The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I shall now repeat a Statement that has been made in another place by my right honourable friend the Chancellor of the Exchequer. The Statement is as follows:
“Mr Speaker, I should like to make a Statement on the final report of the Independent Commission on Banking. The report is an impressive piece of work—broad in scope, incisive in its analysis and clear in its recommendations. The commission has done what we asked it to do. It has come up with an answer to the question of how Britain can be the home of successful international banks that lend to families and businesses without exposing British taxpayers to the massive costs of those banks failing. Frankly, it is a question that should have been asked and answered a decade ago.
We should all thank Sir John Vickers and the other members of the commission—Clare Spottiswoode, Martin Taylor, Bill Winters and Martin Wolf—for a job well done. But this commission and this report have not come about by accident. It was set up by this coalition Government to learn the lessons of what went so catastrophically wrong: a decade long debt-fuelled boom that ended in a dramatic financial crisis, a deep recession and a debt overhang that is still holding back our economy; a regulatory system that totally failed to spot enormous imbalances building up and proved incapable of dealing with the crisis when it first broke; and, most importantly in the context of this report, huge global banks that turned out to be “too big to fail”, so that taxpayers were called upon for many billions of pounds in order to prevent a financial meltdown. We still do not know, and may not know for many years, how much of that money will ever be recovered, despite irresponsible promises made at the time that not a penny would be lost.
We are fundamentally changing the system of regulation and tackling the debts but this bailout for banks is the element of the crisis that has, justifiably, caused the most anger. It is an affront both to fairness and to the very principles of a market economy. It is not available to any other sector of the economy, and nor should it be. It breaks the principle that those who take risks should face the consequences of their actions and, as a result, it played an important role in encouraging the excessive risk taking that caused this crisis.
Of course, taxpayer bailouts did not only happen in this country. An international regulatory response to the crisis is now emerging, with the new Basel rules and the anticipated new additional requirements for systemic banks, but here in Britain we cannot rely only on the international reform process to make our banking system safe. The scale of the challenge we face and the risk for our taxpayers is on a different scale from most other countries.
The balance sheet of our banking system is close to 500 per cent of our GDP, compared to just over 100 per cent in the US and around 300 per cent in Germany and France. Only Iceland, Ireland and Switzerland had larger banking systems relative to their GDP, and they have now all taken action that goes well beyond new international standards. As the report says,
‘part of the challenge for reform is to reconcile the UK’s position as an international financial centre with stable banking’.
This is what I have called ‘the British dilemma’—how to remain a successful global centre of finance without asking taxpayers to bear unacceptable risks or put the broader economy at risk. We set up the Banking Commission to help us solve the British dilemma. Let me set out its recommendations and how we propose to respond.
The first proposal is the introduction of a ring-fence around retail banking. The Government have welcomed this recommendation in principle. As the report says,
‘the objective of such a ring-fence would be to isolate those banking activities where continuous provision of service is vital to the economy and to a bank’s customers’.
In other words, the provision of key domestic retail banking services, such as taking deposits from individuals and small businesses or providing them with overdrafts. The central benefit of a ring-fence is not to end large universal banking groups but to make them more easily resolvable in a crisis. The costs should fall on shareholders and the wholesale debt holders, not small depositors or taxpayers. A successful ring-fence will be able to ensure the continuation of vital payment services that are crucial to preventing an economic collapse. This directly addresses the perceived implicit taxpayer guarantee which is at the heart of the too-big-to-fail problem.
The commission has also proposed a more flexible ring-fence. In terms of its scope, it says that,
‘domestic retail banking services should be inside the ring fence, global wholesale/investment banking should be outside, and the provision of straightforward banking services to large domestic non-financial companies can be in or out’.
Many will see this as sensible and it will reduce inefficiencies resulting from any mismatch between customer deposits and business lending within an individual bank.
On the strength—or height, if you like—of the ring-fence, it recommends that the retail subsidiary should have what it calls ‘economic independence’. In other words, it should meet regulatory requirements on a stand-alone basis and its relationships with other parts of the group should be arm’s length and regulated in the same way as relationships with third parties. A great deal of detailed work will now be required to see how that principle can be put into practice.
Secondly, the commission has also made important recommendations to ensure that banks have bigger cushions to withstand losses. These are that the large retail ring-fenced banks should have equity capital of at least 10 per cent. It also recommends that retail and other activities of large UK banking groups should have primary loss-absorbing capacity of at least 17 per cent to 20 per cent, including long-term debt that can be written off, so that, unlike last time, both shareholders and bondholders bear losses, not the taxpayer. Within this, it recommends some regulatory discretion about the composition of this loss-absorbing capacity. Again, many will see that as sensible.
