Financial Services (Banking Reform) Bill
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The Commercial Secretary to the Treasury (Lord Deighton)
My Lords, the Bill is a central part of the Government’s response to the financial crisis of 2007-09. Noble Lords will recall the terrible events of those years. Britain saw the first bank run in over a century. Depositors in Northern Rock queued in the streets to take their money out. The biggest bank in the world, the Royal Bank of Scotland, teetered on the brink. RBS and HBOS had to be bailed out and the Government had to inject £65 billion of taxpayers’ money to save the banking system from collapse.
Huge though this direct cost to the taxpayer was, the full costs of the crisis were still greater. Gross domestic product fell, peak to trough, by 7.2% as the supply of credit dried up and tight credit continues to be a problem for many businesses and families. This is why the Government have had to intervene to support credit supply through measures such as Funding for Lending, Help to Buy and the Business Finance Partnership. These will help to address the consequences of the crisis. To tackle its causes and to prevent a repeat, the Government are taking forward a programme of reform built on three pillars.
The first pillar is reform of financial regulation. This was achieved through the Financial Services Act 2012, which received Royal Assent last December and came into force this spring. The second pillar is structural reform of the banking industry. That is the focus of the measures in the Bill before us today. The third pillar is reform of banking standards and culture. The Parliamentary Commission on Banking Standards—the PCBS; I am afraid there will be quite a few abbreviations today—last month made important recommendations in this area. The Government have accepted the PCBS’s principal recommendations and where those require primary legislation they will be incorporated into this Bill through government amendments at Committee stage.
Let me first turn to the measures already in the Bill. The bulk of these implement key recommendations of the Independent Commission on Banking, or ICB, chaired by Sir John Vickers. As noble Lords will know, the Vickers commission was established in 2010 to consider both structural and non-structural reforms to the banking sector. It reported in September 2011 and recommended, first, the ring-fencing of retail from investment banking. The ICB also proposed measures to improve banks’ ability to absorb losses and to ensure that losses can be made to fall on banks’ creditors and not the taxpayer if a bank fails. These measures included higher capital requirements for ring-fenced banks, a bail-in power and preference in insolvency for bank depositors over other creditors. The Government accepted virtually all the ICB’s recommendations.
This Bill will implement the ring-fence as recommended by the ICB. It defines core activities—that is, taking deposits—which must be inside the ring-fence, and it defines excluded activities—that is, trading in investments as principal—which must be outside the ring-fence. As the ICB recommended, activities that are neither core nor excluded may be either in or out. The Bill makes safeguarding the continuity of services connected to deposit-taking a part of the Prudential Regulation Authority’s general objective. It requires the PRA to make rules to ensure the independence of ring-fenced banks from their wider corporate groups. In response to the recommendations of the PCBS, we have amended the Bill in the Commons to electrify the ring-fence. I will come on to the details of that shortly.
The Bill also makes deposits protected by the Financial Services Compensation Scheme preferential debts in the event of insolvency. This will increase the FSCS’s expected recovery in the event that a bank fails and the FSCS has to pay out, reducing the risk of contagion and protecting the taxpayer. The ICB also recommended that if a bank fails the authorities should have the power to bail-in creditors, imposing losses on them rather than letting those losses fall on the taxpayer. The forthcoming EU bank recovery and resolution directive should deliver a bail-in tool at European level and a requirement for national authorities to ensure that their banks have in issue a minimum amount of credibly bail-inable liabilities, necessary to ensure bail-in is effective and credible. This Bill gives the Treasury power to set the framework within which the PRA imposes requirements on banks to have in issue minimum amounts of bail-inable debt.
In addition to the ICB’s recommendations, the Bill also reforms the governance of the Financial Services Compensation Scheme manager to ensure proper oversight and accountability for its use of public funds. It extends to subsidiaries of the Bank of England exemptions from Companies Act accounting requirements given to the Bank itself where the Bank considers that necessary for reasons of financial stability. It also allows for the costs of the Treasury’s participation in international organisations dealing with financial stability to be recovered from the industry.
