(11 years, 10 months ago)
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The Commercial Secretary to the Treasury (Lord Sassoon)
My Lords, I am pleased to have the opportunity to debate the Government’s proposals for financial services regulation. We have an impressive list of speakers today, including former Chancellors, government Ministers and Cabinet Secretaries, so I am sure that it is going to be a lively and interesting afternoon and evening. I am sure that, like me, noble Lords will be particularly looking forward to hearing from the noble Lord, Lord O’Donnell, my esteemed former boss, who will be giving his maiden speech today.
A thriving financial services sector is vital to the prosperity of the United Kingdom, and we can be justifiably proud of the country’s position as a world leader in financial services. As your Lordships are well aware, though, the UK financial system is emerging from the most serious financial crisis in more than 100 years. The Government are determined to learn the lessons from that crisis, which is why we have initiated a fundamental and wide-ranging reform of the financial services sector. That reform will be delivered not only through important changes to the regulatory system contained in the Bill; on Thursday the Government will publish a White Paper setting out how we plan to implement the recommendations of the Independent Commission on Banking. We are also shaping the international response to the crisis with our counterparts in Europe and elsewhere.
The causes of the financial crisis were many and diverse. Certainly it is clear that financial institutions took on risks that they did not understand or effectively manage. As a result our banks became among the most heavily leveraged in the world. Northern Rock was offering 120% mortgages, with an excessive reliance on wholesale funding, and the Royal Bank of Scotland’s acquisition of ABN AMRO was plainly very risky. It was a deal described by the next RBS chairman as,
“the wrong price, the wrong way to pay, at the wrong time and the wrong deal”.
However, the regulators also failed to act on the risks that were building up, both in individual institutions and across the system as a whole.
Let me be clear: the UK’s financial regulatory system was not fit for purpose. The tripartite system, made up of the Financial Services Authority, the Bank of England and the Treasury, failed. This was because no one had the single responsibility to monitor the financial system and address the causes of financial instability.
I was part of the system, as a Treasury official, from the end of 2002 to the end of 2005 and even then, in benign markets, some of the deficiencies of the tripartite were clear. The private sector was already asking who would be in charge in a crisis. When the financial crisis hit, this lack of clarity in responsibility initially meant that there was an inadequately orchestrated response. The FSA, the UK’s monolithic financial service regulator, was asked to do too much. On the one hand, it was required to assess the prudential viability of financial services firms; on the other, it was required to police the conduct of those firms. Because of the wide remit of the FSA, process too often became valued above judgment and box-ticking above informed regulation and supervision. This is why the changes contained in this Bill are vital. We are creating a framework based on clarity of responsibility for regulators. This Bill puts the judgment of expert supervisors at the heart of the new system. Instead of dividing responsibility for financial stability, we are putting the Bank of England clearly in charge.
I will now briefly outline several key themes of the Bill. First, the Bill addresses the widely acknowledged shortcomings of the arrangements in times of financial crisis. This Bill will give the Bank primary operational responsibility for financial crisis management, but the Chancellor of the Exchequer will retain responsibility for any decisions that require the use of public funds. In cases where there is a serious threat to financial stability which puts public funds at risk, the Chancellor will have the power to direct the Bank.
In order to oversee and address systemic risk throughout the entire financial sector, the Bill creates a powerful new macroprudential body in the Bank of England, the Financial Policy Committee or FPC. The Bill gives Parliament the power to bestow important new macroprudential tools on the FPC so that it can act to address the risks it identifies. The FPC will promote a healthy financial system, but not a zero-risk system. It will be a system that can both thrive on and withstand appropriately managed risk. As my right honourable friend the Chancellor of the Exchequer has said, the FPC should not seek to achieve the “stability of the graveyard”, so the Bill recognises that in pursuing a stable financial system, the FPC must not impact on the ability of the financial sector to contribute to sustainable growth in the medium or long term. I know, of course, that the way this is dealt with in the Bill was the subject of some debate in another place.
Since the Bank of England will be taking on a more powerful role, it is right to consider the robustness of its accountability mechanisms. I want to take this opportunity to highlight the work of the Treasury Committee, which engaged constructively with this Bill in a range of areas, not least the governance of the Bank. We welcome the commitment of the Court of the Bank of England to enhance the Bank’s governance arrangements in line with the recommendations of the Treasury Select Committee. As my honourable friend the Financial Secretary to the Treasury set out in another place, the Government will seek to amend the Bill in your Lordships’ House to put these enhanced arrangements on to a statutory footing. I will be listening carefully to your Lordships’ views on Bank governance as we finalise our thoughts on the appropriate amendments to put forward.
The Bill also provides for two focused financial regulatory bodies: the Prudential Regulation Authority and the Financial Conduct Authority. I will take each one in turn. This Bill will establish the Prudential Regulation Authority—the PRA—as a subsidiary of the Bank of England bringing together macroprudential policy and microprudential regulation under the Bank. In its role as a microprudential regulator, the PRA will regulate and supervise firms that manage significant risks on their balance sheets. This includes not only banks but insurers and the more significant investment banks. Crucially, the PRA will be required to take a strong, judgment-led approach. Indeed, it will have a specific duty to supervise to ensure that it actively engages with businesses, scrutinises their business models and carries out forward-looking risk assessments.
The Bill will also establish the Financial Conduct Authority as a focused conduct-of-business regulator. The Bill is good news for consumers of financial services. The FCA will be proactive in securing better outcomes for consumers, with a new competition objective and a new power to ban or impose requirements on products that could cause consumer detriment, enabling the FCA to intervene earlier, before there is evidence of widespread harm. This means that the FCA will be better equipped than the FSA to deal with mis-selling scandals, such as that of payment protection insurance. This morning the Government announced the appointment of John Griffith-Jones as the chair-designate of the FCA. Mr Griffith-Jones is currently UK chairman of KPMG and a professional with many years’ experience of the financial sector. His appointment marks an important step forward in the continuing establishment of the FCA.
The Bill enables responsibility for consumer credit regulation to be transferred from the Office of Fair Trading to the FCA. This transfer will ensure that the consumer credit market also benefits from the FCA’s focused remit, proactive approach and wider powers. However, we are clear that securing effective competition in financial services markets will lead to better outcomes for consumers. That is why the FCA will have an objective to promote effective competition in the interests of consumers. It will also have a duty to seek competition-led solutions to conduct issues when pursuing its other operational objectives. For example, the FCA will consider barriers to entry, encouraging switching, increasing transparency and focusing more on the requirements for information of different consumers, including those who are vulnerable or marginalised.
We are confident that these reforms will make the UK a more attractive place in which to do business. They will help maintain the UK’s position as the leading global financial services centre. A more stable and sustainable financial sector will undoubtedly be a more competitive one. However, markets in financial services are not contained by national boundaries. That is why the Bill contains extensive arrangements to ensure that the new regulators co-operate fully with each other in their dealings with international regulatory bodies.
The Bill’s introduction to Parliament was preceded by an intensive process of policy development. It included three separate public consultation exercises, all of which served to improve the legislation now before the House. I take this opportunity to pay tribute to the valuable work of the Joint Committee on the draft Bill, which included a number of noble Lords who will contribute to today’s debate. They made valuable contributions during pre-legislative scrutiny and I look forward to hearing them share their expertise today. I look forward to working closely with your Lordships during the Bill’s consideration in this House and I welcome the informed scrutiny and expertise that will no doubt be offered.
The Bill comprehensively addresses the failings of the current financial regulatory system. It makes it clear that the Bank will be responsible for monitoring and ensuring the financial stability of the system as a whole. It makes it clear who leads in the event of a financial crisis. Never again will people ask, “Who is in charge?”. It creates two new focused regulators, placing judgment at the heart of microprudential and conduct-regulation. The PRA will be empowered to use its judgment to challenge the excessive and inappropriate risk-taking that led to a run on Northern Rock and the government interventions in RBS and Lloyds TSB. The FCA will be empowered to take proactive steps to regulate conduct in financial markets, preventing detriment to consumers of financial services. I am pleased to present the Bill for noble Lords’ consideration. I beg to move.
Lord Eatwell
My Lords, I am grateful to the noble Lord for introducing this important Bill. Its importance can hardly be in doubt, given the core dilemma presented by the place of financial services in the British economy. On the one hand, Britain is a world leader in financial services and a considerable measure of our future prosperity depends on that industry. On the other hand, as we have seen, it is the industry that has greater potential than any other to inflict severe damage on Britain’s economy. The goal of regulation is to secure the benefits while minimising the costs and to achieve that in a manner that passes the tests of accountability, clarity, efficiency and transparency. Regrettably, the Bill fails all those four tests.
It certainly fails the test of clarity, being both complex and incomplete. The Bill is unnecessarily complicated because, instead of drafting a new template for the financial services industry, superseding all past relevant Acts and incorporating the new banking Bill that is yet to be published enacting the Vickers proposals, the Government have constructed a dog’s breakfast of amendments to earlier legislation.
Last week, noble Lords were no doubt surprised to receive a passionate entreaty from the Treasury Committee of the other place insisting that the Bill had been cobbled together with undue haste and had not received adequate consideration—in the case of some clauses, no consideration at all—and providing a checklist of serious failings in the legislation as currently drafted. From these Benches, I can assure the Treasury Committee that its despairing plea will not go unanswered. We intend to devote just as long as it takes to sort out this flawed Bill and thank goodness that the procedures of this House will allow us to do so. I am sure that all sides of the House will support this commitment, since this is essentially a non-partisan Bill. We all have a strong vested interest in getting it right. I hope that the Government will approach our deliberations in that spirit, although their negative performance in the other place was not encouraging.
The noble Lord, Lord Sassoon, referred to the regulatory failures that have been all too evident in the financial crisis. That there were serious failures is beyond doubt—most notably in the operation of the tripartite memorandum of understanding. But these were less failures of structure and more failures of the then conventional wisdom with respect to regulatory theory and practice. As the Joint Committee on the Bill noted:
“Successful regulation depends more on the regulatory culture, focus and philosophy than on structure”.
That point was made even more forcefully by Mr. Alan Greenspan in his evidence to the US House of Representatives in October 2008. Referring to the intellectual framework that guided the regulatory stance of the Federal Reserve System, Mr. Greenspan said:
“This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year”.
That was as true of the thinking of British institutions as it was of the United States.
In this context it is worth remembering why the tripartite system was created in the first place. One of the key reasons was that the Bank of England had proved to be such a fallible regulator. The cases of Johnson Matthey, BCCI and Barings come to mind. In the latter instance, the Bank’s performance was so bad that the Board of Banking Supervision was moved to comment that it would be a good idea if the Bank of England understood the products that it was supposed to be regulating.
Nonetheless, on the basis of what we have all learnt over the past four years, the fundamental thinking behind the reforms set out in this Bill is clearly well-founded, even if the execution falls a little short. The key thing that we learnt was that focusing on the stability of individual institutions, however large—so-called microprudential regulation—is not enough. The whole is bigger than the sum of the parts; systemic risk is all pervasive and by its very nature cannot be managed by individual firms. Hence the need for macroprudential regulation, spelt out so clearly in the FSA’s Turner review. But macroprudential regulation poses major new challenges to economic and financial policy-making. It will necessarily involve measures that cross what has previously been deemed to be the boundary between actions that might reasonably be left to unelected officials and actions that are necessarily the province of politically accountable decision-makers.