Thirdly, the commission recommends the introduction of depositor preference. I repeat again that the Financial Services Compensation Scheme covers 100 per cent of eligible deposits up to the new European limit of €100,000. The depositor preference proposals would bolster this scheme by ensuring that other bank creditors are subject to losses first when a bank goes bust, minimising the cost to the FSCS and ultimately to the taxpayer.
The fourth set of recommendations relates to competition in the banking sector. They have not got as much attention as the other recommendations, but they are as important to families and businesses. I agree with the commission that the best way to ensure a reliable and affordable supply of lending to our families and businesses is through competition. The collapse of banks such as Bradford & Bingley and the merger of Lloyds and HBOS, welcomed by the previous Government, mean that there is too little competition and switching bank accounts remains difficult. I welcome the recommendations to change this. On the divestment of the Lloyds branches, the commission has said that the key test should be the emergence of a strong and effective new challenger bank. I agree that that would be very much in our country’s interest.
Those are the recommendations. Let me now turn to the implications for the wider economy, the implications for Britain as a global financial centre and the timetable for the Government’s response. The report is clear that the right solution, implemented properly and to the right timetable, will help our economy, not hinder it. Let us remember that the mistakes made by poorly regulated banks ended up costing the economy many many billions of pounds. The commission notes that some of its recommendations could reduce the profitability of some banks’ investment banking operations. That is largely because we would be removing the subsidy that comes from any perceived implicit taxpayer guarantee. We should not confuse the interests of bank shareholders with those of British taxpayers. It is also critical that reforms of this kind do not lead to a worsening of credit conditions in the economy. Indeed, Vickers says:
‘Banks with more robust capital, together with the creation of the ring-fence, would provide a secure and stable framework for the supply of credit to businesses and households in the UK economy’.
Indeed, the commission believes that its proposals could help to rebuild the culture of relationship banking that has been so sadly lost over the past decade and would help banks understand the credit needs of their customers better.
Let me turn to the UK’s role as a global centre for finance and banking. I will be very clear. This Government want Britain and the City of London to be the pre-eminent global centre for banking and finance. We want universal banks headquartered here, with all the advantages that that brings. The Vickers report explicitly addresses this issue, and for those investment banks with credible recovery plans, it has not recommended higher equity requirements than those agreed at an international level. This would mean that the global investment banking operations of UK banks can continue to be as competitive as any in the world. We will continue as a Government to keep the City as a whole internationally competitive, as was clear last week when we welcomed, with the Chinese Government, the development of the offshore renminbi market in London.
Let me end by explaining to the House how we will now take forward the commission’s report. We welcome the recommendations in principle. They would require far-reaching and complex changes. John Vickers is the first to say that they cannot be delivered overnight. The detailed work will start immediately. We will consult on the costs and benefits of the most appropriate way to implement these changes. We will provide a response by the end of this year, so that there is no uncertainty hanging over the industry.
We will legislate in this Parliament to put the needed changes into law. We will consider which changes can be in the existing Financial Services Bill and which will need a new Bill, and we will discuss these changes with international partners to ensure consistency with international agreements and EU law. We will follow the advice of the independent commission and ensure that any changes to the British banking system are fully completed by 2019. This is a sensible timetable that fits with the international regime. As Vickers himself said this morning,
‘short-termism got us into this mess and we need long-termism to build a more stable system for the future’.
The question of how Britain can be the home of successful, global banks that lend to British families and businesses but do not have to be bailed out by British taxpayers should have been answered a decade ago, but it was not even asked—and that failure means this country is still paying the price for that failure. Billions of pounds have been spent and hundreds of thousands of jobs have been lost as a result. It is this Government who set up the banking commission—not just to ask the questions but to provide the answers. Today represents a decisive moment when we take a step to a new banking system that works for Britain. I commend this Statement to the House”.
My Lords, that concludes the Statement.
Lord Sassoon
My Lords, I was never a boxer, so I have never understood the concept of leading with the chin, but I really think that we have seen the noble Lord, Lord Davies of Oldham, doing exactly that this afternoon. I am pleased that he recognises the importance of this report; but how he has nerve to stand up and tell this Government that we should be addressing the report with urgency, I simply do not know. I do not want to make cheap points this afternoon when there are much more important things to say.
