvency. It is important to note that changes to the creditor hierarchy must be considered carefully to ensure there is clarity for investors and market participants as to how they would be treated in a failure scenario. Treating the funds provided by the Financial Services Compensation Scheme as a debt only at the point of winding up the firm, and not prior to that, might create uncertainty as to its interaction with insolvency law more broadly.
Finally, I note that the super-preferred status in the creditor hierarchy that the Financial Services Compensation Scheme currently enjoys in insolvency reflects a different set of objectives. In those circumstances, the Financial Services Compensation Scheme is standing in the shoes of depositors and that preferred status is seeking to protect depositors’ interests. That is different to the intent of the mechanism delivered by the Bill, which is to provide a source of resolution funding to recapitalise a failing firm.
I appreciate the Committee’s interest in what is a technical but important matter. I hope that I have been able to clarify the intent of the Bill and that the noble Lord is able to withdraw his amendment as a result.
Lord Vaux of Harrowden (CB)
I understand what the Minister says about the equity of the original shareholders being effectively written down to zero, but what happens with, for example, lenders who are transferred into the bridge bank? It cannot be right that they probably lose everything in the event of an insolvency situation, but if the FSCS, via the Bank of England, has injected a load of money into the failing bank and it then goes into insolvency, there is more money there and therefore those lenders will receive a share of their cash, if there is enough, which they would have lost in an insolvency situation. However, the FSCS gets nothing back because there is nothing to recoup as it has gone to the lenders. In effect, in certain circumstances the lenders to the failing bank may be bailed out by the FSCS through the Bank of England. That does not seem right to me. Those lenders took a risk in the first instance that was not predicated on being bailed out. I think there is something here that needs to be followed up. Have I got that right?
Lord Livermore (Lab)
In the letter I will write, we will set out exactly what would happen in the example that the noble Lord gives.
Lord Vaux of Harrowden (CB)
I thank the Minister for that explanation and look forward to receiving the letter with the details and, I hope, a detailed worked example. However, an issue remains. The principle must be that a recapitalisation of the bank by the FSCS will not, in effect, bail out the existing shareholders—which it seems it does not do—or existing creditors, with the exception of the depositors, who are protected separately. There is something that needs looking at quite carefully here. I think we will come back to this on Report, but for the moment I beg leave to withdraw the amendment.
Baroness Noakes
“(2A) In section 4 (special resolution objectives), at the end of subsection (9) insert— “(9A) Objective 8, which applies in any case in which the Bank of England uses the power in section 214E of the Financial Services and Markets Act (recapitalisation payments), is to ensure that the costs which are born through the Financial Services Compensation Scheme do not exceed those which would have been born if the bank insolvency procedure had been used.””Member’s explanatory statement
This amendment adds to the special resolution objectives so that the Bank of England has to consider the net costs recouped via the FSCS if it uses the recapitalisation power with the counterfactual of the use of the bank insolvency procedure.
Baroness Noakes (Con)
My Lords, this amendment would insert a new special resolution objective into Section 4 of the Banking Act 2009. That objective is to ensure that the costs of using the recapitalisation payment power, thus loading costs on to the banking sector and in due course on to its customers, are not more than if the bank insolvency procedure had been used.
The special resolution objectives in Section 4 are not absolute requirements. The Bank has to have regard to them when using the resolution and related powers under the 2009 Act. There are seven existing objectives, and I am simply adding one more “have regard” for use only when the bank recapitalisation payment power is used. Section 4(10) states:
“The order in which the objectives are listed in this section is not significant; they are to be balanced as appropriate in each case”.
Thus, I am not trying to impose a requirement which trumps everything else in the special resolution regime. I regard this amendment as quite modest.
Two strands of analysis underlie my tabling of this amendment. The first is that the code of practice is clear that the bank insolvency procedure is the default option, unless there are public interest considerations that outweigh the important market discipline of failure. I am not sure we have seen in practice the use of the default option, but it ought to remain the core option for smaller banks in particular, which the Government insist are the main target of this new power.
The second concern was expressed during the consultation on this Bill—that there ought to be something akin to the “no creditor worse off” provisions of the Banking Act 2009. These provisions ensure that creditors are not disadvantaged by the use of one of the resolution tools compared with the option of insolvency. I am trying to ensure that the banking sector, which is footing the bill via the recapitalisation payment, should not be worse off than if the failed bank had been put through the insolvency process, resulting in the banking sector picking up the costs of reimbursing protected depositors.
I completely accept that there are difficulties in making this an absolute rule, because the Bank of England may well prioritise other matters, such as the continuity of banking services for critical functions. That is why I have drafted this amendment as an additional objective rather than an absolute rule. However, its inclusion in the 2009 Act would ensure that the Bank was especially mindful of the costs that would fall on the banking sector when using the bank recapitalisation power. I beg to move.
Baroness Bowles of Berkhamsted (LD)
I have mixed feelings about this amendment. I am grateful for the comments of the noble Baroness on why it was an objective; I understand that. Very definitely, the costs should not be disproportionately larger, but, if it was a relatively small amount larger than an insolvency and there was a good public interest case, I would not want to bar it. I am not quite sure whether the words used and having it as an objective necessarily convey that; if we were to proceed further with it, we could somehow make it a little more explicit in that regard. It needs to be in the same order of magnitude, not hugely more. With that caveat, I am probably in the same position as the noble Baroness, Lady Noakes.
Lord Vaux of Harrowden (CB)
I was not going to speak on this amendment, but I am also slightly in two minds. One hesitation is that it is very hard to know on the day you do the recapitalisation payment what the cost of an insolvency situation would be. However, I understand where the noble Baroness is heading with this, and there is a lot of sense in the sentiment behind it. This gives more ammunition to the question around reporting—we need the Bank of England to give a very clear explanation as to why it has chosen recapitalisation over insolvency. That might be my preferred way of going about it, but I understand absolutely what the noble Baroness said and support the sentiment behind it.
Baroness Vere of Norbiton (Con)
I also support the sentiment in the amendment from my noble friend Lady Noakes. I think all noble Lords here, including the Minister, would agree that this has the right intention but, as the noble Baroness, Lady Bowles, mentioned, there will be edge cases which we cannot foresee at this time. The question is: should such a statement of intent be in the special resolution objectives and, if not, where should it go? I do not know—perhaps in a code of practice, or perhaps not. I am interested to hear what the Minister has to say.
Lord Livermore (Lab)
My Lords, the amendment tabled by the noble Baroness, Lady Noakes, seeks to introduce a new objective into the special resolution regime. The new objective would state that the costs in using the new mechanism should not exceed those that would be incurred in the counterfactual of placing the firm into insolvency. This amendment therefore touches on an important point raised both in consultation and during Second Reading, which is whether there should be a formal test or objective that seeks to prevent the use of the new mechanism, or make its use significantly more challenging, where the cost is higher than insolvency.
I also note that the noble Lord, Lord Vaux, raised similar points on the first day of Committee, which he alluded to today, making the case that the Bank of England should be required to present an assessment of costs in reports to the Treasury and to Parliament.
The Government carefully considered the case for inclusion of various forms of such a safeguard, sometimes referred to as a least-cost test, in response to feedback received during the consultation. In considering this matter, it is important to strike the right balance between ensuring that the Bank of England can respond quickly and flexibly to a firm failure and ensuring that costs to industry are properly considered. Having considered this, the Government concluded that the existing public interest test and special resolution regime objectives remained the appropriate framework for deciding whether the mechanism in this Bill could be used.
Adding a specific objective for the Bank of England to ensure that the costs to industry from using the new mechanism do not exceed insolvency could prevent it taking the most appropriate action to advance its broader resolution objectives. Those objectives include protecting financial stability, certain depositors and public funds. It is right that these aims are prioritised at a time of significant risk, which is part of the reason why the Government have not proposed changes to the broader resolution framework.
There is also the potential for such a change to impose important practical challenges. Resolution would likely take place in an uncertain and fast-paced context. Estimating the costs of different approaches during this period will be highly challenging and could change over time. There is therefore a risk that such an objective could create legal uncertainty around any resolution action, which in turn may undermine the usability and effectiveness of the new mechanism in situations where it is justified. This could have significant and undesirable consequences, including crystallising a set of indirect costs for the financial services sector and the wider economy. Further, it should be borne in mind that the alternative if the new mechanism is not available may be to use public funds.
However, I appreciate the intent behind the noble Baroness’s amendment and hope that I can provide some reassurance by reiterating previous points on the subject of the scrutiny and transparency of the Bank of England’s actions. As I have noted, the Bank of England is required under the Banking Act 2009 to report to the Treasury when exercising some of its stabilisation powers and, as was set out in response to the consultation, it is the Government’s clear intention to use these existing reporting mechanisms to ensure that the Bank of England is subject to appropriate scrutiny when using the mechanism provided by the Bill. However, I take the point that the noble Baroness made in response to my earlier point.
The Government have committed to updating the code of practice to provide further details on how these reporting requirements will apply when the mechanism is used. I reaffirm that the Government intend to include confirmation in the code that, after the new mechanism has been used, the Bank of England would be required to disclose the estimated costs to industry of the options considered, including the comparison with insolvency. The Government consider that using the code of practice in this way, rather than putting these requirements in the Bill, is the best approach to hold the Bank of England to account for its actions.
The Bank of England is legally required to have regard to the code and the Government are required to consult the Banking Liaison Panel, made up of regulatory and industry stakeholders, when updating it. Using the code will therefore ensure that a full and thorough consultation is taken on the approach. Given the complex and potentially fast-moving nature of bank failures, this will also ensure that any approach is sufficiently nuanced to account for the range of possible outcomes under insolvency or through the use of other resolution tools.
As I have previously said, the Government will share drafts of the updates to the code of practice as soon as practicable and provide sufficient opportunity for industry stakeholders to be consulted on them. The noble Baroness also made the case that insolvency should be a preferred strategy for small banks and I stress that this is the case. I hope that I have provided some helpful explanation to her of the Government’s position on this matter and respectfully ask that she withdraws her amendment.
Baroness Noakes (Con)
My Lords, I thank noble Lords for supporting the principle behind my amendment, even if they did not fully align with the mechanism that I have chosen. We have had a useful debate on the issues involved. The Minister’s response was clearly helpful and I want to consider it carefully.
The Minister talked about things being very fast-paced, which I completely accept. Nevertheless, the Bank has to make a decision on the best information that it has. I am trying to build only on what it should be doing anyway, even though that is difficult to do when things are moving very fast.
Let me reflect on what the Minister said. It may come back to the issues which I am going to discuss in the next amendment, which are about the code of practice and needing to see what is likely to be said in that. I will shut up at this point and save my powder until the next group. I beg leave to withdraw the amendment.
Baroness Noakes
“(2A) In section 5 (code of practice), at the end of subsection (1) insert “and—(iv) the bank recapitalisation power under section 214E of the Financial Services and Markets Act 2000.””Member’s explanatory statement
This amendment requires the Treasury to include the use of the recapitalisation power created in this Bill in the Code of Practice issued in respect of the special resolution regime.
Baroness Noakes (Con)
Amendment 21 would amend the Banking Act 2009 so that the code of practice, which has to be issued for various aspects of the special resolution regime, must cover the use of the bank recapitalisation payment power being created by the Bill.
My reading of Section 5 of the 2009 Act is that it would not require the Treasury to cover the use of the recapitalisation payment power in the code of practice. Although I am aware that the Treasury says that it intends to update the code of practice—the Minister repeated that again, a few minutes ago—it should be put beyond doubt in the Bill that it is one aspect of the resolution regime, as a result of the Bill, that should be covered in the code of practice. It should not be optional now or at any point in the future.
We debated the code of practice a little in our first Committee day, and we do not yet have any idea of when the revision to the code will appear. Can the Minister assure the Committee that it will be reissued before the Bill comes into force? The Treasury has control of that because it has control of the regulations bringing the Bill into force, and it clearly is important that there is a revised code of practice covering the use of the recapitalisation of payments available at the same time.
The Minister would not give any specific timing for the updated code or the consultation on it when he responded last week. He repeated that a few minutes ago. Last week, I specifically asked him whether the draft updates, which he had said to my noble friend Lady Penn would be provided, would be available ahead of Report. On checking Hansard, I found that he had sidestepped that question. I hope that he will answer it today because, if he cannot commit to sharing draft updates before Report, it puts the House in a difficult position when it comes to that stage of the Bill.
Turning from timing to topics, can the Minister outline which topics are likely to be addressed in any updates?
In our first Committee day, when we debated the first group of amendments which sought in various ways to constrain the scope of the bank recapitalisation payment power to small banks or those on the glide path into the MREL regime, the Minister said:
“I appreciate noble Lords’ concerns about this issue and am happy to commit to exploring how to provide further reassurance on the Government’s intent via the code of practice”.—[Official Report, 5/9/24; col. GC 11.]
I found that rather alarming, as it implied that it was not the Government’s current intention to include something about the key target of the bank recapitalisation payment power being small banks. However, that is exactly how the power in the Bill has been marketed—a power to deal with the insolvency of small banks or the failure of small banks. I would have expected the code to set out where the Government expect the new power to be used, especially as the power has been drawn so very broadly.
Our second group of amendments on the first Committee day concerned the extremely wide definition of costs which can be covered under the bank recapitalisation power. The Minister said that it was important that the Bill was “not overly prescriptive”; that might have been an opportunity for him to say that the issues would be covered in a code of practice, but he did not do so. Does that mean that the code of practice will be silent on the important issues surrounding this very wide ability to charge practically any cost under the recapitalisation heading? That may be important to those of us who think that the current formulation of the Bill goes too far.
When we discussed double dipping into the FSCS last week, I asked the Minister whether the code of practice would cover the use of the power more than once for the same institution. This would also cover the need to reconsider the resolution strategy of not using the banking insolvency procedure before using the power a second or subsequent time. When I asked the Minister if that would be covered in the code of practice, he said:
“We can certainly take that away and look”.—[Official Report, 5/9/24; col. GC 25.]
at it. In other words that, too, was not in the plans for updating the code of practice. The only definitive reference to the content of the updated code of practice that the Minister made last week—he made it again in the previous group today—was in relation to the reporting requirements, where he said that the bank
“would be required to disclose the estimated costs”.—[Official Report, 5/9/24; col. GC 47.]
involved in using the power.