Before reaching this House, the Bill already received very substantial scrutiny. The Government published the Bill in draft last October for pre-legislative scrutiny by the PCBS, which of course included several Members of this House. In light of the PCBS’s report on the draft Bill, the Government made a number of changes both before the Bill was introduced to Parliament and while it was before the House of Commons. In the Commons, the Bill was scrutinised line by line over the course of eight Committee sittings and had two days of debate on Report. For a Bill of just 35 pages, that was intensive, detailed scrutiny.
Throughout this process the Government have consistently adopted a constructive approach. We have welcomed suggestions from all quarters on how the Bill might be improved. Where we found those suggestions valuable, we have amended the Bill accordingly. For example, in pre-legislative scrutiny the PCBS argued that the regulator’s objective for ring-fencing could be made clearer. We accepted this suggestion and amended the Bill before its introduction and again on Report in the Commons. The PCBS also called for specific requirements for ring-fenced bank independence to be put in the Bill. We agreed and amended the Bill in a way that the PCBS acknowledged arguably went even further than it had suggested. The PCBS proposed that the PRA be required to report on ring-fenced banks’ sale of derivatives to clients. We will amend the Bill to this effect while it is before this House.
On the procedures for exercising delegated powers, the Government not only accepted recommendations made by the House of Lords Delegated Powers Committee, but also accepted a further amendment tabled by the Opposition in Committee in the Commons.
Perhaps most significantly, as I alluded to earlier, in response to the recommendation of the PCBS, the Government amended the Bill in the Commons to provide for a power for the full separation of an individual banking group. This is what the PCBS termed “electrifying” the ring-fence. The power we have added to the Bill will substantially reinforce the ring-fence. It will allow the regulator to require a banking group to separate completely its retail from its wholesale banking operations. This power can be exercised if the regulator believes that a ring-fenced bank is insufficiently independent of the rest of its group, or that the group’s conduct might in some other way threaten the regulator’s ability to safeguard the continuity of core retail banking services. As the PCBS recommended, given the momentous consequences for a banking group of a requirement to separate, the regulator can only use this power with the consent of the Treasury.
As noble Lords will know, when this power was debated in the Commons, questions were raised about the process for exercising it set out in the Government’s amendment. Some argued that the procedure was too complicated or lengthy. The Government have listened to these arguments. We accept that the process for requiring a group to separate could usefully be streamlined. We will therefore bring forward amendments to that effect while the Bill is before this House. And we will listen to the contributions of noble Lords to ensure that the process in the Bill meets the objectives that the PCBS set out, and which the Government share.
The Government remain unpersuaded, however, that a reserve provision for full separation across the entire industry would be appropriate. A firm-specific reserve power will reinforce the ring-fence by deterring banks from seeking to undermine or weaken it. However, to move to industry-wide separation would be to abandon the ring-fence altogether, in favour of an alternative structural reform. Let us be clear: this would not be a sanction, it would be a different policy. That alternative policy was considered in detail by the ICB, which rejected it. As noble Lords will know, the ICB concluded that full separation similar to Glass-Steagall would entail very significant additional costs, for doubtful—or even negative—additional benefits to ring-fencing. The Government have accepted the ICB’s recommendation and are therefore implementing the ring-fence through this Bill.
Like the ICB, the Government believe that the ring-fence will succeed. A future Government would, of course, be within their rights to come to a different conclusion, and to shift to an alternative policy. But if they did, the only proper and democratic way to implement that new policy would be to return to Parliament with new primary legislation which could be properly debated and scrutinised. The proposal made by the PCBS would potentially lead to full separation with no more than a short debate in Parliament and a vote. This would stand in extreme contrast to the extensive consultation and scrutiny that the current policy has gone through.
We have also recently heard proposals from the PCBS on the issue of the leverage ratio. The PCBS has suggested that control over the leverage ratio should be taken out of political hands and given to the regulator. The Government strongly support the principle of a binding minimum leverage ratio, as agreed in the Basel III accord. We believe that it is entirely appropriate for minimum standards to be set in statute. This applies to all the minimum requirements in Basel III, which we continue to push to have implemented through EU legislation.