Lord Sassoon
Well, should I or not? Perhaps I will. This is important because it exemplifies what this Government are doing and what the previous Government did not do. There were 18 months between the collapse of Lehman Brothers and the general election in which work such as that which we commissioned could have been commissioned by the previous Government. There were two and a half years after the appalling events following the collapse of Northern Rock in which the previous Government could have looked at the structure of banking, but they did nothing. There were more than 10 years in which they presided over the debt-fuelled boom that led to this disaster that we are now mopping up. So I really do not think that we need lectures about urgency on the follow-up. We are taking the timetable suggested by the independent commission, and that will be our guide.
I apologise if my droning on with a 2,000-word Statement means that not every sentence or paragraph can be picked up. However, as the noble Lord asked about the use of the existing Financial Services Bill and the international dimension, I remind him that both points are addressed in the same paragraph of my right honourable friend’s Statement, which I will read out again:
“We will consider which changes can be in the existing Financial Services Bill and which will need a new Bill, and we will discuss these changes with international partners to ensure consistency with international agreements and EU law”.
So I completely agree with the noble Lord, Lord Davies of Oldham, on these two points, which is why my right honourable friend has addressed them in his Statement. I look forward to any more constructive thoughts that he and his noble friends may be able to come up with as we go forward discussing these very important matters.
Lord Newby
My Lords, on these Benches we welcome the report and the Government’s response to it. We also welcome the degree of urgency with which the noble Lord, Lord Davies of Oldham, wishes the report to be implemented, not least because some of us had to put up with withering scorn from the Labour Benches during the previous Parliament when we suggested exactly the proposals that are now in this report.
The report says that while the full implementation of the proposals might take a number of years, there is much to be gained by moving quickly to set the framework in place so that the banks know what they are up against. The Minister has already mentioned that the Government will look at the extent to which the financial services Bill might be a vehicle for doing that. As we now have a Joint Select Committee on the Bill, of which I have the privilege to be a member under the chairmanship of Peter Lilley MP, would he accept that this offers Parliament a golden opportunity to take evidence quickly on the principal issues that the Vickers report raises and to move with some determination? I am sure that the vast bulk of rule-making that will be required to implement this series of proposals will not need primary legislation but will need FSA regulation or secondary regulation, and that the legislative framework in primary legislation should be relatively short and straightforward.
Lord Sassoon
I am very grateful to my noble friend. We will work as hard and as fast as we can now to take forward consideration of the detail. As I have stressed, we have accepted the recommendations of the report in principle, but there is a lot of potential devil in the detail and we need to do a full cost-benefit assessment. Indeed, we need to work through what would be appropriate to introduce into the financial services Bill and what would need a stand-alone Bill. I have no idea how the committee may want to proceed, but it now has the Vickers report in front of it and we will get on with sorting out all these issues as quickly as possible. However, we should not underestimate the amount of work for officials and the amount of consultation needed to get the detail right.
Lord Barnett
I welcome the Statement and I note that, in its recommendations, the commission talked about the short-term report being dealt with as soon as possible, although it would take until 2019 to deal with the full action that needs to be taken. I would like to clarify this with the noble Lord. He talked about some of the points and he repeated part of the long Statement about what will happen, but could he clarify how soon he expects the banks to be in a position to do the kind of reform recommended in this report, which is so strongly supported by the Chancellor? Is not the real current danger that, if the eurozone banks collapse, as, regretfully, seems all too likely—recently the Chancellor said that that would not just be disastrous for Europe but for us as well—we could be bailing out banks long before 2019, whether we are in the eurozone or not and we may have to bail some out in the very near future? How would that fit in with the reform in the short term that will enable the actions which are strongly recommended by the report to be carried out?
Lord Sassoon
I am grateful to the noble Lord, Lord Barnett, for welcoming the Statement. Clearly, there is a series of different sorts of recommendations in the report. Some of them relate to ring-fencing and the adequacy of capital, where the date of 2019 fits in with the move to implementation of Basel III. So there is a clear logic for making sure that the construct that we are putting in place here is targeted at the same date as the related international recommendations in the same area. On the other hand, of course there are recommendations in areas such as competition, connected, for example, with the ongoing disposal of Lloyds branches, where the timetable is rather different and where the commission, quite rightly, is looking to see action on a shorter timescale. We need to look at the pacing of some of the reforms in relation to 2019, that being the date of Basel III implementation, and others in relation to the individual merits of the case. That is the approach we will take.