Lord Vaux of Harrowden (CB)
My Lords, on this amendment I agree with every word that the noble Baroness has just said. Like most noble Lords, I have an inherent preference that things should appear in a Bill, rather than relying on slightly woolly statements of Ministers that this is what they intend to do. There are circumstances when that is appropriate but in a case like this, where the code will be so important, there should be an obligation that the code is updated to take account of the recapitalisation process.
To repeat what I said on Thursday, and what the noble Baroness has said, it is deeply unsatisfactory that the Minister seems to be relying on the existence of the code and its updating to avoid detailed amendments being put down on Report and pushed through. If that is the case, it is surely important that we get a chance to look at the revised code before then, or at least a draft of it—or, at the very least, clear details of what Ministers are expecting to include in it. I urge the noble Lord to see what we can do to achieve that. Otherwise, he will face detailed amendments to deal with the issues that we have discussed, because we have nothing else on which to base our position.
Baroness Bowles of Berkhamsted (LD)
I agree with what both previous noble Lords have said. We cannot rely just on the fact that something is going to be revised. It is the same old problem that we have with primary legislation a lot of the time: it lays out something that could be good or bad, but it says, “Trust me, we will get it right when we come to secondary legislation or something else down the track”. That is not satisfactory and, in the absence of some more detail, we have to see something about the code of practice or similar—whatever one calls it—in the Bill, just to make sure that there is an understanding of the direction of travel for the sort of detail that we are asking about.
Lord Eatwell (Lab)
I should like to pick up on the request for detail put forward by the noble Baroness, Lady Noakes. I am concerned that the powers that the Bank of England has to act in an emergency, which this would presumably be, should not be constrained to any degree other than that which is absolutely necessary. In other words, we should not load up the code with detail, the reason being that the next crisis will be one that none of us has anticipated. It will be completely different.
If we look at the financial crises that have occurred, the major one in 2007-09 and some minor ones since, they have appeared in completely unexpected directions. The Bank must then have the freedom to adapt its procedures to whatever new challenge arises. I quite understand that we do not want just to say it can do anything it likes, but I feel strongly that we must be very careful about loading the code, and indeed the legislation, with excessive detail.
Baroness Vere of Norbiton (Con)
My Lords, I added my name to the amendment in the name of my noble friend Lady Noakes about the code of practice because it is important that we have this debate. I recognise what the noble Lord, Lord Eatwell, says, but it slightly struck fear into my heart because it is about those circumstances where there is not sufficient guidance or a code of practice. Essentially, this is not necessarily just for the Bank of England; it is for all those stakeholders who will be involved in the other side of a resolution. A lot of people will read the code of practice and internalise it. When it is needed, it will therefore already be in their hearts because they will have read it, so I am not as concerned as the noble Lord is about putting in too much detail. The simple fact is that we have not seen anything, so we do not really know what we are dealing with.
It struck me that in the slight rush to bring forward some legislation to keep Parliament occupied, perhaps, the Government are not providing all the information that the House needs to consider this Bill fully. It is complex, and as noble Lords go through it, it is clear that we are all picking up new nuances that we consider might be of concern in the future. The code of practice makes up an important component of the regime and the Committee is slightly flying blind, having not seen a draft of the changes—not only a draft of what would happen as a result of the Bill, but also potentially to fill gaps that we know are not going to be part of the Bill. We know that the code is potentially the only protection between anybody who uses banks—essentially, the taxpayer—and the Bank being able to perform maximum adaptation to a situation. There has to be something in the middle that stops that happening.
I am warming to my noble friend Lady Noakes’s suggestion that the Bill should not come into force until the code of practice is finalised, but I sense that that might be a little churlish. The amendment itself is a little anodyne. I think all noble Lords agree that the Government will, of course, make changes to the code of practice, but I would appreciate hearing more information from the Minister about what changes are anticipated—specifically, what will be left out—and the timing for any code of practice because while it remains outstanding, even in draft form, there is a significant lack of clarity.
At Second Reading, the Minister stated that the update will happen in due course. How many times have I used that phrase? I know exactly what it means. It means “when we are sort of ready”. We need to be a bit more ambitious than that. Can the Minister give any further guidance on timing? If he cannot, would it be helpful if I tabled an amendment on Report that required the code of practice to be updated within, say, three months and subject to approval by both Houses? I am happy to do that if it is helpful.
As my noble friend Lady Noakes and the noble Lord, Lord Vaux, pointed out, the Minister has referred to these things being addressed in the code of practice. Many of the elements in the reporting are also supposed to be in that code. My concern is that six weeks have now passed since the Minister said “in due course” and the House rises at the end of the week for Conference Recess. I presume that the Treasury is still working, so that would be a further window during which progress on a draft code of practice could be made. Therefore, I very much hope that the Minister can commit to having a draft document available for review before Report stage is scheduled. I look forward to hearing from the Minister.
Lord Livermore (Lab)
My Lords, I should state at the outset that the Government have no objections to the principle under discussion. Indeed, the Government have already stated publicly in our response to the consultation on these proposals that we intend to update the code of practice to reflect the measures in the Bill. I have already committed to share a draft of the proposed updates at the earliest opportunity, and I am happy to reaffirm that commitment today. I am aware that this is not the answer that the Committee is looking for, but I am afraid that I cannot commit to providing that before Report. However, I expect it to be available before the Bill comes into force.
As set out in the Government’s consultation response, the updates to the code will do three things: first, they will ensure that the code appropriately reflects the existence of the new mechanism; secondly, they will set out that the Bank is expected to set out estimates of the costs of the options considered and, as noted elsewhere, this is expected to include the case of insolvency; and thirdly, they will set out the expectation that any use of the mechanism is subject to the ex post scrutiny arrangements that I have described elsewhere.
The noble Baroness, Lady Noakes, perfectly fairly asked for a series of clarifications of what the code will include. She asked about two points specifically. The first was whether the code will confirm the mechanisms intended for small banks and the expenses covered? Yes, it is the intention that it will. She also asked whether the code will cover multiple uses of the mechanism. Yes, the code will cover that. I will answer other specific questions in writing.
In preparing these updates, the Government are mindful to ensure that they are done efficiently and carefully to ensure that they achieve the intended effect within the wider resolution framework, for instance, ensuring that the right set of costs is considered on the appropriate basis.
The Government will ensure sufficient opportunity for industry stakeholders to be consulted on these proposed updates to the code of practice. In particular, the final wording of any proposed updates would be subject to review by a cross-section of representatives from the authorities and the industry on the statutory Banking Liaison Panel, which advises the Treasury on the resolution regime. As noted, the Government will aim to progress these updates and make the proposed changes available for consultation with industry as soon as practicable.
Finally, I note that the Banking Act 2009 already imposes an implicit requirement on HM Treasury to update the code of practice, even without this amendment. Addressing the operation of the new mechanism would therefore already fall within the scope of this requirement.
I know that this explanation may not be sufficient, but I respectfully ask the noble Baroness to withdraw her amendment.
Baroness Noakes (Con)
The Minister just referred to an “implicit requirement” in the Act. Does he believe that Section 5 can be interpreted only as requiring the code of practice to include matters relating to the bank recapitalisation power? That would be extraordinary because nobody knew about the bank recapitalisation power when the 2009 Act was drafted, so under the principles of ordinary interpretation, it would not be included.
Baroness Noakes (Con)
I thank noble Lords for taking part in this short debate. There were three parts. First, Section 5 of the 2009 Act needs to mention the bank recapitalisation power, which is what the amendment does. The Minister is going to write on that.
We moved on to issues with the content and timing of the code. I say to the noble Lord, Lord Eatwell, that we all understand that the Bank needs powers to act as quickly as possible. Nobody is trying seriously to harm that. Taking what the noble Lord said to its logical conclusion, the statute would say just that the Bank of England can do whatever necessary when it comes to situations of bank failure—full stop. We would not have the many pages of the 2009 Act and all the complicated, mind-blowing arrangements that exist, holding companies and everything like that. We would not need that because we could just say that it could do everything. It is overstating the case to say that trying to write codes of practice would hold the Bank up in doing its duty when things go wrong.
What the Minister said on content is a helpful move forward from where we were. We may want to explore that a bit further on Report. However, timing is a concern, as we will not have further clarity by the time we reach Report. The only useful thing he has said is that they expect to reissue the code of practice prior to this Bill coming into force. I suggest that it would be pretty negligent not to update it before bringing the Bill into force.
Member’s explanatory statement
This amendment seeks to ensure that the FSCS should only be used for recapitalisation not for bailing out shareholders.
Baroness Bowles of Berkhamsted (LD)
I am afraid that I will have to spend a little time on this, although we will still close well before time. We are in a slightly new world. The noble Lord, Lord Eatwell, referred to how—although he did not say it like this—once upon a time, when there were problems, you left it to the Bank of England to do the right thing. By and large it did, within the state of knowledge of that time.
However, banking and the way that we deal with resolutions have moved on a long way since then. We are moving further with this small but significant Bill, using the funds of other banks to give to a bank that has failed. Beyond the public interest of depositor guarantees, which in their day were a new thing, we are using private money for what would in the past have been done with public money. That is a different place. Just as with insolvency, you put in the right safeguards about priority orders and so on, we need to put in priority orders for how that money is properly used.
Turning to my amendment, I will have to delve into realms where words have taken on different meanings over time. “Recapitalisation” now seems to incorporate bits of resolution; it does not just mean “putting capital in”. I used that sense of it in my amendment but I will carry the Committee through it as best I can.
The purpose of this amendment is to probe further whether the language used in the Bill, which ends up meaning “reducing the shortfall”, is too broad and therefore allows the FSCS funds to be used not only as new capital for the ongoing bank but to reduce the write-down of other capital instruments and correspondingly increase the amount that would otherwise have been taken from the Financial Services Compensation Scheme above the level that would have been needed if those other capital instruments were fully written down, as is the present presumption under the Banking Act 2009 and everything that feeds into it.
When I wrote the amendment, I was thinking of the ordinary meaning of recapitalisation—replacing capital—and not covering write-down manoeuvrings. So, please think about it as if I had said that and at the end it said: “and without reducing write-down of loss-absorbing capital instruments or shareholdings”, or some such wording. That was the intention of the amendment; if I go around the loop again, I will have a better shot at it.
Overall, I now come to the thought that my previous Amendment 22, which just deleted this, was probably a better option and a good thing for a variety of reasons. We need to avoid capture by the dubious “shortfall” wording from the Banking Act 2009 and the EU BRRD. The things that feed into shortfall are now synonymous with the things that are called MREL but they are looking at it from different ends. If we are going to tie back to the BRRD, I remind noble Lords that the shortfall is the sum of write-down of eligible liabilities to zero—that is what it says under Article 47.3(b)—plus the recapitalisation amount under Article 47.3(c). In essence, I am saying that the FSCS should be used only for amounts under Article 47.3(c)—that is the recapitalisation, which is what I am trying to capture—and that it cannot be used ahead of the writing down to zero of what is in Article 47.3(b). However, the trouble is that we are dealing in this world now where different things have been put in a pot, this time called the shortfall, linked by “and”, and we have no idea which bit we are allowing to be changed.
If we look at the broader picture of trying to cover banks with MREL, that is where it starts to get messy. It was quite simple if we just did it for the smaller banks, and we did not have to worry about things that were supposed to be written down to zero not being written down to zero again. It seems that that is exactly what the Explanatory Notes are telling us—I will quote from my copy to keep myself on track. They say that Clause 4(3)
“amends section 12AA”,
which goes back to the things I have just talked about,
“to allow the Bank to take into account the funds provided by the FSCS when they are calculating the contribution of shareholders”—
that is what it says at paragraph 26—
“and creditors required when exercising the bail-in write-down tool. This is to ensure that the Bank is not required to write-down more capital than necessary”.
However, as I read the law when it came from BRRD in the Banking Act 2009, you have to write down to zero unless you have so much that you get there before you have written it down to zero, and then you should not be going fishing in any other ponds anyway. So, there is some inconsistency or there is a hidden agenda.
There are some things in the insolvency stack that are worthy of rescue, as was the Silicon Valley Bank reasoning—such as uninsured deposits—but not things in that loss-absorption stack, especially not shareholders, because they are right at the top. Otherwise, what is the point of all the expense and effort that we go to to provide MREL, which is further on down, if we are then not going to use it? I really cannot understand what is meant to be going on by adding in this reference to the shortfall. I tried to amend it to say that it should not do bad things, in effect, but I think that we are a lot better off without it.
I then went back and looked at the response the Minister gave me when I raised this on the first day in Committee. He said:
“The noble Baroness, Lady Bowles, asked whether the Bank of England should reduce MREL requirements in the knowledge that it could instead use FSCS funds. The Bank of England sets MREL requirements independently of government but within a framework set out in legislation … The Bank of England will consider, in the light of this Bill and wider developments, whether any changes to its approach to MREL would be appropriate”.—[Official Report, 5/9/24; col. GC 11.]
The Minister was answering a question that I did not ask, but it is an interesting response, which the larger banks should get quite excited about. Is a quid pro quo for chipping in through the FSCS that you end up having less MREL? What an interesting suggestion. I can read what was said that way. According to that interpretation, reading through what is in the Bill, it is perfectly open that you could then not write down to zero things that appear under article 47.3(b) of the BRRD.
I can skip a lot of the other things that I was going to say but, to summarise, if the Explanatory Notes are correct, the intention is to use the FSCS to reduce the amount of write-down for shareholders or other loss-absorbing capital instruments. That is almost going backwards to the days that the noble Lord, Lord Eatwell, was perhaps recollecting of the Bank basically choosing who it should favour in the capital and liability stack. That seems to be the power we are giving it. If we are returning to something like that, it should be done in the context of a proper review of the Banking Act 2009, not in a kiss-me-quick Bill like this one, which was sold to us as being rather more about saving uninsured deposits, not saving sophisticated investors who have enjoyed good returns from bail-inable bonds or who are at the top of the stack and are the shareholders in the failing bank.
