The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I shall now repeat a Statement made in another place today by my right honourable friend the Chancellor of the Exchequer.
“Mr Speaker, the Government are proposing the most far-reaching reforms of British banking in our modern history. Our objective is to make sure that what happened in Britain never happens again, that taxpayers are protected and that customers get a better service.
Last year the Business Secretary and I set up the Independent Commission on Banking to look at what I called the ‘British dilemma’: how Britain can be home to one of the world’s leading financial centres without exposing British taxpayers to the massive costs of those banks failing. In the years leading up to the financial crisis, a failure of regulation contributed to the build-up of a debt-fuelled boom. Banks borrowed too much and took on risks they did not understand. When the bubble burst these banks turned out to be too big to fail and the previous Government had to spend billions of pounds bailing them out.
Of course, major financial institutions in other countries were bailed out by their taxpayers, but the British bailouts were on a different scale. The Royal Bank of Scotland bailout was the biggest in the world. The FSA’s recent report into the failure of RBS attributed this to ‘poor decisions made by the RBS management and Board’ against a backdrop of a regulatory regime that failed to stop them. The politicians responsible are named in the report.
This Government are determined to do better at protecting British taxpayers from the cost of failing banks while at the same time acknowledging the importance of the financial sector to our country. Britain should remain home to one of the world’s leading financial centres and the home of global banks. However, the strength of this industry is also a potential weakness to the economy if not properly regulated. The sector supports nearly 1.4 million jobs, not just in the City but across the whole of the UK. The balance sheet of our banking system is close to 500 per cent of our GDP, compared to 100 per cent in the US and 300 per cent in Germany and France. So while a European and international regulatory response to the crisis is important, we cannot rely on this response alone to make our banking system safe.
We in this Parliament have to take action, and under this Government, we are. We are putting the Bank of England back in charge of prudential regulation. We have created the Financial Policy Committee to look at risks across the financial system. I also welcome today’s report from the Joint Committee on the Draft Financial Services Bill. I wanted proper pre-legislative scrutiny. That has happened, and we will respond in the new year so that we improve the legislation. We have also introduced a permanent bank levy on wholesale funding, and we have introduced the toughest and most transparent pay regime of any major financial centre in the world. However, we also need to address the structure of our banks. That is why the coalition Government set up the Independent Commission on Banking. I want to thank Sir John Vickers and the other members of the commission—Clare Spottiswoode, Martin Taylor, Bill Winters and Martin Wolf—again for their impressive report.
The commission made three main recommendations: first, that everyday high-street banking services should be separated from wholesale and investment banking activities, and that this be done via a ring-fence; secondly, that banks be required to have bigger cushions to absorb losses without recourse to the taxpayer; and thirdly, that competition in the banking sector be strengthened by increasing the number of banks on the high street and the power of customers to switch accounts. When its final report was published in September, I made it clear that I welcomed these recommendations in principle, and would return to the House by the end of the year. Today I fulfil that commitment.
Let me now set out in detail how the Government plan to respond and invite further views before we publish a White Paper next spring. First, the Government will separate retail and investment banking through a ring-fence. It is important to know that this ring-fence will not prevent banks failing, but it does mean that if banks get into trouble, those elements of the banking system that are vital for families, businesses and for the whole economy can continue without resort to the taxpayer. So the following will be in newly ring-fenced banks: the deposits of individuals; their overdrafts too; and the deposits and overdrafts of small and medium-sized businesses. They will all be kept separate from riskier wholesale and investment banking—which will have to be outside the ring-fence.
Larger corporate deposits and lending, and private banking, can either be in the ring-fence or outside. The ring-fenced bank will be legally and operationally independent. It will be able to finance itself independently, have its own board and there will be limits on the amount it can lend to the rest of the group. The commission’s interim report proposed a de minimis exemption for small banks that were clearly not systemic and we invite opinion on whether to proceed with this.
Our objective is clear. We want to separate high street banking from investment banking to protect the British economy, protect British taxpayers and make sure that nothing is too big to fail.