Lord Higgins
This is certainly a massive and comprehensive report which is rightly welcomed by the Government. I have two questions. First, there is certainly a point of view which says that the right answer is to have complete separation of investment and retail banking. The commission has not come down in favour of that but in favour of ring-fencing. The danger is that there are loopholes in the ring-fence. Could my noble friend say in what circumstances resources might flow from one side of the ring-fence to the other, thereby continuing, albeit perhaps in a more limited form, the dangers which arise if there is a degree of connection between investment and retail banking?
Secondly, as far as timing is concerned, I understand the point my noble friend is making about Basel. However, it has also been suggested that, given the state of the economy, it would be dangerous to implement these changes too quickly, because it would inhibit the continued recovery. Would my noble friend agree that it is right to review that aspect of timing as we go along, and not set in concrete the idea that we should wait until 2019 before going ahead with the ring-fencing proposals?
Lord Sassoon
My Lords, I regret that I may fail to satisfy my noble friend Lord Higgins in my answers. On his first point about the design of the ring-fence, and whether there are loopholes, the commission has been quite clear in relation to one or two major structural elements of the ring-fence. It has recommended that discretion should be allowed to the banks as to whether the lending business to large industrial companies should be on one side of it or the other. That will be the first of a number of detailed issues that need to be looked at in the design work. I would not wish to pre-empt that work, other than noting that my noble friend’s question of loopholes and how they might come about will be, I am sure, very much in the minds of those doing the detailed work.
On the speed of implementation, I do think it is important—as it was with the Basel III work, and the European directive that flows with it—that the banking industry, taxpayers and all those who deal with the banks have a clear understanding of what the end position will be. There is a separate question as to what the appropriate implementation timetable will be. I am sure that the commissioners thought very carefully about this when they put forward the date of 2019. I repeat that—as my noble friend will know—it is the same date as the Basel implementation. I am sure they thought about that very hard.
Lord Forsyth of Drumlean
My Lords, I draw the House’s attention to my entry on the register as a director of MBNK, which is seeking to establish a new bank.
I congratulate my noble friend and the Chancellor on the way in which they have gripped this difficult subject, by appointing the Vickers commission, which has done an outstanding job. Some of us may not agree with all of the report, but it is a careful and sensible analysis. Some people have argued that this will damage the competitiveness of the City of London, but does my noble friend not agree that the City of London will benefit from having certainty? The fact that the Chancellor has the courage to take this on will help with the process and help our competitiveness.
I suggest that if my noble friend is thinking of giving a Christmas present to the noble Lord, Lord Davies of Oldham, he might buy him a copy of the right honourable Alistair Darling’s memoirs, in which he will find why it is not a good idea to look to the previous Government’s behaviour in this area. May I remind the House that it was the previous Government who gave Sir Fred Goodwin his knighthood for services to banking?
Lord Sassoon
I am very grateful to my noble friend Lord Forsyth for welcoming this report. It is a fine piece of work that has been done under a lot of time pressure. The commissioners have developed the analysis very considerably from their interim report, and I share my noble friend’s conclusion that by coming out now with these reforms to strengthen our banking system, we will place our banks and the City of London in an even better position to compete globally, as the Government want them to be able to do.
Lord Elystan-Morgan
My Lords, I appreciate that it is wholly necessary that there should be an effective firewall between retail and wholesale banking, and that the detail of that remains to be determined. However, perhaps the Minister will accept that the seriousness of the situation is illustrated in this way. Section 6 of the Theft Act 1968 defines theft as occurring in circumstances where a person uses the property of another as if that property were his to dispose of, irrespective of the rights of the other. In that way, the revelations of 2008 show quite clearly that in many instances there was moral theft, if not actual legal left.
Lord Sassoon
I am certainly no lawyer, so whether there was legal theft I will leave to lawyers to sort out. On the question of moral theft, I look to the Bishops’ Benches for guidance. The noble Lord makes the serious point that these events were deeply shocking and needed the sort of serious response that the Government and the commission have given. That is why we will drive through the recommendations that we accepted in principle today.
Baroness Ford
My Lords, I have a slight disagreement with the noble Lord, Lord Higgins. I particularly welcome the flexibility around the ring-fence, which is a very intelligent response to the dilemma of separation that clearly reflects the reality of modern Treasury management. That is greatly to be welcomed. However, given that a huge component of the problems that we have experienced concerns the misallocation and mispricing of risk, and the failure of regulation, will the Minister say whether, in line with the changes that the commission set out today and that Basel III will introduce, the Government have any proposals for further strengthening the regulatory framework in this country? Banking systems in other countries such as Canada did not fail. I declare an interest: I worked for a Canadian bank in that period. One of the distinguishing features of the Canadian system was the strength of regulation. Are there any plans for further strengthening the regulatory framework in this country?