The essence of the macroprudential structures as set out in this Bill is that the Treasury cannot be trusted. Just as it was feared that the Treasury might approach the setting of interest rates with an inappropriate eye to political advantage, and hence the Bank of England was given control over interest rates, so now it is feared that the Treasury will fail to take away the punch bowl of loose credit in order to reap the short-term political benefits of a debt-fuelled boom. Accordingly, the Bank of England is given, via the new Financial Policy Committee, virtually autonomous control over a variety of instruments to manage the supply of, and perhaps later the demand for, credit. In addition, microprudential regulation is also taken into the Bank, in the form of the Prudential Regulation Authority.
This agglomeration of powers in the Bank of England poses two vital questions. Is the governance of the Bank of England such as to result in accountable, clear, efficient and transparent utilisation of these extraordinary powers? Equally, does the relationship between the Bank of England and the Treasury, as set out in the Bill, meet the test of these four principles? The answer given by the Treasury Committee to both of these questions is a resounding no. We on this side broadly agree with the Treasury Committee, though we differ in some details. We certainly agree that the governance of the Bank should not be a matter for the Bank itself. Our major disagreement with the Treasury Committee’s proposals is that they do not go far enough.
First, with respect to the governance of the Bank, the Government have responded to the evident lack of co-ordination in the crisis by designing a model of perfect co-ordination; namely, that one person should be responsible for everything. The Governor of the Bank of England will chair the Monetary Policy Committee, the Financial Policy Committee and the Prudential Regulation Authority, as well as being in overall charge of the Bank of England’s special resolution unit and its payment and clearing and settlement systems oversight department. When he or she has some spare time, this individual will also chair a number of important international committees. Even if it is possible to find the exceptional individual who can effectively take on all these tasks simultaneously, that person will be driven mad, for many of these activities will demand contradictory policies. Moreover, if ever there were a structure likely to result in the dangers of group think, this is it, since the group is a group of one.
Side by side with the inefficient, unaccountable and untransparent role of the governor is the now anomalous position of the court of the Bank. The Financial Policy Committee is to be a committee of the court. It is envisaged that primary responsibility for determining and keeping under review the strategy for achieving the financial stability objective will sit with the court, although the court will be required to consult the FPC and Treasury, and the FPC may at any time make recommendations to the court. On a moment’s reflection, it is clear that the court’s composition and powers are simply not up to the job.
In Grand Committee we will propose wide-ranging reform to the governance of the Bank of England to ensure that it has a structure of decision-making appropriate to the first half of the 21st century, rather than to 1694. In particular, we will require a more collegiate form of decision-making and propose measures to improve the accountability of what is, after all, a public institution. I was delighted to hear from the Minister that the Government are searching for good ideas in that area. I think that we have some.
Given that the governance of the Bank, as the Treasury Committee puts it, falls,
“well short of what would be expected in a modern institution, whether public or commercial”,
and that this is,
“especially important given that vitally important decisions made by the Bank’s executives, especially during times of financial instability, may not reasonably be made public and therefore be immediately available for scrutiny”,
the next question obviously arises. Are the powers of autonomous action endowed on the Financial Policy Committee and, accordingly, the Bank, appropriately balanced with the need for political oversight by the Treasury of the overall conduct of economic and financial policy? Does the Bill provide for sufficient parliamentary scrutiny to endow the FPC and the Bank with an appropriate level of legitimacy? Again, we believe that the Treasury Committee does not go far enough. The FPC is described by the Government as,
“a powerful new authority sitting at the apex of the regulatory architecture”.
The mechanisms to ensure democratic accountability of the FPC need to be commensurate with the strength of its powers.
The most important aspect of the relationship between the Bank and the Treasury is what should be done in a crisis. After all, it was in a crisis that the system failed. This is spelt out in Part 4 of the Bill and in the draft memorandum of understanding on crisis management. The draft memorandum of understanding, which, by the way, is in general far less clear than the old tripartite memorandum, at least makes clear that the Bank is the gatekeeper, defining when the Treasury may play a crisis management role. It is worth quoting the MoU. It states:
“The Bank has primary operational responsibility for financial crisis management. The Chancellor and the Treasury have sole responsibility for any decision involving public funds. When the Bank has formally notified the Treasury of a material risk to public funds, and either there is a serious threat to financial stability, or public funds are already committed by the Treasury to resolve or reduce such a serious threat and it would be in the public interest to do so, the Chancellor may use powers to direct the Bank. … Where the Bank is able to manage a financial crisis without public funds being put at risk, it will have autonomy in exercising its responsibilities”.
This is the most extraordinary nonsense, a fetishisation of the use of public funds. First, whatever is happening, the Treasury must wait for notification by the Bank of England before it can act. Given the Bank’s record on Northern Rock, that notification will come far too late. But secondly, and more seriously, households may be losing their savings, businesses may be collapsing, and economic activity may be in precipitate decline as the result of financial instability, but if there is no threat to public funds the Treasury is shut out of any active financial stability role until the governor invites it in.
This betrays a lack of understanding of the mutually reinforcing co-operative role that the Bank and the Treasury need to adopt to tackle macro-risk. This was put very clearly by Jacques De Larosière to the Economic Affairs Committee of your Lordships’ House three years ago. He said:
“Let us not hide ourselves from reality. Often ... fiscal policies can be part of systemic risk”.
The only sensible solution seems to be for a fundamental rewriting of Part 4 of the Bill to allow the Treasury to act when severe financial problems arise without the Bank acting as a gatekeeper. In 2008, the problem was not that the Treasury was too strong but that it was too weak. To ensure that the roles of the Bank and the Treasury are clear beyond all reasonable doubt and given that the MoU will evolve in the light of operational experience, the MoU itself must be the subject of enhanced parliamentary scrutiny. By the way, the definition in the Bill of the objectives of the Financial Policy Committee, with its peculiar emphasis on leverage, debt and credit growth in the UK, also betrays a worrying lack of understanding of the nature of systemic risk in a global financial system.
Many other aspects of the Bill require substantial revision by your Lordships’ House, ranging from procedures for consultation at all levels, the role of the tribunal in disciplinary cases, to the duty of care that retail financial institutions should exercise towards their customers, and the range of access to financial services and to the procedures for parliamentary scrutiny of the avalanche of secondary legislation that the Bill will stimulate. My noble friends and I are committed to playing a constructive part in that revision. However, at the core of the Bill—the core that we must get right—are the new procedures for macroprudential regulation. If an open and successful financial services industry is to be sustained, it is imperative that an accountable, clear, efficient and transparent mechanism for the management of systemic risk is established. Moreover, that mechanism must have as its ultimate objective the promotion of employment and growth in this country.
Lord Forsyth of Drumlean
The noble Lord has made a passionate and powerful speech about the importance of the Bill. Why have the Opposition agreed that it be referred to Grand Committee for its Committee stage?
Lord Eatwell
Our experience from the Bill establishing the Office for Budget Responsibility, given that everyone was trying to get it right, was that we managed to have a very constructive debate. The noble Lord, Lord Sassoon, was constructive in accepting numerous amendments from the Opposition and we felt that detailed debates on complex matters could be conducted more effectively in that less formal arena.
Baroness Kramer
My Lords, I am trying to do this for the first time by reading from an iPad, in order to become more technically capable.
We are all agreed in this House that the Bill is in need of significant work and study. It has had a review in the other place but, as always, such a review was reasonably limited. However, we have the advantage of a range of committees that have contributed knowledge, expertise and a great deal of evidence for us to use as we address the Bill. I do not share the gloom of the noble Lord, Lord Eatwell, but I agree that substantial changes can improve the Bill and achieve the goal that we all hope for.
Perhaps I may make some general comments. The Bill essentially looks back, as do all Bills that deal with regulation—in this case to the crisis of 2007 and 2008. It is therefore framed around risk avoidance—both systemic risk and micro risk. All such legislation tends to be backward looking and, as a consequence, the emphasis throughout the Bill is on financial stability. I would argue—as I suspect others in this House would—that the regulator, who will presumably be in place for many years, and the underpinning regulation that will exist for many years, must encompass issues of economic growth. One can make a tortuous argument that if growth is not achieved, financial stability becomes at risk, but the Bill and the role of the FPC in particular have to recognise the economic growth objective. I very much hope that as we proceed with the Bill we find ways in which to do that. The Chancellor has, in a sense, set the challenge with his phrase of wanting to avoid the “stability of the graveyard”.
There are a number of areas on which I suspect our discussions in Grand Committee will focus. The first is accountability and transparency—what might be called the “sun king” issue. The noble Lord, Lord Eatwell, has described that in some detail, but we can say without disparaging any individual who is the Governor of the Bank of England, either now or in the future, that putting so much power and responsibility on to one individual is a matter that requires extremely serious scrutiny and one that we must in many ways question. The danger of group think, which the noble Lord mentioned, is one of the key problems we have seen. Challenge somehow has to be built into this system so that we do not constantly look backwards to the risks that we are aware of and fail to see those that are coming towards us, because it is always the unexpected that causes trouble the next time around.
I am glad that the Government have said that they will look at the role of the court. Many people in this House are supportive of the proposals put forward by the Treasury Select Committee and the Joint Committee, which did such excellent work in pre-scrutiny of the Bill. Issues of transparency again fall into this arena. We will have to study carefully what goes into the Bill and what sits in secondary legislation, and how that balance is to be handled. I suspect that some of us will question the slow pace that the Bank of England has adopted as regards engaging in a proper review of the lessons to be learnt from its behaviour and performance during the financial crisis, and the narrow remit that has been given to such reviews. That stresses the importance of the court.
The second set of issues that we will certainly address in great detail is generally known as the “twin peaks” strategy. I am not entirely convinced about this but I am very much open to persuasion. However, coming at it very much from the outside, this looks more like a small mountain range than twin peaks, with the Treasury, the Bank of England, the MPC, the FPC, the FCA and the PRA—frankly one can keep adding to the list. There is a tendency in British government to operate in silos. This is obviously partly down to culture but I believe that the direction that we give in this legislation can help to challenge that. Culturally, it is going to be extremely difficult to cope with regulation as we move forward because the kind of culture that needs to be inherent in the FCA is very different from the one that will be present in the PRA. One can see the PRA adopting the notion that it is the hard man with the FCA being in some ways the soft man throughout all this. I suspect that maintaining real exchange, communication and proper challenge throughout all this complexity is going to be exceedingly difficult and we have a pattern to set here.
This regulator, in its various forms, will be looking out at the European Union, which, after all, is the source of much financial regulation. I recognise that there will be a co-ordinating committee but I think we are all going to need some convincing that communication will work appropriately. It is a case not just of making sure that in conversations with the EU all UK regulators talk from the same page but of making it clear to those within the EU and beyond whom they must communicate with and how. It strikes me as an exceedingly difficult programme to put together. Although it is a real challenge, again I am willing to accept that it is a question of culture as much as of language within the Bill, and that we can discuss and establish some kind of framework.
The question of competition concerns me. We talk about competition and the kind of context that the FCA will use, but the barriers to entry into the banking sector are very much impacted by the way in which the regulator behaves and has behaved. There has been one new bank in the past century. When it still takes individuals who are reasonable and well financed two and a half years and costs between £25 million and £35 million to get through the regulatory process, I would argue that that is failure, and I do not think that the regulator has taken that crucial point on board.