Secondly, we will make sure that banks have bigger cushions, so they are better able to withstand losses. The international Basel III requirement—which the UK was instrumental in negotiating—requires banks to hold minimum equity capital of 7 per cent, and there is a top-up for systemically important banks. We will go further. Large ring-fenced retail banks will be required to hold equity capital of at least 10 per cent. There will also be a minimum requirement for the loss-absorbing capacity of big banks of at least 17 per cent. This requirement will apply to the UK operations of British banks. It will also be applied to the non-UK operations of UK headquartered banks, except where they can demonstrate they do not pose a threat to the UK taxpayer.
I can also confirm that this Government will introduce the principle of depositor preference. In other words, the principle that unsecured lenders to banks, who are better placed to monitor the risks that banks are taking on, should have to take losses ahead of ordinary depositors. We seek further views on the best way to implement this principle. This comes on top of the guaranteed protection that the Financial Services Compensation Scheme offers, which covers 100 per cent of eligible deposits up to £85,000.
All these proposals on loss absorbency will also strengthen the European single market. One of the greatest distortions to the single market in banking is the perceived implicit taxpayer guarantee for all European banks. Through these proposals the UK is setting out a plan to remove this distortion for UK banks. The European Commission has indicated plans to consider what it can do to reconcile that distortion at an EU level. I welcome that, and the UK will engage actively in the debate.
This House and other member states have objected to the European Commission's proposals to impose maximum standards for bank capital. These proposals undermine efforts we and others are making to improve financial stability and the single market. In the view of bodies like the IMF, the European Commission's proposals also water down the international Basel III agreement, giving exemptions to globally active banks in certain European countries. We will be seeking, with others, changes to ensure that the EU faithfully implements international agreements.
Thirdly, the Government will take action to increase competition in the banking sector. The disappearance of banks such as Bradford & Bingley and the decisions taken by the previous Government on the merger of Lloyds and HBOS mean the banking sector is dominated by a handful of large banks. Last year, just four banks took 70 per cent of the market share. We need new banks to enter the market to provide consumers and businesses with more choice. The Government announced the sale of Northern Rock to Virgin Money last month, creating a new competitor in our retail banking sector.
In the coalition agreement, we made clear we wished to foster diversity in financial services, including promoting mutuals. We welcome last week’s announcement that Lloyds has identified the Co-op as preferred bidder for the divestment of more than 600 branches to create a strong challenger in the high street. We will also make it easier for people to switch their current accounts. This recommendation from the commission has received less attention from the media, but could be of huge benefit to millions of customers. The idea is that individuals and small businesses can switch to another bank within seven days and all the direct debits and credits will be switched for them at no cost. The Government have secured the banking industry’s agreement that it will implement these proposals by September 2013.
We will also support the Treasury Select Committee’s proposal to bring the Payments Council within the scope of regulation and I can confirm that our financial services legislation next year will specify that one of the objectives of the Financial Conduct Authority is to promote effective competition in the interests of consumers. A new statutory competition remit will provide the FCA with a clear mandate for swifter, more effective action to address competition problems in financial services. So within months of the ICB report, legislation to bring this change into force will be introduced.
This brings me to timing. Some have questioned whether the Government will seek to delay implementation of these reforms—questions that come from people who never even contemplated reform when they were in office. In fact the reverse is true. On the advice of Sir John Vickers and others, I will be bringing forward separate legislation to implement the ring-fence. The Government’s intention is that implementation should proceed in stages, with the final changes related to loss absorbency fully completed by the beginning of 2019 in line with the Basel agreement. But I can confirm to the House today that primary and secondary legislation related to the ring-fence will be completed by the end of this Parliament in May 2015 and banks will be expected to comply as soon as practically possible thereafter. The Government will work with the banks to develop a reasonable transition timetable.
