Grand Committee
Arrangement of Business
The Deputy Chairman of Committees (Baroness Morgan of Drefelin) (Lab)
My Lords, if there is a Division in the Chamber while we are sitting, this Committee will adjourn as soon as the Division Bells are rung and resume after 10 minutes.
Secondary International Competitiveness and Growth Objective (FSR Committee Report)
(1 day, 8 hours ago)
Grand CommitteeRead Full debate Read Hansard Text Read Debate Ministerial Extracts
Baroness Noakes
That the Grand Committee takes note of the Report from the Financial Services Regulation Committee Growing pains: clarity and culture change required. An examination of the secondary international competitiveness and growth objective (2nd Report, HL Paper 133).
Baroness Noakes (Con)
My Lords, it is a pleasure to introduce this debate on the Financial Services Regulation Committee’s report on the secondary competitiveness and growth objectives. These were set for the Prudential Regulatory Authority and the Financial Conduct Authority by the Financial Services and Markets Act 2023.
I must start with some thanks. Special thanks go to the noble Lord, Lord Forsyth of Drumlean, formerly my noble friend, still my friend, but now our distinguished Lord Speaker. He chaired the committee from its inception some two years ago with great skill and energy, and the House owes him a debt of gratitude. Thanks also go to our clerk, Beth Hooper, and her colleagues in the Committee Office, as well as to our specialist advisers Professor Rosa Lastra and Mr Michael Raffan. Of course, no committee could exist without its members, some of whom are speaking today, and I thank them, too.
The committee was set up as a direct result of debates about the accountability of the financial services regulators during the passage of the 2023 Act and we chose as our first major inquiry the secondary competitiveness and growth objectives created by the Act. These require the PRA and the FCA to facilitate the international competitiveness of the UK economy, in particular in the financial services sector, and its growth in the medium to long term. They do not override the regulators’ primary objectives, but they are an important element in the complex hierarchy of objectives, have-regards and regulatory principles that we summarise in Appendix 7. These objectives are new territory for the financial services regulators and there is great interest in the financial services sector about the impact that the objectives will have. It is unsurprising that we received a large amount of evidence, both written and oral, as set out in Appendix 2. We have also received responses from the Government and both regulators.
The 2023 Act was Conservative legislation but, with growth as the Labour Government’s number one mission, it was good to see that they embraced the initiative. The financial services sector is important both directly as a component of the UK economy and as an enabler of growth in the real economy. Financial services account for about 9% of GDP. As the Government’s financial services growth and competitiveness strategy, which was published after our report, pointed out, the sector’s contribution to output and productivity growth has fallen behind the rest of the UK economy, so this focus on financial services is important.
I have one final opening remark. We reported at a point in time—last May—that this is not a static area. I have just mentioned the competitiveness and growth strategy, but many other initiatives from the Government and the regulators have emerged or been fleshed out in more detail since then. I am sure that the Minister will reel off a lot of that when he responds later, but let me just say to him that those who are following this debate are interested in what is actually being achieved in terms of growth and competitiveness. I hope that his closing remarks will reflect that.
Our report is long and our conclusions and recommendations run to 77 paragraphs; I will not be able to cover them all, noble Lords will be relieved to hear. There are three angles on the secondary objectives in our report: first, the impact of regulation on the financial services sector; secondly, the impact of that regulation on the wider economy; and, lastly, the role of government.
The UK has a complex regulatory architecture, which we set out in Appendix 6. The PRA and the FCA are the lead actors, but there are many interfaces and overlaps with other bodies. The Government have started to address this with plans to roll the Payment Systems Regulator into the FCA and a consultation to address the interface between the Financial Ombudsman Service and the FCA, which many cited as a major problem. We welcomed these reforms, which must be completed.
In evidence, we heard how financial services firms are inundated by information requests, that the cost of regulatory compliance in the UK was considerably higher than in other jurisdictions and that the regulators did not focus on the cumulative burden of regulation on firms. The FCA’s consumer duty was often cited as lacking clarity and proportionality. We also heard that the regulators take far too long to deal with authorisations, with a disconnect between the regulators’ views of their performance and the experience of firms.
While we were encouraged by a new focus on operational efficiency in the regulators, in particular in authorisations and related performance metrics, we were disappointed that the Government resisted our recommendation that they should undertake international benchmarking as a spur to further UK improvements. Cumulatively, the evidence that we received pointed towards there being a regulatory premium, which discourages investment in UK financial services.
Lurking beneath all these detailed areas lies the complex area of culture in the regulators, which we characterised as risk aversion. Culture is the most difficult thing to change in any organisation. There are encouraging signs that the regulators are trying to change what they do and how they do it—for example, overhauling their voluminous data requirements—but the jury is still out on whether their culture is changing in a deep way.
Turning to the impact of the secondary objectives on growth in the wider economy, one of the problems that we found was that the effect of actions by financial services regulators is not well articulated either by the regulators or by the Government. In addition, the metrics that the Treasury has set in order to monitor progress simply do not deal with much beyond operational processes in the regulators.
Financial services firms, particularly banks, are an important source of funding to businesses, enabling the investment that is needed to underpin growth in the economy. Despite constant assertions that a lack of investment is one of the key factors behind lack of productivity growth in the UK economy and that more productive investment is essential to achieving the Government’s growth mission, we were surprised to find that data do not exist on the proportion of total lending that finds its way into productive investment. We said that the Government and the Bank of England should work on this and, while the Financial Policy Committee has published some findings on high growth firm financing, this falls a long way short of our call for proper data on economy-wide investment. On Monday this week, Positive Money reported that only 6% of bank lending last year went into productive investment. The Government really must start to take this seriously.
The Committee delved into the arcane territory of bank capital, which is a key determinant of lending capacity. We received evidence that, unlike in other countries such as the US, the approach of the PRA starts from the position that the Basel rules, which were aimed at international banks, should apply to all UK banks. The PRA is at long last introducing a small domestic deposit takers regime, which is less onerous and which we welcomed, but the PRA applies the rules in their entirety to mid-sized banks. Mid-sized banks are also hit by the minimum requirement for eligible liabilities—or MREL—rules, which mean that they have to raise costly capital once they hit the MREL threshold or alternatively manage their businesses so as to keep below the threshold. Neither course is good for lending into the productive economy.
An additional problem is that large banks can minimise their risk-weighted assets, and hence their capital, by using approved models—called the IRB approach—but the approval process takes many years, and few mid-sized banks have achieved it. We made a number of recommendations, including asking the PRA to consider a more proportionate judgment-based approach to setting bank capital requirements rather than slavishly following Basel III, and to speed up its IRB approval process. We also said that the Government should work with the Bank of England to look at the cumulative impact on regulatory capital to get the right balance between financial stability and the need to finance productive investment.
The Bank has now increased the MREL threshold, but only to keep pace with inflation. In addition, the Financial Policy Committee has reported that overall bank capital levels can be reduced by one percentage point, and the PRA has said that it will improve the IRB process. Although this is welcome, there is no sign yet that it will improve matters for mid-sized banks, and the PRA is unreceptive to the idea of a proportionate, judgment-based approach. This may be a missed opportunity.
We did not focus entirely on banks. We noted that the Solvency II regime should help insurance companies to unlock more capital for productive investment. We also noted the Government’s pension scheme reforms and recorded our serious reservations about the mandation power, which could force pension schemes to invest in particular ways. The House will express its opinion on that next week during the Report stage of the Pension Schemes Bill.
The final area of our report covered the role of government. We did not find clarity about how the policy objective of growth in the economy was to be achieved by the regulators, and the Government have set metrics that shed no light. The Government need to grasp this issue. I have already referred to our recommendation on benchmarking the performance of the regulators internationally; the Government have not embraced that either, claiming that it is difficult to do. That is not a good reason for not doing it, and I urge the Government to look at it again.
We could not avoid getting into risk appetite, especially as the FCA has regularly called for the Government to set their risk appetite. We did not fully agree with that, but we did think the Government could be more specific about the policies they wanted the regulators to action. We called for this to appear in the Government’s financial services sector strategy, but that strategy was silent. I hope the Minister will explain why the Government refuse to get involved in risk appetite.
Lastly, we recommended that the Government should keep the secondary objective under review. I do not think it controversial to say that it is still a work in progress. We asked that the Government update Parliament and the committee annually, in particular on whether the objective is achieving growth in the UK economy. I hope the Minister will today confirm that the Government will do that, and say when we will see the first of these annual reports. I beg to move.
Lord Kestenbaum (Lab)
My Lords, I congratulate the noble Baroness, Lady Noakes, on an excellent opening to the debate. I am aware that she has recently taken over the chairing of the committee and will no doubt bring to that role her hard-earned reputation for penetrating insight, intellectual rigour and—above all, for all those who have worked with her—no-holds-barred candour. This is also an opportunity to pay tribute to her distinguished predecessor as chair of the committee, the noble Lord, Lord Forsyth, whose chairmanship was nothing less than a master class and who, as noble Lords are well aware, has gone on to a higher place.
I was privileged to serve as a member of the committee and believe that the report is particularly timely, for in pursuit of economic growth in this country we continue to confront short-term headwinds and long-standing structural reform. In simple terms, the unenviable combination of no clear engine for economic growth, decades of low productivity and weak business investment compared with other advanced economies makes the Government’s secondary objective for our regulator all the more critical at this time.
With that said, and however much we would wish it otherwise, it does not seem self-evident that the primary and secondary objectives sit in perfect alignment; or at least, as evidenced from this report, much change is needed for that to be the case. With that in mind, allow me to draw three illustrations from the very subtitle of this inquiry: namely, culture change—the noble Baroness referred to it already—or, as I will suggest in my remarks, it is more like an aching need for nothing less than cultural transformation.