When we talk about competition and diversity, we should also mention mutuals, co-operatives and social enterprises. I have often talked about the need for local and community banks, and my noble friend Lord Phillips is very involved in these same issues. We have to get the regulator to understand that it is looking not at one homogenous sector but at a sector with different facets which may need very different kinds of regulation. It is often argued that legislation should not favour one sector over another but, frankly, by reinforcing the status quo one could argue that the regulator is in effect engaged in some of that process.
Many of the other issues that we will want to raise within the context of the Bill, such as consumer protection, peer-to-peer lending and the new financial alternatives, will be dealt with in this debate by my noble friend Lord Sharkey, so I shall resist covering them to make sure that I finish within my allotted eight minutes. However, I specifically want to raise clearing houses—a matter on which I gave the Minister a slight heads up. It sounds like a minute issue but it is the kind of thing that we are going to have to watch for as we go through the Bill. As the House will be aware, European directives mean that derivatives contracts will be clearing on the exchanges and those exchanges will be taking counterparty risk. They are regulated by the Bank of England, not the PRA. Mostly they are not capitalised but are owned by the banks, and one can see a potential crisis coming down that line. We need to have a discussion around issues such as that to make sure that the Bill has the width and breadth that it absolutely needs.
Going into this legislation, I am very hopeful. It seems to me that this is a challenge that the country has given us. If we run into economic difficulties in the future, at the very least the financial and regulatory framework should be right. It should be transparent and accountable and should respond to the needs of our broader economy. I think that this Bill gives us the opportunity to put that in place and I am glad that the Government have brought it forward.
Lord Turnbull
My Lords, this Bill illustrates much of what is wrong with our legislative process. It has arrived with many major issues unresolved. Worse still, large areas of the Bill have not yet even been considered. It reminds me of those French paperbacks that we used to buy where the pages had not yet been cut.
I agree with the noble Lord, Lord Eatwell, that there is a problem with the way in which the Bill has been presented as amending legislation to three other major Bills. That is totally illogical. If the Government were to argue that they were refining the status quo, that would have been appropriate but they are, of course, claiming precisely the opposite. One of the drawbacks of the amending approach, for example, is that it is very difficult to make comparisons between how the MPC and the FPC operate.
The first question that we face is whether the Bill provides the right solution; it does not in my view. If something fails, one is always faced with the choice of whether to mend it or buy a new one. Of course, the latter is politically expedient as it enables the Government to say that they are sweeping away the faulty structure created by their predecessor. However, that is not necessarily the right answer.
In my view the existing system could have been improved by a number of changes. The first is the creation of a separate macroprudential responsibility located in the Bank, which would allow it to identify when the economy, the financial system or particular markets were running too hot—or even too cold. That would be a natural extension of its monetary policy expertise. It would enable the Bank to bring to bear certain controls or require the FSA to tighten capital requirements of the organisations it regulates. It was not necessary in my view to transfer the detailed prudential regulation of all financial institutions, large and small, insurance as well as banks, to the Bank of England—something for which it has little experience and which will overload it.
Secondly, it is curious that the Chancellor and the Treasury appear so little in the Bill, moving under a kind of invisibility cloak. However, the Chancellor, not the governor of the Bank, is ultimately the most powerful player, partly by his ability to co-ordinate policy at the highest level, partly by being the real lender of last resort and partly by providing the key link of public accountability. A judgment has to be made on when it is appropriate to delegate powers to a non-elected body and when the impact on citizens and organisations is such that a degree of democratic accountability needs to be introduced. In my view the extension of the powers of the Bank and the widening of those subject to its actions means that we have gone beyond what was appropriate for it when it was simply a monetary authority.
Thirdly, the demerger of prudential and conduct of business regulation was unnecessary. It has created a lot of overlap which will produce confusion. A number of processes are effectively shared: business model analysis, enforcement and vetting of key board appointments. My concern, though I need to declare my interest as a director of a regulated insurance company, is that regulated companies will find themselves having to deal with two shops rather than one. So, I would have retained a single FSA but with an enhanced macroprudential function in the Bank, overseen by a Chancellor-chaired council, rather like the US Financial Stability Oversight Council. However, we are where we are and we face the dilemma of the sat-nav lady. Does she tell you to turn round or recalculate your route? Reluctantly, we have to work with what we have and try to improve it.
I would start with the function of the FPC, which has oversight of the macroprudential function. Currently its terms of reference are rather narrowly drawn, emphasising very strongly the avoidance of risk. Alastair Clark, a member of the FPC, in a recent speech noted that there is a need,
“to strike the right balance between encouraging banks to strengthen their position and avoiding any undue constraint on the availability of credit”.
This is important because much of the public debate in this country on the current situation is in terms of an antithesis between the tightening of fiscal policy and the loosening of monetary policy. What this misses is that there is a third point of the triangle—the decision of the FPC about the liquidity and capital requirements of the banks. Clearly one of the lessons of the financial crisis is that the banks were undercapitalised for the risks they were taking. There is international agreement that their capital should be built up, but there is no consensus about the speed at which this should happen. There are many who think that the FPC is pushing this too fast and requiring the liquidity to satisfy highly demanding stress tests, thereby nullifying the expansionary effect of the Bank’s monetary operations.
A mechanism will be needed to ensure that we get the best combination of the different policy instruments, which brings us to the question of how we should design organisations to achieve that. One approach might be called synthesis. We should bring interlocking problems under one roof to allow those at the top to produce the optimal trade-off between them. The danger is that if those at the top have a particular bias, one view may be subordinated to another without full debate.
The opposite approach is the separation of powers or of focus. Organisations will pursue their objectives with a mechanism created above them to resolve differences. The old tripartite system followed this principle but the new arrangements are in the synthesis mould. This means that if the Bank overemphasises the financial stability objective and imposes costs on other functions, there will be nothing to correct it. The cross-membership of the governor and his immediate colleagues on the two committees will be an inadequate substitute and may even exacerbate the problem.
The Bill includes a number of checks and balances, but they could go further. For example, we could create a secondary objective to support the Government’s economic objectives, along the lines of those already provided for the MPC. The latter will have to maintain price stability but, importantly,
“subject to that, to support the economic policy of Her Majesty’s Government, including its objectives for growth and employment”.
The objectives of the two committees should be made symmetrical.
As with the MPC, the Treasury should be able to set out how the FPC should interpret its remit. We should consider whether the balance of the FPC is correct and perhaps add an additional external member.
I do not have time to go into the provisions relating to the FCA in any detail. I will simply say that I share the concerns that were expressed about how we can ensure that it operates in a way that is proportionate, fair and reasonable. I particularly commend the analysis provided in a paper published jointly by Herbert Smith LLP and the LSE.
It is clear that there is a lot of work to be done on the Bill. I hope that we can create something that will last longer than its predecessors.
The Lord Bishop of Durham
My Lords, the Bill emerged from the financial crisis of 2008. Therefore, a lot of the attention of the debate is likely to focus on the prudential issues that have already been mentioned at some length. We look forward to the speech of the noble Lord, Lord O’Donnell, whose great expertise and extraordinary experience over the past few years give us much to hope for.
However, in looking at the macroprudential issues, we should remember that the complexity of the Bill grew through an extensive period of consultation and debate so that it now covers the whole range of financial services, from things that happen on the streets of Sunderland in my diocese to international loans and bond issues, and the use of derivative instruments that have been behind much of the exacerbation of risk in the system since I first traded them 25 years ago, to the point today where their volume is many scores of times that of the underlying cash transactions. It is no wonder the Bill has become something of a complex monster.
Given the Bill’s complexity it is easy to overlook its impact on the consumer, and particularly the role of the FCA, which is warmly to be welcomed in many ways. At the retail level we are all aware that we have the most concentrated financial services sector in Europe, with decisions taken far from local communities, and that the lack of penetration of mutuals, credit unions and friendly societies—I was very glad to hear the noble Baroness, Lady Kramer, mention this—is unrivalled in the rest of Europe, where there is far greater and more extensive mutual work at local level than in this country. Our societies have diminished very significantly since the 1980s and the period of catastrophic demutualisation that we should all regret so much. The result is that access to financial services in many of the more deprived areas of our society is now very limited, and we come back to the old problem of loan sharking and payday loans. Payday loans, of course, are legal and proper. It is a great relief that they will move from being watched over by the OFT to being supervised by the FCA, with its responsibilities for integrity, consumer affairs and competition under its three main objectives. However, as has already been alluded to, the danger is that these regulatory organisations essentially operate in a negative and protective manner rather than having, as the FCA has, an obligation to introduce more competition.
The Bill does not seem to provide for accountability and for a measure of what more competition would look like. This must be a serious concern. Contrary to much of what has been said, for example, in Scotland recently by the General Assembly of the Church of Scotland, the answer to the payday lenders is not to limit interest rates as this will simply drive matters back into the hands of the illegal loan sharks. At the moment, if you go outside the Darlington Building Society when the benefit payments come in, you will find a queue of people who will withdraw from their accounts everything but one penny in order to pay it straight into the hands of the loan sharks who are standing by their doors threatening to break up their furniture. Payday lenders do not, of course, operate in this way, but I have numerous examples in my diocese of the serious impact that their high costs have had on people who find themselves caught up in an ever growing cycle of higher interest rates.
The answer to this is not in limiting interest rates but in providing effective competition from local savings at a mutual level and recreating the system that worked so well from the early 19th century until the 1980s. I fail to see this in the Bill and that gives me great concern. I hope the Minister will explain how the competition obligation will not only reduce the problems of access for banks and for other large organisations—as we have already seen with the co-operatives’ problems in taking on the branches of Lloyds Bank—but increase the opportunity for much smaller and more locally based organisations to contribute to their local communities. This will affect a large number of people on the most marginal points of society.
The other point I wish to raise concerns the governance of the Bank of England, which has already been mentioned. It is an old rule of organisations that robust checks and balances within them are much more effective than external legal constraint. A severe challenge to management from the court will be much quicker in enabling group-think to be destroyed and a creative approach to the problems to be seen than any kind of legalistic approach from a regulator subsequent to the event. I shall not waste the time of the House in expanding on this, save to say that I agree with the views that have been expressed already. I look forward to the Minister’s response in explaining how the governance can be strengthened and widened.
Lord Lawson of Blaby
My Lords, the House will have listened with great attention to what the right reverend Prelate has just said with a mixture of expertise and eloquence. It was certainly unusual in one respect; he must be the first speaker from the Bishops’ Bench, certainly in my time in the House, who has come out as a former derivatives trader. This adds great weight to everything he said.
I hope the Minister will pay particular attention to the area on which the right reverend Prelate has focused, as he has on a number of occasions outside this House, of the arrangements and problems associated with payday lending and the people who require and use it. However, I will not follow him further down that route because other things need to be said about this long, highly complex and important Bill, which I warmly welcome.
Before I turn to the measures in the Bill, there is one thing of fundamental importance that cannot be put into it: the relationship between the Chancellor of the Exchequer of the day and the Governor of the Bank of England. Again, this is of fundamental importance. While it cannot be put into a clause of the Bill, that does not mean that it cannot be institutionalised, and I hope that my noble friend the Minister can reassure me that something will be put in place along the lines of what used to happen in the United States, although I do not know whether it still does. There were regular breakfast meetings between the Secretary of the Treasury and the Chairman of the Federal Reserve. The relationship needs to be institutionalised. Just because they get on well is not good enough. In my judgment, that needs to be done.