This does not mean that there is no role for the regulator. Judgment-based regulation means the regulator having the ability to impose additional requirements if it feels that these are necessary to achieve its statutory objectives. Only last month, the PRA required a number of banks to meet higher leverage standards sooner than the Basel III deadline. The PRA thus demonstrated that it already has the power to impose higher requirements on leverage. So beyond minimum requirements set in statute in line with international standards, day-to-day control over the leverage ratio lies in the hands of the PRA.
Structural reform of the banking industry is the second pillar of the Government’s reform programme. The third pillar is reform of banking standards and culture. As noble Lords well know, the Government have welcomed the recent report of the PCBS, one main theme of which was to strengthen individual accountability in financial services. The PCBS argued that the existing approved persons regime has failed in this, and that new measures are needed to replace it. The PCBS also called for criminal sanctions for reckless misconduct in the management of a bank.
The Government have accepted these recommendations. While the Bill is before this House, we will therefore bring forward amendments to introduce a new senior persons regime. We will reverse the burden of proof for senior persons so that they will be accountable for any breaches of regulatory requirements in their areas of responsibility, unless they can prove that they took all reasonable steps to prevent them. We will also amend the Bill to give regulators the power to make rules governing the conduct of anyone employed in financial services, and to extend the time limit for enforcement action from three to six years.
Lord Forsyth of Drumlean
I am most grateful to my noble friend. Perhaps I should declare an interest as a regulated person. This new criminal offence of reckless misconduct is to apply—according to the excellent report which was produced—only to the senior management of banks. Can the Minister explain why, if someone is responsible for major systemic difficulties arising from the collapse of a bank, this new criminal offence should be limited only to the management of the bank and not apply to regulators or Treasury officials?
Lord Deighton
I thank my noble friend for that interesting observation. The purpose of the Bill is to look at the management of the financial institutions themselves rather than the system. I would welcome that discussion later, in Committee, if my noble friend would like to take it further.
As a further deterrent against misconduct, the Government will table amendments to make reckless misconduct in the management of a bank a criminal offence. Those found guilty will face the possibility of prison sentences. Together, these measures represent an historic overhaul of the system for holding bankers to account for their actions. However, rules and sanctions alone will not guarantee good conduct. The PCBS argued that effective competition between banks is essential to ensuring high standards of behaviour, and the Government agree. We will therefore amend the Bill to give the PRA a secondary competition objective. This will give the PRA a greater role in championing competition in the banking market, to the benefit of consumers.
One key barrier to competition in banking, and in particular to new entrants and smaller firms looking to challenge the big high street banks, is the big banks’ control of payments systems. The Government will therefore introduce amendments establishing utility-style regulation of payments systems. To ensure the safety and stability of payments services, we will also bring forward amendments to provide for a special administration regime for payment and settlement systems. This will require critical payment and settlement services to be continued even in insolvency, until the firm recovers or alternative provision is available.
While the Bill is before this House, the Government will also make some technical amendments to provisions on the pension liabilities of ring-fenced banks and introduce amendments to modernise the rules for building societies, helping to create a level playing field between building societies and banks while preserving the distinct nature of the building society sector.
In the other place, the Government set out our intention to use this Bill to require the Bank of England to produce a resolution strategy for each major UK bank—that is, a plan for how the authorities propose to respond in the event that that bank failed. We still believe that resolution plans are necessary, but given that the European Council of Ministers and the European Parliament have recently published proposals for the EU recovery and resolution directive that include similar provisions, it may be more appropriate for this requirement to be imposed through transposition of the directive than through the Bill. The Government will continue to review this issue in the light of European developments while the Bill is before this House, with a view to bringing forward amendments if necessary.