My first illustration of the cultural impediments that stand in the way of the regulator grasping this inquiry’s nettle is implicit in the regulator’s very own response to the report, for consider this: this has been the most comprehensive inquiry of its type on this issue. It lasted over a year, it runs to 145 pages and hundreds of hours of evidence were taken from industry, trade bodies, government, financial services and the like, all of which culminated, as the noble Baroness said, in 77 recommendations. They are 77 individual, well-evidenced, tightly argued recommendations for comprehensive change at the regulator, if this secondary objective is to be pursued in earnest. So it was rather dispiriting to read a somewhat patronising opening response from the regulator to the inquiry, whose top line is:
“We are pleased that we have work underway, or already completed, that addresses most of the Committee’s recommendations”.
Perhaps one could not wish for a more tangible illustration of the need for cultural overhaul, one that puts a premium on a regulator that acknowledges its shortcomings, embraces radical evidence-based solutions—this inquiry —and demonstrates full accountability, rather than a response that basically said, “Nothing to see here”.
My second illustration of the pressing need for the type of cultural transformation that the inquiry called for is a subtle one. It is a deft line in the report:
“We were disappointed by the difference in candour between the evidence we received from industry in public and the views expressed to us in private”.
It is the inverse of my favourite political joke: the senator who was asked what he felt of a young, promising congressman, Bill. He said, “Bill? I think so highly of him that I am even prepared to praise him in private”. In this case, it is the opposite: the suggestion—not just a suggestion—that, in public, firms and trade bodies would toe the party line but, in private, they were somewhat more forthcoming, if I can put it that way. That might say everything about the health of the ties between the regulator and the regulated and, perhaps more particularly—I am sorry to say it—the trust deficit that lies between them. The fear of the regulated in expressing a candid view in public is hardly conducive to the type of dynamic, competitive business sector that the secondary objective has in mind.
Finally, the third illustration emerging from the report also draws on my personal experience. As declared in my register of interests and elsewhere, I have spent much of my career in the financial services, particularly in listed and regulated businesses. As a result, and sadly so, I fully recognise evidence that spoke of supervisory teams mostly having limited or no experience of the fields that they were supervising. My own experience has been of enforcement being overrigid and often indifferent to the realities, complexities and uncertainties of business life. This inflexibility becomes a brake on competitive ambition and often seems to run through supervisors like a stick of rock. A slavish adherence to what has been described elsewhere as the
“total elimination of all risk”
hardly seems conducive to the innovative competitive economy that Governments of all stripes aspire to. My own experience was simple, and sometimes positive. At the top of the food chain, our interactions with regulators were often constructive, engaging and solutions-oriented. Deeper into the system, the middle and junior ranks might show a modicum of willing, but too often a lack of understanding of financial services businesses and their complex realities.
So I offer three practical illustrations based, in some measure, on my experience of not just the culture change needed, as the report suggests, but the culture transformation. If we have learned one thing about competitive economies, it is that, when you have the right culture, especially a leadership culture, you will overcome most structural impediments. Conversely, if you do not have the right culture, especially at the top, no amount of structural overhaul or, indeed, well-meaning secondary objectives will help—a cautionary tale for our regulators and their political masters.
Lord Vaux of Harrowden (CB)
My Lords, I start by declaring an interest: I have a registerable shareholding in Fidelity National Information Services Inc. It has been fascinating to be a member of this committee, which for this report, as we have heard, was so ably chaired by the noble Lord, Lord Forsyth of Drumlean, who, as we all know, has moved on to greater things. I also thank our new chair, the noble Baroness, Lady Noakes, for introducing this debate with her usual clarity.
The noble Lord, Lord Kestenbaum, said that this report is timely and I agree with him, but I would not go as far as to agree with him about the timing of this debate. The report was published almost nine months ago and I confess that it has taken me a little while to get back up to speed and remind myself what it said. I hope that future reports will be considered in a more timely manner.
At the outset, it is worth saying, as we do in our report, that the secondary growth and competitiveness objective has provided a valuable stimulus for the regulators to consider the impact of their activities on growth and competitiveness. We should recognise that they have taken this seriously. Of course, there is a balance to be reached between looking at the impact of regulation on growth and ensuring that risks, both systemic and to the consumer, are proportionately managed. There is a sense that, following the 2008-09 financial crisis, the pendulum has swung too far towards eliminating risk, but we clearly need to be alert to the danger that it might swing back the other way, as we rightly put greater emphasis on growth. We must also recognise that a stable, predictable, even dull regulatory environment has been and is an important aspect of the attractiveness of our financial services sector, but it must be proportionate.
It is a long report, so I will highlight just one or two of the points that we raised. First, as the noble Lord, Lord Kestenbaum, pointed out, concerns were raised about the culture of the regulators. It was very noticeable that witnesses seemed much more prepared to be candid with us in private sessions than in public. Miles Celic, CEO of TheCityUK, put it rather bluntly when he said:
“There is a concern … that, as one person put it to me, being critical of the regulator publicly will result in an enforcement punishment beating later”.
That is concerning. It implies a lack of trust between the regulators and the industry. The regulators should recognise that and do everything possible to overcome it.
Mr Celic also gave us the example of an American company with operations in both the UK and the US, which said that
“regulators in the US … started from the position of asking, ‘What will the impact of what we are doing be on growth?’ But his experience in the UK was that the regulatory starting point was, ‘What will the impact of what we are proposing here be on risk?’”
It seems more difficult than one would expect to make international comparisons of the burden of regulation and there seems to be a reluctance on the part of both the regulators and government to research this fully. We received plenty of evidence that the UK regulatory burdens are significantly greater than those in comparable jurisdictions such as the US. The CEO of Marsh McLennan told us that
“on a direct cost-only basis, the UK is at least six times more expensive than our next most expensive country from a regulatory perspective”.
The Investment Association told us that
“industry headcount for Compliance, Legal and Audit has almost tripled from 2009”,
and other witnesses gave us stark examples of the amount of data that has to be provided, often for unclear purposes, as the data requirements are greater in the UK than in other countries. This may be anecdotal, but it is clear that, at the very least, the UK has gained a reputation for being a disproportionately high-cost environment from a regulatory perspective.
Rigorously analysing compliance costs internationally may be difficult, as the regulators and other analysts make clear, but unless we gain a clear understanding of how we compare to other countries it will be very difficult to understand if and where regulation is creating barriers to growth. This really must be addressed and measured to the extent possible.
However, the Government say in their response that “direct comparison is difficult”, which, to be frank, is pretty weak. They go on to say:
“The government and regulators will continue to consider how the regulators’ efficiency and performance can be meaningfully compared to those of international comparators”.
That was over six months ago, so perhaps the Minister can update us on what further consideration they have carried out in those six months.
The driver for this apparently higher level of regulation in the UK is the risk-averse culture that our report highlights. Regulators understandably became more risk averse after the financial crisis. I have some sympathy for the regulators here; it is very easy for us politicians and the Government to tell the regulators that they should tolerate greater risk, but the regulators know that if some serious risks were to crystallise, the blame would still fall squarely on them. If the Government want to see greater risk tolerance and a lighter-touch regulation, which I think we all want to see, they need to be much clearer about what is acceptable and to accept their share of responsibility if the risk crystallises, not just blame the regulators when it goes wrong.
We also mention in our report regulatory mission creep. Again, there is always a tendency for this—regulators will regulate—and it is right to call it out. But again, we in Parliament and those in government need to take some responsibility for this, too. We keep putting an ever-growing list of objectives, and in particular have-regards, on to the regulators. I know that I am guilty of this myself; I supported the net-zero have-regards in the FSMA 2023, which I now regret, having gone through this process. It can be no surprise that, if we keep adding to regulators’ remits, they will react by adding rules, data requirements and other onerous burdens to meet those. There needs to be a regular review of the objectives and the have-regards so that regulators are able to concentrate on their core purpose and reduce unnecessary burdens on the firms that they regulate. The Government and we as politicians need to be more disciplined about adding to the mission creep of regulators.
It is welcome that the FCA appears to be learning lessons from other jurisdictions. A good example is the creation of a Singapore-style concierge service to support international investment, which is very welcome. I look forward to seeing real metrics about how effective that has been once it has been up and running for a while.
The committee had a lot of discussions about what we mean by growth and competitiveness. First, there is the growth and competitiveness of the financial services industry itself. It is a very significant part of the economy, as the noble Baroness, Lady Noakes, said, so growth of the industry will have an impact on overall GDP of itself. But the secondary objective goes beyond the industry itself, requiring the regulators to consider the international competitiveness of the economy of the United Kingdom and its growth in the medium to long term. It is there that the secondary objective becomes rather less clear.
The link between financial services regulation and wider economic growth does not seem to be widely understood or well researched. Economic growth is driven by new investment into and by business and into productive assets. We saw very limited evidence of how regulation has much impact on that and a lack of data on how much investment is made by the financial services sector into productive assets or growth companies. This needs to be improved. Perhaps the Minister can tell us what the Government are doing to improve that understanding, as we recommended.