I approve of the broad lines of the Bill. The regulatory architecture that it introduces is a big improvement on what it replaces. As my noble friend Lord Sassoon has already pointed out, the so-called tripartite system introduced by Mr Gordon Brown in 1997 proved to be a dysfunctional disaster and did not cause, but certainly contributed to, the severity of the UK banking meltdown in 2008. What was particularly perverse about the Brown structure was that it destroyed and replaced the greatly strengthened system of prudential supervision that as Chancellor I put in place in the Banking Act 1987, with the indispensable assistance of the then Economic Secretary to the Treasury, my noble friend Lord Stewartby. I am glad to see that he is in his place and I hope that he will speak later today. I should like to refer to two specific aspects of the 1987 Act later in my remarks. While the new architecture is a great improvement, it may not be right in every respect. It will need to be monitored carefully to see how it works out in practice, and I trust that the Government will be prepared to modify it in the light of experience. That will almost certainly be necessary.
The most fundamental flaw in the tripartite system was not the removal of responsibility for the prudential supervision of the banks from the Bank of England. There is a valid case for that, as I spelt out in my memoirs some 20 years ago. The most fundamental flaw was yoking together in the FSA prudential supervision of the banking system and the conduct of business regulation, in particular consumer protection. Perhaps I may say that I disagree with the noble Lord, Lord Turnbull, on this point, although I agree with some of the other remarks he made. These are two completely separate activities requiring completely different skills, people, cultures and approach. While the intensely detailed, bureaucratic, box-ticking approach may have been appropriate for consumer protection, it was wholly inappropriate for the task of prudential supervision of the banks.
It was also a serious mistake, in my judgment, to separate responsibility for the stability of the banking system as a whole, which was left with the Bank of England, from responsibility for supervising individual banks, which was given to the FSA. While it is true that there is a distinction between the regulatory system as a whole and the day-to-day supervision of individual financial institutions, at the end of the day the system is the sum of the institutions that comprise it, and regulation and supervision need to be intimately linked. Moreover, the grossest excesses of banking imprudence, although economically devastating when they occur, happen probably at most only once in a generation, while consumer abuses such as mis-selling are ever present and politically sensitive. As we saw, they inevitably became the FSA’s principal focus of attention, at the cost of its disastrous neglect of prudential supervision.
The new architecture proposed in this Bill rightly separates these two activities completely, making consumer protection the remit of the new Financial Conduct Authority. However, it is a mistake to give the Bank of England, through the Financial Policy Committee, responsibility for the oversight of the Financial Conduct Authority. It has enough on its plate as it is.
I am also unconvinced by the wisdom of having two separate bodies—the Financial Policy Committee and the new Prudential Regulation Authority—to supervise the system and the individual banks respectively. It is quite true that both these bodies will be within the Bank of England, so there is likely to be constant cross-fertilisation, but the practical effect of having two bodies rather than one will need to be carefully monitored.
The decision to give the Bank of England full responsibility for financial regulation and supervision on top of its responsibility for monetary policy, which may on occasion conflict, places a heavy burden on the Bank in general and the governor in particular. The Government plan to recognise this by having a strong Financial Policy Committee with former practitioners on it and by beefing up the Court of the Bank of England, but I am far from sure that that is enough.
The Banking Act 1987 created inter alia the Board of Banking Supervision, which has already been referred to by the spokesman for the Opposition in this debate. This was charged with supervising the Bank’s conduct of its supervisory responsibilities and was chaired by the governor, but with as part-time members the most effective recently retired bankers that I could find. Moreover, and importantly, if these poachers turned gamekeepers had any concerns about the way in which the Bank was conducting any part of its supervisory responsibilities, they had the power under the Act to insist on a private meeting with the Chancellor, at which they could voice their concerns—a powerful sanction. I urge the Government, even at this late stage, to put in place a body that is more narrowly and expertly focused than the FPC, along the lines of the former Board of Banking Supervision, to supervise the work of the PRA.
Another innovation introduced by the 1987 Act was dialogue between bank supervisors and bank auditors. Until that time, it was illegal for there to be a dialogue between the auditors and the supervisors, as that would have constituted a breach of the auditors’ commitment to client confidentiality. The 1987 Act not only changed that but stated that there had to be a dialogue. Given the extreme and understandable reluctance of auditors publicly to qualify a bank’s accounts as they might qualify the accounts of any ordinary company when they discover something amiss, for fear of causing a run on the bank, it is particularly important that they should privately tip off the supervisory authority. Equally, if the Bank of England has a concern, it is important that it should share it, privately, with the auditors of the bank or banks involved, and ask them to look into it more closely. Regrettably, with the Brown changes, the dialogue demanded by the 1987 Act fell into desuetude.
I am pleased that the Bank of England and the Government have decided to do something about this, and to introduce a code of practice designed to reinstate the dialogue. The Economic Affairs Committee of your Lordships’ House, under the excellent chairmanship of my noble friend Lord MacGregor, looked into this in its report on auditors of March last year. I declare an interest as a member of that committee, which unanimously concluded that in the light of experience a code of practice was not good enough and there should be a statutory requirement for the dialogue to take place. That must be right, and I urge the Government to look at it again.
I will raise two other matters before I leave the subject of bank auditing, which is so important to the task of bank supervision. First, I mentioned the reluctance of auditors to use the nuclear weapon of qualifying a bank’s accounts, which may be one reason why they did nothing at all about major banks, which, in the event, turned out to be insolvent and had to be bailed out at great expense to the taxpayer and at massive economic cost. It might be worth considering a system in which, instead of the present all or nothing system, bank accounts are graded in the way in which the ratings agencies grade financial instruments.
Secondly, it is clear that the change in accounting standards from UK GAAP, which I admit was not perfect, to IFRS is a change from prudence to box-ticking, which has been particularly malign in the case of the banks. This is true not least when it comes to provisioning. Linked with that, IFRS has also enabled banks to this very day to conceal substantial bad debts, the failure to face up to which is a significant cause of their reluctance to lend to small businesses, which badly need it at present. To accept IFRS blindly, with all its faults, simply because other countries do, is not good enough.
The Bill before us today is not, of course, the only Bill this Session to implement the lessons of the disastrous banking meltdown of 2008. As my noble friend Lord Sassoon has reminded us, we have also been promised a banking reform bill to implement the recommendations of the Vickers commission and in particular to enforce the separation of investment banking from retail banking by the so-called ring-fence. I welcome this, which I have long called for.
However, one reason why we need this split has not perhaps been sufficiently recognised: that is, that bank supervision is an extremely difficult and complex task, given the unprecedented complexity of modem banking. A system in which the failure of an investment bank does not threaten the core banking system means that the regulators and supervisors can concentrate on the health of the core banking system, a less complex and more practical task. My fear, however, is that the ring-fence will not prove impermeable or wholly effective. Bankers, despite the greed and folly that many of them evinced during the Goodwin-Brown era, are clever people, and they will find ways round it. Moreover, what we are talking about here is, at bottom, a matter of banking culture.
Earlier this year, the FSA published a report on HBOS—Halifax Bank of Scotland—which has not received the attention that it merited. Finding that the bank was “guilty of serious misconduct”, it ascribes this to a culture,
“of optimism at the expense of prudence”.
That is a nice euphemism for reckless gambling.
Culture matters and the plain fact is that the prudent culture of retail bankers and the adventurous culture of investment bankers are diametrically opposed. With the best will in the world, it is hard to see how two quite different and opposed cultures can co-exist within the same corporate entity. There needs to be complete structural separation, not just a ring-fence.
Finally, I turn briefly from the structure to the content of bank regulation and supervision. Progress is being made on the subject of capital ratios and capital adequacy—indeed, with the economy in its present condition, there is an overwhelming case for allowing the banks to go more slowly towards achieving the desired higher capital ratios. Here, I entirely agree with the noble Lord, Lord Turnbull.
However, there has been no comparable progress in dealing with the problem, which is at least as important, of bank leverage.
Baroness Garden of Frognal
My Lords, I apologise for intervening on my noble friend—
Lord Lucas
My Lords, this is a Second Reading. We are a self-regulating House. Whips have no business telling us what to do. We are listening to my noble friend with great fascination and I hope that he takes another 10 minutes.
Lord Lawson of Blaby
My Lords, I am grateful for that. This is a very important and complex Bill, and we should be able to speak if we are not waffling—and I hope that I have not been waffling—at adequate length. However, I assure the House that I shall not take another 10 minutes.
No banking system is likely to be stable if it is financed by a mountain of loan capital on an exiguous equity base. Yet that is what we now have. I suspect that this is unlikely to change unless there are two supporting changes.
First, the bank regulators and supervisors should at least strongly discourage if not actually forbid the remuneration of bankers on the basis of the rate of return on bank equity. Secondly, there needs to be a fundamental change in the tax system as it applies to banks, or at least banks that conduct ring-fenced activities, à la Vickers. At present, a bank that finances itself by raising loan capital finds that the interest paid on that capital is tax-deductible, whereas the dividends paid on equity capital are not, so there is a clear tax incentive in the system for the banks to capitalise themselves on the smallest possible sliver of equity—the very reverse of what is needed in the interests of stability. That should be changed. Interest on the bank’s loan capital should no longer be tax-deductible. The quid pro quo might well be the abolition of the blunt instrument of the bank levy.
In conclusion, I warmly welcome the Bill, but there is much still to be done.
Lord Myners
My Lords, it is an honour to speak in this debate after the noble Lord, Lord Lawson of Blaby, and to express my appreciation for the intervention from the noble Lord, Lord Lucas, which was properly respectful of the rights and procedures of the House on Second Reading.
I speak with the experience of having been an independent member of the court from 2005 until 2008 and then a Treasury Minister dealing with the Bank of England, and I will focus primarily on the Bank. I agree that this is not a Bill where partisan issues will be found but one where the House should come together to find good solutions. I share the regret that I think lay behind the question of the noble Lord, Lord Forsyth of Drumlean, about why the Bill is being taken in Grand Committee rather than in the full House. This is a Bill that should be taken through the House rather than Grand Committee, but I understand that that decision has been taken through the usual channels.
Clearly, we must learn the lessons of the past. The tripartite arrangement did not work as well as had been expected in anticipating the crisis, although it is only fair to say that it worked very well during the crisis. In fact, it worked rather better during the crisis than some of the crisis management arrangements that we currently see within the European Union, where they continue to grapple with the problems of the European banks.
Of course, the tripartite arrangement was not the only regulatory architecture to fail to contain the risks to financial stability. Regulatory architectures failed in numerous forms and in various geographies as part of the global crisis. In my belief and experience, no one architecture is assuredly superior to all others. There can be no certainties brought by architecture alone. Failure of architecture tends to be due to a shortcoming of skills, behaviour or culture. That is where the tripartite arrangement fell short of expectation, rather than architecture. Architectural solutions, as proposed by the Bill, involve simply the movement of organisational boxes. The proposals in the Bill might well work, but whether they work or not will be less to do with the architecture of regulation and more to do with the culture and conduct of those who work within regulation. In practice, there is little that the Bill can do to prescribe or guarantee that the right culture and behaviours are promoted, but it is incumbent on us to make the best efforts to secure such outcomes, or be alert to any shortcomings that might exist in the constitutional architecture of the Bill.