We can all agree that this is legislation of the highest importance. It is essential that we address the causes of the terrible banking crisis of five years ago, whose consequences remain with us today. The Bill is a vital step towards ensuring that this crisis is never repeated. Its current provisions represent a once in a generation reform of the structure of British banking, while forthcoming amendments will revamp the accountability regime for bankers’ conduct and standards. I look forward to constructive engagement with all sides of this House over the months ahead. To support noble Lords’ consideration of the Bill, last week the Government published drafts of the principal secondary legislation exercising delegated powers under the Bill, and I will ensure that my officials are available to noble Lords to discuss any details of the Bill. I am pleased to present the Bill for the consideration of noble Lords. I beg to move.
Lord Newby
My Lords, I thank all noble Lords who have spoken in the debate this evening, particularly members of the Parliamentary Commission on Banking Standards—not so much for their contributions tonight, excellent though they were, but for the phenomenal amount of work they did on the commission. For months on end it was impossible to discuss anything with my noble friend Lady Kramer because she was either in a meeting, just going to one or in the middle of reading great piles of stuff. I know they did a huge amount of work. I share the views expressed by my noble friend Lord Lawson and others about the extraordinary leadership that Andrew Tyrie gave in driving that process forward.
I believe the Bill has been marked by a readiness on the Government’s part to listen and respond to a wide range of views. The Government have already made a series of amendments to the Bill in response to the recommendations of the PCBS and have shown willing to keep listening and to fine-tune their provisions as the debate on these issues continued to unfold. We will make further changes to the Bill in this House in response to the constructive debates in another place and here, in particular on the firm-specific electrification power. We will also introduce amendments to implement the recommendations of the PCBS’s final report on culture and standards.
The debate today has confirmed the broad consensus and strength of feeling across the House about the great significance of the measures contained in this Bill and those shortly to be added to it. In the time available now, I cannot deal with every issue that noble Lords raised. Indeed, some issues went significantly further than the Bill itself. Of course, we will return to all these issues in Committee. Many of the principal issues mentioned by a number of noble Lords were first raised by the noble Lord, Lord Eatwell. I will deal with them in the same order that he did.
There has been a lot of discussion about whether this is a watering-down as opposed to an enabling Bill in terms of what it contains. There are many further, detailed provisions to be made to implement the changes and we have taken the view that these are not all most suitably dealt with in primary legislation. That is why there is a lot of material to be done in secondary legislation. A lot of the detailed rules will be made by the PRA. I hope that we are able during the course of debates to explain how we see some of those being implemented in detail but the principle of having much of the regulation done by secondary legislation was agreed by the parliamentary commission.
The noble Lord, Lord Barnett, asked where we disagreed with the commission. I recommend that he looks at our response to its first report, which we issued on 4 February, and our response to its other four reports, which we issued earlier this month. In the second of those, a table at the back lists each of the recommendations and the text earlier on explains our response to it. Both those responses are available on the Treasury website.
Lord Lawson of Blaby
I accept in principle that there is a lot which will need to be in secondary legislation. Nevertheless, it would be helpful if the proposed secondary legislation could be provided in draft so that we know exactly what the Government have in mind and can form a view accordingly.
Lord Newby
Of course, my Lords. Much of the secondary legislation was published earlier this month. I would like to suggest—both in terms of the secondary legislation and the amendments and how we reconcile the text in the Bill with earlier legislation—that we contact noble Lords between now and the end of the Session explaining our timetable for producing material, if we have not already done so. If we have produced material, we will let noble Lords have it at that point. Specifically, the noble Lords, Lord Higgins and Lord Tunnicliffe, referred to reconciling the Bill with the existing FiSMA. We will make a Keeling schedule available before the end of the Session showing the effects of the amendments in the Bill.
Baroness Kramer
I thank the Minister for giving way. The commission recommended some form of ad hoc committee to try to look at secondary legislation. The problem with secondary legislation is that you vote it up or down, so you cannot actually amend it. Given that it carries so much of the weight of the purpose of this Bill, is there a way in which there could be a more constructive discussion of its contents so that it could come finally and formally in an amended form after that discussion has taken place?
Lord Eatwell
Before the Minister stands up, can I firmly second what the noble Baroness, Lady Kramer, has said? It would be enormously valuable if there were an ad hoc committee which could consider the secondary legislation, write a suitable report and thus inform the House’s debate.