I will finish by referring to a current piece of legislation that is going through the House—the Pension Schemes Bill, to which we will be returning on Monday and indeed on which we had an exchange just 45 minutes ago in the main Chamber. Our report highlights that the pension industry is fragmented and underinvests in UK productive assets. I, and I think the committee, agreed with the Government that action should be taken to improve this, which the industry has also agreed. The Pension Schemes Bill tries to address that and a lot of what it includes is good. For example, the proposed value-for-money framework should encourage funds to look more at returns rather than just fees, which should allow funds to consider a wider range of investment types. However, the Bill also includes the blunt instrument of giving the Government the power to mandate asset allocation by pension funds, which the committee raised serious concerns about.
I will ask this Minister exactly the same question that I asked the Minister in the Chamber 45 minutes ago and that I did not receive an answer to. I have asked this several times and still have not received an answer, so I hope the Minister will actually answer it this time. If not, I would be perfectly happy for him to write to me with a real answer, rather than the platitudes that I have received so many times so far.
It is really simple: why do the Government think that pension funds have been so reluctant to invest in these UK productive assets that the Government are so keen for them to invest in? They keep telling us that these are fantastic assets and that there are fantastic returns to be made from them, so why are pension funds not doing it? This is not a rhetorical question, and I really would like an answer.
The reason I ask is that surely a better way to encourage pension funds to invest in UK productive assets would be to identify and remove the barriers that are preventing such investments from being made, and to make those investments more attractive. Surely that is a better way than forcing pension funds to make investments that they do not wish to make.
Baroness Moyo (Non-Afl)
My Lords, I point to my registered interests: I serve on the boards of Chevron Corporation, Starbucks and the Oxford University investment endowment, all of which are impacted by the regulatory environment in the United Kingdom. I welcome that we are having a debate about a growth objective for our financial regulatory environment and regulators—the Financial Conduct Authority and the Prudential Regulation Authority. Even so, this report is clear that, although Parliament gave the mandate of a growth objective to the regulators back in 2023, it has not yet adequately been acted upon.
It is understandable that, in the report, many in the financial services industry have expressed frustration at the persistently high regulatory burden in the United Kingdom. But, in the historic context, the intrinsic caution shown by regulators is not a surprise, given the scale of the damage caused in the 2008 global financial crisis to both the financial system and the wider economy. Yet such an aggressive regulatory stance has considerable costs. For example—I know this from my own experience, having served as a board member of Barclays bank from 2009—the regulatory reaction and, specifically, the costs ascribed by the UK regulators to holding certain assets ultimately led to the disposal of international businesses, a decision that the firm would likely not otherwise have taken.
Overcoming regulatory caution is clearly not simply down to a mandate in a piece of legislation; it is about a fundamental shift in mindset, culture and risk aversion, which has already been mentioned—a shift that those working in a regulatory body may see as counterintuitive. Yet this shift is much needed. I therefore support the call in the paper for the FCA’s and PRA’s senior leadership to drive cultural change through their organisations. We of course must all recognise that, although not impossible, this is a very difficult proposition.
Such a shift must surely recognise and involve a concerted investment in education around two specific points. The first is the need for a fundamental understanding of the harm of the prevailing regulatory burden and the cost to business and economic growth of the status quo. In particular, it is vital to understand the consequences of regulatory duplication and overreach for business output, productivity, employment, taxation and wider economic growth. Specifically, regulators need a better and more practical understanding of how high regulatory burdens impose real costs in terms of time and financial expense, making the UK less competitive on the international stage. I was struck by the data showing that one firm employed 78 compliance officers for the UK market alone, compared to 73 covering 40 other countries in its European and Middle Eastern operations.
Secondly, it is important to innately understand the impact of regulation on innovation. This is a particularly crucial point given the enormous benefits as well as the costs that AI promises. It should be a priority to really grasp how this AI supercycle could append the UK’s growth fortunes and longer-term outlook for the country’s prosperity. In the United States today, for example, estimates suggest that, through productivity gains and increased capital investment, AI could add as much as 1.5 percentage points per year to the country’s GDP growth.
Were similar gains to occur in the United Kingdom— I am in a sense spitballing here—GDP growth could soar close to 3% per year here in the UK, thereby clearing a crucial hurdle to where we can put a dent in poverty and materially improve living standards within a generation. Yet, despite this appealing prospect, UK regulation is regularly blamed for weak capital markets, including a poor IPO environment, and paltry investment by cornerstone investors such as UK pension funds, endowments and insurance companies, all of which should be powering AI investment.
The unattractive UK investment landscape, buttressed by constraining regulation, could at least in part explain why the report highlights concern over a series C funding gap, which is forcing much-needed growth companies to leave the UK when they seek to raise in excess of £50 to £100 million.
To put it simply, the country needs less regulation, not more. In essence, policy should be attracting investment, not forcing investors, and a more growth-focused regulator is bound to attract more capital investment. I therefore agree with the serious reservations expressed by the committee regarding any proposal to mandate pension funds to comply with the prescribed asset allocation.
This debate comes when the Chancellor of the Exchequer has downgraded the growth outlook of the country to just 1.1% in 2026. Worryingly, this reflects how the country was already on a long-term structural economic decline, and the war in Iran will only dampen our growth prospects.
The essential question is this: in five to 10 years from now, will Britain’s economy in real terms be bigger, smaller or just the same? To alter our economic prospects from today’s growth malaise and set us on a prosperous trajectory, regulation must be relevant, on point and, most importantly, appropriately curtailed. Doing so will ensure the longer-term prospects of the financial services sector, which, as noble Lords have already heard, is critical for the economy. It will ensure that the sector is stronger and better equipped to serve as an engine of growth for our economy.
Lord Hill of Oareford (Con)
My Lords, I declare an interest as a board member of Intercontinental Exchange in the United States, and as an adviser in Europe to Santander and Visa Europe. This enables me to see the very different regulatory approaches in different jurisdictions, which is, indeed, one of the themes that we have already referred to today.
I am very grateful to my noble friend Lady Noakes—in keeping with tradition, I almost called her Lady Bowles, an in-joke among committee members—for setting out the range of issues so clearly at the beginning and for taking on the burden of chairing us. I much enjoyed the comments from the noble Lord, Lord Kestenbaum. How sad we are that he is no longer with us—on the committee, I mean; it is not that the noble Lord sits before us as a hologram, or agentic AI as I believe it might be called. I want to highlight a couple of points from the deliberations of the committee and the report.
First, as I think the noble Lord, Lord Vaux, has already said, the secondary international growth and competitiveness objective has made and is making a difference. I admit that when it was introduced I was initially sceptical and thought it might just be a piece of window dressing. But in fact, in the hands of motivated Ministers—which I am glad to say we have had—it has turned out to be of real use. It has helped us open up a more intelligent discussion about risk. Direct parliamentary accountability through our committee, backed up by a system of metrics, has also given us some scaffolding, off which we have been able to build a better debate and a better system of holding regulators to account. I think we have seen how the regulators themselves—it must be said that they were initially extremely doubtful about this requirement, if not resistant to it—have started to warm to it. Indeed, they now argue that it is helping them to improve both their regulatory and their supervisory practice. So far, so good.
But as our report points out, and as my noble friend Lady Noakes has already said, we should think of this whole area as a work in progress, not as a fixed point. After all, our own risk appetite as a society is not fixed, nor is that of our international competitors. Indeed, we have only to look at recent regulatory developments in the United States since we started our inquiry to see just how dynamic and competitive that landscape is.
Therefore, as the report argues, we need to keep the metrics by which we judge the performance of the regulators under constant review. We should seek to tighten them, to be more ambitious, to raise the bar and to keep on pushing for better performance. Here, as we have already heard, the Government’s response to the committee’s recommendations was, I have to say, disappointing. Metrics may not sound very dramatic or poetic, but they are the means by which we can shine a light into the world of regulation and supervision. I argue that the Government should be more ambitious here, and so should our regulators.
I will draw attention to one other area: the question of whether we could do more to differentiate between how we think about regulating wholesale and retail markets. We raised this in the report, and we heard evidence that suggested that attitudes of mind developed in the field of consumer protection are, as it were, leaking across into the regulation of wholesale markets. Here, obviously, risk appetite and sophistication of investors are completely different, and it is in wholesale markets that London’s claim to be a global financial centre will be won—or lost. Ministers have given us hints that they think it is worth thinking more carefully about this wholesale/retail distinction, and perhaps the Minister might feel able to give us another hint today.
I have a final word for the financial services sector itself. Just as we want to prevent mission creep from regulators and supervisors, so the sector needs to prevent it in its own compliance departments, legal advice and board discussions. If we want to have a new attitude in Britain that is more accepting of risk, we cannot just blame everything on the poor old regulators. Yes, they have their share of responsibility, but the primary responsibility surely rests with the politicians, who have for too long outsourced the management of risk.
I believe that this report starts to unpack many of these issues, and it helps us in the long march of improving how we regulate and supervise financial services, unlocking more innovation and, ultimately, more capital to invest in our economy.
Lord Eatwell (Lab)
My Lords, I draw attention to my declaration of interests in the register, in particular to my role as a non-executive director of Unity Trust Bank.
It is a privilege to serve on the Financial Services Regulation Committee, and it was a particular privilege to be part of the team producing this report under the able chairmanship of the noble Lord, Lord Forsyth. The evidence gathering gave committee members a bird’s eye view of the complexities and confusions embodied in current thinking on the role of the financial services industry in the pursuit of growth—everyone’s goal for the UK economy. Hence the need, as the report’s title stresses—and as noble Lords have also raised in the speeches we have heard—for clarity and culture change.