The FSCS cannot just be a pot for general usage; it has to be targeted. I tried to amend it with this amendment, but I am now coming to the conclusion that linking back to shortfall has no place in this Bill because it introduces too many ambiguities. I beg to move.
Baroness Noakes (Con)
My Lords, I will be brief. The noble Baroness raises some important issues in her amendment. I think the Minister confirmed earlier that shareholders would disappear because the Bank of England would take over their share capital, so they could not benefit from the use of the recapitalisation, but if there is any suggestion that the recapitalisation amount will excuse the bail in of some of the bail-inable liabilities, that would be pretty unacceptable. I hope that the worked examples that I hope the Treasury will enjoy working on while we are on Recess can illuminate how all this is going to work.
Lord Vaux of Harrowden (CB)
My Lords, I find my head spinning a little about some of this. It comes back to the confusion about how the various flows here work, so that worked example is becoming more and more crucial. I come back to the principle that I raised before: recapitalisation by the industry should not bail out those who should be at risk in the case of a failure. MREL capital et cetera must surely be used up first before we take recourse to the industry. It is similar to, but slightly different from, the point we made in Amendment 17 that, again, people who are creditors of the failing bank should not be bailed out by the recapitalisation in the event that it all goes wrong. It seems rather confused, so I look forward to the worked example, and I wish the Minister good luck with getting something that covers all the aspects.
Lord Eatwell (Lab)
My Lords, I was rather enjoying being characterised as an old-fashioned central banker, until the noble Baroness, Lady Bowles, attributed to me to me the idea that selecting from whichever pot would be entirely at will, so to speak. I add my support to what the noble Lord, Lord Vaux, just said: in a recapitalisation, shareholders and MREL must clearly be used first, and FSCS money used simply when those pots have been exhausted.
Baroness Vere of Norbiton (Con)
My Lords, I simply make the same point. The noble Lord, Lord Vaux, was absolutely right to summarise the principle which I think all noble Lords on the Committee feel is the purpose of the Bill. There cannot be any circumstances by which there is MREL or whatever it might be left, yet money is going in from FSCS to ensure the resolution of the bank. I cannot see any circumstance in which that would happen—perhaps Treasury officials would be able to think of one—but I think all noble Lords are agreed on the need for some clarity on what would happen.
I appreciated the comments from the noble Baroness, Lady Bowles. I got about 60% of them, so I was really proud of myself; the other 40% went way over my head. I am going to try to understand her points. We are in quite a difficult situation, but the way that she has been so forensic about it has allowed the noble Lord, Lord Vaux, to state what the principle is. It is about combining those two things—the forensic attitude to “This is what the Bill could say if read in a certain way” versus “Just tell us whether the Bill abides by the very simple principle that basically FSCS money should be a last resort, not there for anybody else, but just to prop up a bank to make sure it gets through to the other side of resolution, for the public interest and no more”.
Lord Livermore (Lab)
My Lords, in response to the amendment tabled by the noble Baroness, Lady Bowles, I reassure her that the Bill does not seek to introduce measures to bail out shareholders. I note that she raised concerns about this point on the first day in Committee, about which I am about to write to her. I hope my response will provide the clarification she is seeking pending that letter and the worked examples that we have discussed.
The amendment relates to a subsection of the Bill that would amend Section 12AA of the Banking Act 2009. This sets out the definition of the shortfall amount, which is a figure calculated by the Bank of England when using the bail-in resolution tool. The shortfall amount determines how much of a firm’s resources need to be bailed in to restore its capital ratio to the extent necessary to sustain sufficient market confidence and enable it to continue to meet the conditions for authorisation for at least one year and to continue to carry out its authorised activities. The methodology for determining the shortfall amount is not changed by the Bill, and it remains the case that when using the bail-in tool a firm’s own resources and eligible liabilities—its shareholders and creditors—would bear losses.
The relevant provision is not intended as a means of reducing the amount of MREL that should be used when bailing in a firm. Instead, it is intended to ensure that, in the event the mechanism is used alongside the bail-in tool, funds from the Financial Services Compensation Scheme are taken into account and used rather than the Bank of England having to bail in other creditors further up the creditor hierarchy. As an example, without this provision, if a firm had insufficient MREL to meet its shortfall amount without being able to take into account Financial Services Compensation Scheme funds, it may need to bail in creditors, such as uncovered depositors. Retaining this provision therefore ensures that the Bank of England may exercise some discretion in not bailing in other liabilities beyond a firm’s MREL, such as uncovered deposits, where to do so might risk further destabilising the business of the firm, other participants in the banking sector or other sectors, or reducing wider confidence in the financial system. Therefore, the Government consider it important to maintain flexibility to respond to the relevant circumstances.
In this context, I also note that funds provided by the Financial Services Compensation Scheme under the new mechanism can be used to cover the costs of recapitalising the failed firm, the operating costs of a bridge bank, and Bank of England and HM Treasury costs in relation to the resolution.
It is important to note that Sections 6A, 6B and 12AA of the Banking Act 2009 require the Bank of England to ensure that shareholders and creditors bear losses when a banking institution fails. This is an important principle that will continue to apply where the new mechanism is used.
I can reassure the noble Baroness, Lady Bowles, that the regime provides an extensive and proportionate set of powers to the Bank of England to impose consequences on the shareholders of a failed firm in resolution. The bail-in tool specifically enables the Bank of England to impose losses on shareholders and to write down certain unsecured creditors. This is an important principle that ensures the firm’s owners and investors must bear losses in the case of failure.
This is of course a highly technical area, and I understand the noble Baroness’s concerns. To that end, I am happy to explore whether there is further material that the Government can make available, such as worked examples, to help illustrate how this approach may work in practice. I hope these points can reassure the noble Baroness and I respectfully ask her to withdraw this amendment.
Lord Vaux of Harrowden (CB)
The noble Lord has just confirmed the point that we talked about in Amendment 17, that there are situations where the use of the recapitalisation payment can, in effect, bail out some types of creditors. Indeed, he referred to unprotected deposits as being one area that might make sense. This is quite complex and I suspect that when we have seen the worked examples and so on, there is going to be more to discuss. Would he be prepared to meet with officials and Members of the Committee to go through these things prior to Report, so that we can make sure that we all really understand in what circumstances that that could happen and in what circumstances it cannot?
Lord Livermore (Lab)
Yes, absolutely; I will very happily meet. I will write a letter setting this out in greater detail, provide the worked examples, and then perhaps we can meet on that basis.
Baroness Bowles of Berkhamsted (LD)
I thank the Minister for his replies but I am still not satisfied, in part because of what is in the Explanatory Notes. They should be amended because they cannot stand alongside everything else that is said. I know that they have no legislative power but if we are looking for ways to interpret, they are there. The problem comes from, as I said, “shortfall”, which is defined in a way that has ambiguities. I know full well that “shortfall” was an unusual word; it did not need to be in the BRRD and was put in by the counsel—I think I know who did so because I was told to guard it with my life—for various operations that may still be needed. Now is the time to make it clear. The linkage back to it is not good.
Alongside worked examples, it would probably be quite useful to have a list of the instruments that we think are covered and those that are outside. MREL, which is loss absorption amount plus recapitalisation amount, covers common equity tier 1, other equity instruments, subordinated senior non-preferred instruments and ordinary unsecured senior instruments. It does not include repayable deposits and non-returnable deposits.
How have we ended up talking about bailing in unsecured depositors when we are talking about MREL, because they should not be there in the first place, as far as I understood things? If we cannot understand that, that is not right to put before the public. Can we have a list of the instruments that we think can be bailed in, where they are bailed in, and then the point at which in that stack the FSCS compensation can come in? Once we have worked out where that is and can see it clearly, I should be much better pleased if we could define that ab initio in the Bill rather than reference back to language that is flawed and risks either leading us up the garden path or not being able to understand it, even though I declare that I have confidence that the Bank of England will probably get it right.
It is splitting hairs, but I cannot make that wording work; I am sorry. Therefore, in hoping that I will get some more explanations, for the present, I shall withdraw the amendment, but it may well be that either this or my Amendment 22 in some form might need to reappear on Report. I beg leave to withdraw the amendment.
Bank Resolution (Recapitalisation) Bill [HL]
Monday 4th November 2024
(2 weeks, 3 days ago)
Lords ChamberRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text Read Debate Ministerial Extracts Amendment Paper: HL Bill 2-R-I Marshalled list for Report - (31 Oct 2024)
15:53 - Division on Amendment 2 - Ayes: 247 / Noes: 125 - Amendment 2 agreed.
17:13 - Division on Amendment 7 - Ayes: 125 / Noes: 155 - Amendment 7 disagreed.
Lord Livermore
Member’s explanatory statement
See the explanatory statement for my second amendment to Clause 1.
The Financial Secretary to the Treasury (Lord Livermore) (Lab)
My Lords, in moving government Amendment 1, I shall speak also to government Amendment 4. The Government have tabled these amendments after considering the concerns raised in Grand Committee by the noble Baronesses, Lady Noakes, Lady Bowles, and Lady Vere, and the noble Lord, Lord Vaux. I am extremely grateful to all of them for all of the points they have raised.
Reflecting in particular on the points made by the noble Baroness, Lady Noakes, the Government have decided to clarify in the Bill whose expenses can be covered by a recapitalisation payment from the Financial Services Compensation Scheme. I am grateful to the noble Baroness for her engagement on this matter since Grand Committee.
The Bill as introduced permitted a recapitalisation payment to cover the expenses that the Bank of England or another person has incurred, or might incur, in connection with the recapitalisation of the firm in resolution. These amendments replace that broad formulation with “relevant person”, then specify that “relevant person” means the Treasury, a bridge bank or an asset management vehicle. They further specify that “bridge bank” and “asset management vehicle” have the meanings given by Sections 12 and 12ZA of the Banking Act 2009 respectively.
In Grand Committee, the noble Baroness, Lady Noakes, indicated that she had no objection to the Treasury, the Bank of England and its entities having certain expenses covered by the new mechanism, but that this should be specified in the Bill. These amendments tabled by the Government seek to do just that; I hope that she and other noble Lords will be able to support them.
In Grand Committee, the noble Baroness, Lady Noakes, also asked questions about the specific expenses that would be in scope under the terms of the Bill. On this point, I should be clear that the Government maintain the position set out in Grand Committee: it is important that the Bill is not overly prescriptive, allowing the Bank to respond flexibly when costs arise. I refer to the explanations given in Grand Committee, in the Government’s response to the consultation and in the draft updates to the code of practice of the types of expenses that will be expected to be covered. The Government maintain that it is prudent to ensure that there is broad provision to cover these potential additional costs. Ultimately, it should be borne in mind that the alternative may be for such costs to be met by the taxpayer.
By way of reassurance, I reiterate that, in determining whether to include certain ancillary expenses in its request for funding, the Bank of England is subject to the usual obligations under public law to act in a way that is reasonable and proportionate. In addition, the legislation does not allow the Bank of England or any other person to claim expenses that arise exclusively for preparing for a Bank insolvency. The draft updates to the code of practice also set out that the Government would expect any final report on the use of the mechanism to explain why certain expenses were considered reasonable and necessary.
I hope that the Government’s approach as set out in these amendments addresses the points raised by noble Lords in Grand Committee, and that noble Lords will feel able to accept them. I beg to move.
Baroness Noakes (Con)
My Lords, I spoke in Committee. I draw attention to my interests as included on the register; in particular, I hold shares in a number of banks that could be affected by the contents of this Bill.
I thank the Minister for the comprehensive letters that he wrote to Members who took part in Committee—and, indeed, for the subsequent meeting that he organised. I also thank the Treasury for publishing the draft extra chapter for the code of practice, which has been very helpful to those of us trying to work through the Bill.
I certainly support the two amendments to which the Minister has just spoken, which go some way to limiting the wide power in new Section 214E(2), but I have some further questions for the Minister, building on the comments he has just made. These amendments constrain to whom payments can be made under that new subsection but they do not do anything to constrain the types of expenses that can be incurred. In Committee, I tried to explore what happens if litigation or regulatory actions arise in relation to issues that had occurred prior to the resolution action being taken but which do not emerge until a little later. We did not get very far, so I will spend just a couple of minutes on them here.
I am talking about material litigation or regulatory action. There could be shareholder litigation, which happened after RBS was bailed out by the Treasury. There could also be other kinds of issues that result in both regulatory action and civil litigation, as happened in relation to Libor, for example. Today’s hot issue is vehicle financing commissions, following the Court of Appeal’s decision recently, and no one knows how much it will cost.
Before this Bill, the working assumption was that smaller banks would be placed into the insolvency procedure and that, in that event, the kind of liabilities I am talking about would likely be extinguished as part of the insolvency because there would simply be insufficient money there to pay for them. However, once the recapitalisation power is used, it opens up the possibility that the Bank of England could use the power to raise capital in order to pay for litigation or regulatory costs that had arisen and were crystallising after the recapitalisation event.
The issue of litigation was raised by my noble friend Lord Moylan at Second Reading, and the Minister wrote to him on 21 August. The letter confirmed that litigation costs could well be covered through the use of the recapitalisation power. The Minister expressed this in terms of it being
“a judgement to be taken at the time, noting that the alternative could be to use public funds instead”.
From the perspective of the financial sector, which will be picking up the costs using the power—then doubtless passing them on to their customers—the alternative is using not public funds but the insolvency procedure. If we let the insolvency procedure take its course, at least nine times out of 10, those costs will not be met at all. So, that is the heart of the problem from the financial sector’s point of view.
I have not tabled an amendment on Report because it is very difficult to table one that would cover all eventualities. The redraft of the code of practice does not appear to deal with this issue either, whether in relation to expenses per se—in the terms of the new subsection we are discussing—or in relation to which liabilities the Bank should allow to go into the bridge bank. Today, I am seeking that the Government recognise that this is an issue and that it should be dealt with somehow as part of the code of practice.