That brings me to the issues relating to the powers and responsibilities of the office of governor and the role of the Bank of England’s court. I am sure that we will spend much time on them when the Bill goes into Grand Committee. Your Lordships’ House will need to ensure that adequate internal checks and balances exist on the powers of the Bank and on its officers. My experience of being a member of court from 2005 until 2008 raises considerable concerns about the proposed concentration of power envisaged under the Bill for the governor. There is a very real risk that we might constitutionally perpetuate the current situation in the Bank where there is room for only one point of view—and that has to be the governor’s view. Significant steps to reduce this risk would include: having the deputy governors chair the FPC, the MPC and the PRA rather than having those bodies chaired by the governor; requiring the FPC and the MPC to meet at least twice a year in joint session—a meeting in which the Bank’s internal appointments would be in a minority, and which should be appropriately minuted; and the giving of a power to the Treasury Committee of a statutory right of veto over the appointment and dismissal of the governor, the three deputy governors and the CEO of the PRA, as is already the case for the chair of the Office for Budget Responsibility.
A further area requiring close scrutiny will be the membership and role of the court of the Bank. My own experience of being a member of the court was unsatisfactory. Indeed, in 2007 and 2008 more than one member of the court sought private meetings with Treasury Ministers and the Permanent Secretary to express their anxieties about the Bank’s detachment from and disinterest in issues of financial stability. Much good work was being done in this area by Bank officials, including Sir Andrew Large, Sir John Gieve, Mr Paul Tucker, Mr Nigel Jenkinson and Mr Alastair Clark, but the governor made clear that the primary focus for the Bank was monetary policy. Financial stability was a tertiary issue, de-emphasised in resource allocation and generally given little focus at court. Indeed, at court we tended to spend more time hearing about the governor’s tennis matches with the heads of various other regulatory agencies than about issues of financial stability. In that connection, if my memory serves me right, we were told that one of the governor’s partners was the noble Lord, Lord O’Donnell, whose maiden speech we look forward to hearing later in the debate.
The need for the court to be seriously strengthened and better equipped to engage in constructive challenge of the executive leadership of the Bank must have been very apparent to anybody who read the transcript of the evidence given by the chairman of the court and a number of independent directors to the Treasury Committee last year, in which it was clear that members of the court had a very poor understanding of the resource allocation and budgeting of the bank—and, indeed, of the constitutional differences between the Monetary Policy Committee and the proposed Financial Policy Committee.
Your Lordships’ House will need to give very careful consideration to the membership, statutory powers and responsibilities of the court, to consider whether the Bill should require that the chairman of the court should have experience of financial and prudential issues in order to ensure that debate at court is informed, and to the court also being appropriately resourced. Court minutes should be published and the court should be clearly accountable to the Treasury and the Treasury Committee. The court should also conduct and publish ex-post reviews of the Bank’s performance in the prudential and monetary policy sectors and address these reports to both the Treasury and the Treasury Committee. Her Majesty’s Treasury should also commission and publish annual reviews of the effectiveness of the court.
The extent of the change required by the Bank to bring its performance up to the standard required by this Bill should not be underestimated. I have already spoken of the need to devolve more power from the office of the governor to the deputy governors and the need for a move to a more assertive and accountable court. The bank will also need to review its skills and culture. In respect of the latter, it needs to be more open and less elitist—open both internally, being respectful and welcoming to the views of others even when they differ from the prevailing consensus, and externally, being more willing to engage with those involved in business and public policy. In terms of skills in issues of financial stability, the extent of the challenge is clear if you look at the Bank’s Financial Stability Report published in April 2007. This was the last Financial Stability Report published before the collapse of Northern Rock. In that report, the Bank stated:
“The UK financial system remains highly resilient”.
It also stated:
“Conditions are likely to remain favourable”,
and,
“Financial innovation and the growing use of credit risk transfer markets have increased the risk-bearing capacity of the system”.
This was after the emergence of the sub-prime problems in the United States.
The governor’s Mansion House speech on 20 June 2007 focused on increasing the number of £5 notes in circulation and the need for the Bank to have greater control over the payments system. It said absolutely nothing of any significance about financial stability. This is the body to which we are proposing to give responsibility for financial stability oversight.
In Committee, we are going to have to look carefully at the skills, competencies and culture of the Bank and ask ourselves whether it really makes sense to give as much authority and responsibility to an institution that has exhibited its own shortcomings in the past, and in particular to put quite as much power into the hands of the governor as currently envisioned in the Bill.
Lord Sharkey
My Lords, I shall speak about two aspects of the Bill regarding two areas that it needs to cover but does not. I think that it is commonly accepted on all sides that a significant problem facing the economy is the question of lending to small and medium-sized businesses. It is generally accepted that we have been unsuccessful in getting sufficient lending to take place. The Bank of England confirms that the UK’s biggest banks failed to meet last year’s lending targets. The five banks that signed up to Project Merlin lent £1 billion less to SMEs than their 2011 target—and the Merlin deal has of course not been renewed. The Bank’s trends and lending report for April this year reports that in the three months to February 2012 the stock of lending to small and medium-sized enterprises continued to contract, and had in fact been negative since late 2009. In January this year, BIS published a report on SME access to external finance. Among its findings, the report states that 21% of SME employers that sought finance from any source did not achieve success, which was a significant increase on the 8% seen in 2007-08.
These figures are bad enough, but they conceal areas where there are more significant problems. The effects of the financial crisis are being most keenly felt in those areas of the country that have long been the most deprived. Workless households are concentrated in the old industrial areas of the north of England, the Midlands, Scotland and Wales, as well as in a number of seaside towns and inner-city urban areas. We urgently need to stimulate demand for SMEs in our deprived areas and to make finance available to help them develop. At the moment, according to a 2012 report by the Centre for Responsible Credit, just 4% of all lending to SMEs goes to businesses in the most deprived areas.
The only data provided by the six largest banks concerning their lending to SMEs are produced on an aggregate basis. This means that there is no information available to allow local economic development agencies, including local enterprise partnerships and community development finance initiatives, to enter into effective dialogue with the banks with a view to assessing and improving performance, nor any way of knowing which banks are performing better than others. Similarly, the current dataset provided by the banks tells us nothing about the terms on which credit is being made available to SMEs. There are other indications that the shift by banks from term lending to overdraft lending will probably lead to a significant increase in financing costs, but we do not know how much or where. We also do not know to what extent, if at all, the banks are supporting the third sector to take advantage of the new rights under the Localism Act. The Act provides for local communities to take over the running of local authority services to build new homes, businesses, shops, playgrounds and meeting halls.
All this requires planning and funding. That means the active involvement of the banks. We need access to information to show us what the banks are doing, area by area, bank by bank, to support this agenda. All this can be achieved by making a couple of simple amendments to the Bill. I believe that we should consider adding a fourth operational objective to the three set out for the FCA. This new objective could be called something like “the sustainable economic growth objective” and could be defined as ensuring an appropriate level of financial services provision in disadvantaged areas by having regard to the needs of SMEs and third-sector organisations in deprived communities for affordable loans, savings and insurance products.
Lord Forsyth of Drumlean
How are the banks expected to provided more lending at the same time that they are being required to make greater provision for capital and liquidity purposes? Surely that is asking them to do two contradictory things.
Lord Sharkey
I had a more minimalist objective: to make it plain that that is the case with the banks at the moment. We need to make sure that we know that they have an obligation to support SMEs and third-sector organisations in deprived communities. I add in passing that the need for some growth objective is evident not only in this part of the Bill, but in the objective set out for the FPC itself. Stability is a necessary objective, but stability without growth is, at best, a recipe for stagnation.
The existing objectives for the FCA include a competition objective. This competition objective includes the statement that the FCA may have regard to,
“how far competition is encouraging innovation”.
Apart from noting that the word “may” should read “must” if the paragraph is to have any real meaning, I also want to note that this is the only time that the word “innovation” appears in the 330 pages of the Bill.
That brings me to the second area that I want to address. Innovation in the provision of traditional retail financial services is obviously important. The Breedon report, commissioned by BIS and delivered in March this year, estimates that by 2016 there will be a shortfall of between £26 billion and £59 billion in finance needed by SMEs for working capital and growth. In their response, the Government acknowledged the problem and said,
“The Government welcomes the development of new and innovative forms of finance such as peer-to-peer lending and recognises the potential of these models to have a positive impact on the SME lending market”.
Currently, the total amount of peer-to-peer lending in the UK is small, but growing rapidly, and even more rapid growth is projected. The Government are encouraging growth in this area with a £100 million investment. Earlier this year, Andy Haldane, head of policy at the Bank of England, even suggested that these non-traditional lenders could eventually replace banks, but if these new models are to succeed in providing real and substantial competition for the banks, they need more help from the Government than £100 million in pump priming. At the moment, the non-traditional peer-to-peer lending sector is unregulated. As the Daily Telegraph said two weeks ago,
“if it is serious about encouraging the growth of a genuine long-term alternative to bank lending for SMEs, the Government also needs to address the thorny question of regulation. At present, alternative funding providers are not regulated by existing financial services legislation, leaving both borrowers and lenders vulnerable to rogue players entering the market”.
Alternative funders are in favour of regulation. They recognise the dangers to their business model of a scandal generated by some rogue entrant to their market. This is not a theoretical danger or a distant prospect and is certainly not a trivial problem. There is nothing to stop such an event occurring and permanently destroying confidence in the peer-to-peer model. As the Daily Telegraph also said:
“SMEs desperately need a genuine alternative to borrowing from banks and those using alternative funders must be protected so that both they and the market can flourish”.
The Government need to take action now, and this Bill provides the perfect opportunity.
Lord Lamont of Lerwick
My Lords, it is a great pleasure to follow my noble friend Lord Sharkey. He made extremely important points about the availability of finance to the economy, which is crucial. We look forward to seeing how he pursues the issue in Committee, as he said he will.
I speak on the Bill with some hesitation because I have not taken part in the extensive consultation process and nor was I a member of the Joint Committee. Many people who are present today have done sterling work in that respect. I welcome the Bill, which is necessary and sweeps away the discredited, fractured, tripartite system that failed its very first crisis. Instead, we are to have two new arms of the Bank, which will handle both macro and microprudential supervision, so that a single institution is in charge of keeping the system safe. At the same time, we will have a free-standing, independent consumer body, the Financial Conduct Authority.
My main point this afternoon relates to what several noble Lords have said and the relationship of the macroprudential side to the current regime of inflation targeting. As Chancellor of the Exchequer, I introduced the inflation objective for the Bank of England in 1992. That was broadly the same framework that was carried forward when the Bank became independent, although two changes were made at that time. Originally, the inflation target was defined in terms of the retail prices index. Thus, it gave greater weight to housing—rather an important difference. Secondly, the inflation target that I set up was accompanied by a requirement for the Bank to monitor different definitions of the growth in the money supply. This was later removed and the inflation target was much more narrowly defined to give less weight to housing and asset prices.
Inflation targeting received quite a good press in general, although I took trouble to say that I did not believe that it was the end of monetary history. Indeed, before 2008 I went out of my way to say in various speeches that we were not paying enough attention to asset prices and the growth of credit, and that the Bank was concentrating on too narrow a definition of inflation. Therefore, in light of that and what subsequently happened, it is right that the Bank should be given a specific and enhanced stability objective. Of course, writing it down is one thing. As the noble Lord, Lord Myners, reminded us, Gordon Brown, as Chancellor of the Exchequer, talked a lot about stability and each year we saw a huge, glossy tome called the Financial Stability Report. Having stability as an objective is one thing; making it happen is another.