Let me deal with complexities first. It was clear from the evidence that the committee received that financial regulators are still operating under the dark shadow of the global financial crisis of 2008 to 2010. Risk aversion is the cultural norm and stability the dominant objective. Combined, risk aversion and stability do not make for the most dynamic growth platform. The combination has arisen due to the lack of macro- prudential tools in the global financial system. Despite the clear recognition of the macro dangers back in 2010, building in the buffers and shock absorbers that might do the job in global financial markets has proved beyond the capabilities of the international regulators in Basel.
Unable to manage risk macroeconomically, regulators have ramped up microeconomic risk management instead, significantly increasing the scale of risk aversion, the complexity of regulation and the costs of compliance. It was clear in the material presented to us that there was little or no evidence of any clear, well-defined relationship between the plethora of microprudential measures and the resultant level of systemic risk. Unfortunately, financial crises, often linked to innovation in financial products, tend to come out of a clear blue sky, from unexpected directions. Think of the role of credit derivatives in the global crisis: they were heralded as an efficient means of management of systemic risk; they proved to be the engine of systemic collapse. Can the Minister be confident that, in today’s world of anonymous, instantaneous, global crypto trading, the financial system as a whole is safer than it was in 2007? Has the new cost-benefit unit at the PRA addressed this question? If so, can the Minister tell us something of its conclusions?
What has been the cost of all this post-crisis regulation? On a pragmatic level, the report, as the noble Baroness, Lady Noakes, noted, calls on the Government to commission an independent study of the administrative costs of compliance and, particularly, the relative costs of compliance as compared with other jurisdictions. It is enormously disappointing that the Government appear not to have taken note of this recommendation. What has been the wider economic impact of post-crisis regulation? It is clear that the proportion of business lending emanating from the UK banking system has fallen from up to 90% in 2007 to less than 50% today. Enforced risk aversion has squeezed business lending out of the banks and into private capital markets. What has been the impact of this migration on systemic risk? I leave that question in the air—a topic for another day.
I turn now from complexity to confusion. Throughout the committee’s investigation, we received evidence that particular institutions, whether banks or building societies, had “invested heavily” in the UK economy. Billions of pounds-worth of investment was itemised, but it soon became evident that the claimed scale of the investment exceeded the scale of gross fixed capital formation in the UK economy—something wrong, surely. The confusion arose because the term “investment” was used in two quite different ways. On one hand, it referred to the financing of the creation of new productive assets—the assets that are counted in the figure for gross fixed capital formation. On the other hand, it referred to the purchase of assets in secondary markets. For example, the representative of a major bank referred to the billions of pounds that his bank had invested in the UK economy, but when asked whether it funded the purchase of new productive assets, he replied, “We don’t do that”. Similarly, both building societies and banks referred to the billions invested in mortgages, yet well over 90% of mortgage lending is for the purchase of assets—houses—that already exist, not for new build. That 90% or more of investment does not fund real investment at all.
A similar mix-up seems to permeate the Government’s calls, via the so-called Mansion House agreement and similar encouragements, for financial institutions, including pension funds, to invest more in riskier equities rather than in the bond markets. But these so-called investments are in secondary markets, not in the creation of new productive assets.
We tried to untangle these confusions in the committee but, as the noble Baroness, Lady Noakes, and the noble Lord, Lord Vaux, noted, we were not helped by the Bank of England. It told us that it did not have data on the breakdown between investment by financial institutions in secondary markets and investment that actually results in the creation of new productive assets. Of course, there is a relationship between the two—the presence of active secondary markets provides the comfort of liquidity to the flow of funds into real investment—but that relationship is ill defined and opaque.
The Government have recognised that the squeeze on microprudential regulation has gone too far, and the Chancellor has suggested that regulators should be less risk averse. But this raises two vital questions that it would be helpful for the Minister to address in his summing up. First, are the Government confident that an increase in secondary market investment will result in an increase in the funding of real investment in new productive capacity? Secondly, are the Government happy to see an increase in systemic risk as the price of the relaxation of risk-management constraints?
The source of the dilemmas that lie behind these two questions is that the competitiveness and growth objective has been characterised as an issue of risk management, but it is not; it should be seen as an issue of institutional reform. The committee received evidence from a number of medium-sized fintech companies, all of which had successfully raised funding in the order of £35 million to £80 million to scale up their businesses. They had all raised those funds from venture capital firms in the United States. None of them could get their money in the UK.
The venture capital industry in this country—the financial institutions that invest in real investment—is tiny, with total assets under management of between £30 billion and £40 billion, which is less than half of 1% of the total value of assets under management in the UK. That is dwarfed by the venture capital funds in the US, with $700 billion under management, which is around 4% of their total assets under management. It is also dwarfed by the EU, which has venture capital assets in excess of $220 billion. The EU venture capital industry is growing rapidly with the support of European Investment Fund programmes. We desperately need real investment institutions—venture capital firms—similar to those in the US and the EU.
Of course, the Government have promoted the National Wealth Fund as a source of real investment in Britain, but even here there is a lack of radical new direction. Companies applying to the National Wealth Fund for the sort of scale-up funding required by the fintech firms I mentioned earlier are typically asked to show evidence of the value of their endeavour by securing private funding first. Note the wonderful paradox: the National Wealth Fund has been established because private funding has failed to do the job, and its investment decisions are dependent on the decisions of the private funders that have failed to do the job. Without major institutional change that directs financial flows toward real investment, the search for growth will be in vain.
What sort of change do I have in mind? What would I propose as a radical alternative? Regulators today require banks to hold specific proportions of their balance sheets in a defined mixture of instruments designed to maintain necessary regulatory capital and necessary liquidity. In the jargon of the day, it is mandatory. Why not add to these requirements the condition that, to secure a banking licence in the UK, a tiny proportion of the bank’s assets should be committed to venture capital, either through an entity of its own or through an approved venture capital entity? Even this tiny commitment would transform the flow of funds into venture capital investment in this country, and indeed would transform the culture of UK finance. This is certainly a radical suggestion but, without radical institutional reform, it is difficult to envisage the financial services sector playing the dynamic part that is required of it in Britain’s economic renaissance. Clarity and culture change are required.
Lord Lilley (Con)
My Lords, it has been a great pleasure and privilege to serve on this committee, not just because I have served under the distinguished and stimulating chairmanship first of my noble friend Lord Forsyth and now of my noble friend Lady Noakes but because of the calibre of the committee. None of the committees I have ever served on, in this or the other House, has assembled so much expertise. Indeed, I shocked my wife by pointing out that I had the least expertise of anybody on the committee. She thought for a moment that I was becoming modest, but it actually is true. This reflects the high level of expertise of everybody else, including the noble Lord, Lord Eatwell, who actually has expertise of having been a regulator as well as having worked, as many of us have, in the financial sector.
The only benefit of delaying this debate, from when the report was committed until now, is that it falls in the week when we celebrate the 250th anniversary of the publication of The Wealth of Nations by Adam Smith. This gives me an opportunity to try to bring to bear some of the insights he brought to this issue of regulation. Above all, he was famous for saying:
“It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest”.
Of course, competition ensures that businesspeople, in pursuing their self-interest, must satisfy the desires of their customers efficiently.
Self-interest is not our only motive, but it is the strongest, and it is the strongest for all of us, not just those working within business—and that includes regulators. That is why we should recognise that regulators regulate in the interest of regulators, and that interest does not necessarily and always coincide with promoting the growth of either the financial sector that they are regulating or the economy as a whole and its competitiveness, which of course are new secondary objectives. Because of the relative absence of competition between regulators—although there is of course competition between the regulators of different countries, as pointed out by previous speakers—we are tasked, as a committee, with ensuring that the regulators in this sector try to pursue the objectives of promoting growth and competitiveness.
We found a number of symptoms of this factor that regulators regulate in the interest of regulators. For example, time can be of the essence for any company setting up, appointing new management or undertaking some new activity for which it requires approval, but time is much less pressing for regulators. There were complaints that regulators take an inordinate time to approve, for example, board appointments and even appointments of people who have been approved for other financial services companies and are active there. The regulators get around time limits that have been imposed on them for concluding their appointments or approvals by restarting the clock whenever they seek new information.
I have a second example. Other people complain that regulators refuse to answer “what if” questions from people being regulated: “What would happen if I did such and such?” But regulators should not see their task as simply deterring or punishing companies for breaching the rules. They should help them actively comply and tailor their business to make sure that it is legitimate.
Thirdly, we were told that in Singapore the regulators offer a sort of concierge service, as it is called, particularly to companies newly entering the market and those newly entering Singapore itself and unfamiliar with its rules and regulations. In the past there seems to have been a reluctance for our regulators to add that role of helping people to the role of telling them what they cannot do.
Fourthly, we had some rather confused discussions with the FCA about its request that the Government should define the appropriate appetite for risk. Many of us thought that it was for individual investors to decide what risks they were prepared to take with their money. Of course, financial advisers need to make sure that investors whom they are advising do not unwittingly take risks that they could not absorb, and the adviser should tailor their advice to the reasonable risk appetite of those they are advising. But it emerged that the regulators meant that they were worried about the risks to themselves, since the regulator would be blamed if any companies failed or defrauded investors. It seems that they wanted some quota of companies that would be allowed to fail or not be properly regulated and carry out frauds. That was their idea of a risk appetite, rather than the risk appetite of the investor.
For a similar reason, regulators—not just in the financial sector—put too great an emphasis on box-ticking. They are conscious that if something goes wrong, questions will be asked about how assiduous the regulator has been. So the regulator needs to be able to show that it has at least ticked all the boxes, made companies go through all the formal checks et cetera, even if those procedures rarely prevent wrongdoing or financial mismanagement. Ideally, regulators should allocate most effort to supervising companies that are the greatest cause of concern. When I was a financial analyst, we were always aware of some of the symptoms of companies that should be a cause of concern—late accounts, constant changes of accountants or lawyers, dodgy people on the board and so on. It is these to which the regulators should devote most of their attention.