I accept, as I have throughout, that there may be public interest reasons for avoiding the bank insolvency procedure, and for settling historical liabilities through the recapitalisation power, but the public interest test is a rather slippery concept and gives no real comfort to those who are expected to pick up the tab. I hope that the Minister will accept that this new power must not become a blank cheque to avoid bank insolvency and to pick up all kinds of costs that would otherwise fall by the wayside. I look forward to hearing what reassurances he can give.
Baroness Vere of Norbiton (Con)
My Lords, I too thank the Minister for the recent letters and documents he published in relation to the Bill. It was incredibly helpful to have them for the House to scrutinise the Bill properly. I am also grateful for these sensible amendments, which clarify the persons to whom the Bill’s measures apply as they relate to expenses. They are a bit technical, but they are improvements to the Bill and I am particularly pleased that the Minister has listened to concerns from across the House, including from my noble friends Lady Noakes and Lord Moylan.
I listened with great interest to the points raised by my noble friend Lady Noakes, and I urge the Minister to note what she said. I hope that some of these issues might be resolved in some way, either through the code of practice or by other means, as she seemed to me to make an awful lot of sense. However, on this basis, we support the Government’s amendments.
Lord Livermore (Lab)
My Lords, I am grateful to noble Lords for their contributions today and, as I said previously, in Committee. As I said at the start of this debate, the purpose of the Government’s amendments is to clarify whose expenses may be covered under the mechanism in the Bill. I hope that noble Lords will be able to accept the amendments, and I am grateful to both noble Baronesses for saying that they will.
I will respond to the points raised by the noble Baroness, Lady Noakes. As she said, I wrote previously to the noble Lord, Lord Moylan, on this matter. I will briefly repeat some of the points I made to him. In relation to litigation being brought against the authorities themselves, the Bill allows the Bank of England to request that funds from the Financial Services Compensation Scheme cover expenses that have been incurred by it or by the Treasury, a bridge bank or an asset management vehicle in connection with the recapitalisation or the use of the stabilisation power. This may include litigation costs arising from the recapitalisation or use of the stabilisation power, such as from challenges to decisions made by the authorities.
Any decision to request Financial Services Compensation Scheme funds for these purposes would be a decision for the Bank of England to take, but I stress that, in making this decision, the Bank of England would consider all relevant factors, including the fact that the alternative may be to use public funds. I note what the noble Baroness, Lady Noakes, said on that point. A decision to use insolvency depends on whether the conditions for resolution action are not met. If the conditions for action are met, public funds would be the alternative for covering these costs instead of FSCS funds.
I hope that the points I have made demonstrate that the Government have engaged in good faith with the concerns raised by noble Lords and have sought to address them where it has proved possible to do so. These amendments put beyond doubt which parties’ expenses may be covered by the new mechanism, and I hope that noble Lords will support them.
Baroness Vere of Norbiton
“(2A) The Bank of England must not require the scheme manager to make a recapitalisation payment if it has directed the financial institution to maintain an end-state Minimum Requirement for Own Funds and Eligible Liabilities (MREL) exceeding minimum capital requirements.”Member’s explanatory statement
This amendment seeks to prohibit the use of FSCS funds to recapitalise large financial institutions, defined as those which have reached end-state MREL.
Baroness Vere of Norbiton (Con)
My Lords, throughout the passage of this Bill, the issue of the size of the bank for which this new mechanism can be used has attracted significant comment and debate. In a letter to all noble Lords introducing the Bill, the Minister stated: “This Bill enhances the resolution regime to respond to the failure of small banks”. Yet that is not what the Bill does. The regime in the Bill is not restricted to small banks or even to small and medium-sized banks; it can be used for all banks, even the very largest. Despite the letter from the Minister on introduction, the Government have maintained their position that the mechanism should be available for use for the resolution of a bank of any size, including the very largest.
Using this mechanism in those circumstances would be astonishingly costly for banks and their customers, not only in the year in which the levy is first implemented but for many years thereafter, adding to a long-term and significant burden on the banking sector and its consumers. I concede that the Government clarified in a policy statement that the mechanism would be used for the largest banks only in exceptional circumstances, but the mechanism being given a statutory footing by the Bill will only ever be used, on a bank of any size, in exceptional circumstances. Therefore, I take only a small amount of comfort from the published statement.
As the noble Baroness, Lady Bowles, said in Committee, there is no differentiation in the Bill on bank size. It should be limited by a defined measure. My amendment, supported by the noble Baronesses, Lady Bowles and Lady Noakes, and the noble Lord, Lord Vaux, seeks to deliver that definition by making it clear that the Bill does not apply to banks that have reached end-state MREL—that is, the very largest banks in the UK. It would mean that only small and medium-sized banks, and those on the MREL glide path, can be supported by the mechanism. I believe that was the Government’s original intention.
My amendment is fairly simple. It does what it says on the tin. I will listen very carefully to what the Minister has to say when he comes to wind up.
Lord Vaux of Harrowden (CB)
My Lords, I add my support to Amendment 2 tabled by the noble Baroness, Lady Vere. From the outset of this process, the Bill was intended to cover only small banks. That was made clear in almost the first paragraph of the original consultation. It was then extended and now covers all banks, regardless of size. I thank the Minister for making sure that the draft code of practice was published by the Treasury before Report; it has been incredibly helpful in this process, and we are all very grateful for that. The draft code of practice is clear that the resolution mechanism is designed primarily to support the resolution of small banks and that the Bank of England will not assume use of the new mechanism when setting a preferred resolution strategy of bail-in and the corresponding MREL requirements of a large bank.
So why does the Bill cover large banks? The argument from the Government seems to be along the lines of, “Well, it might be useful to have this flexibility”. That does not seem a very strong argument. As we have heard, larger banks are required to hold additional capital resources, known as MREL, effectively to ensure that they are able to bail themselves out—a process known as bail-in. If the Government are not confident that the MREL regime is sufficient for those larger banks, they should be looking to strengthen that regime rather than extending a measure that is designed specifically for smaller banks whose failure would not create systemic risk, to act as a further insurance policy for the big banks.
I am afraid that unless the Minister can come up with a stronger argument than he has so far, I will be minded to support the noble Baroness, Lady Vere, should she decide to test the opinion of the House.
Baroness Noakes (Con)
My Lords, I add my support to my noble friend’s amendment.
If the power were used on a bank that had already achieved the MREL set for it, that use of the mechanism would raise questions about whether MREL and the minimum capital requirements had been set correctly—and whether there had been a regulatory failure. In either event, the Bank is conflicted, whether through the setting of MREL in its capacity as a resolution authority or through setting capital levels through its PRA arm. I am clear that the Bank should not have the power to cover up regulatory failure, which this unconstrained provision allows. There is no way for the Treasury to stop the Bank using the power other than by using the power of direction that exists but has never been used in the existence of the Bank since nationalisation. Unconstrained powers are unhealthy. That is why I support my noble friend’s amendment.
Baroness Bowles of Berkhamsted (LD)
My Lords, I concur with what other noble Lords have said about this amendment: that is why I have added my name. It cannot be left as a possibility for any size of bank; if it needs to apply to a larger bank, perhaps the MREL level should have been set higher. We have this rather unusual situation in the UK where we set MREL at a much lower level; it is set at about a quarter of the level of other countries. If there is a nervousness about needing to use it for a bank that is a little bit larger, perhaps some other fundamentals about where MREL is being set are wrong.
The premise of this Bill is based on it being an alternative to insolvency, where that would have been the normal end result. Maybe the compensation scheme would have had to pay out on deposit guarantees and so there is the happy thought that the money could be perhaps put to different use this way round. But the assumption should still be insolvency and we need a public interest test before we go looking at the Financial Services Compensation Scheme. It is already an extraordinary event—so how extraordinary are extraordinary events? I do not think one can layer extra extraordinariness on top of it: there has to be a line somewhere.
We do not know how many dips into the Financial Services Compensation Scheme there are going to be. In insolvency, there is one dip for the deposits that are guaranteed. It does not say that there cannot be multiple dips. There is already the notion that there is this enormous pot of money. Maybe it looks like a bank tax—and everybody hates banks and it is a pot to raid—but it is a very good way to cause more issues within the wider banking sector. Frankly, it is unfair if there are not some bounds somewhere. So I think this is the right one and, if the Minister is not going to incorporate the amendment, which I think would be a jolly good idea, we on these Benches will be supporting the noble Baroness, Lady Vere.
Lord Eatwell (Lab)
My Lords, my colleagues from the Financial Services Regulation Committee are rather confused on two issues; that is very unusual, but they do seem to be. First, there is the idea that somehow, if MREL were exceeded in a financial crisis, that would be a regulatory failure. The only way to prevent such a regulatory failure is to have MREL at 100%; that is to avoid the total failure of the financial system. That would be a disaster for lending in this country. At the moment, MREL is set at levels that are deemed to be a reasonable buffer under circumstances that might reasonably, even in extremis, be expected to occur. As we saw in 2008-09, even events that are deemed to be events that would occur only once in a millennium can occur several times in a week in a severe financial crisis. An MREL which can never be exceeded is 100% and if my colleagues are seeking to impose that on the British financial system, I would be very surprised.
The other point that seems to be neglected—it is why I deem this amendment to be irrelevant—is that my colleagues should recall that, in one of the letters from the Financial Secretary, he pointed out there was a cap on the amount that would be raised from the financial compensation scheme for these purposes. That cap, as I recall, was £2.5 billion. In those circumstances, £2.5 billion would never be sufficient to deal with the collapse of one of the big banks. So the cap itself defines these regulations as fitting only relatively small banks.
Baroness Kramer (LD)
My Lords, perhaps I could be helpful at this point. That £2.5 billion is certainly not in the Bill. If that is the argument being made by the noble Lord, Lord Eatwell, is it an interesting one but not one that the Government have grasped.
Perhaps I should clarify the issue of the threshold at which MREL kicks in, because that was the point to which my noble friend Lady Bowles referred. The UK demands MREL or bail-in bonds as the mechanism for resolution in the case of the failure of a much smaller bank than in any other country across the globe. The differential between us and everybody else is very large. That, we assume, is why the Government want to keep this mechanism available for banks that have been required to have MREL: they are trying to deal with that small to medium-sized group that, quite frankly, should probably never be in the MREL group in the first place.
Lord Livermore (Lab)
My Lords, I am grateful to all noble Lords, and to my noble friend Lord Eatwell for the points that he made. The scope of firms in relation to which the mechanism can be applied has been a key issue in all our deliberations to date. I am very grateful to noble Lords for their engagement on this topic since Grand Committee.
As I stated then, the Government’s policy intention is for the mechanism provided by the Bill to be used primarily to support the resolution of smaller banks. We have reaffirmed that intention by including it in the updates to the special resolution regime code of practice, drafts of which have now been published and shared with noble Lords. The Bank of England must have regard to the code of practice when exercising its resolution powers, and this is set out in statute.
The Treasury is involved in the exercise of any resolution powers, either by being required to provide a response to consultation or by consent. Nevertheless, the Government maintain that it is right for the Bill to contain some flexibility for the Bank of England to be able to use the mechanism more broadly in some circumstances. That is because firm failures can be unpredictable and there could be circumstances in which it would be appropriate to use the mechanism on other firms. To repeat the example I gave in Grand Committee, this may be especially relevant in situations where a small bank has grown but is still in the process of reaching its end-state MREL requirements. Firms in this position would have at least some MREL resources to support recapitalisation, but the new mechanism could be used to meet any remaining shortfall if judged necessary. Without the proposed mechanism, there will be a potential gap in this scenario, creating risks to public funds and financial stability.
There is, of course, a counterargument here that the scope could instead be constrained, such that firms on the glide path to their full MREL requirement remain in scope of the mechanism but firms that have met their end-state MREL are excluded. The Government note that this is the desired intent of the noble Baroness’s amendment and it is an argument that we have considered carefully.
Ultimately, noting what has been set out in the code of practice and the strong expectation that the mechanism will be used on small banks, the Government’s view is that it is still right for the tool to have additional flexibility for unpredictable circumstances. To narrow the scope would constrain the Bank of England’s optionality, particularly where it might be necessary to supplement the resources bailed in with additional capital resources.
I note that these are considered unlikely outcomes, rather than a central case. However, given the uncertainty and unpredictability of a crisis scenario, the Government consider it important to avoid constraining that optionality.
None of the Bank of England’s other stabilisation powers are constrained for use on a specific type of in-scope firm and that the choice of stabilisation option used remains a decision for the Bank of England to take, having considered the resolution conditions and objectives. The Government believe that it is right for a similar approach to be taken in relation to the new mechanism. To be clear, the Government’s clear view remains that this mechanism should be intended for smaller banks and that the Bank of England should not assume the use of this mechanism for larger firms. In that regard, I agree with the noble Baroness on the crux of the issue she is raising. The Government simply do not wish to hard-wire that principle into the Bill.
Since we last debated this issue in Grand Committee, the Bank of England has published a consultation on proposed changes to the MREL regime. These proposals include the removal of the additional MREL requirement associated with the transactional accounts threshold for being set to the transfer strategy, given the availability of FSCS funds under the mechanism in the Bill as an alternative. There are currently only a limited number of firms with a transfer strategy, and firms with such a strategy would typically be expected to have a relatively small balance sheet. As such, the proposed change to the MREL regime is modest, consistent with the policy intention for the Bill mechanism to be intended primarily for smaller banks and it has the additional benefit of seeking to ensure that the MREL regime is proportionate for growing firms.
I reiterate the message delivered in the Written Ministerial Statement I made on the day the Bank of England’s consultation was published. As I have already said, the Government and the Bank of England agree that the Bank should not assume use of the new mechanism when setting a preferred resolution strategy of bail-in and corresponding MREL requirements for larger banks.
Recognising the level of interest rightly expressed in Peers being able to scrutinise the changes to the code of practice before the Bill begins its passage in the other place, the Government published updates of that document on 15 October. Notably, on the issue of scope, these updates to the code of practice explicitly state that the Bank of England will not assume use of the new mechanism when setting a preferred resolution strategy of bail-in and the corresponding MREL requirements for a large bank. Those updates to the code also made it clear that the Bank of England is still expected to abide by the so-called 5% and 8% rules in the case of larger banks.