I am not entirely convinced that the new, separate Financial Policy Committee is the best way to achieve financial stability. It might be better if macroprudential responsibility was handed to the existing MPC, which would then have a broader remit to stabilise the economy, not just consumer prices. After all, interest rates are an important tool for stabilising the economy. They are important for controlling leverage and the growth of credit. Other tools, such as how far the banks could use their buffers of capital and liquidity, could go to the MPC rather than the FPC. Other duties of the FPC, such as making the financial network safer, could be carried out by the Prudential Regulation Authority.
Views on stability will often have implications for interest rates. Having two committees whose views might go in completely divergent directions does not seem the most obvious way to achieve stability. The fact that the governor sits on both committees, as has been referred to by several noble Lords, underlines the point. Only one committee can ultimately take the interest rate decision and some body at some point—not just the governor but the MPC—has to measure the trade-off and balance stability and the inflation objective. My noble friend Lord Lawson said that perhaps the three committees should become two. I would say a similar thing, although I would choose a different two from the two that he chose.
I hope the fact that we are to have a separate Financial Policy Committee does not mean—this is one reason why I chose to go in the direction that I did—that we are going all the way back to the 1950s with more emphasis being laid on quantitative controls of credit. That would be a step backwards. Interest rates are the most flexible and the best way to control credit and leverage.
In some ways, the Bill recognises the problem by laying down some extremely detailed provisions about how one regulator must consult another. Acres and acres of the Bill are about the PRA consulting the FPC, the FPC liaising with the PRA and one giving orders to the other. One could be forgiven for forgetting that they are meant to be parts of the same organisation. These provisions remind one of Burke’s dictum that,
“laws reach but a very little way”.
As the noble Lord, Lord Eatwell, said, regulation is not just about structure; it is about culture and judgment.
Many noble Lords will remember that a previous deputy governor responsible for stability said in front of a Select Committee of the House of Commons that it was not his job to look at the accounts of financial institutions. I am not making a criticism of him. Of course, he was quite right. That was how the system was set up. But it shows how the macroprudential and the microprudential sides are intertwined.
As several noble Lords have said, the Bill has great implications for the Court of Directors of the Bank of England, which will have to change. At the moment, the Court of Directors is what Bagehot would have called the dignified rather than the efficient part of the constitution. The directors are to be more involved in the stability objective than they are in the current inflation objective. Perhaps I may remind the House that the Bank of England’s website currently says that the court’s,
“functions are to manage the Bank’s affairs other than the formulation of monetary policy, which is the responsibility of the Monetary Policy Committee”.
We will now have quite a different stability objective relationship for the court. Clause 3, which will insert new Clause 9A into the Bank of England Act, states:
“The court of directors must … determine the Bank’s strategy in relation to the Financial Stability Objective”.
As the noble Lord, Lord Turner, said, there is no symmetry between the relationship of the court to the inflation objective and the relationship of the court to the stability objective.
It must be remembered that the Financial Policy Committee is exactly what its name suggests. It is a policy committee and not a regulatory committee. That has implications for where it should be accountable and to whom it should be responsible. Undoubtedly, the Bill requires the direct involvement of the Court of Directors, which will be in a way that has not been the case in the past. That will require very different sorts of persons to be directors of the Bank. If the Bill comes out as presently structured, it will require real banking and financial experts.
The Joint Committee suggested that the court should be replaced with a supervisory board, which I am sure we will consider in Committee. The Bank needs to be accountable but it seems to me that it should be accountable in a different way for its regulatory activities. There must be an appeals procedure and it must be subject to regular scrutiny. Its policy work needs to be done by an independent bank, but to be accountable in a retrospective and periodic way to the House of Commons.
One important aspect of the Bank’s role will be representation in Europe, where the regulatory regime seems likely to alter very quickly. I assume that the PRA will represent the Bank at the European Union’s banking and insurance authorities. Perhaps the Minister will confirm that the FCA will deal with the European Securities and Markets Authority. It is vitally important at this of all times that the Bank has heavyweight representation in the European Union. Many people outside are calling for the PRA to set up practitioner panels in the same way as the FCA will be required to do. That is a sensible recommendation, which I am sure will be discussed further in Committee.
I support this Bill, subject to two qualifications. First, it must be emphasised that the Bill must have regard to international competitiveness. I know that the chief executive of the London Stock Exchange has suggested that that should be written into the Bill. Secondly, we must pay due and careful regard to the overall cost, because as well as the new twin peak system adding to costs, costs on financial institutions are already going up very quickly, not least due to contributing to the Financial Services Compensation Scheme. No one organisation has responsibility under the Bill for reviewing the cumulative impact of these costs.
Subject to those provisions, I support the Bill and hope that we will never again see the paralysis and confusion that did so much harm in 2008.
Lord O'Donnell
My Lords, as this is my maiden speech, I would like to take the opportunity to thank all the Members of your Lordships’ House, and all its officers and staff, for making me so welcome. I have had the privilege to serve and collaborate with many noble Lords on all sides of the House, not least our previous speakers, and I look forward to working with them again. As an ex-Cabinet Secretary and Permanent Secretary to the Treasury, I want to pay particular homage to my predecessors. Their advice has always been wise, their criticisms constructive and, thankfully, private. It was a particular privilege to work with the Prime Minister and Deputy Prime Minister as they took on the challenges of making the coalition work effectively, and I have been privileged to serve with other Prime Ministers. The strength of purpose of Sir John Major and Tony Blair over Northern Ireland; the decisive action of Gordon Brown at the London G20 summit during the financial crisis; and the coalition’s actions to help the people of Libya—all these examples demonstrate one clear principle. Strong leadership can transform situations that look almost impossible. This is a message that I would like to get across to the leaders of the eurozone.
I have been blessed with a highly supportive family. The O’Donnells have had an interesting journey from Roscommon in Ireland via the coal mines of Durham to the south-east of England, which explains my passion for improving social mobility. There are many other areas where I hope to contribute in this House, but today it is right to concentrate on economic and financial issues.
As someone who was heavily involved in the five tests analysis on UK membership of the euro, published nine years ago, I will be observing very closely how the euro crisis unfolds. The nature of the resolution will have profound effects on our economy, and particularly our financial sector. No one can be sure what will emerge, which is why the changes proposed in the Bill need to be robust across a range of outcomes.
Before I turn to my specific comments on the Bill, I need to register two interests, one actual and one potential. Having obtained the approval of the business appointments committee, I will be working as a strategic adviser to Ed Clark, the chief executive of Toronto-Dominion Bank in Canada. Mr Clark is one of the most respected bankers in the world, and the regulatory regime in Canada has enabled its banks to weather the financial storms remarkably well. Mr Carney is, interestingly, both governor and chair of its Financial Stability Board.
There has also been press speculation that I may be a candidate to take over from Sir Mervyn King as Governor of the Bank of England. As I have already made clear, I will decide whether to compete for the job when it is advertised. However, I have already noted two issues from today’s debate. First, the noble Lord, Lord Eatwell, has made it clear that whoever takes this job will be driven mad within a few short weeks. Secondly, I have realised that whatever experience I may have, the right reverend Prelate the Bishop of Durham has far more financial experience in trading.
Coming back to the banks, Sir Mervyn has been a governor during a very stormy time for the world economy. He worked successfully with the Government to limit the damage of the global financial crisis and established the Monetary Policy Committee, which is envied in many parts of the world. His intellectual leadership has proved invaluable. In short, he will be a very hard act to follow. I have to plead guilty to the suggestion of the noble Lord, Lord Myners, that the governor and I had been collaborating on the tennis court. This is certainly true but it was very important from a policy point of view that we demonstrated to our US counterparts that fiscal/monetary co-ordination in the UK exceeded that in the US—and we won.
It is fair to say that the financial crisis has inevitably exposed some weaknesses in our current structures, as it has for a very large number of countries around the world. I believe that it is right to give the Bank control over macroprudential regulation, but this is not without severe dangers for the Bank, the governor and the economy. The new arrangements concentrate a lot of power in the Bank. With power goes the need for accountability. The Treasury Select Committee, under Andrew Tyrie, has done an excellent job of holding the Bank to account. The Joint Committee has also done a good job of pre-legislative scrutiny. As a result, the Bill overall contains much that I strongly support. However, I believe that we should make one further change to the accountability structure. We should set up a new standing joint committee, under the chair of the Treasury Committee, to assess the effectiveness of the new arrangements once they are established. The new committee would combine the advantages of the democratic legitimacy of the Commons with the undoubted expertise that lies in this House, as we have already heard. In particular, it would look at how well the Bank’s proposed oversight committee was operating. I agree very much with the right reverend Prelate the Bishop of Durham on that point.
As a number of speakers have said, it is important not to lose sight of the overall objective, which is to enhance the well-being of the country by having a financial system that is both stable and supportive of the whole economy. This will inevitably involve judgments on how to balance the need to have enough capital to withstand shocks with the need to support British industry. As the noble Lord, Lord Turnbull, said, the Bank of England Act calls on the Bank to hit an inflation target but, subject to that, to support the Government’s economic policy,
“including its objectives for growth and employment”.
Similarly, I believe that the Financial Policy Committee should have the objective of financial stability but, subject to achieving that, it should be required to support sustainable growth and employment. A healthy financial sector that makes a fair contribution to the tax base, supports all sectors of the economy and has a sensible, more symmetric remuneration system would be a real asset to this country—we have a comparative advantage in this area—but never again should taxpayers pay for the consequences of failure when the rewards of success are concentrated in the hands of so few.
There is one important imbalance that the Bill cannot correct: that is, the imbalance between the resources available to the financial sector, the Bank and the Treasury respectively. The Treasury is a brilliant department and I was proud to be its Permanent Secretary, but it is in danger of being swamped by the pressures placed upon it. As Sharon White’s excellent report makes clear, the Treasury’s turnover rate is far too high and its pay levels too low.
It is in the interests of all of us that the Treasury is able to continue attracting the best and retaining their skills and experience. To avoid this being at the expense of the taxpayer, perhaps the part of the Treasury dealing with financial services and stability should be funded in the same way as the Bank and the FSA, namely by the financial industry which benefits from their work. Otherwise, the Treasury is in danger of cutting off its arms as well as its nose to make its hair shirt fit.
Finally, can I urge the Government and all Members of this House to try to write legislation that will endure for the long term? We should not be fixated by today’s problems, important as they are. We need a principles-based system that is not overprescriptive. It must allow the accountable individuals to have the freedom to tackle crises in what might be a very different and fast-changing environment. That is why we should concentrate on getting the objectives right and sorting out the accountabilities for those whose job it is to handle whatever this dynamic and volatile world throws at them. This Bill will have a profound impact on the well-being of our nation, and it has been an honour to be able to contribute to what has so far been an excellent debate.
Lord Bilimoria
My Lords, it is a privilege to follow noble Lord, Lord O’Donnell, and I am sure that I speak for all your Lordships in congratulating him on the most superb maiden speech. I have known Gus O’Donnell from the time he was Permanent Secretary to the Treasury, going back 10 years. I can honestly say that not only did I always like him as an individual but I never ceased to be impressed by him. After the Treasury, he was at No. 10 Downing Street, Cabinet Secretary, Head of the Home Civil Service, and Secretary to the Cabinet Office. In fact, he followed exactly in the same footsteps as our noble friend, the noble Lord, Lord Turnbull, who also went from being Permanent Secretary to the Treasury to holding those three positions at Downing Street. Now the jobs of the noble Lord, Lord O’Donnell, are being performed by three individuals. Let me emphasise that I am not saying that any of his successors are one-third the man that the noble Lord, Lord O’Donnell, is. He also had the distinction of serving three Prime Ministers—Tony Blair, Gordon Brown and David Cameron—in his six years at No. 10. Talk about high-flyers—you do not fly any higher than the noble Lord, Lord O’Donnell. No wonder people call him “GOD”—not just because of his initials but because of the huge respect that we all have for him. He has achieved all this as a youngster—he is still in his fifties; he has not even hit middle age yet. That will start when he turns 60 in October.