Lord Newby
My Lords, there is an issue about the timing of an ad hoc committee which produces a report to inform your Lordships’ debate. Agreement has been reached with the usual channels that we start Committee stage very soon after we come back and I am not sure that such an ad hoc committee would help. I will talk to colleagues in the Treasury and in another place to see how best we can facilitate proper discussion of secondary legislation, because, obviously, as everybody agrees, much of the meat is in the secondary legislation.
Can I reassure the noble Lord, Lord Barnett, that the banks had no part to play in drafting the Bill? It was produced by parliamentary counsel in the normal way. I should have said that draft secondary legislation was published on 17 July.
There was much discussion about standards and culture. The right reverend Prelate the Bishop of Birmingham talked about banks discussing doing what is right and about personal virtue. I agree with him that a wind of change is blowing through the banks and I am not as gloomy as a number of noble Lords have been about the extent to which the culture within banks may change. I would not put it any higher than that. I think there has been a big change in Barclays, and that is not a legislative change, it is because of the change of leadership and a change in culture.
In response to the commission, the Government propose to bring forward a number of amendments which specifically deal with standards and culture. These include a new senior persons regime for senior bank staff; introducing a new criminal offence of reckless misconduct; reversing the burden of proof, so that bank bosses are held accountable for breaches of regulatory requirements within their areas of responsibility; and giving the regulators new powers to make rules to provide enforceable standards of conduct for all bank staff.
Virtually every noble Lord who spoke has talked about the need to increase the degree of competition in the banking sector. I absolutely agree with the noble Lord, Lord Flight, that this is, if anything, the fundamental issue now facing the sector. I congratulate him and Metro Bank on its third birthday, and I congratulate him on the work that he is doing to increase competition in a very practical way.
Clearly, there is no simple way of getting to the state that most noble Lords would like, which is having a plethora of new banks providing effective competition to the existing big banks. What we have done, however, is to make it a lot easier for new banks to enter the market. In July last year, the Chancellor commissioned an FSA review of barriers to entry and expansion in the banking sector and the result of that review, in answer to the noble Lord, Lord Northbrook, is that for new banks we could see capital requirements fall by up to 80% over what was previously required. This is a big change and one of the many components that will be needed to transform the competitive landscape.
The noble Lord, Lord Eatwell, said that he was concerned about whether branches of EEA banks in the UK could arbitrage the ring-fence. EU passporting law makes branches subject to regulation and supervision in the home state, so UK branches of EU banks would not be subject to UK regulation or to ring-fencing, as the noble Lord said. The presence of EEA banks in the UK market at the moment is very small and we believe that domestic banks enjoy a strong home advantage, so there is not likely to be significant arbitrage. However, EU law has within it provisions to ensure that institutions cannot simply move to avoid regulation. We and the regulators will of course be keeping that issue very much under review.
A number of noble Lords talked about leverage—what an appropriate ratio should be, and where the power to set ratios should lie. There is a certain confusion about where powers lie at the moment. Although I am sure that we will discuss this at greater length later on, I would point out that the Government’s proposal, based on the Basel process, is that we would have a statutory minimum leverage level across the piece. However, the regulators already have the power to set a different leverage ratio for individual institutions, as we have already seen in the way that they have looked at Barclays and Nationwide—and completely without any political interference. That power will obviously continue.
The noble Lord, Lord Eatwell, drew a comparison between the 3% leverage ratio here and the 6% ratio in the US. We do not believe that these are even remotely comparable. Indeed, Mark Carney described comparing the two as being like comparing apples and oranges. I am sorry that I do not have time to explain in great detail why we believe that to be the case.
Electrification was possibly the issue that took most of your Lordships’ time. There are two issues here, given that we have agreed that in respect of an individual bank we will take powers in the Bill to enable that bank to be wholly separated. In respect of that, there has been considerable criticism of the provisions in the Bill on the basis that they provide too low a voltage, as the noble Lord, Lord Lawson, possibly said. We will be bringing forward amendments before Committee which seek to provide an appropriately increased level of voltage. I hope that they will commend themselves to your Lordships’ House.