Of course, there are both costs and benefits to these reforms. The Government estimate the total costs to UK banks to be between £3.5 billion and £8 billion, broadly in line with the commission’s estimate. Most of this reflects the cost to them of removing the subsidy that comes from any perceived implicit taxpayer guarantee, which is precisely what we intended. The cost to GDP is estimated by the Government at just £0.8 billion to £1.8 billion—slightly lower than the commission’s estimate. These are far outweighed by the benefits of the ICB’s recommendations. Even a relatively modest reduction in the likelihood or impact of future financial crises would yield an incremental economic benefit of £9.5 billion per year. Such is the cost of financial crises to the economy. Since the wholesale arms of non-UK banks would be unaffected by these reforms and the principal recommendations relate to UK retail banking, the competitiveness of the City of London as a location for international banking will not be affected.
We are fixing the banking system to protect taxpayers in the future. But we also need to clear up the mistakes of the past. I have already mentioned Northern Rock and Lloyds but the biggest call on the taxpayer was the bailout of RBS. The FSA’s recent report was a damning indictment of all that went wrong in this crisis. Those responsible are clearly identified in it. We need to deal with the mess that they created.
Despite promises from the previous Government that taxpayers would profit from the RBS bailout, the Government’s shareholding is now worth around £27 billion less. We are already reforming the regulatory structures that allowed these catastrophic failures to occur. Bonuses are a fraction of what they were four years ago. Early this year we placed a limit of £2,000 on cash bonuses for RBS and Lloyds. We have made it very clear that the bonus pool next year must be lower again and more transparent. We are also clear that at a time like this the Financial Policy Committee’s advice should be followed—that bank earnings should be used to build capital levels, not pay out large bonuses.
RBS itself has also made significant changes since 2008, including reducing the size of its investment bank by half. But I believe RBS needs to go further and the management agrees. We are the largest shareholders. Let me set out our view: RBS has already announced that it will further shift its business strategy towards its personal and SME customers and its corporate banking business which serves UK and international companies. We believe that RBS’s future is as a major UK bank, with the majority of its business in the UK and in personal, SME and corporate banking.
Investment banking will continue to support RBS’s corporate lending business but RBS will make further significant reductions in the investment bank, scaling back riskier activities that are heavy users of capital or funding. RBS should emerge a stronger, safer bank, able to maintain lending to businesses and consumers, and which in time can be returned to full private sector ownership.
The British people are angry about what happened in our banks and angry at the politicians who let it happen. This coalition Government see two parties working together to clear up the mess of the past and to create a banking system that protects taxpayers and serves customers better. Today, we present the most far-reaching changes to banking in our modern history so we can build an economy that works for everyone. I commend this Statement to the House”.
My Lords, that concludes the Statement.
Lord Sassoon
My Lords, I suppose I should be grateful that we got one cheer from the noble Lord, Lord Eatwell, who is a hard man to please. I am sorry that he finds serious flaws in the ICB’s analysis where most other commentators have not found flaws with what is widely recognised as an impressive and important analysis and one that is being looked at well outside the UK for the light that it sheds on continuing issues that other countries have around their banking systems.
I shall take a number of the noble Lord’s many questions. First, he asked about risk weights and the loss-absorbing capacity. The ICB did a detailed analysis of almost 40 banks. Its key chart is picked up in the Government’s document today. Of the 40 banks that suffered significant losses that the ICB looked at, the noble Lord, Lord Eatwell, highlighted the Anglo Irish Bank as the only one where the loss exceeded the 17 per cent—I think he referred to 10 per cent—loss absorbency which the ICB recommends for big banks. As my right honourable friend the Chancellor of the Exchequer made clear, this is not about making sure that no banks will fail but about a combination of things, including loss absorbency, that will make our banking system much more resilient in the face of the range of losses that are likely.
The noble Lord also asked whether the Government have accepted all the ICB’s proposals on the ring-fence. A detailed discussion of ring-fencing issues takes up one chapter, or some 15 pages, of our response today. A number of outstanding technical considerations are clearly set out in the discussion. As I have already said in repeating the Statement, this is the first round of a sequence of consultation and draft legislation, both primary and secondary, to get this right. I make no apology for not having answers to all the very detailed questions at the moment. We are putting out this 70-plus-page document today as the start of the discussion that must go on.