The noble Lord was an Oxford Blue in football, and I think that by now he must be realising—football being a game of two halves—that our Chamber, unlike the other place, is not just about the Government and the Opposition; we have the added dimension of the Lords spiritual and the Cross-Benchers. We, the Cross-Benchers, are so proud and happy to have the noble Lord in our fold. He has already said that he could be in the running for the position of the next Governor of the Bank of England. Watch this space. We look forward to many more fabulous expert contributions from the noble Lord in the years to come.
I have always said that one of the best things that Gordon Brown ever did was create the independent Monetary Policy Committee when he took over as Chancellor in 1997. It was able every month to set interest rates on an independent basis, proactively and reactively—and transparently. However, one of the worst things he did was create the tripartite arrangement of the Treasury, the Bank of England and the FSA. In the good times—the boom times—until 2007, this tripartite system was a happy merry-go-round. When we hit the crisis, this happy merry-go-round became a hopeless blame-go-round, and we realised that the tripartite system was not fit for purpose, as the Minister said. It was disastrous, and I am so happy to see that with this Bill, the buck will now stop firmly and squarely with the Governor of the Bank of England.
We know that the Governor of the Bank of England, Eddie George, was extremely concerned when the tripartite system was set up, and he voiced his concern that the Bank of England was having its powers taken away and transferred to the FSA. We now know that this was the most foolish thing to have done. The FSA has the joint remit of financial services in the consumer market, protecting consumers and promoting competition, and was so focused on that consumer-facing aspect that its role of supervising and regulating the banks was ignored and neglected. Frankly, the FSA was out of its depth and ignored the most crucial aspect of its job. I could say that the FSA stood for “fairly sleepy agency”. I remember taking part in debates in the House in the run-up to the Northern Rock nationalisation in 2008, four and a half years ago. I remember finding out at that point that the FSA had researched Northern Rock and in 2006 had marked it as “high impact” and as requiring close supervision. It also marked it for a review in three years’ time. That was an organisation that was on top of things and wanted to act quickly, but of course it was all too late. By September 2007, Northern Rock was bust and £26 billion was required to bail it out—the largest amount required for any company in the world at that time. Of course, following the sub-prime crisis that led to the credit crunch, which led to the financial crisis, which led to the great recession, which led to the sovereign debt crisis, which has now led to the eurozone crisis, we now know that £26 billion is pocket money.
I welcome many of the Bill’s provisions but I am concerned that there is too much focus on the new bodies being created and on the theme of stability. No one would dispute the need for these bodies—and I congratulate the Government on introducing them—but I worry about the implication of leaving the Monetary Policy Committee pretty much as it is. No one could dispute the requirement for stability and prudence but, as many noble Lords have said, these must go hand in hand with growth in the economy.
In the spring of 2008, when Northern Rock and Bear Stearns had already gone to the wall, seeing the writing on the wall the MPC sat idle. It was so obsessed with its inflation targeting and so afraid of having to write to the Chancellor that it kept interest rates at 5% for six months after the collapse of Bear Stearns. Instead of bringing them down straight away, it waited too long and then had to bring them down sharply from October 2008 onwards. We must change the myopic, blinkered approach that the MPC has been forced to take, focusing solely on inflation and not, as in America, and as the noble Lord, Lord Lamont, suggested, on maximising employment and, as my noble friend Lord O’Donnell said, looking at the overall state of the economy. Through this Bill, the Government must consider revising the MPC’s mandate to ensure that it plays its part in securing recovery for the long term.
Talking about new bodies, the FPC’s mandate is seemingly pulled from the Hippocratic oath. Its mandate is to do no harm to the economy. It seems to have left out the rest of the oath, as there is no real mandate to cure the economy of the ills from which it may be suffering. I ask the Minister whether the mandate of the FPC—as well as the general system of financial and monetary regulation, including the MPC, which does not really seem to fall under the Bill at the moment—can be expanded to target growth and full employment and not just stability.
The acid test of the Bill is: if this new structure had been in place five years ago, would it have prevented the scale and effect of the crisis that we had? Would it have been able to anticipate things—to hear the warning bells and react to them in time? Would it have been able proactively to see things coming? That is the test, and I should be interested to hear whether the Government have assessed that, even in a simulation exercise.
When I chaired the UK India Business Council, of which I am president, I would boast to our counterparts in India about the wonderful light-touch regulation that we had in Britain. Of course, we now know that it was flawed. It is not about light touch; it is about the right touch. Do the Government really think that this new system strikes the right balance of regulation that this country so desperately needs?
What about the structure of the Bank of England? Much power has been given to the Bank but, as has been said, cannot the court be restructured to have a more supervisory role, reporting directly to Parliament? Not enough non-executive directors are proposed. Can the Government say that they have the balance right on all the boards—the FPC, the PRA and the Court of the Bank of England—with enough non-executive directors? Are they going to be properly resourced in terms of access to information in order to perform their roles properly? Also, the MPC publishes information every single month and is very transparent. Will the FPC, the FCA and the PRA also publish regular reports in a transparent manner?
I go back to the point that the MPC is neglected in the Bill. The only crossover seems to be the governor himself. I do not have too much of a problem with the buck stopping with the governor and with the governor having all these roles. However, I am worried about whether there is a mechanism for co-ordinating all these, which the noble Lord, Lord Myners, who is not in his place, spoke about. There could be conflict between boards. There are dual roles and there could be duplication. If there is a problem, things will fall between the cracks and we will go back to the old blame-go-round. This clarity of co-ordination where the cultures are concerned is not clear and we need to work on that in Committee.
What about the powers of the PRA? It is important to get this figured out. It is focused too much on large institutions; but the Australian Prudential Regulation Authority implemented the whole of Basel II through guidance alone and shows how general guidance can sometimes be given. This whole area of guidance is completely missing in the Bill.
To conclude, this Bill is wonderful news. We are actually putting power back into the hands of the Bank of England and I welcome that very much. However, I think that we are missing a key aspect—the role of the MPC and the co-ordination between the MPC and the FPC in making sure that the new structure is focused on achieving stability, preventing crises, generating maximum employment, generating low inflation and moderate interest rates, and, most importantly, on generating and sustaining growth in the economy.
Baroness Wheatcroft
My Lords, I shall begin, if I may, by congratulating my noble friend Lord O’Donnell on his masterful maiden speech. I hope that it is not the prospect of speedy abolition of this House that is making him contemplate another full-time job so quickly when he could be such a great asset to the work of this House.
No one can doubt the need for change in the way in which we regulate financial services. Even if the euro had not imploded, the huge build-up of debt in the UK in recent times would have ensured that a messy denouement was inevitable. Regulation that was supposed to be light touch had become not only light touch but blind. The Bill should improve the way in which we regulate although we should never lose sight of the fact that regulation is only ever as effective as those who apply it. The regulatory structure, whether it be twin peaked, three peaked or, as my noble friend Lady Kramer suggested, an entire mountain range, is not as important as the quality and attitude of the regulators themselves.
The structure of regulation set down in the Bill is already being implemented. The crucial point is that we are moving from a rules-based system to a judgment-based system of regulation. That has to be right. Judgment should have told any regulator that to allow a bank to lend 120% of value on a property to an individual on the basis of self-certified earnings would be potentially catastrophic, and so it proved. I applaud the general direction of the Bill and as a member of the pre-legislative scrutiny committee, which made many recommendations for amending the legislation, I am pleased that the Government accepted many of our suggestions. However, there are still areas where I believe there is scope for further improvement.
I should declare that I am on the board of a regulated entity and hold a small—very small—shareholding in another.
Much has been said about the governance of the Bank of England. The governor’s role is no sinecure at the best of times but now with his—or perhaps, at some stage, her—powers and duties significantly enhanced under this legislation, it is indeed an onerous role. It has not always seemed that the court at the Bank provided any foil to that power and we have heard much along those lines today, not least from the noble Lord, Lord Myners, whose recollections of his time on the court do nothing to allay one’s qualms. I must say that his recollection of the Mansion House dinner in 2007 leads me to believe that I must have been at a different Mansion House dinner in 2007 because, at the dinner I attended, the governor voiced great qualms about what was going on in the debt markets, particularly on the CDO front, and he talked of a real threat to global financial stability.
Those qualms over the governance of the Bank exist. It has responded to some extent by establishing an oversight committee to review the work of the Bank and its committees and to summon outside assessment and advice. This is progress. While I am not overly concerned about whether the non-executive directors of the Bank are called a court or a statutory body, I feel that there is scope for them having increased accountability. Clearly, this is something that will be discussed at some length in Grand Committee. If the court is to have sufficient clout, there should be provision for the Government to consult the chairman of the court or the statutory board on the identity of the next governor.
This brings me to the make-up of the Financial Policy Committee—a committee of the Bank. The Bill lays down that there will be only four truly external members on this vital committee. However, there is a strong case for having a majority of non-executives—and not just people with experience of the financial services sector. We want people there who know what is going on in the real world of manufacturing and construction. This is a crucial committee; we must get the membership right.
The remit of the committee is, and has to be, very clearly to protect and enhance the stability of the financial system of the UK. Nothing should be allowed to detract from that. As the Minister pointed out, we do not want the stability of the morgue, and many noble Lords talked about the need for a growth objective. The Bill requires the FPC to have an eye on growth, but the wording is strangely negative. The FPC’s responsibilities,
“do not require or authorise the Committee to exercise its functions in a way that would in its opinion be likely to have a significant adverse effect on the capacity of the financial sector to contribute to the growth of the UK economy in the medium or long term”.
I suggest that we might be able to improve on that triumph of drafting. A secondary growth objective seems a logical thing to impose in the Bill. While never jeopardising the primary objective of the Financial Policy Committee, we must have regard to growth.
We must look also at relationships between the Treasury and the Bank, which have been the focus of much attention. The Bill makes it clear that when the Bank tells the Chancellor that there is a financial crisis, the latter is in charge. However, as my noble friend Lord Lawson pointed out, there must be regular communication between the Chancellor and the governor. This should happen naturally in the course of events, but occasionally there might come a time when the odd psychological flaw gets in the way and communication will not work as effectively as we would like. This is another thing that the Grand Committee should look at.
I turn to the quality of information. Noble Lords will recall that banks were decreed by auditors to be perfectly healthy—until it became apparent that they were not. The Joint Committee recommended that the PRA and the FCA should meet regularly with auditors to ensure that the dialogue would continue. We need to go further, and the Bill gives us the opportunity. My noble friend Lord Lawson of Blaby pointed out the need to recognise the flaws in bank accountability and accounts. The executive director of the Bank of England, Andrew Haldane, pointed to the problems with bank accounts and described getting an accurate view of them as like trying,
“to pin the tail on a boisterous donkey”.