I hope the explanations I have given have been helpful. Throughout the commitments I have given today and in Committee, in publishing draft updates to the code of practice, in the Written Ministerial Statement and in the engagement I have had with noble Lords, I have sought to reassure noble Lords on the question of scope, the primary intention for the mechanism in the Bill and the importance of maintaining flexibility for the Bank of England to act in the public interest. I recognise that I may not have been successful and that strong views remain, but I hope that the noble Baroness may feel able to withdraw her amendment as a result.
Baroness Vere of Norbiton (Con)
My Lords, I am grateful to all noble Lords who have contributed to this debate, particularly those who have spoken in favour of my amendment. This has been the subject of numerous discussions with the Minister. I listened carefully to what he had to say, and I still cannot quite understand why the Government will not accept this amendment and are unfortunately still using terms such as “It is the strong expectation that it would be used for X, Y, Z-type of bank”, or “It’s primarily for smaller banks”. That does not give me comfort, as we may be storing up significant challenges for the future. Therefore, I am not encouraged by the Minister’s response, and I wish to test the opinion of the House.
Lord Sikka
“(3A) Before exercising the power in subsection (1), the Bank and the scheme manager must assess whether they consider that there should be a clawback of any part of executive remuneration from the previous 12 months.”Member's explanatory statement
This amendment seeks to address potential moral hazards through requiring the Bank and scheme manager to take directors’ pay and bonuses into consideration when a recapitalisation payment is made.
Lord Sikka (Lab)
My Lords, a wise man once said that history repeats itself, first as tragedy and secondly as farce. So it is with successive Governments’ obsession with going easy on the banking industry. We are sleepwalking into the next financial crash, but this modest amendment seeks to check some of the moral hazards by imposing personal costs on bank directors through a possible clawback of their remuneration.
History shows that moral hazards give rise to heavy economic and social costs. The secondary banking crash of the mid-1970s forced the state to bail out banks and insurance and property companies. We have had a banking crisis every decade since the 1970s but Governments continue to indulge the City of London. The big bang, the Financial Services Act 1986 and the Banking Act 1987 formalised light-touch regulation. Then came the banking crash of 2007-08. The obedient state dutifully provided £133 billion of cash and £1,029 billion of guarantees to bail out banks. It also provided £895 billion of quantitative easing to support capital markets.
The reforms that were introduced after the crash have been gradually reversed and the race to the bottom is accelerating. The regulators once again have the secondary objective of promoting the growth and competitiveness of the industry. The Bank of England has watered down the capital requirement rules that were meant to shock-proof the banking system from another 2007-08 style crash. Banks would now have to increase their current capital buffers by less than 1% to abide by the Basel 3.1 standards. That is down from the previous proposal for a 3.2% rise last year, as the Government are now more interested in getting the banks to help to promote growth.
Research by my colleagues at Sheffield University shows that between 1995 and 2015 the scandal-ridden finance industry made a negative contribution of £4,500 billion to the UK economy. No questions have been asked about that, and Governments have done their best to conceal the criminal activities of banks. Documents relating to the 1991 closure of the Bank of Credit and Commerce International are still a state secret. No one has explained why in 2012 the Chancellor and the regulators urged US authorities to go easy on HSBC after it admitted in writing to “criminal conduct”, along with money laundering for criminals. To this day, no Statement about that has been made to Parliament. However, in Committee on the Bill, the Minister urged the House to trust the regulators.
Due to the absence of personal sanctions, there is no urgency for dealing with banking fraud. Thousands of people suffered from frauds at HBOS; these date back to 2003. The Government washed their hands of the matter and left it to Lloyds Bank to investigate its own failures. Dame Linda Dobbs was appointed by Lloyds Bank in 2017 and a report was promised by 2018. To date, no report has been published and no regulator or Minister has inquired into the reasons for the delay or done anything to help the victims of those frauds.
Despite warnings, swathes of banking remain unregulated. The shadow banking system, which is now bigger than retail banking and is enmeshed with the regulated sector, remains unregulated. The cap on bankers’ bonuses has been abolished and bankers are free to be reckless as they pursue personal riches. This Bill ensures that the banks will be bailed out, therefore there are even fewer incentives for the directors to behave in a responsible way. There are virtually no pressure points on directors to curb predatory practices and it takes years to disqualify any company director. Prosecutions for predatory practices are rare and the Government say that the prisons are already full, so we cannot send these people to prison either.
On 5 September, in opposing my amendment during Committee, the Minister said that
“it is a key principle of the resolution regime that natural and legal persons should be made liable under the civil or criminal law in the UK for their responsibility for the failure of the institution. This is delivered by Section 36 of the Financial Services (Banking Reform) Act 2013, which provides for a criminal offence where a senior manager of a bank has taken a decision which caused the failure of a financial institution”.—[Official Report, 5/9/24; col. GC 41.]
Following that exchange, on 12 September 2024 I tabled a Written Question to the Ministry of Justice. The reply on 23 September said:
“The Ministry of Justice Court Proceedings Database has not recorded any prosecutions under section 36 of the Financial Services (Banking Reform) Act 2013 since its introduction”.
There is no pressure on directors; they are not prosecuted —although they may get some honours.
I am not really persuaded that there are sufficient pressure points upon bank directors to curb predatory practices. I urge the Government to accept my modest amendment. The Government can stand up to the banking industry or perhaps, one day, they may well have to pick up the tab from the next banking crash. I beg to move.
Baroness Vere of Norbiton (Con)
My Lords, I thank the noble Lord, Lord Sikka, for bringing his amendment and for explaining it so well. We on these Benches are concerned that a statutory requirement to make assessment of potential clawbacks of executive pay may simply hinder the efficient use of the recapitalisation mechanism, which of course usually has to be done in a very timely fashion. Having considered his amendment, we feel that it would not be an improvement to the Bill and will not be supporting it.
Lord Livermore (Lab)
My Lords, the amendment tabled by my noble friend Lord Sikka replicates the one he tabled in Committee. I hope that my noble friend will therefore forgive me for repeating some of the points that I made when we discussed this amendment then.
Amendment 3 seeks to ensure that the Bank of England and the Financial Services Compensation Scheme consider whether there should be a clawback of executive pay and bonuses from a failed firm before using the new mechanism. Although the bank resolution regime does not set out powers allowing the Bank of England to claw back money from management, it does provide it with an extensive and proportionate set of powers to impose consequences on the management of a failed firm in resolution.
First, we expect that any existing shareholder equity would be cancelled or transferred when a firm is placed into resolution. This ensures that the firm’s owners bear losses, which is an important principle of the resolution regime. In many circumstances, this will affect directors and management who hold shares or other instruments of the failed firm.
Lord Sikka (Lab)
My Lords, I thank the noble Baroness, Lady Vere, for her comments and the Minister for his detailed reply. I am not really persuaded by either of their replies. I feel that this is an important question and there are still no effective checks on the moral hazard created by institutionalised bailouts of the banking sector.
I have made my point and it has gone on the public record. I hope no Government live to regret not accepting this amendment, but given that there is a lack of support, I beg leave to withdraw it.
Lord Livermore
“(4A) In subsection (2)(b), “relevant person” means—(a) the Treasury,(b) a bridge bank, or(c) an asset management vehicle.(4B) In this section, “bridge bank” and “asset management vehicle” have the meanings given by sections 12 and 12ZA, respectively, of the Banking Act 2009.”Member's explanatory statement
This amendment, together with my first amendment to Clause 1, clarifies the persons (in addition to the Bank of England) in respect of whose expenses a recapitalisation payment may be made.
Lord Vaux of Harrowden
“(6) When the Bank exercises its power in subsection (1), the Bank must make a report to the Chancellor of the Exchequer within 28 days of the date of any recapitalisation payment being made.(7) The report must comply with any requirements specified by the Treasury, but must include—(a) the reasons why the Bank decided to make a recapitalisation payment in preference to allowing the financial institution to go into insolvency;(b) a breakdown of the costs referred to in subsection (2);(c) a comparison of the expected recapitalisation payment or payments that will be paid by the Financial Services Compensation Scheme, compared with the expected costs to the Scheme in an insolvency process.(8) The Bank must make a further report to the Chancellor of the Exchequer within three months of the date of the sale of the institution to a private sector purchaser, or the sale, closure or winding up of the institution or bridge bank, providing such information as the Treasury may require, including the breakdown of the actual recapitalisation payment or payments and the reasons for any differences to the expected costs referred to in subsection (7)(b).(9) The Chancellor of the Exchequer must lay a copy of each report under subsection (7) or (8) before Parliament.”Member’s explanatory statement
This amendment is intended to ensure that the reasons for decisions of the Bank to follow a resolution process in preference to an insolvency process are explained and the explanation laid before Parliament, both at the time of the decision and once the resolution process has been completed, and that the costs can be compared to what would have been expected if the institution had been placed into insolvency.
Lord Vaux of Harrowden (CB)
My Lords, this group covers reporting and accountability to Parliament on the use of the resolution mechanism, which was probably the greatest area of discussion in Committee. The Bill gives significant rights to the Bank of England to impose costs on the banking industry. It can only be right, therefore, that the Bank should have to explain the reasons for its decisions and the outcome to both the Treasury and Parliament.
A number of concerns have been expressed throughout the process, and again today, about how the Bank might use the mechanism. At Second Reading, the noble Lord, Lord Macpherson of Earl’s Court, said:
“I can foresee circumstances where the Bank will choose to recapitalise a small bank rather than put it into a bank insolvency process, less because it is in the national interest and more as a way of minimising the reputational damage of regulatory failure”.—[Official Report, 30/7/24; col. 914.]
The noble Baroness, Lady Noakes, said something similar earlier today. The noble Lord and others have pointed out that there is nothing in the Bill that would incentivise the Bank to control the expenses of the process; again, we discussed this to an extent earlier. Those expenses will be picked up by the FSCS, by the wider financial services industry and, ultimately, by the customers of that industry.
As we have just seen, the Government have tabled amendments to clarify that last point, which we have already discussed—but the point remains. Fears, which I share, have been raised that this resolution mechanism could become the default, rather than insolvency. I believe—others share this view, I think—that, in principle, a failing institution should be allowed to fail unless it is in the public interest for it to be bailed out. The draft code attempts to deal with this but the concern remains.
For all these reasons, it is essential that the Bank should have to explain its decisions and that Parliament should have the ability to scrutinise those decisions. For that reason, I have tabled Amendment 5, which would require the Bank to make a report to the Chancellor that must then be laid before Parliament every time a recapitalisation payment is made. The amendment sets out some minimum requirements for what the report should cover, including why the Bank chose to make a recapitalisation payment rather than allowing the institution to go into insolvency; the costs that will be incurred; and how those costs compare to the costs the FSCS would incur in an insolvency situation. It would also require a final report explaining what actually happened—and, if different, why—at the end of the resolution process.
Since I tabled Amendment 5, I am pleased to say that the Government have issued the draft code of practice—for which we are all grateful, as I said—and tabled Amendment 8. I am extremely grateful to the Minister for his constructive approach on this. Given that the two together deal with most of the areas covered by my Amendment 5, I will not push that.
However—there is always a “but” in these things—there is one important omission in the Minister’s Amendment 8. Although it requires the Bank to report within three months of any recapitalisation payment, it does not require a final report on what actually happened at the end of the resolution process. Although the resolution will happen quickly in many cases—the example of Silicon Valley Bank, where it happened over the weekend, is a good one—that may not always be the case. Under these rules, a bank can be put into a bridge bank for up to two years, which can be extended further. We can have multiple recapitalisation periods during that period, so the process can last a number of years. If the Bank reports within three months of each payment, we may never see a report on what actually happened at the end—for example, if the failing institution is put into insolvency two years later.
It is essential that the Chancellor and Parliament have an opportunity to review how the resolution worked out and, most importantly, to ensure that any relevant lessons are learned. So I have tabled Amendment 9, as an amendment to the Minister’s amendment, to cover that point. I think that this may have been the Minister’s intention all along, but I cannot agree with him that his amendment, as drafted, actually achieves this. On the report it requires, his amendment says:
“The Bank must report to the Chancellor of the Exchequer about … the exercise of the power to require a recapitalisation payment to be made, and … the stabilisation power and the stabilisation option to which the payment relates”.
Nowhere does it talk about what happened at the end, which could be a number of years later.
I am alive to the concern that we should not have too many potentially repetitive reports, so my amendment would have effect only if the reports published by the Bank, in accordance with the Minister’s amendment, do not cover the final resolution results. I hope that this is not controversial and that the Minister will be able to accept Amendment 9 to his amendment. However, as I say, it is essential that the final outcome of any resolution is made transparent and open to scrutiny.
If the Minister is unwilling to accept my proposal, or accepts the principle but does not like some of the detail—he has mentioned to me that he is not terribly keen on the three-month timeframe—perhaps he could commit to coming back at Third Reading with his own version of the amendment that satisfies the guaranteed requirement to report on the final outcome. He can tweak it as he likes on timing and things—I cannot get too excited about that—but, if he is not prepared either to accept it or to do that, I will be minded, I am afraid, to test the opinion of the House on Amendment 9 when the time comes.
The other amendments in this group relate to notifying the relevant committees of both this House and the other place of the use of the recapitalisation power. The amendments tabled by the Minister, as well as the amendments to his amendments tabled by the noble Baroness, Lady Noakes, arose from amendments that the noble Baroness put down in Committee. I am pleased that the Government have accepted those amendments. However, all the amendments do is say that the committees must be notified. Those committees need something to look at; it makes it all the more important that we have the reports we are talking about, both on the use of the recapitalisation power and on what finally happens, at the end of the day. I beg to move.