The noble Lord then questioned what activities should be inside and outside the ring-fence. On the question of where the ring-fence is located, he picked up on the adjective “flexible”, which is advisedly used in the Government’s response document. The key driver about what should be inside and outside the ring-fence in the ICB’s analysis is whether it is an essential banking service, the interruption of which would cause great difficulty. For individual and SME deposits and overdrafts it is quite clear that interruption of normal banking activity would cause hardship whereas large corporates and private banking are clearly categories of banking consumer much better able to look after themselves for a period in those circumstances. That is what has determined in principle where the ring-fence should be. On this flexibility, in order to have an efficient banking system, it is quite right that the banks should be able to decide on a one-off basis whether their large corporate activity should be inside or outside the ring-fence so that they can match up their activity on the lending side with the structure of their deposit base.
The noble Lord, Lord Eatwell, then raised questions about the situation of branches of a European bank in this country. It is certainly the case, as he recognises, that branch activity of a European bank would not fall within the provisions of this ring-fence. They cannot and should not do so under the arrangements for the single market. However, in relation to branch activities in this country, the supervisors—the FSA and, in future, the Bank of England—will of course have regard to subsidiarisation in relation to the scale of activities that are carried out through foreign bank branches.
Lastly, the noble Lord asked about implementation and timing. As I have said, both the primary and secondary legislation will be completed in the course of this Parliament. The final part of the proposals in line with the ICB’s timetable—on loss absorbency and with regard to capital—will be in place on the same timescale as the Basle III implementation in 2019, but between now and then we expect to see the ring-fence itself put in place. As I have said in repeating my right honourable friend’s Statement, we will work with the banks on what is judged by the Government to be a practical implementation timetable. That, I emphatically say, will, along with all the rest of it, be a decision for the Government and, where appropriate, for the legislation that will come before Parliament in due course. We have been fast on the case to respond to what has been an enormously detailed report and, as I say, we will get the legislation through in the course of this Parliament.
Lord Sassoon
My Lords, I am grateful to my noble friend for welcoming the Government’s response to the ICB. On his question about timing, I cannot go further than what I said already: that we will bring out a White Paper in the spring, followed by the draft legislation and that we will get all the draft legislation, primary and secondary, through in this Parliament. There is a detailed table in the response document published today of all the ICB recommendations and whether they require legislation or could be put in place by regulatory action. There are other things which are already proceeding, particularly on competition, and there are other matters where regulatory action can take place.
I was grasping to think what my noble friend’s second question was. I can indeed confirm what he said about the Government’s firm intention regarding bonuses for this year.
Lord Sassoon
My Lords, I well recognise the consistency, firmness and clarity with which my noble friend has held his views on separation from very early on in this debate; we discussed it three years ago. However, the Government agree with the ICB that full separation is not the route to go down. I say to him that having independent directors on the boards of the ring-fenced banks will go a long way towards making up for, as he puts it, possible deficiencies of top management and their ability to get around these things. Having independent directors of ring-fenced subsidiaries is a model that has worked well in utility companies. As he says, it is right that the Bank of England will be watching this in its new role of supervising the system.
Lord McFall of Alcluith
My Lords, when Sir John Vickers appeared before the Draft Financial Services Bill Joint Committee, it was clear that his report would not solve the “too big to fail” issue. What was required was a good regulatory structure, and no regulator globally succeeded in that.
In the draft Financial Services Bill report there were a number of issues relating to the governance of the Bank of England, and I should like an assurance from the Minister that the Government will take these all-party proposals very seriously. As a previous speaker said, culture is more important than architecture. I think that will be one of the main recommendations of our report.