As we have seen, bank accounts are full of numbers that tell us nothing. It should be incumbent on auditors to spell out the risks that lie behind the numbers. This would enable regulators to monitor and limit risk-taking even more than they will do by their own efforts. Auditors need to shine a light on the risks that banks are taking rather than to obscure them.
Finally, we must acknowledge, for the time being at least, that Europe will shape much of our financial regulation. We need to be clear that we have the right structures to properly liaise and influence such regulation. In particular, we need to hold on to the right to set our own minimum requirements on capital ratios rather than be put in a straitjacket by European minima.
Lord McFall of Alcluith
My Lords, I am delighted to participate in this debate and to welcome the noble Lord, Lord O’Donnell, to this Chamber. He is an individual with whom I have had many formal and informal dealings. He is a person of the highest integrity, respectful of every individual he meets, irrespective of status, and an exemplary model of a civil servant. It is a model that the Government should ensure they get more of in the years to come as the complexity of the financial services dawns on us. So I welcome the noble Lord, Lord O’Donnell, to this Chamber.
I bring to your Lordships’ attention my entry in the Register of Members’ Interests. Like the noble Baroness, Lady Wheatcroft, I was delighted to be a member of the Joint Committee on the draft Financial Services Bill. A number of areas arose during that committee: first, architecture; secondly, complexity; thirdly, accountability; fourthly, ring-fencing; and, fifthly, and most importantly—a phrase to which we all signed up—that to be successful the reforms will have to change the regulatory culture and philosophy. Those should be the guiding principles.
We all agreed that architecture is of secondary importance. The issues that matter are culture, conduct and communication. These issues were key to what went wrong with the tripartite authority. Alastair Darling’s devastating evidence to the Joint Committee brought that out.
On the issue of complexity, we should note that we are moving from a tripartite to a quadripartite system involving Her Majesty’s Treasury, the Monetary Policy Committee, the Financial Policy Committee and the Prudential Regulation Authority, not to mention the Financial Conduct Authority. We have more interfaces, and therefore a higher degree of complexity. It was the interfaces and the information that fell down between them on the last occasion that caused the problem.
The question that bedevilled the tripartite authority when it came before the then Treasury Committee in the House of Commons was very simple: who is in charge? Everyone said that they did their job properly. However, we had to face one of our biggest crises with a vacuum in the making and no clarity for the Chancellor. The Minister rather boldly said at the Dispatch Box that never again would we ask who was in charge. I suggest that those words could come back to haunt him in years to come if the Government do not get the correct legislation.
As other noble Lords have said, at present we have opaque decision-making structures and still require clarity and explicit guidance and information, either through memorandums of understanding or whatever, on the view of the governor and his key deputies. We should remember that on many occasions the governor and his deputies will have contradictory views as a result of the responsibilities they are given and that the Chancellor must have clarity from them. There has to be no hiding place so that we can answer the question about who is in charge, but at present we cannot do that.
I mentioned the issue of regulated culture and philosophy. Business models are the key to understanding the issues within a company, from the policies followed to the individual behaviour of the executives. Auditors are the key to this. A number of years ago I asked auditors what the point of an audit was. It is presently a backward look at accounts. Auditors are doing everything that is required but not much of what is expected. This was illustrated by Northern Rock. In the first six months of 2007, this small building society was responsible for 20 per cent of all new mortgages in the United Kingdom. The chair of the Audit Committee, and not least the auditors, should have asked why the company was doing so well compared to others. However, that question was not asked.
Auditors therefore need to give a realistic view of the state of a company, taking into consideration the present and the possible future risks. I suggest that auditors should report to the Financial Policy Committee so that it understands both the microeconomic and the company landscape environments in an area of no more sensitivity than risk.
At the moment, risk is a black box. This was illustrated in the comments made by Professor John Kay and Professor Charles Goodhart to the Treasury Committee a number of years ago. When asked whether we could evaluate risk, Professor Goodhart said very clearly, “No”. Professor John Kay said, “I have been teaching at Oxford University for 25 years and I have ripped up my notes on risk”. So risk is a black box, and more regulations and rules alone are not the way forward.
We have to recognise that no regulator in the world spotted the problem. The Governor of the Bank of England said that the regulators were like locusts in Citibank. JPMorgan Chase is the latest example in the City, with the “London Whale” and a loss of £2 billion. Ten regulators were sitting in JPMorgan Chase when it happened. The question that arises out of that is: why did Jamie Dimon, someone supposedly alert and cute, need a call from Bloomberg to tell him that there was a £2 billion loss to his company? Jamie Dimon retorted by saying that it was a “tempest in a tea pot”, but if you put your arm right next to a tea pot, you can get a really bad burn. Maybe he did not realise that.
The situation of JPMorgan Chase and others reflects a systemic breakdown in management and risk control systems. Incidentally, the chief risk officer receives $14 million a year before foreign excises, so I would have thought that the risk officer could take quite a bit of a risk if $14 million is going into a current account as a result. I suggest that the Treasury Committee or other committees of the House should invite Jamie Dimon to explore the concept of risk and ask this question: are the largest banks still too big and complex to be managed safely? Are we now seeing “too big to fail” being followed by “too big to behave” in companies such as this one?
The way forward lies in good corporate governance to tackle these deep-seated problems, not only changing the way people behave but the way they think. We need to promote values and a culture that drives people to do the right thing even when no one—that is, the regulator—is looking. Culture is behaviour and ethics is resolving conflicts of interest. That is what the Government should be promoting. The motto of the City of London is, “My word is my bond”. In a recent survey, over 80% of people working in the City did not realise that. In other words, there is a big repair job to be done in order to restore trust.
I am delighted to see that the departing chief executive of the Financial Services Authority devoted his last speech to culture. That is a small but positive step. If we focus more on these issues, we can hope eventually to realise a market system that is fair to both consumers and businesses, where risk is rewarded, failure punished, and growth and employment are paramount.
Baroness Noakes
My Lords, our rules say that, on behalf of the whole House, the noble Lord, Lord Bilimoria, should welcome the maiden speech of the noble Lord, Lord O’Donnell, but I hope that I may be permitted to add my congratulations on his forthright and interesting speech. I hope in particular that eurozone Ministers heeded his wise words on leadership. I should declare my interests as set out in the register of interests. I am a non-executive director of RBS and a shareholder in a number of financial services companies.
My first point on this Bill is that it misses opportunities to ensure that UK plc is at the heart of financial services legislation. Bodies such as the CBI have pointed out that none of the new regulatory bodies is due to inherit the FSA’s current requirement to,
“have regard to the international character of capital markets and the desirability of maintaining the competitive position of the UK”.
The misguided reason given in another place is that this was associated with light-touch regulation and its disastrous consequences, but that is not good enough. Just as important, as other noble Lords have pointed out, is that the FPC’s remit does not have an explicit requirement to have regard to growth in the UK. When I read the attempt made by my honourable friend the Financial Secretary to the Treasury to justify this in another place, I nearly lost the will to live.
The financial services sector is a crucial part of the UK economy both directly in its contribution to GDP and tax yields and indirectly in its underpinning of the rest of the economy. It would be truly disastrous if the new bodies created by this Bill were merely technocratic and divorced from the needs of the wider economy. I hope that the UK’s economic success will be hard-wired into this Bill and that we will avoid the stability of the graveyard.
I cannot pretend to be enthusiastic about everything in this Bill. In particular, I believe that the twin-peaks approach may well create as many problems as it seeks to solve. That the FSA failed as a part of the tripartite arrangement is beyond doubt, but it is less than clear that the Bank of England would have made a better fist of prudential supervision before the financial crisis or that separating out conduct will be net positive.
The FSA was expensively created in the late 1990s and now we are even more expensively creating new arrangements that will have different gaps and overlaps. I can sense the law of unintended consequences waiting to spring into action. My noble friend will be relieved to hear that I am not going to fight a rearguard action, and shall instead concentrate on other areas of the Bill where I believe improvements are required.
I support the creation of the Financial Policy Committee to give focus to the Bank’s financial stability objective, but the Bank and the Financial Policy Committee must operate in an accountable and transparent way. My noble friend has helpfully confirmed that the Government will make changes in the Bill as it goes through your Lordships’ House, and I hope that this will go beyond the Bank’s own suggestions. I hope that my noble friend will heed the wise words of several noble Lords on this topic, including the noble Lord, Lord Myners, and my noble friend Lord Lamont.
I am sure that creating new macroprudential tools that will be available to the FPC can make a significant contribution to financial stability, but they are much too important to be created and operated in an accountability vacuum. As a minimum, the super-affirmative procedure will be necessary to give parliamentary oversight to their creation.
If we are to have the twin peaks of the PRA and the FCA, they must be made to work together. I am concerned that the solution in Clause 5 rests on a memorandum of understanding, the very mechanism that demonstrably failed the tripartite authorities. My noble friend may already be aware that there is concern about the practical impact on regulated firms of the separation of the FSA into the two arms that will shadow the PRA and the FCA.
There is no requirement in the Bill for the PRA and the FCA to consult on the creation of the memorandum of understanding; nor is there any parliamentary approval of the arrangements or provision for independent review of the effectiveness of co-ordination. This area of the Bill seems decidedly weak, and we need to strengthen it.
The Government have usefully set out in the Bill the regulatory principles to be applied by the PRA and the FCA, including the rather elusive concept of proportionality. This is described in terms of burdens being proportionate to benefits—which sounds okay—but is then qualified by “in general terms”, which of course begs a lot of questions. The London Stock Exchange believes that this needs to be explained in much more detail and that it should be calibrated both internationally and by reference to specific sectors. We need to look at the detail of this in Committee.
The PRA will be charged with operating judgment-based supervision, which of course marks a radical departure from the last decade or so under the FSA. It is important that the PRA gets this right. I do not understand why the FCA will have a practitioner panel that it must consult but the PRA does not. The Joint Committee thought that this might lead to regulatory capture but wanted to see the PRA’s approach to consultation laid out. We have now seen that approach and it has been described as “dismissive” by the British Bankers’ Association and “insufficient” by London First. I am sure that we will need to look again at the way in which the Bill mandates consultation.
I know that the FCA has a number of supporters, who see it as a consumer champion. But we must not forget that the FCA also has responsibility for wholesale markets and as the listing authority. It is the FCA that will have the UK’s seat on the European Securities and Markets Authority. We will need to look carefully at the proposed membership of the FCA and its objectives to ensure that it will be properly focused on its whole range of responsibilities.
The FCA will have many powers and responsibilities in relation to consumer protection, including product banning powers. We will need to scrutinise these carefully to ensure that they are proportionate and balanced and that they do not stifle product innovation, which could very easily happen.
I would like to mention three final areas before concluding. First, I welcome the Treasury’s new powers of direction. However, like the noble Lord, Lord Eatwell, and the chairman of the Treasury Select Committee in another place, I believe that those powers should be very considerably extended.
The consumer credit responsibilities of the OFT are to be transferred to the FCA, which is a good idea in principle, but a number of practical issues have been raised by market participants, in particular the Finance and Leasing Association, and I hope that we will be able to deal with those in Committee.
Finally, important clauses in Part 5 of this Bill lay the ground for independent inquiries. My test for these clauses is whether or not they would have made the Bank of England set up reviews of its own role in the financial crisis earlier and more comprehensively. I suspect that we need to amend Part 5 so that duties rather than powers are created.
In conclusion, I hope that my noble friend will be receptive to the many improvements to this Bill that our debate today is showing to be necessary.