Baroness Noakes (Con)
My Lords, I have Amendments 11 to 13 in this group; they are amendments to the Government’s Amendment 10, to which the noble Lord, Lord Vaux, has referred. Before I address those amendments, I shall refer briefly to the reporting amendments in this group. I certainly praise the Government for bringing forward their Amendment 8, as well as for beefing up the code of practice on reporting. However, I agree with the noble Lord, Lord Vaux, that the issue of the final report made by the Bank of England is outstanding; I therefore support his Amendment 9.
On Amendments 10 to 13, I start by thanking the Minister for listening to the case, made in Committee, that parliamentary committees should be notified of the use of the bank recapitalisation power. I had tabled an amendment that named the Treasury Select Committee in the other place and the Financial Services Regulation Committee in your Lordships’ House; this was supported in Committee by fellow Members of the latter committee, as noble Lords might imagine. I retabled my amendment for Report—the noble Baroness, Lady Bowles, and the noble Lord, Lord Vaux, added their names—but the Government then tabled Amendment 10, which was similar in principle to my amendment but drafted using the language of the Financial Services and Markets Act 2023. That Act did not refer to the Financial Services Regulation Committee for the simple reason that it did not exist at the time—indeed, it was that Act that led to creation of that committee. So, following the helpful meeting that we had with the Minister, I was told that the Government were happy to refer directly to the Financial Services Regulation Committee. They suggested that this be achieved by my tabling amendments to the Government’s amendments. So I hope that, when the Minister gets up to speak to his amendment, he will confirm that he accepts my Amendments 11 to 13.
Noble Lords who have joined the House in the past eight years might be mystified by the reference to the Chairman of Committees in my Amendment 13. Although the House has not used the title since 2016, the post to which we now refer as the Senior Deputy Lord Speaker technically remains the Chairman of Committees. One learns something every day in Parliament.
Let me conclude by saying that I hope the principle of requiring notification to the Treasury Select Committee in the other place and your Lordships’ Financial Services Regulation Committee is now regarded as a precedent for any future creation of significant or unusual powers granted to the Bank of England or any of the other regulators in future. The strength of parliamentary accountability for those bodies, with their massive powers, must always be maintained—and, indeed, enhanced.
Baroness Bowles of Berkhamsted (LD)
My Lords, I think that everything that needs to be said about these amendments has probably already been said. I have added my name where I could; one came in very late, so I could not. I congratulate the noble Baroness, Lady Noakes, on her diligence in getting the committee name in properly so that everybody knows where to go, with all these hundreds of people who are going to be reading this legislation. Nevertheless, we are an institution, as it were, so it is good to see our name there.
I also congratulate the noble Lord, Lord Vaux, on his diligence in hounding to a conclusion the final report, because it is, as he said, very important. In the meeting we had recently, those present from the Bank of England wondered why we might want this and suddenly nodded when I said, “Because otherwise Parliament may never find out what really happened”: that is what it is all about. They might think we do not want to know, many years on, if it is a long period. The sorts of people who sit on these committees do want to know, because we are the ones who have to learn and have to ask the questions, to make sure that it is not going wrong again. It is very important, and I hope the Minister will accept it. If votes are called, these Benches will be supporting the noble Lord, Lord Vaux.
Baroness Vere of Norbiton (Con)
I am enormously grateful to all noble Lords who have spoken today. I too add my thanks to the noble Lord, Lord Vaux, for tabling his amendment. This group epitomises what is so good about your Lordships’ House: a lot of movement has happened to date on these issues from the Minister, and we are grateful for his engagement and for the fact that we have been able to get a little further down the road. However, like terriers with very sharp teeth, noble Lords are not quite willing to let it go just yet, and I too support the amendments in the name of the noble Lord, Lord Vaux, and of course those of my noble friend Lady Noakes, who has also done a fantastic job in ensuring that the issues she raised, and which most noble Lords agreed with in Committee, come to the fore. Helpfully, the noble Lord, Lord Vaux, has tabled Amendment 9, which plugs a big gap, and I hope the Minister will accept that and the amendments in the name of my noble friend Lady Noakes.
Lord Livermore (Lab)
My Lords, this large group includes a number of the Government’s proposed amendments to the Bill. I begin by responding to the amendment from the noble Lord, Lord Vaux, which is intended to ensure that there is transparency about the Bank’s use of the new mechanism. It does this by creating a requirement for the Bank to report to the Chancellor of the Exchequer within 28 days on certain matters where a recapitalisation payment is made, and for the Chancellor of the Exchequer to lay these reports in Parliament.
I assure noble Lords that the Government recognise absolutely the importance of transparency and accountability regarding the new mechanism and appreciate the strength of feeling in the House. The debates at Second Reading and in Committee were helpful and constructive and have informed the Government’s approach. The Government therefore agree that there should be an explicit requirement for the Bank of England to report to the Chancellor when it uses the new mechanism. To that end, government Amendment 8 means that the Bank of England must report to the Chancellor about the use of the mechanism in any circumstances where it is used.
The Government’s amendment outlines two elements to reporting. First, it would require the Bank of England to produce a final report at a time to be specified by the Treasury. This is intended to be a comprehensive account of the use of the new mechanism and to include an assessment of the relative costs to insolvency. Secondly, the amendment would require the Bank to provide an interim report within three months of using the mechanism in the event that a final report has not been provided within that time. This would ensure a prompt initial public justification for the use of the new mechanism, even if further details would follow later.
Government Amendment 14 would require the code of practice to include guidance on what should be included in the reports. Taking these points together, the Government’s approach has a broadly similar intent to that of the noble Lord’s amendment. However, there are some points of detail where the Government have taken a different approach in order to avoid unintended consequences. In particular, while recognising the importance of clear reporting arrangements, the Government believe that it is critical that the timing and content of any reports do not complicate a successful resolution.
I would highlight two challenges with the approach set out in Amendment 5 from the noble Lord, Lord Vaux. First, the Government believe that requiring an initial report as soon as 28 days after using the mechanism is likely to be too soon. As noble Lords know, the complexity of firm failures mean that they may not always be fully resolved within a short period of time. This is particularly the case when using the bridge bank tool, which is anticipated to be an interim step before an eventual sale. It is possible that a resolution process remains ongoing 28 days following a firm failure. It is therefore important that sufficient time is allowed so that the Bank can focus on its primary function of maintaining financial stability through managing the failure of the firm, before turning to the process of reporting. The Government therefore believe that providing an interim report within three months is a more proportionate approach to take, allowing the Bank more time to ensure that an interim report is as meaningful as possible while still ensuring that the Chancellor and Parliament are updated on use of the mechanism in short order.
This takes me to my second point, which is that disclosing certain information too early in the resolution process, especially information relating to the relative costs of different options such as insolvency, risks complicating a resolution because such information is either incomplete or highly sensitive. Regarding the noble Lord’s proposal to require an initial report to disclose certain costs, it is worth noting that when conducting the resolution conditions assessment, the Bank of England would make an assessment of the costs that the Financial Services Compensation Scheme may incur if the firm was placed into insolvency. However, by virtue of necessity, this would be only an initial assessment based on the information available at the time. It is therefore important that the Bank of England’s assessment of relative costs is reported on only once the resolution is fully complete. This will ensure that the Treasury, Parliament and industry are provided with a comprehensive and accurate account.
In addition, if the firm was in a bridge bank, as it may well be after just 28 days, the early disclosure of this interim financial information could complicate negotiations regarding a sale, especially if it was subsequently revised. It may also be market sensitive and increase speculation about the failed firm during a period of heightened sensitivity. Ultimately, therefore, the Government see risks in requiring the Bank to report too early and in too much detail during a highly unpredictable and sensitive situation. This is in part why the existing reporting provisions within the Banking Act in relation to resolution require reports as soon as reasonably practicable only after a year has passed.
The Government have sought to reconcile these different issues in our proposed amendment, while recognising the important substantive point of principle raised by the noble Lord, Lord Vaux. First, the Government have proposed an interim report to be provided within three months. While it is possible that a resolution process may not have concluded by this point, as the FSCS is likely to levy firms within this timeframe, it seems reasonable to expect the Bank to provide a public justification of the decision to use the new mechanism by this point. I note that, alongside the notification requirement covered in government Amendment 10, which I will turn to shortly, this will ensure that the Treasury and Parliament have a prompt explanation of why resolution has been undertaken.
Secondly, the Government’s amendment means that the Bank of England must provide a separate final report, in the event that this has not already been provided within three months of using the mechanism. This final report is where the Bank would outline its assessment of the relative costs of different options. This reflects the points that I have already made, namely that the Government believe that the key reporting obligation should fall once the resolution process has concluded. This reduces the risk that disclosure frustrates that process and ensures that any report can be meaningful.
To support this approach, the Government have also tabled an amendment requiring guidance on the content of such reports to be included in the code of practice. This will ensure that there is clear public understanding of the key issues that any interim or final report is expected to cover. As I have noted, both interim and final reports would be expected to provide a justification for the use of the mechanism, and as set out in the current draft of the code of practice, the final report would need to set out an assessment of the costs if the firm had entered insolvency. The current draft updates to the code of practice also make clear that the Government expect to require the Bank of England to provide an explanation of why ancillary costs were considered reasonable and prudent.
I am grateful for the helpful engagement that I have had with the noble Lord, Lord Vaux, who has rightly emphasised the importance of the Bank of England providing a comparison of the expected and actual costs in its final reports. I am happy to reassure the noble Lord that the Government intend to request that the Bank of England include this in final reports and will ensure that the final updates to the code of practice reflect this.
The noble Lord, Lord Vaux, has also tabled Amendment 9 to require the Bank to produce a report three months after the resolved firm has been sold or otherwise closed. I understand that the intent of this similarly reflects a desire to ensure that the Bank of England is compelled to report after a resolution process has fully concluded and provide an assessment of how the expected impacts of its actions compared to the actual events that took place in resolution. The Government of course appreciate the importance of the Bank of England reporting promptly. Reflecting on the noble Lord’s proposal, the Government intend to further update the code of practice to make clear that, where feasible and appropriate, the Treasury would expect the Bank of England to report soon after the sale or closure of the resolved firm.
The Government believe that it would be preferable not to put this expectation into legislation. This reflects the point I have already made: that the Bank of England should be required to provide final reports with the more detailed assessments only at the appropriate moment. While the Government do expect, as I have said, the Bank of England to be in the position to report soon after the end of the resolution process, this cannot always be guaranteed. For example, in the case of selling a firm, it may not have been possible in all cases to complete the full post-resolution independent valuation process within three months of a sale. I believe the Government’s approach still captures the intent of the noble Lord’s amendment, which is to ensure that full reports following the conclusion of a resolution process are presented expediently, with some discretion for the Treasury to ensure that reports are still provided only at the right moment.
I hope that, taken together, the Government’s amendments address the noble Lord’s concerns on both the timing and the content of reports, while retaining the flexibility necessary to avoid unintended consequences. On the specific additional point raised by the noble Lord’s Amendment 9, I agree of course with his intention and I will be happy to update the code of practice to this effect. However, the Government believe it would be preferable not to put this into legislation. I would be happy to consider this matter further and discuss it with my honourable friend the Economic Secretary to the Treasury, but I cannot give any firm additional commitments at this stage.
Turning to government Amendment 10, on notifying Parliament when using the power, I note that both the noble Baroness, Lady Noakes, and the Government tabled similar amendments on the theme of parliamentary scrutiny. I am extremely grateful to the noble Baroness for raising this issue and for her engagement on the matter; I am especially grateful to her for agreeing to withdraw her original amendment. The Government’s amendment reflects the point made by noble Lords in Grand Committee concerning parliamentary notification and the creation of the Financial Services Regulation Committee in your Lordships’ House as a result of passing the Financial Services and Markets Act 2023.
Building on that innovation in parliamentary scrutiny and accountability, the Government’s amendment seeks to harness the role played by that committee, as well as the Treasury Select Committee. It requires the Bank of England to notify the chairs of both committees as soon as reasonably practicable after the new mechanism under the Bill has been used. It includes provisions to future-proof this requirement following use of the new mechanism, such that if the names or functions of those committees change, the requirement for the Bank of England to notify the relevant committees by which those functions are exercisable would still stand.
The noble Baroness, Lady Noakes, has rightly argued that the Government’s amendment requires some tweaking, in particular to refer to the Financial Services Regulation Committee in the House of Lords by name. I am grateful to the noble Baroness for bringing this to my attention, and I note her amendments to the Government’s amendment—Amendments 11, 12 and 13—which attempt to address this point. I am of course very happy to agree to those amendments being made.
I hope that the Government’s approach across all the issues debated in this group demonstrates that the issue of accountability to Parliament is being taken seriously, ensuring that there will be transparency in use of the new mechanism. In particular, I hope that the Government’s amendments on the new reporting requirements address the noble Lord’s concerns on both the timing and content of the reports, while retaining the flexibility necessary to avoid unintended consequences. On the basis of these points, I hope noble Lords will be able to support both the Government’s amendments and those tabled by the noble Baroness, Lady Noakes, and I respectfully ask the noble Lord, Lord Vaux, to withdraw his amendment.
Lord Vaux of Harrowden (CB)
My Lords, first, I thank all noble Lords who have taken part in this debate, and the Minister for his constructive approach to it. I take on board everything he said about Amendment 5, which is why, as I have already indicated, I do not intend to push it to a vote.
However, I take issue with the Minister’s thinking it is appropriate that the relative costs of the recapitalisation process versus the insolvency process are looked at only after the event, at the very end of the process. It is quite important that we see why the Bank made decision it made at the time it made it, and that it has not reverse-engineered the results and facts to justify what it did. So I am not totally sure that I fully agree with the Minister on that point. Be that as it may, I am not going to push Amendment 5, because Amendment 8, along with the code of practice, covers most of what is needed.
However, as to Amendment 9, I am afraid that I did not hear anything particularly new there. The Minister has confirmed that his intention is that the reporting should cover the final result of the resolution process, which, as I say, could be a number of years later—but that is not what government amendment 8 says. The amendment specifically refers to
“the exercise of the power to”
recapitalise and
“the stabilisation power and stabilisation option to which”
it
“relates”.
It does not refer anywhere to what happens at the end. It is all very well saying that it might go in the code of practice and that there is an expectation that this will happen, but this is a really important issue.