The Minister mentioned the issue of switching current accounts. Will he accept that the portability of current account numbers is the key? That revolutionised the mobile phone industry. Only with the portability of current account numbers will we see a revolution in switching accounts in the banking industry.
Lord Sassoon
My Lords, I can confirm to the noble Lord, Lord McFall of Alcluith, that the Joint Committee’s report, which was published only today, will be taken very seriously on governance and all the other matters that are contained in it. As to switching accounts, I hear what he says about number portability, which is not at all an easy issue, as he well knows. All I would say is that the ability for seven-day switching, including all direct debits, credits and standing orders—which we now have the banks’ agreement will be implemented by September 2013—is a significant advance that will help millions of consumers.
Lord Higgins
My Lords, the report by the ICB is very large, comprehensive and detailed. It says that it would be desirable for the Government to express a view on it as soon as possible, which they have done. However, the Statement appears also to include one or two items that—I think I am right in saying—are not in the report. In particular, I understood my noble friend to say that there would be a tightening up of the Basel proposals, or that the Government would propose that. Secondly, he said that there would be depositor preference, which does not appear in the report unless I am mistaken. Will that require primary legislation and, if so, when are we likely to have that? Overall, it seems that we have just had another Statement, which has become available only recently. When will we have an opportunity to debate it? We have not really had any opportunity to comment on it now, since it appeared only a few moments ago.
Finally, on timing, there are two things. I agree very much with my noble friend Lord Lawson about the timing of the legislation. The banks need to know what is in the legislation. We should get that through the House at the earliest possible moment. Saying that we will do it in the course of this Parliament means that it will take far too long. Waiting until 2019 for the overall implementation is absurd. To suppose that there will be no financial crisis that is related to these proposals until 2019 would be the height of optimism. We have to get it through before then.
Lord Sassoon
My Lords, on the tightening up of Basel III, as my noble friend puts it, the provisions around loss absorbency of 17 per cent and the bailing provisions are items that go beyond Basel. They are welcomed on a global basis. We now have to make sure that the way in which the EU implements Basel III is not only compatible with Basel III itself but allows the UK to go further for as long as the global community is entirely comfortable with that. Depositor preference requires primary legislation. In relation to primary legislation, discussion of all this and the process, the next major stage will be a White Paper, setting out in greater detail how the remaining important detailed matters will be handled in the draft legislation. The draft legislation will then come. I believe that there will be plenty of opportunity, in a staged way, for noble Lords to consider all the detail.
Lord Lea of Crondall
My Lords, is this what one might call the final stage in a number of statements about reform of the banking industry, following what has happened over the past four years? Is the Minister aware of the concern about this up and down the country? I welcome the Statement, with the sort of qualifications given by my noble friend Lord Eatwell.
There is great concern about accounting standards which led to false accounting regarding the state of many banks. While no one is suggesting that any senior banker should be shredded in front of his family, the fact is that there seems to be a total black hole as regards anyone taking any responsibility in the banking industry. Is that not something that still needs to be corrected?
Lord Sassoon
My Lords, the report today is a response to the Vickers commission’s work on the structure of banking. I fully accept the noble Lord’s reference to other matters, particularly accounting standards. The committee of this House did some extremely important work in that area. I do not pretend that we are solving everything today and accounting is another issue that I am sure Members of this House will not forget as we go forward.
Lord Stewartby
My Lords, will my noble friend say something about supervision and where it fits into this very complicated arrangement of new committees and authorities? The report of the Joint Committee, which was published only today, states that it is planned that microprudential regulation will be done through a new subsidiary body called the prudential regulatory authority. However, regulation is not a micro-activity. Supervision is a micro-activity, but regulation is not. If microprudential regulation is meant to refer to supervision, it would be better to say so and not to put it in that form of verbiage.
Lord Sassoon
My Lords, I am sure that there will be other occasions and places in which to discuss the Joint Committee’s important report on the Bill, so I do not want to get dragged too far into doing that. I recognise that, even for those of us who have been involved in the banking industry, confusing “regulation” and “supervision” can sometimes be a trap into which it is easy to fall. Supervision will be the responsibility of the Bank of England in the new structure, if the Bill is passed by Parliament.