Lord Sassoon
I am grateful to the noble Baroness for pointing out the good sense with which the commission addressed the question of the ring-fence. Clearly it has thought about the arguments that have been put over recent months. In respect of the failure of regulation, on which I completely agree with her, the overhaul of the regulatory structure, which is coming forward in the financial services Bill, is very significant. It puts the primary responsibility for looking at the risk in the entire system where it ought to be: that is, with the central bank. That is a fundamental change. The new Financial Policy Committee of the Bank of England is up in effective shadow mode, ahead of the legislation going through. It is able to address—and is addressing—risk issues as we speak, and I am sure that it will take note of whether there is anything further in the report that it ought to pick up on.
Baroness Kramer
My Lords, I join others in welcoming the Government’s enthusiastic acceptance of the report, and particularly of ring-fencing, which is much harder to erode than changes in regulation. However, I am sure that the Minister will agree that those who have suffered the most from the failure of the banks and the depth of the economic crisis that followed have been among the most vulnerable and disadvantaged, along with the smallest businesses. Would he be willing, as he looks to introduce a new bank that will provide more high street competition, to encourage banking services that will address the micro and the very small business, and which will reach out to the economically disadvantaged, who currently get a basic bank account offered with ill grace and very few services?
Lord Sassoon
I am grateful to my noble friend Lady Kramer for bringing us back to one of the constituencies most affected by the state of our banking system. That is why I welcome the discussion in the report about issues concerning the ability of individuals to switch accounts. There are important recommendations about the Lloyds Bank disposals, which make the point that this is not just a numbers game, of counting the branches that must be disposed of, but about creating another competitor out there. Therefore the report addresses critical aspects of the challenges that she poses, but in addition—whether it is looking at mutual models, credit unions or all the other aspects of a rich and varied banking system—there are significant other channels which the Government continue to address.
Lord Flight
My Lords, I draw attention to my entry in the register indicating that I am a director of Metro Bank, one of the new banks.
I would like to make three points while generally welcoming the recommendations. First, I remember over 10 years ago, following what I believed then to be the mistaken collapse of Barings, talking to the then Governor of the Bank of England about changes to the lender-of-last-resort doctrine, which had stood this country’s banking system in very good order for nearly 100 years. It changed by it being said that it was available only to larger banks, walking straight into the moral hazard problem whereby very large banks were of the belief that they could not be allowed to fail, which was the case, and smaller banks were not able—if there were a banking run—to get lender-of-last-resort support. That is why a whole lot of them wound up. It is very important in achieving competition that, broadly, the lender-of-last-resort doctrine is restored to what it was.
Secondly, I am slightly worried that increasing banks’ capital may be brought forward too quickly. I draw noble Lords’ attention to the very convincing writings of Professor Tim Congdon to the effect that if we increase capital requirements very speedily, we will end up shrinking the money supply, which is the last thing we want to do when the country is trying to struggle its way out of recession.
Finally, one banking system, Lebanon’s, escaped all the problems because the governor of the central bank of Lebanon had the wisdom to spot what was coming, to warn the banks and to keep them out of it. There is nothing more important than having a really good central bank governor who actually knows what is going on and blows the whistle in good time.
Lord Sassoon
All I can say is that my noble friend Lord Flight makes three important and interesting observations which we need to dwell on as we take all this work forward.
Baroness Noakes
I declare my interest, as recorded in the register, in particular as a director of the Royal Bank of Scotland, although my views are and always have been entirely my own.
My noble friend the Minister will be aware that there remain concerns, not least from organisations such as the CBI, about the impact of these proposals on the availability and cost of lending to smaller businesses. There are also concerns about the impact of the proposals on the strength of our financial services industry, which is and will remain a significant contributor to the economy. I therefore welcome the emphasis in my right honourable friend the Chancellor’s statement on cost-benefit analysis being carried out before implementation. Will my noble friend say a little more about when this cost-benefit analysis will be undertaken?
Lord Sassoon
I am grateful to my noble friend Lady Noakes. We will get on with all the consideration of the detailed recommendations and the cost-benefit analysis as soon as possible. I cannot be more specific than that, but as my right honourable friend said, it may be that some things can be brought forward for the financial services Bill, which is an indication of the speed with which we will go at this.