We must know what actually happened, to be able to see how that compares with what we were told was going to happen, and to be able to learn the lessons arising from that. With the best will in the world, it may not be the Minister who is at the Treasury whenever this is used. I absolutely believe and trust that he would do exactly the right thing, but whoever comes next might not. It is important that this is in the Bill.
I am afraid that I intend to divide the House when the time comes, but in the meantime, I beg leave to withdraw the amendment.
“(6) When discharging its functions in respect of the exercise of recapitalisation payments under this section, the Bank of England must observe the competitiveness and growth objective.(7) The competitiveness and growth objective is facilitating, subject to aligning with relevant international standards—(a) the international competitiveness of the economy of the United Kingdom (including in particular the financial services sector), and(b) its growth in the medium to long term.”
Baroness Bowles of Berkhamsted (LD)
My Lords, I will speak principally to Amendment 7 in this group, which has also been signed by the noble Baronesses, Lady Vere and Lady Noakes. Amendment 6 was my first attempt, when I was worried that defined first and secondary objectives were not already specified in connection with resolution. In fact, there are a whole load of objectives that have to be balanced in Section 4 of the Banking Act 2009. However, I then hit upon the formulation of claim 7, to make it agree with how it had been rendered in FiSMA 2000. I am suggesting that this is a secondary objective to all the existing ones, and the formulation is the one with which we are already familiar.
We on these Benches are not always certain of the merits of the competitiveness and growth objective, which is what I am inserting into the Bill here, in respect of the resolution authority. Our concern is that in other places, it might return to too much of the animal spirit that led to the financial crisis, but here, it has a different and particular role. The Bank has to balance all the Section 4 objectives to get the best results, and, in its resolution capacity, it is not really in a situation to be prey to animal spirits.
When it comes to the Financial Services Compensation Scheme as a source of funds, as we have already said, there are no bounds, or at least no written ones. How many dips into it can be made if the first one is not enough? How big can those dips be, compared to what might have been needed to compensate depositors if the Bank had gone bust instead? What happens if there are multiple resolution events in a narrow period of time? For how many years can the extra levy be put on to the banking sector in order to pay back the scheme? As the noble Baroness, Lady Noakes, has said before, how can we be certain that, years later, it is not called upon again in connection with some kind of legal action?
All these things are left open for the Bank of England resolution authority to decide and to do its best on. It will, of course, receive advice from the PRA, which has to consider what is an affordable levy for the industry, but it is receiving advice from a body which has in one sense just failed, and to which it is always close. It is advice that it does not actually have to take, either.
The only lever—other than the one suggested in the amendment of the noble Baroness, Lady Noakes, a requirement to minimise cost—is to impose the objective of competitiveness, which in this instance means affordability, and for that to be imposed on the resolution authority itself. It is secondary to everything else, so it cannot kick the other objectives into touch in any way; it is just making sure that there is a small reality check about what this does to other banks, especially in the circumstance that this is not the only bank or that this is not the only dip into the fund.
So, this is an instance where the secondary competitiveness and growth objective is relevant, and I hope the Minister can see his way to accepting it. If not, I shall probably seek to test the opinion of the House. I beg to move.
Baroness Noakes (Con)
My Lords, I have Amendment 16 in this group and added my name to Amendment 7, to which the noble Baroness, Lady Bowles of Berkhamsted, just spoke. As she indicated, the two amendments are related in that the imposition of unnecessary costs, which is the target of my Amendment 16, will do nothing to help the financial sector grow, be competitive or, indeed, support the real economy.
I fully supported the growth and competitiveness objectives introduced for the PRA and the FCA in the Financial Services and Markets Act 2023, and I am very glad that the Chancellor of the Exchequer has given her support to those. But I hope that the Government will want to go further and make all regulators, and indeed all other public sector bodies, pay attention to growth and competitiveness. Extending this to other organisations is important, particularly in the financial services universe, as they were not included within the competitiveness and growth objective in the 2023 Act.
One of those omitted at that time—perhaps we should have spotted it during the passage of the Financial Services and Markets Act—was the Bank of England in its capacity as a resolution authority. The noble Baroness, Lady Bowles, has had to confine her amendment to the use of the bank recapitalisation power because of the Long Title of the Bill. But the competitiveness and growth objective ought to apply to the Bank as the resolution authority in toto, not simply when it exercises the new bank recapitalisation power but also when, for example, it is setting MREL levels.
My Amendment 16 adds a special resolution objective to the seven already listed in Section 4 of the Banking Act 2009, and it requires the Bank to consider the minimisation of costs borne by the financial sector when the recapitalisation power is used. It is not an absolute requirement, as it would be just one of eight objectives, and it is for the Bank to determine, under the 2009 Act, how to balance those various objectives.
When it is using the power, the Bank is playing with other people’s money. Ultimately, it is the money of those of us who are customers of the banks, because at the end of the day the money that flows through the banks will end up being borne by customers, and it is only right that the Bank should have regard to the minimisation of costs that are ultimately borne by the banks’ customers.
In Committee I tabled an amendment that focused on the costs being borne through the FSCS not exceeding the counterfactual of the bank insolvency procedure to which the Bank should be paying regard in any event. My amendment today is a less complex test and is simply designed to act as a reminder to the Bank that it should treat other people’s money as carefully as it treats its own. If it does that, it should also help to keep the sector competitive and to help it grow. I hope that the Minister will agree that this amendment is right in principle and that it responds to a number of concerns expressed by several respondents during the consultation on the power over the last year or so.
Lord Vaux of Harrowden (CB)
My Lords, I support both the amendments in the names of the two noble Baronesses who have just spoken. I probably have a slight preference for Amendment 16 on the expenses—it is more direct—but we need something in the Bill that reminds the Bank of England that it is spending other people’s money, and that it needs to do that carefully and with care. These amendments are aimed primarily at that end, so I support them both.
Baroness Kramer (LD)
My Lords, I will speak briefly in support of Amendment 7 in the names of the noble Baronesses, Lady Bowles, Lady Noakes and Lady Vere, but I am not as minded to support Amendment 16 for the following reasons. Some in this House will know that I dislike intensely the competitiveness and growth objective that has been attached to the PRA and the FCA. If you were going to set out a pattern to repeat the crash of 2007-08, those two objectives would be essential paving stones on that route, so I do not look to attach that particular amendment to the Bank of England in its overall resolution role in, for example, setting MREL. It should be setting MREL to reduce risk, not to follow the lowest common denominator in the international banking arena.
Ironically, if you take the growth and competitiveness secondary objective and just apply it to recapitalisation, it turns on its head and becomes a risk-reduction tool, because it basically limits the ability of the collapse of one bank to then infect all the other banks within the system. That seems to me to be a risk-reduction strategy, so I am very much in favour of the way in which it has been crafted under Amendment 7. I say that to reassure others in this House who may be afraid that playing fast and loose with the competitiveness and growth agenda is always a risk-increasing agenda rather than a risk-reduction agenda. In this narrow role, it works in the opposite direction.
Baroness Vere of Norbiton (Con)
I rise briefly to speak to Amendment 7 in the name of the noble Baroness, Lady Bowles of Berkhamsted, and Amendment 16 in the name of my noble friend Lady Noakes.
On Amendment 7, I will not reiterate the points raised. I deeply appreciated the explanation by the noble Baroness, Lady Kramer, as to how she got to her supportive position. From our perspective, we feel that Amendments 7 is a reasonable objective that would ensure the Bank facilitates the international competitiveness of the UK economy and economic growth in the medium term—that is very clear. It also has the ability to look at the level of risk within the banking sector over the medium term. Given the Government’s stated objective of focusing on economic growth, I am very interested to hear the Minister’s view on these amendments.
Amendment 16 in the name of my noble friend Lady Noakes, which I have signed, seeks to minimise the net costs recouped from the banking sector via this mechanism. Again, it is a very sensibly drafted amendment that would improve the Bill, and I look forward to hearing the Minister’s response.
Lord Livermore (Lab)
My Lords, I start by noting that the Government fully understand the concerns raised by noble Lords regarding the objectives the Bank of England should adhere to when taking resolution action.
Amendments 6 and 7 tabled by the noble Baroness, Lady Bowles, seek to ensure that the Bank of England considers growth and competitiveness when using the new mechanism, by introducing a new objective that the Bank of England would need to consider. In the case of Amendment 6 this would be alongside the existing special resolution objectives, while in the case of Amendment 7 it would be a secondary objective. This objective would be to facilitate the competitiveness and growth of the UK economy, subject to aligning with relevant international standards.
I appreciate wholly the intent of the noble Baroness’s amendments. The Government have reflected carefully on this issue in the weeks running up to Report. Growth and competitiveness are, of course, fundamental priorities for this Government. The Government are resisting these amendments because, while we understand and appreciate their intent, they would pose challenges within the specific context of this Bill. I intend to make three main points—about the wider context of the Bill; the particular challenges a new objective may pose in the case of the new mechanism; and the steps the Government are taking to ensure that costs to industry are properly considered.
First, I note that the aim of the Bill is to enhance the resolution regime, but in a way that avoids making more fundamental changes to the regime or to the way in which the Bank of England exercises its resolution powers. This reflects a key conclusion from the Government’s consultation, which is that the regime already broadly works well. This was demonstrated by the successful resolution of Silicon Valley Bank UK.
As noble Lords are aware, the resolution regime has been developed over a number of years to align with international best practice. The relevant authorities have invested considerable time and energy in contingency planning to use the existing powers within their existing framework of objectives. As it stands, the regime therefore reflects a carefully calibrated judgment about the key priorities that should be considered in what is an emergency, firm-specific failure scenario.
Baroness Bowles of Berkhamsted (LD)
I thank the Minister for his explanation. I have some sympathy for the position in which he finds himself, which is the usual one with the Bank of England: you cannot touch it or interfere with it, and it is infallible. You cannot occupy its mind with even a tiny other thought, as it might distract it from the resolution that it has in mind. I find that quite concerning.
Yes, we have the code of conduct and other things that are not in the Bill, but we are dealing with something a little different here. It is ruled by a public interest test, but what about the private interest test? You are using private funds to replace public funds, so there is a big difference. Some little corner of the mind of the Bank of England’s resolution authority has to register that point: private funds are replacing public funds—a special tax on the banking sector to help keep its competitors going.
Imagine you started doing this with grocery stores; what would they think about it? It is quite remarkable. It is not using private funds, by agreement, for a deposit guarantee in the public interest—that would be a specific amount that has previously been agreed—it is stretching the piece of elastic when you do not know how long it is and you are not prepared to have another little test. I find that unacceptable. Something is needed there.
I intend to press my Amendment 7 to a vote and to beg leave to withdraw Amendment 6. If the Minister can find a better way of doing that—this is a private interest test to go alongside the public interest test—he might come up with a better amendment, but this was the best that I could find for now, just to put something in the Bill that shows that we acknowledge what we are doing. This is a momentous precedent, and to say that we cannot have something in the Bill that acknowledges that is a very bad state of affairs. Where will it take us next? I beg leave to withdraw Amendment 6.
“(6) As a secondary objective to the special resolution objectives in section 4 of the Banking Act 2009, when discharging its functions in respect of the exercise of recapitalisation payments under this section, the Bank of England must observe the competitiveness and growth objective.(7) The competitiveness and growth objective is facilitating, subject to aligning with relevant international standards—(a) the international competitiveness of the economy of the United Kingdom, and(b) its growth in the medium to long term.”
Baroness Bowles of Berkhamsted (LD)
I wish to test the opinion of the House.
Lord Livermore
“ReportingIn the Financial Services and Markets Act 2000, after section 214E (as inserted by section 1 of this Act) insert—“214EA Recapitalisation payment: report(1) This section applies where the Bank of England requires the scheme manager to make a recapitalisation payment under section 214E.(2) The Bank must report to the Chancellor of the Exchequer about—(a) the exercise of the power to require a recapitalisation payment to be made, and(b) the stabilisation power and the stabilisation option to which the payment relates.(3) The report (“the final report”) must—(a) comply with such requirements as to content, and(b) be provided within such period or at such time,as the Treasury may specify.(4) The Bank must provide an interim report if—(a) the period specified under subsection (3)(b)is a period of more than 3 months beginning with the day on which the Bank requires the recapitalisation payment in question (“the first 3 months”), or the time specified under subsection (3)(b)is after the first 3 months, and(b) the Bank does not provide the final report within the first 3 months.(5) An interim report must—(a) comply with such requirements as to content as the Treasury may specify, and(b) be provided within the first 3 months.(6) Subject to subsection (7), the Chancellor of the Exchequer must lay each report, and any interim report, before Parliament.(7) The Chancellor of the Exchequer may omit from the report, and any interim report, any information which the Chancellor of the Exchequer considers it would not be in the public interest to publish.”” Member's explanatory statement
This new Clause imposes a reporting requirement on the Bank of England when it requires a recapitalisation payment to be made.
Lord Vaux of Harrowden
“(5A) Unless already covered by the final report under subsection (3), the Bank must make a further report to the Chancellor of the Exchequer within three months of the date of the sale to a private sector purchaser of the financial institution to which the recapitalisation payment relates, or the sale, closure or winding up of the financial institution or bridge bank to which the recapitalisation payment relates, complying with such requirements as to content as the Treasury may specify.”
Lord Vaux of Harrowden (CB)
My Lords, I have had the opportunity to consider further, based on the discussions that we have had. The Minister made some helpful commitments to discuss the matter further with his boss back at the Treasury and that the issue would be covered in the code of conduct going forward. On that basis, I will not press my amendment.