Lord Newton of Braintree
My Lords, I have two quick questions. First, is there any estimate or expectation of a rise in the costs of retail banking as a result of these proposals? It seems to me that that must be a possibility. Secondly—I declare an interest as a 55-year long customer of Lloyds TSB bank in Harwich, Essex—given that the Minister has welcomed the sale of some Lloyds branches to the Co-op Bank, what will happen if we immediately use our switching rights to go back to another branch of Lloyds Bank if we are sold like a commodity?
Lord Sassoon
My Lords, the ICB estimates that the increased cost of borrowing could be of the order of 0.09 per cent to 0.16 per cent as a result of implementing these proposals. That is a very modest additional cost which is well within the smallest ever incremental change to the bank rate introduced by the Bank of England. I will not speculate about what might happen to bank customers where they are sold from one bank to another, but I believe that it is completely right that we should make it easier in all circumstances for bank customers to be able to switch their accounts. That is what the banking system is going to deliver.
Lord Hamilton of Epsom
My Lords, like my noble friend Lord Lawson, I shall sleep at night only when retail banks and investment banks have separate shareholders. Will the noble Lord answer my noble friend’s point about the ingenuity of those who run banks to find a way round the ring-fencing, thereby enabling retail banks to continue to back investment banks?
Lord Sassoon
My Lords, as I have said, the way that the governance will work is that the ring-fenced subsidiary will have to have independent directors in the way that, for example, regulated utilities have to have directors who are independent of the holding company’s board. That is the principal protection in these circumstances.
Lord Hollick
My Lords, I welcome the Government’s response. It is an important step, but only a first step, to what surely must be full separation of the banks. That is the logic of the Vickers report and is, I should point out, the logic of the Government’s response, which states:
“The Government believes that the ring-fenced bank should not be dependent on the financial health of the rest of its corporate group for its solvency or liquidity”.
If that is to be achieved, the treasury function, which is right at the heart of banking, would need to be split and there would need to be two treasury functions. Similarly, loan capital would have to be provided separately from the high street bank. That would simply leave the question that my noble friend Lord Eatwell raised: what happens to the capital in the event that the holding company goes under? Surely, the logic of this is to separate these two completely. Can the Minister confirm that banks would be required to separate the treasury function, whereby loan capital will have to be raised separately for the high street bank?
Lord Sassoon
First, I do not accept that the Government’s logic drives towards complete separation any more than the ICB itself argued for it. The ICB and the Government believe that there are efficiency and other benefits in allowing banks to keep the two parts of the business together under one holding company. However, the principal protection in the areas to which the noble Lord refers is that there will be limits on the exposures of the ring-fenced bank to other parts of the group. That is what, in particular, will deal with the noble Lord’s concerns.
Lord MacGregor of Pulham Market
My Lords, in the recent hearings of the Select Committee on Economic Affairs, the banks accepted that the Vickers report is more or less a done deal but argued that the costs would be considerably higher than those that Vickers calculated and the costs that the Government have estimated today. If in the forthcoming negotiations there is a major dispute about costs and their possible effect on customers, will the Government keep reminding the banks that there is still more to be done to contain costs on bonuses, salaries and other payments?
Lord Sassoon
I agree with my noble friend’s sentiments on costs and I have stressed in the Statement that the position of the Bank of England, at this time in particular, is that banks should be using profits they generate to rebuild their balance sheets rather than pay out bonuses. However, to differ a little from my noble friend, I do not see this as representing any negotiation with banks over the costs. The ICB carried out an analysis, and the Treasury made a separate analysis that has resulted in different figures. We have used the input of the banks and their modelling in order to arrive at those numbers. We have come up with numbers for the costs that were higher in some areas than those originally estimated by the ICB. They are very much based on a lot of numbers that the banks themselves have modelled. I do not see a negotiation to be had in that area.