An unusual feature of financial regulation is that since Brexit the regulators have had the task of setting regulations as well as administering them. They have had to review the body of regulation inherited from the EU, at the very least adapting it to make it work where they—the FCA and the PRA, rather than the EU—are now the ultimate regulators, but also revising it to fit the UK’s needs now that we are free to do so.
So far, there have been only relatively modest changes. Why is that? Partly, I think it reflects bureaucratic inertia: people are always happy with the status quo. More significant is that even companies that implemented EU regulations reluctantly and at great cost are not keen on changing it, even to make it simpler, especially if those companies recognise that the more burdensome the regulations, the greater the barrier they are to the entry of new competitors.
Despite there being only modest changes so far to the rules that we inherited from the EU, industry values the changes that have been made and seems to have lobbied successfully to be excluded from the reset of our relationship with the European single market, which is currently going on. The financial sector seems to have no desire to return to EU rules, still less to accept dynamic alignment in future without even having a vote on it. Indeed, the Chancellor herself is implicitly willing to diverge further where it helps and has called on the regulators to seek ways to change the regulations to make them encourage growth and competitiveness.
I recommend that the Government go back to the ministerial briefs that were prepared when these directives and regulations were first negotiated. I had to negotiate some from the very first in the single market, the second banking directive and so on. I cannot remember a brief that did not begin, “We don’t want this directive, Minister, but we can’t avoid it so let’s try to seek some of the following list of amendments to improve it”. If we went back to those briefs, we would find a good working idea of changes that might be needed to make those directives simpler, less burdensome, more appropriate and more growth and competitiveness promoting.
The final point that I want to make echoes that made by the noble Lord, Lord Eatwell. It became known as the Eatwell thesis and I was its seconder in the committee. It is that the impact on the economy—the growth of the whole economy, not just the financial sector—depends on the amount of lending by banks and investment of the nation’s savings by financial institutions that goes into the creation of new assets, not just the purchase of secondary assets. Sadly, in this country the total volume of lending has not recovered to the previous level since the great financial crisis of 2008, unlike in the United States where, after a couple of years of delay, it returned to that rate of growth. We received conflicting evidence about why this may be. Some said that it is simply that the United States is different from us and the rest of Europe because it has the tech giants and that stimulates the economy and demand for lending. That may be part of the reason, but others said that US banks, especially regional banks, have been regulated with less onerous demands for new capital, which means that they are freer to increase the amount of lending to the real economy. That is a crucial issue, to which we need to return and make sure that, if it is true, we increase the amount of lending that meets the Eatwell criterion.
Baroness Bennett of Manor Castle (GP)
My Lords, in following the noble Lord, Lord Lilley, I thank him for giving me the opportunity to reflect on the life of Adam Smith. The noble Lord said that Adam Smith wrote that it was not benevolence that ensured that he got his dinner. I point the noble Lord to a book by the Swedish feminist writer Katrine Marçal, Who Cooked Adam Smith’s Dinner? Through all his life, not just when he was a child but including when he was writing The Wealth of Nations, the answer was his mother. The benevolence of his mother kept Adam Smith fed all through her life. Perhaps we should think a bit more about benevolence and caring and those aspects of our society. The inability to see that is, of course, one of the great faults of our current mainstream economics.
I thank the noble Baroness, Lady Noakes, for her clear introduction and I thank her and her committee for their labours, even though I come at the issues covered in this report largely from a different perspective, one that is not represented in the report, although it is widely represented in civil society by organisations such as Positive Money, the Finance Innovation Lab, Transparency International and Spotlight on Corruption. While the noble Lord, Lord Vaux, and I often agree, I have respectfully to disagree with his statement that we all want to see lighter-touch regulation. I do not agree with that statement. I will, however, commend the noble Lord, Lord Eatwell, for raising concerns about the engines of systemic collapse that we face and his commitment to radical institutional reform that is so urgently needed.
In response to the noble Baroness, Lady Mayo, who asked whether in the future the economy will be bigger, smaller or the same, I think that there is a far more important question than that. Will the economy—our financial systems, enterprises and activities on these islands—be able to feed us, house us and not threaten the security and stability of our society and state or those of other states on this single, fragile planet on which we all depend? Will the financial sector be harming or threatening us or supporting our well-being and survival?
It is notable that I am one of few speakers in this debate who does not have to declare financial interests or a past record of working in the financial sector. That is a grave pity. I address this comment to noble Lords who are not in the Committee today but perhaps are reading Hansard tomorrow. It is far too important to the state of our country—to the issues of poverty, inequality, housing and food security, which I will come back to—for these issues of financial regulation to be left only to insiders. These are crucial issues for all of society and we need far broader perspectives on them.
On those broader perspectives, during the passage of the now enacted Financial Services and Markets Bill, I spoke at Second Reading, in Committee and on Report against the inclusion of a competitiveness and growth objective for the Financial Conduct Authority and the Prudential Regulation Authority. In its report, the committee focuses on
“the progress made in driving the regulators”—
the word “driving” is interesting—
“to support growth, both in the financial services sector and, crucially, in the wider UK economy … while maintaining the UK’s position as a global financial centre with a robust financial regulatory system”.
As I said at Second Reading, the final cause or aim—robust regulation—is essentially incompatible with growing the sector. Corruption and fraud are so enmeshed in the system that growing it inevitably means growing financial crime, and our regulatory approach is failing to address that. As I said in Committee, we should aim for a more secure financial sector that provides useful, effective and safe services to individuals and the real economy.
As organisations such as the International Monetary Fund have reported, there is an optimal size for a country’s financial sector, at which it provides the services that an economy and population need. Expansion beyond this size causes damage, increases inequality, boosts criminal behaviour and creates many other ills. Among those ills is what is broadly known as the London laundromat—the dirty and corrupt money of oligarchs and dictators that is being deposited, held and, all too often, washed here in London.
That is not in any of our interests. Nor is the level of risk in this age of shocks—geopolitical, climate, health and more. I note that the headline in today’s Financial Times:
“America has become an agent of chaos in world energy markets”.
And it is not just energy markets, of course. It is telling that, as the Evening Standard reports this week, the new Iranian leader of a theocratic, dictatorial, deadly-to-its-own-people regime, Mojtaba Khamenei, the successor to his father, Ali Khamenei, is said to own high-end Kensington properties through associates. They are apartments situated on the sixth and seventh floors of a building close to Kensington Palace and believed to be worth more than £50 million—although there are also servants’ quarters on the ground floor.
Regarding the current lack of regulation and the level of risk taking, a report in today’s Financial Times is headlined:
“Collapse of UK bridging loan specialist has sent reverberations across Wall St amid fears of weak underwriting standards”.
It refers to the refinancing merry-go-round of Market Financial Solutions, into which Barclays, Jefferies, Santander and many others put hundreds of millions of pounds before it suddenly collapsed last month amid allegations of fraud and double pledging of collateral, with creditors claiming a shortfall of £1.3 billion, and about £283 million unaccounted for.
My focus would be not, as in recommendation 1 from the committee, the cost of compliance but rather the costs and risks of non-compliance. These are practical costs and reputational costs, as the UK seeks to establish its place in a fast-changing, unstable geopolitical environment. I note in that context that the latest Corruption Perceptions Index from Transparency International shows that Britain has been slipping down the rankings since 2015. We were in seventh place then, and we are now in 20th place, with a score of 70 out of 100. That is a scoring of our financial regulation and how the outside world sees this.
Lest it be thought that I am picking just one example, I note that some other work by Transparency International identified a £40 million central London commercial property held by a company controlled by a trustee who is a member of a Singaporean money laundering gang serving time in jail, as well as £55 million-worth of commercial property owned by a former Malaysian Finance Minister via trusts—he died before a criminal trial into his wealth could take place.
I have identified areas in which I very much disagree with the committee, and I will now pick up some points with which I agree to some degree, particularly that made by the noble Lord, Lord Eatwell, and touched on by the noble Baroness, Lady Noakes: the failure of the financial sector to actually serve the real economy. I am drawing here particularly on excellent work by Positive Money and the figure that the noble Baroness, Lady Noakes, mentioned: only 6.6% of bank lending last year went towards productive investment in the real economy.
Baroness Bennett of Manor Castle (GP)
As I was saying, only 6.6% of bank lending last year went towards productive industries in the real economy— I am basing this on Positive Money. The group used the Bank of England’s annual money and credit statistics to find that net lending to productive industries increased by just £9 billion last year, compared with £52 billion for mortgages and £68 billion for the finance, insurance and real estate sectors.
To break that down, lending to electricity, gas and water industries made up more than half of the increase among all the productive industries. I have to slightly question the “productive” label, given that we know that the privatised water sector in particular has seen a huge amount of payments out in terms of dividends and fat-cat pay and has continued to be loaded down with debt. There is a question over how productive that actually is. Manufacturers and transportation firms did indeed see a small uptick in credit, which is encouraging, but lending to the wholesale and retail trade fell by £1.8 billion—a decline for the fourth year running. In these figures—this picks up points made by the noble Lord, Lord Eatwell—mortgages accounted for 57% of bank lending and the FIRE sectors for 28% of lending. We are seeing a real misallocation of resources if we come back to the questions with which I started: is the financial sector making sure that we can feed ourselves, house ourselves and be secure in a very uncertain world?