Lord Livermore
“Notification to Parliamentary CommitteesIn the Financial Services and Markets Act 2000, after section 214EA (as inserted by section (Reporting) of this Act) insert—214EBNotification to Parliamentary Committees(1)Where the Bank of England requires the scheme manager to make a recapitalisation payment under section 214E, the Bank must, as soon as reasonably practicable, notify in writing the chair of each relevant Parliamentary Committee that it has done so.(2)The relevant Parliamentary Committees are—(a)the Treasury Committee of the House of Commons, and(b)the Committee of the House of Lords which—(i)is charged with responsibility by that House for the purposes of this section, and(ii)has notified the Bank that it is a relevant Parliamentary Committee for those purposes.(3)The reference to the Treasury Committee of the House of Commons—(a)if the name of that committee is changed, is to be treated as a reference to that committee by its new name, and(b)if the functions of that committee (or substantially corresponding functions) become functions of a different committee, is to be treated as a reference to the committee by which those functions are exercisable.(4)Any question arising under subsection (3) is to be determined by the Speaker of the House of Commons.”Any question arising under subsection (3) is to be determined by the Speaker of the House of Commons.””Member's explanatory statement
This new Clause requires the Bank of England to notify relevant Parliamentary Committees when it requires a recapitalisation payment to be made.
Baroness Noakes
“(b) the Financial Services Regulation Committee of the House of Lords”
(b) the Chairman of Committees of the House of Lords, in relation to committees of the House of Lords.”
Lord Livermore
“Code of practiceIn the Banking Act 2009, in section 5 (code of practice), after subsection (2) insert—“(2A) The code must include guidance on the contents of a report, and of any interim report, under section 214EA of that Act (recapitalisation payment: report).””Member’s explanatory statement
This new Clause require the Treasury to include, in a code of practice under section 5 of the Banking Act 2009, provision relating to the content of reports about recapitalisation payments.
Lord Vaux of Harrowden
“Treatment of recapitalisation payments on a winding up(1) In section 215 of the Financial Services and Markets Act 2000 (rights of the scheme in insolvency), after subsection (2A), insert—“(2AB) Any recapitalisation payment made by the scheme manager under section 214E in respect of a bank, building society or investment firm is to be treated, in the event of such bank, building society or investment firm or associated bridge bank being wound up, as a debt due to the scheme manager from that bank, building society or (as the case may be) investment firm.”(2) In Schedule 6 of the Insolvency Act 1986 (categories of preferential debts), after paragraph 15AA, insert—“15AB Any debt owed by the debtor to the scheme manager of the Financial Services Compensation Scheme under section 215(2AB) of the Financial Services and Markets Act 2000.””Member's explanatory statement
This amendment creates a mechanism that would allow the FSCS to recover its money in preference to creditors who would otherwise have no right to be bailed out. This mirrors the existing treatment of stabilisation payments made by the FSCS in Clause 215 (2A) of FSMA 2000.
Lord Vaux of Harrowden (CB)
My Lords, we come to the end of this process; I am sure everyone will be relieved. I rise to speak to my Amendment 15, which is a somewhat technical and perhaps even slightly nerdy amendment, but it deals with an important wrinkle within this Bill.
When a failing bank is recapitalised under this Bill, the money is paid, by the Financial Services Compensation Scheme, partly to the Bank of England to cover the costs of the Bank and other parties, and the rest is then injected, as equity, into the failing bank by the Bank of England. In the case of the Bank putting the failing institution into a bridge bank, the recapitalisation is intended to cover the likely costs of the bridge bank for a full year. This has some quite important unintended consequences.
To give a simple example, if it is expected that the bridge bank will be sold quickly, but this does not happen for some reason, and, shortly afterwards, the Bank of England decides to put it into insolvency, it would still have a year’s worth of Financial Services Compensation Scheme money injected into it. We could then have a situation where that money gets used to pay off the liabilities of the bridge bank; these would be liabilities that, had it gone into insolvency in the first place, would not, and should not, have been paid.
This has two consequences. First, creditors who would otherwise have received nothing may get paid out just because of the recapitalisation. That is not the intention of this Bill, but it is the consequence. Secondly, it becomes highly unlikely, if not impossible, that the FSCS could ever recover any of its money in such a situation; it would be last in line to receive the money, after everyone else has been paid off, because its money would have been turned into the equity of the bank. Again, that does not feel right.
Clause 2 sets out that the Bank of England must reimburse any part of any recapitalisation payment that is not needed to cover the costs and expenses of the resolution. However, what I have just explained means that in reality Clause 2 is, in effect, redundant. There is no realistic chance, as it is structured, that any money could ever be recovered for the FSCS. It would go to pay off the creditors who should not otherwise have been paid off.
Baroness Noakes (Con)
My Lords, I added my name to the amendment but I am glad that the noble Lord, Lord Vaux, will not be pressing it because, as he explained, there are difficulties with it.
I pay tribute to the noble Lord for chasing this issue down because it is a very real issue that could arise in certain defined circumstances, as he explained. I am not convinced that the solution of simply transferring assets into the bridge bank actually works. The complexities of a bank mean that you have liabilities—that is how you fund yourself from market sources—and in practice it may well be difficult. I hope the Government will take this away and find a way of minimising the likelihood that that ever happens, whether in the code of practice or otherwise, in discussion with the Bank of England.
Baroness Kramer (LD)
My Lords, the point that the noble Lord, Lord Vaux, has been making is significant and crucial in shaping the way in which the Bank of England approaches the resolution of banks when they fail.
Unlike the noble Baroness, Lady Noakes, I think there is a potential path of looking at the sale of the assets rather than the sale of the equity. That is the normal practice that one would follow in order not to transfer liabilities over to the new recovering entity. I fully understand all the complexities, and I hope the Minister will take this up with the Bank of England in his discussions. It requires a lot more work but it could get us out of some very nasty traps in future, and it will be more likely to do so if there has been thought beforehand rather than it being a reaction in a situation of emergency.
Baroness Vere of Norbiton (Con)
I wholeheartedly support the noble Lord, Lord Vaux, in his work in this area. Over the course of our scrutiny of the Bill, we have had some happy and quite nerdy discussions around this amendment. It is clear to me that it is a complicated situation. There is clearly an issue to be solved, but unfortunately the issue may not be exactly the same for each case of resolution that one might be addressing, so it needs further thought.
I am pleased that we will not be voting on this, but I impress upon the Minister that if there is something we can do in this area, whether that be in the code of practice or by other mechanisms, it is important. It is unconscionable to me that, because a particular entity goes down the route of resolution rather than insolvency, certain creditors could be significantly better off. That cannot happen and we must do something about it.
Lord Livermore (Lab)
My Lords, the amendment tabled by the noble Lord, Lord Vaux, seeks to give the Financial Services Compensation Scheme rights with respect to the recapitalisation payment, in the event that the firm in resolution is subsequently placed into insolvency or wound up, by then requiring it to be treated as a debt. It also seeks to grant the Financial Services Compensation Scheme super-preferred status in the creditor hierarchy with respect to that debt, enabling it to recover that claim in an insolvency process before other unsecured creditors, uncovered depositors and shareholders.
I am grateful to the noble Lord for the constructive engagement that I have had with him on this matter prior to this debate, and I am especially grateful for his time and expertise on it. I assure him that my officials and I have spent considerable time considering the concerns that he raises, and I shall set out the Government’s position.
The Government’s concern about the amendment is that it could frustrate the primary intention of the Bill to achieve recapitalisation in a way that restores financial stability and, as such, could potentially result in the resolution failing. The Government’s view is that the amendment could create uncertainty as to how such a payment would be perceived by the market when a firm was operating, rather than only in the unlikely circumstance of the firm winding up.
The effect of the amendment would be to create a shadow claim on the recapitalisation. Potential purchasers, investors and unsecured lenders to the firm would be aware that in the event of insolvency a new debt would materialise above them in the creditor hierarchy. Indeed, the shadow claim would follow the firm in perpetuity for as long as it was a going concern, even after the resolution was complete and the firm had been sold to a buyer.
It would also follow the firm even where the original shareholders and creditors were no longer involved with the business, creating a series of risks. That raises a number of potential issues. First, it could inhibit the sale of the firm in resolution. While the insolvency position would not be a primary consideration for potential buyers, it would naturally be part of the potential purchaser’s due diligence to understand the risk to its investment in a subsequent failure. That risk may be substantially greater with the existence of this debt, which may in turn impact potential interest in purchasing the firm and any purchase price.
Secondly, both while the firm was in the bridge bank and once it had been sold, current and potential future creditors and investors in the firm could be deterred from investing in and engaging with the firm for similar reasons. That would frustrate a key goal of the resolution, which is to maintain continuity. For example, uncovered depositors would have an additional incentive to withdraw deposits as they may perceive a potential risk to the seniority of their claim in insolvency. Thirdly, it could potentially undermine restoring market confidence in the resolved firm.
As a result of the issues that I have outlined, the amendment could make it more expensive to run the firm, putting it at a competitive disadvantage. It may perpetuate the circumstances that the resolution is intended to address; namely, uncertainty around how and to whom potential future losses would fall. It may also make it difficult to secure the agreement of directors, who may not be comfortable running a firm under such a shadow while it was in a bridge bank.
In addition, existing legislation means that instruments may currently be classified only as common equity tier 1, the highest form of capital, if they are not subject to any arrangement, contractual or otherwise, that enhances the seniority of claims in insolvency or liquidation. The noble Lord’s amendment would mean that a capital injection arising from a recapitalisation payment under the Bill may not count as the highest form of capital, as it creates a seniorised claim for the Financial Services Compensation Scheme in the event of a subsequent insolvency. That brings into doubt whether it would have the desired effect of restoring market confidence in the firm.
Overall, the effect of granting the Financial Services Compensation Scheme a super-preferred claim over the recapitalisation payment, even if only at the point of insolvency, would be to increase the risk of the resolution not achieving its objectives. Therefore, while the Government absolutely understand the noble Lord’s concerns, we have concluded, for the reasons I have outlined, that the amendment may end up doing more harm than good.
I appreciate that this is a matter that the noble Lord feels extremely strongly about, but I hope this explanation has provided some clarity over the risks attached to the amendment and that as a result he feels able to withdraw it.
Lord Vaux of Harrowden (CB)
My Lords, I thank every noble Lord who has taken part in this short debate. It is a fairly nerdy and technical subject, and the Minister has just described very well why it is a complicated situation. I am sorry that he was unable to say that the Government would keep it under review —to keep an eye on the situation—because there is a problem. This process could lead to creditors being preferred unreasonably over the FSCS money in some circumstances, and that is not desirable. It comes back to some of the moral hazard points that the noble Lord, Lord Sikka, made earlier as well, albeit in a different context, so I am sorry that the Minister was unable to say anything on that front.
I agree with the Minister that it is complicated and that there probably are unintended consequences to my amendment. I again urge him to keep this under review and to look at whether anything might be done on it under the code of conduct. On that basis, I beg leave to withdraw the amendment.
Bank Resolution (Recapitalisation) Bill [HL]
Tuesday 12th November 2024
(1 week, 2 days ago)
Lords ChamberRead Full debate Bank Resolution (Recapitalisation) Bill [HL] 2024-26 Read Hansard Text Read Debate Ministerial Extracts Amendment Paper: HL Bill 2-R-I Marshalled list for Report - (31 Oct 2024)
The Financial Secretary to the Treasury (Lord Livermore) (Lab)
My Lords, the Bank Resolution (Recapitalisation) Bill will enhance the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of banks. The recapitalisation mechanism introduced by this Bill will strengthen protections for public funds and promote financial stability, while promoting economic growth and the competitiveness of the UK financial sector by avoiding new upfront costs on the banking sector.
I thank all noble Lords for their valuable scrutiny and engagement which has genuinely led to some important improvements to this Bill. I would like to formally thank the Opposition Front Benches, particularly the noble Baroness, Lady Vere of Norbiton, for her valuable input and overall support for the Bill and its intentions. I thank the noble Baronesses, Lady Bowles, Lady Noakes and Lady Kramer, and the noble Lord, Lord Vaux, for the invaluable expertise they have brought throughout the passage of this Bill. I thank my noble friend Lord Eatwell for his support for the Government’s position and my noble friend Lord Sikka for his contributions to the debate. The Government will, of course, continue to reflect carefully on all the points raised and debated as the Bill moves to be debated in the other place.
I also extend my gratitude to my officials in the Treasury for their hard work in developing this highly technical Bill. Specifically, I thank Henry Grigg, Prakash Parameshwar, Katie Evans, Helen Lowcock, Ted Hu, Ed Henley, Chris Goodspeed, Rosie Capell, Andrew Clark, Minesh Gadhvi, Kate Lowden, George Barnes and Will Smith for providing me with their support as the Bill passed through this House. I also thank the House staff, parliamentary counsel and all other officials involved in the passage of this Bill to this point.
I am grateful for the engagement with this Bill and its broad support across all Benches, which will ensure that the bank resolution regime is as effective as possible. I beg to move.
Baroness Bowles of Berkhamsted (LD)
My Lords, I also thank the officials and other noble Lords, the Minister and, notable among those who did most of the heavy lifting, the noble Lord, Lord Vaux, and the noble Baronesses, Lady Vere and Lady Noakes. This Bill contains useful measures improved by amendments but is notable for diverting private bank money to addressing a matter of public interest in place of public funds. For that reason, I hope that the Government will reflect on the wisdom of keeping the amendment limiting the mechanism to small banks.
Baroness Vere of Norbiton (Con)
My Lords, I am pleased that this Bill leaves your Lordships’ House to wend its way to the House of Commons for further consideration. The Bill has widespread support and has been somewhat improved by the deliberations in your Lordships’ House over the last few months.
I am extremely grateful to the core crack team pulled together specifically for this Bill: my noble friend Lady Noakes, the noble Baroness, Lady Bowles, and the noble Lord, Lord Vaux, whose expertise—far greater than mine—ensured that the roughest edges were smoothed away. I am also grateful to my noble friend Lady Penn, who so skilfully stepped up for Second Reading, and to the new opposition research team for their support.
Last but certainly not least, I am enormously grateful to the Minister and his officials, who were as accommodating as they felt able to be in improving the Bill. All noble Lords will share my hope that this mechanism is never, ever used but if it is, the statutory framework is now there to support one or more small banks through the resolution process and ensure that the first port of call is not taxpayers’ funds.
Lord Livermore (Lab)
I thank again all noble Lords who have participated in debates on the Bill. I look forward to working together in the future on similar issues.