In terms of total separation and a reversion to Glass-Steagall, our view is very straightforward. If ring-fencing were to prove ineffective, the only proper and democratic way to introduce full separation would be to return to Parliament with new primary legislation. However, given that it is a separate policy—not the same policy with a bit tacked on—we do not believe that the proposals in the Bill will be a failure. It would not be sensible to legislate for a failure that we do not think will happen; if we did that with every bit of legislation, the statute book would be many times its current length.
The noble Baroness, Lady Kramer, asked whether the Government had gone further than the PCBS on competition. It is a small thing, but we have recommended that the PRA and FCA review barriers to entry in a shorter time—the commission said two years; we have said 18 months—and that they publish annual statistics on the authorisation process so that we can see how things are going. The noble Baroness asked about game-changers in retail banking. The truth is that there will be no game-changer, but a series of small steps. The one step that will help is the seven-day switching service, which will be introduced in September and to which a number of noble Lords referred.
The noble Baroness also asked who will buy bail-in bonds. The Government have consulted on that; feedback suggested that there should be demand for bail-in debt instruments of the type that the ICB said banks should issue. Therefore we do not share her concern that there will be no effective demand for that.
The noble Lord, Lord Lawson, made a very eloquent argument for breaking up RBS into the good bank and bad bank. He knows that there will be a government response to that suggestion in the near future. He asked also about proprietary trading and believes that that is a bad idea. We believe that the ring-fencing method is superior to the Volcker-type rule in respect of prop trading and do not see a compelling case for a ban on prop trading in addition to the ring-fence. I can confirm that a difficulty in which an investment bank found itself would not threaten a high street bank. In terms of where funds can flow, it is a one-way valve: there would be no possibility of funding going from a ring-fenced bank back to an investment bank.
The noble Lord, Lord Flight, asked about the mis-selling of CDOs where that was being done, as I understand it, by foreign banks in this country. I can confirm that UK regulators could take action against any firm for mis-selling in the UK, including, obviously, foreign firms that were based here.
The noble Earl, Lord Caithness, talked about banks owning your money. He proposed what is essentially the same as full reserve banking and limited reserve banking, as it is known in the trade. The ICB has considered that issue and rejected the approach that he suggested.
The noble Lord, Lord Sharkey, asked whether the Government had gone soft on payday loan regulation: no, they have not. The FCA will be bringing forward proposals about how it intends to regulate the sector early in the autumn, which means that regulators are not waiting until next April to start to have impact. On central counter-parties, the noble Earl said that perhaps this is not the right Bill, and he is correct. The Financial Services Act 2012 extended the resolution powers in the Banking Act 2009 to systemically important investment firms, CCPs or group companies. Those powers will commence when secondary legislation has been laid in the autumn.
The noble Lord, Lord Northbrook, said that the SIs do not allow ring-fenced banks to provide export finance to SMEs. That is not the case. They can support UK businesses trading internationally. Obviously that is a very important issue for many small businesses.
I am extremely grateful to the noble Lord, Lord Tunnicliffe, for the constructive approach he took to the way we deal with this. I completely accept that we are asking noble Lords to work very hard over a relatively short space of time looking at a lot of new material. From the Government’s point of view, we will be making available all amendments and secondary legislation the moment we have them, and we are very keen that the House has the full opportunity to give all the proposals, not just those already in the Bill but those that will be coming forward, the maximum possible considered scrutiny.
Lord Tunnicliffe
A noble Lord asked that the amendments be accompanied by explanatory memorandum-type documents to help us understand them. Will the Government be providing those sorts of documents?
Lord Newby
I am very happy to give that assurance. Apart from anything else, Ministers will need such documents, so it is only reasonable that everybody else should have them, too.
The strength of this legislation will be due in no small part to the intense degree of scrutiny that it has already undergone and will undergo. It will be an onerous job, but I am confident that we will be able to strengthen the Bill further and look forward to further debates in the constructive spirit we have seen this evening. I look forward to the autumn, and I commend this Bill to the House.
Bill read a second time and committed to a Committee of the Whole House.