One of the other things that this is very much associated with, as Positive Money often draws attention to, is rising inequality. For people who own assets, this lending funds further increases in the price of those assets, while people without assets are left even further behind. In fact, it is interesting that mortgages are the only type of lending that has seen significant increases in outstanding credit since the last financial crisis. This is one of the main reasons why property prices have skyrocketed. It is of course very clearly interlinked with the housing crisis that is affecting so many millions of people.
I will conclude with a point that I do not believe anyone else has raised but that I think is important. It is about the importance of financial education, and I entirely agree with the committee in its recommendation on this. I note this with regard to the Department for Education, as there is now an independent curriculum review. This surely has to be part of that review in focusing on ensuring that our schools provide education for life, to help people to live rather than just for exams or just for jobs. I also agree with the recommendations— I think the Government broadly agreed too—that the Treasury must work with the FCA and the industry to support adult education about finance. There is a huge inequality of arms in the information that consumers have when they are faced with the financial sector.
The noble Lord, Lord Eatwell, raised the issue of cryptocurrencies. That is perhaps a particularly extreme area where we are seeing the targeting of younger people and people from minoritised communities, but, for everybody, many feel a real fear when confronted with having to deal with the financial sector, particularly online. Increasingly, of course, most dealings are online. This is something that stresses people out. They worry about being ripped off or about being the subject of fraud—of course, we are the global fraud capital. Giving the public—consumers—the tools to try to somewhat level the playing field with the financial sector is a crucial point on which I can entirely agree with the committee.
Lord Altrincham (Con)
I thank the Minister and my noble friend Lady Noakes for hosting this debate. I also thank the committee for the quite long inquiry it has done for us and for its report. The creation of the committee was an important outcome of the Financial Services and Markets Act, and this might be a moment to reflect on the importance of this committee in holding regulators to account, as well as its findings in this, its first report. It is particularly welcome that it uses its first report to look at the growth and competitiveness agenda because, if we remember, that was contentious during the passage of the Bill and, at the time, the regulators pushed back quite consistently. It is helpful for us to start with that aspect of the Act. Of course, things have changed because the Government themselves have made growth and competitiveness quite an important objective, so the Act fits with the Government’s own objective.
I greatly enjoyed reading the report, despite its enormous length. It attracted an exceptional cast of English characters—regulators, parliamentarians and civil servants—all of whom performed their role before the committee to perfection. In a way, the report reads like a play, each of these characters speaking their parts. We had the deputy governor of the Bank of England saying that the Bank would consult on MREL but that, on the whole, there should be only gradual change. The deputy governor for prudential regulation pointed out to the committee that it was unhelpful to compare the UK to other jurisdictions, that risk weightings did not affect credit into the economy and that the regulators’ overall risk position did not need to be changed but that there might be a need for a little— I had to check and it is at paragraph 338—“decluttering”. That is a lovely word from our central bank. That was the position of the regulators.
The committee heard from the former lord mayor, who said that we should look to Singapore. He reminded the committee that there were huge Asian markets. The former City Minister talked about the amount that regulation is preoccupied with net zero and diversity. The former Secretary to the Treasury talked about the FOS problem, which has not come up yet, but the City Minister at that time said that the FOS situation was going to be sorted out. It has not yet been sorted out, so we have a problem in car lending at the moment. So the regulators all said what might be expected and, from their feedback, you might expect no change.
The committee also heard from some quite senior bank executives. It heard a particularly good set of feedback from a retiring bank chairman, who had been a regulator himself. He said that the regulatory costs on banks were too high and that the cost of the ring-fence was too high. That was quite helpful feedback; he is retiring, so he says what he believes, and the ring-fence might be something that the committee will look at in the future.
The chief executive of the country’s largest building society pointed out that the leverage ratio restricts credit for him and for the amount of lending that it can do—no surprises there. The chairman of Aberdeen said that people should be investing more, perhaps with Aberdeen—perhaps there are no surprises there. The American insurance executive said, very helpfully, that the cost of regulation in the UK was higher than in any other of the hundred markets in which the company operated. That would obviously be disappointing for the regulators, but they had a friend because the executive from JP Morgan—a firm quite famous in London regulatory circles for the epic fiasco of the “London Whale” credit derivatives blow-up—said that the regulators were excellent and very professional. She had no problems with her regulators. More than that, in words surely her own, she said that the regulators could not be expected to look after the other 42,000 firms as well as they look after JP Morgan.
So we had very useful feedback and a good survey of where the regulation was a year ago. As we meet now, we might reflect on what has changed or what has happened since the publication of the report. To the credit of this committee, as well as the Government—but, for now, let us say that it is to the credit of this committee—quite a bit has changed. The MREL requirement was changed by September, in time for the letter from the Government to the noble Lord, Lord Forsyth, so there was change on MREL after all. The leverage ratio threshold—this is the amount of bank deposits when the threshold kicks in—moved from £50 billion to £70 billion in November. That directly addressed the question of the leverage ratio.
Then, as my noble friend Lady Noakes pointed out, the remarkable change is that the Bank cut the UK’s tier 1 capital ratio from 14% to 13%. This was the first cut since 2008 and it was an enormous change, because the Bank had not been very keen to do it and there was no hint that this was coming in any of the submissions that the committee heard. But the Bank’s tier 1 capital ratio was in fact changed.
As we meet now, it is remarkable to reflect that this committee, which was set up as required under the Financial Services Act to supervise the regulators, or rather to hold them to account, has raised issues on which there has been change. Some other issues have not been addressed yet; we mentioned the FOS, the car lending problem and the ring-fence problem, which, despite the Skeoch review, is still there and very expensive. Whether the ring-fence makes any difference is quite unknown; it is not even clear whether bail-inable capital in MREL makes any difference, but that is a discussion for another day.
Other issues are raised in the report, but the capital changes that the report has raised and then got changed mark an important moment and an achievement of this committee. That is to the credit of the committee and the Government. I thank the committee for its work, for the credit that extends into the UK economy following these changes, for looking into the cost of regulation and for holding powerful regulators to account.
Lord Pitt-Watson (Lab)
My Lords, I should start by declaring an interest. By background, I am an investor, but I teach a course and run a centre at Cambridge that focuses on the purpose of finance, thinking about what are the aspects of the finance industry that allow it to perform its purpose well. Of course, regulation is one of them. I am particularly struck that this committee has not fallen into the trap of “either it is a market or it is regulation”. Regulations are there to try to make markets work well so that customers know what there are getting, suppliers know what they are committing to and the public are protected.
The interesting thing about the secondary legislation on the PRA and the FCA is that that is what it is trying to get to. It is trying to get to: “We want to measure the regulator by how well the finance industry is performing its function of being able to lend to and support the British economy”. That seems a step forward. Of course, it is tricky to do this because it is not just regulation and it is not just markets. There are also institutions, infrastructure, professionalism, good will, incentives, technology, information, branding and ethics. We do not all agree on that, as we saw in the debate between the noble Baroness, Lady Bennett, and the noble Lord, Lord Lilley, about how all those things work. Regulation tends to be rather rigid, whereas all the other factors—technology, for example—are changing quite quickly. Professionalism is something that changes depending on the circumstances to which it is addressing itself.
We used to have lots of self-regulation, which, of course, Adam Smith was very much against, and that has now changed to more and more government regulation. I think it was Andy Haldane who noted that in 1980 there was one regulator for every 11,000 people in the finance industry and, by 2011, that had changed to one for every 300. By the way, that is for every regulator—there are however many people in compliance. I rather like Robin Ellison. He is a senior pensions lawyer at Pinsent Mason who said that there were 3,000 pages of pensions regulation in 1990 and that, last year, there were 180,000 pages, which is three to 180.
We have been playing a sort of regulatory whack-a-mole. Whenever anything goes wrong, we put in another regulation. We built this Jenga tower of regulation. Sometimes you can take a block out of the tower when you play the game of Jenga, but sometimes, if you take too many blocks out, the whole tower collapses. I also worry that, if there is too much regulation, you leave the professionalism of the industry behind because people will say that, if it is not in the regulations, they can do it, and that is not a good way of thinking about how you run a finance industry. I think it was Laozi, the Chinese philosopher, who said more rules and regulations, more thieves and robbers.
That is why the secondary objectives are interesting: they are trying to focus back on what is the purpose of this industry, and the purpose of this industry is to serve the outside economy. It seems to me that this is not in the gift of the regulator, nor, to be honest, do we really understand the relationship between the finance industry and the growth in an economy or the role of the regulator in creating a successful finance industry. It is a great idea to have as many international comparators as we possibly can, but when you lack that sort of information it is awfully difficult to know where you are going.
It would be great to have someone who would tell you the risk appetite. I think it was twice in October 2008 that the move on the New York Stock Exchange was something that, according to the risk models, would have happened only once in the history of the world. Indeed, I think in one case it was once in the history of the universe. Unfortunately, there we were in October 2008. So, I think we need to be a little bit careful. I even wonder whether we should be cutting the Government a bit of slack so that they do not give us quick answers now, but give us proper answers long- term on how we are going to make this work.
On the points that have been made about primary investment, for example—the Eatwell criterion—I hate to have the regulators asking more questions, but surely we need to know where this money that is protected is going.
We need some definitions. I think there are definitions of the things we want the finance industry to do. Here are some basic ones: we need someone to keep our money safe; we need someone to help us transact; we need to be able to share risks; and, critically, we need to be able to take money from point A, where it is, and invest it in point B, where it is needed. If we look at the academic studies of how much the finance industry has improved in taking money from point A, where it is, to point B, where it is needed, over the past 80 years and how much the cost of doing that has gone down, the answer is very little indeed.
If the finance industry depends on trust, we have a huge problem. Ten years ago, the Bank of England— I think it was—did a study of British people to find one word that described their feelings about the direction of the finance industry. They chose “corrupt”. If we want companies to invest, they need to be convinced that the finance industry will not do to them what happened after the global financial crisis, where, as we all know, small and medium-sized companies were extremely badly treated.
What we have got is regulation on regulation. Some 42% of the fines issued to companies were to people in the finance industry, which is 9% of GDP. Yet, if we could get this right, the prize would be huge. In 2023, NatWest was involved in the issuance of £83 billion of green bonds. That outscales anything that the Government are doing. However, it needs to be the whole system. I am concerned that all our banks are targeting a return on equity above 15%. That surely is restricting the amount of money that will be available to the real economy.
As the noble Lord, Lord Kestenbaum, said, none of this will work if we have a standoff in trust between the regulator and the people who are trying to provide these services. I have one simple example. It is really difficult to open a bank account in Britain. I do not know whether noble Lords have tried it. If you ask the bank why this is, it will say, “Oh, we have all these regulations about knowing your customer, and we have those because we’re trying to stop money laundering”. That sounds fine, but in Bangladesh, if you have 10 taka—10 pence—you can open a bank account. I was talking to the governor of the Bank of Bangladesh and asked him how they manage to stop money launderers opening accounts. He said, “David, I don’t know too many successful money launderers who have only 10 pence in their account. Obviously, if somebody puts £10,000 through, we will do something about it”.
I note that there are folk within the finance industry who are trying to respond to all this. For example, Scottish Financial Enterprise under Sandy Begbie says that it will offer basic financial services to all those who want such services, and that this will include financial education and financial literacy materials. I wonder whether there is a regulator who is saying thank you, and a regulator who is keeping tabs on whether that happens.
I will finish optimistically, if I may. I talked about fines in the UK. One bank in America has been fined four times more than the entire British finance industry during the same period. Frankly, the regulation of finance in America is now felt by many to be very erratic indeed. In the European Union, the regulation feels suffocating, particularly on information. Surely this is an opportunity for the UK to do something to have an industry that fulfils its purpose well and is competitive as a result.
Let us not try to rush at this. I see that the Government have said that they want to embed these new secondary obligations and base them on independent evidence of how the financial services industry best serves the economy. That seems like a good thing that we should be pushing, not just as a destination but as a journey. Laozi’s most famous quote is:
“A journey of a thousand miles begins with a single step”.
We are already well along the journey, and the committee has done a wonderful job of taking us a few miles further. I look forward to this debate continuing, with reform appropriately administered by our regulators as we look to the future.
Lord Johnson of Lainston (Con)
My Lords, I shall first declare my interests. I am on the board of a crypto data business and have investments in companies regulated by the FCA and the PRA. More usefully for this debate, I ran a regulated asset management firm for 15 years, a job that I enjoyed greatly at the beginning, when I was able to offer my investors from all over the world a fabulous and, for us, very profitable service, but, by the end of my time, I became dominated by compliance with absurd rules designed by people with limited to no knowledge of the financial services sector who have caused untold damage to the lives of our citizens, all under the guise of a misunderstood notion of risk reduction and consumer safety.
That is why the debate today is so important, and I congratulate the members of the committee for writing one of the best reports from the House of Lords that I have ever read. I am delighted that, as the noble Lord, Lord Altrincham, suggested, some effect has been achieved, something has been done. The growth mandate, which is the main focus of the report, which I supported, by the way, as a Minister for Investment, was fought by everyone in the system who I met. I think even the noble Lord, Lord Hill, was cautious about the opportunity, sadly. It was felt that it would create untold risks, that it would distract the regulators from their task of ensuring that the consumer is treated properly and that it was not appropriate—that dreaded word. However, the people in charge should be focusing on the growth requirement every waking minute; that is their purpose. Finance is only about growth.
Of course, we need regulations and registrations for the market to function. The noble Lord, Lord Eatwell, gave some exceptionally good explanations around that. The rest is the hard bit, and it is the bit that the leadership of the FCA, the PRA, the Bank of England and, to some extent, the Government, are dodging, as the report clearly demonstrates.
Imagine an FCA that was judged by how many new firms came here from abroad to set up. The noble Baroness, Lady Moyo, gave examples of banks that have withdrawn from this market. I ask noble Lords to consider, if I may call on their imaginations, a regulator that acts as a service to business rather than a hindrance. When I set up my office in Singapore, how did the MAS, the Monetary Authority of Singapore, treat us? Did it ask for endless forms to be completed or say that it could not say how long our application would take to process but maybe six months, or a year? No. It sent two delightful people to our office in London. They helped us to navigate the documentation. They even suggested schools for the children of the staff moving out there and offered, unbelievably, some funds to manage from the Singapore Government. Can anyone here seriously think that the FCA or the PRA would do anything like that? It is a shame that they would not.
This report also shows something extremely worrying, which is that they have created a culture of fear. Firms, like some poor downtrodden citizen of a dictatorship, asked to be anonymous when discussing issues with the committee. They are frightened that if they criticise these people, they will be given some type of regulatory punishment beating. I cannot remember whether it was the noble Lord, Lord Vaux, who made that astonishing comment—today, in this country. In my view, this is unacceptable and shameful. From this House, I demand an answer to this awful culture that these people have created. I ask them to note that we are not frightened of them, and that they work for us.
Let me turn to some of the specifics of their failures. By the way, we in this House must share the blame, as should my own party, which presided over so much of this damaging nonsense. The idea that no one can die and no one can lose money is what destroys civilisations. My first point is MiFID, which was a UK, not a European, idea. We tried to blame the Europeans, but it came from this country; it came from the FCA or its predecessor. It was thought of by people with no knowledge of how research is generated or paid for or its vital importance to the market. They felt that companies were charging too much, as if that is something that a Government should question. We want companies to make money so long as the market is competitive, since the market sets the price. I know that it is a bizarre and outdated idea. Adam Smith’s 250-year anniversary seems to have been forgotten—but not, I am pleased to say, by the noble Lord, Lord Lilley; I am not sure that his dinner will be cooked by anyone at this rate. MiFID destroyed the small cap market. For those listening from the regulators—I bet no one is, by the way—that means that small companies cannot get coverage from brokers, so they cannot raise money. So we cannot grow our businesses, and they have to go abroad for capital. Does that sound familiar?
RDR is the next atrocity. This onerous regime governing advice that can be given to individuals is now so complicated and expensive that millions cannot afford to receive proper advice. The effect is that many people have no idea what to do, so either do not save or drift into non-regulated areas such as cryptocurrencies.
Not separating retail investors from institutional investors was covered well by the report. By our not properly separating these two regimes, specialist firms—which through their number and size reduce, not increase, risks to the system—cannot make their products easily available to other institutions and face the same burdens as a multinational bank.
The senior managers regime is a sclerotic absurdity designed to make us feel good about ourselves but merely discourages companies from managing their staff in a flexible and timely fashion. It thus increases risks for the system, because they cannot get the right people in the right places.
Banking regulation has been well covered in the debate. Through the fear of mis-lending, we have now prevented banks lending to businesses, especially domestic banks. This lack of capital has severely hurt our economy, stopped people getting mortgages and created a far larger unregulated credit market that could blow up at any time. I am sure that the officials who run the PRA and FCA say, like Captain Smith of the “Titanic”, “But no one ever thanked us for the icebergs we missed”, but they are creating an ever-bigger berg into which we will crash unless something is done. All Labour needs to do is tweak these requirements for capital, as we have heard, to make them sensible. It would create untold economic growth—that is my gift to the Minister, if he wishes to receive it.
Another terrible act, which I am afraid was probably thought of by some of my colleagues in the Conservative Party, is the concept of consumer duty. That too was well covered in the report, but I do not believe it has been discussed today. It is truly the worst of all—a tortuous process where a company has to work out how a user many parts down a chain may be advantaged or disadvantaged by a product or service. Every firm I know already has such a duty embedded in its mandate; it is how business works. But these days we love holding everyone to account so that blame can be apportioned if something goes wrong.
The problem is that things change—or, in another phrase, go wrong. Capital needs to be reallocated to the highest point of return for humans to progress—that is the beauty of life—and trying to prevent that is truly selfish and foolhardy. After all, that is what diversification is for: it is what risk and return are, which seems to elude the regulatory environment and the people creating these rules.
People, by the way—this is the kicker as I come to a conclusion—are also, and should be, responsible for making their own decisions. Things such as the consumer duty will remove further from the citizen good savings products and advice. The compliance costs will increase, reducing profitability for the sector and capital for growing companies. Documentation will increase in size and complexity, yet again befuddling us all, who now just click “yes” to everything. Dangerously, people will think they are protected from losing money or their house simply because of the size of the disclaimer that they have clicked, so they will act with less caution and rationality, spelling worse crises than before.
I am afraid to say that the fact is we have unsuitable people running these organisations. I have been specific in not naming anyone because I do not think that is fair. Ultimately they are civil servants—for whom I have the greatest respect. But they have no real experience —or any experience at all, actually—of running financial services firms, and their priorities are not growth but, in my mind, their own convenience and self-justification. We have seen examples of that in their responses to this report.
We in the UK are in an emergency. Unless the Government, we in this House and most especially the regulators take note of the importance of the growth mandate, we will drift further from being a middle power to becoming an emerging one, poor and defenceless. It is an unkind thing to do to us. So I ask the regulators responsible to wake up today. I am afraid I ask them to replace their leadership; I know that is a strong expectation and unlikely to happen, but it is essential that the responsibility borne by these individuals for the acts that they have committed is made clear. I ask them to correct their course of action and focus on growth and, importantly, how to serve the businesses in the same way the MAS serves the financial sector in Singapore. We forget the amazing people who work in these organisations. We need to regulate to make the financial services industry in the UK not contained, small or limited but the greatest in the world. That is why I commend this excellent report to the House.
Baroness Kramer (LD)
My Lords, I come from a different perspective from many of the people who have spoken today, because I am approaching this debate from the perspective of spending nearly two years on the Parliamentary Commission on Banking Standards following the financial crash of 2008, which was due to credit and derivative manipulation, much of it either deliberate or, frankly, due to people casting a blind eye. That was at the same time as the Libor scandal, which probably took away from creditors across the world something in excess of a quadrillion dollars through 10 years of consistent lying to the setting of the benchmark, and, frankly, at a time when mis-selling to individuals was on an industrial scale.
I quote from the final report from that committee:
“Policy-makers in most areas of supervision and regulation need to work out what is best for the UK, not the lowest common denominator of what can most easily be agreed internationally. There is nothing inherently optimal about an international level playing field in regulation. There may be significant benefits to the UK as a financial centre from demonstrating that it can establish and adhere to standards significantly above the international minimum”.
In taking evidence from those involved in causing the crash and knowingly manipulating Libor, it was consistently apparent that outperforming international competitors and generating higher profits were the two core motives, and these motives look very much like the secondary international competitiveness and growth objective.
In that context, the work of the Financial Services Regulation Committee is crucial, especially as, post-Brexit, the Conservative Government chose to transfer virtually all meaningful control of the financial sectors to the regulators by embedding that control in regulation and guidance, neither of which can be amended by Parliament. I am a strong supporter of the FSRC but I want to make sure that it understands where and why all this began.
The report that we have received reflects ongoing tensions between financial stability and an industry and some politicians who want the leash off. I completely understand the frustration with undue complexity and uncertainty of regulation—that helps no one. I also understand the need to reflect the different characteristics of different entities in regulation, and some of the discussion around MREL has addressed that. I am convinced that parts of our regulators are often slow to respond. I want to make the point that regulation is not cast in stone, but improving and customising regulation should not be a shorthand for deregulation.
I read in evidence to the FSRC that deregulation is the industry agenda—and the tool for its attack is the secondary objective.
Let us look at the risk that has been reintroduced into the financial system under the secondary objective rubric. I will give a few examples, as did the noble Lord, Lord Altrincham: the PRA’s easing of bank capital requirements; the undermining of the ring-fencing regime—there is a consultation in place but undoubtedly this will be a consequence; removal of the bankers’ bonus cap; significant limiting of the senior managers and certification regime—I am especially exercised by the removal of individual accountability; the reduction in the risk margin for insurance companies and the expansion of matching adjustment eligibility to cover highly illiquid assets; and the Mansion House Accord to put 10% of the pensions of low-income people and workers into high-risk, illiquid assets without their consent. With these changes, we see the industry, and this includes the banks, release its animal spirits—exactly what everybody wanted—and they have galloped, at quite some speed, into the private equity markets, often with little understanding of the assets.
There have been numerous red flags. On 6 March, BlackRock finally limited redemption of private credit funds as outflows continued to swell. Today, JP Morgan is marking down the loan portfolios of private credit groups. Most of this happened before the Iran war. It will accelerate with the Iran war, and in a way, which is incredibly sad, one of the side effects—perhaps we ought to regard it as beneficial but I do not want a war to create this—is that it may burst a bubble before it gets even more out of control.
While I can see the return to a much-increased level of risk, I cannot see the return to growth in either the financial sector or the broader economy. That is what is supposed to follow—you deregulate, the growth comes —but I cannot find that growth. We gave away our utter dominance of the European financial sector with Brexit, not in one step but salami slice by salami slice. The effect is somewhat masked because people always compare us with individual financial centres across the EU, which is of course functioning as a network of multiple financial centres, so we do not see how our competitive position has diminished very significantly. I am truly anxious that in June 2028 the EU will reduce its recognition of UK central counterparties because by then it will have achieved much of its own clearing capacity, and so much high-level finance co-locates with CCPs. You cannot deregulate your way out of a fundamental issue like that.
Frankly, we cannot deal with our biggest problems through deregulation. Financing scale-ups will not happen because we have made some kind of regulatory change to financial institutions; the problem we are dealing with here is one of huge market failure. In a sense, this picks up a point made by the noble Lord, Lord Eatwell. There is no point kidding ourselves that we can fuss with regulation and deliver the money that is needed for scale-up.
Neither do any of the rule changes suggest that we can cure our other fundamental problem: our lack of a layer of community banks, which were once the Captain Mainwarings of this world—the backbone of finance for local, small businesses. I do not mean those which intend to be unicorns but those which want to grow just a little faster than organically, which are the backbone of our local communities and economy. Dealing with these market failures goes way beyond fiddling with the risk weightings of banks’ capital holdings. That is regulatory intervention already.
The noble Lord, Lord Eatwell, mentioned that added to banking licences could be a requirement that banks fund some money for VCs. I have long argued—it has never got anywhere—that we ought to attach to banking licences a requirement that major banks fund people who can deliver that community banking profile. Exactly that happened in the United States under the Community Reinvestment Act, which has grown a community sector that, today, is the complete backbone of small businesses and the US economy. When I last looked at that sector, which was zero in 1970, it had something in excess of $300 billion in loan assets to small businesses. It is absolutely critical and it has been used by US Presidents to make sure that the US was able to survive two major economic crises.
The report asserts that
“regulators have made progress in advancing the secondary objective”.
I can see where they have advanced the objective of deregulation, but I cannot see the growth. We are pulling on a lever to create growth that does not really work. Professor Kern Alexander said to the FSRC:
“The gap we have is that, in many countries where they have been using secondary objectives for 25 or 30 years, there is no policy conclusion about whether they work, how they are applied or how the secondary objectives are defined”.
Of course it is right that Parliament and the FSRC scrutinise and question the regulators on their performance but, if we think that the answer to growth in the real economy is deregulation, we are looking in the wrong place. Its impact is marginal at best; when it is handled badly, it is a recipe for a cycle of crises. Regulation is a financial stability and anti-abuse tool. When we seek growth, as we should, we need to find other, real levers: investment, skills and productivity—to name but three.
Baroness Neville-Rolfe (Con)
My Lords, I thank my noble friend Lady Noakes for her typically clear and telling introduction as the new chair of the committee, my noble friend Lord Forsyth of Drumlean—now our distinguished Lord Speaker and the masterful previous chair—and other members and the staff of the Financial Services Regulation Committee for their work. The committee has done a great job; it tackled a very important question, which hangs over one of the great problems we face at the moment: the sluggishness of economic growth since the financial crisis, exacerbated by the present Government’s actions on employment, tax and energy.
How did we get here? We got here by a predictable overreaction to the financial crisis of 2008 and by the failure of many to recognise that regulation itself has a cost, particularly in compliance. The more of it there is, the greater the cost.
Moreover, the costs of regulatory failure, which the noble Baroness, Lady Bennett of Manor Castle, concentrated on, are more obvious than the costs of regulatory overreach. The former leads to people losing money in criminal or near-criminal enterprises, while the latter leads to lost opportunities and competitiveness, and is much less visible. The noble Baroness, Lady Moyo, gave a telling example from her experience of Barclays’ departure from its international businesses, and the noble Lord, Lord Eatwell, described the shift of fintech finance to US venture capital.
The performance of the UK financial sector since the financial crisis suggests that excess caution may be even more costly over time. It is likely that the country has paid a high price over the last 15 years for overregulation of the financial sector, so let us hope that my noble friend Lord Hill of Oareford is right in saying that the secondary objective is improving things. It was introduced by the last Government, and I am grateful to my noble friend Lord Johnson for helping us to make it a reality. The noble Baroness, Lady Kramer, came from a different perspective, but there is quite a lot of common ground on things like complexity, uncertainty and the lack of parliamentary scrutiny, and the fact of absent growth.
That brings me on to the role of the FCA, the PRA and the Financial Ombudsman. The report makes uncomfortable reading for these organisations. The truth is that, while the first job of a regulator is to protect consumers, that is insufficient. If they act as a break on innovation and growth, as they appear to have done, their net contribution to national life is much reduced and could even be negative.
The problems identified in the report are numerous, and the committee has done well to cover so many, although perhaps it would have had even more impact with a shorter report. I commend the then Minister Emma Reynolds MP, now transported to higher things, for the five-point summary of objectives in her letter to my noble friend Lord Forsyth of 2 September. However, she missed out two essential objectives for UK growth: reducing regulation, bureaucracy and the attendant compliance costs, and improving and prioritising financial education.
Because of the length of the report, I shall limit myself to three areas. I begin with the regulatory culture. What emerges clearly from the report is the existence of a damaging “culture of risk aversion” within the UK financial regulators. I note that the findings of the Fingleton report on nuclear regulation were very similar. We have identified a pernicious trend.
The noble Lord, Lord Kestenbaum, provided some telling examples, showing the need for culture transformation and mentioning the concerning difference in candour between private and public hearings—a point also picked up by my noble friend Lord Johnson of Lainston.
In the years since the financial crisis, the regulatory framework has increasingly tilted towards the prevention of risk at almost any cost. While the intention behind this shift is understandable, the report suggests that it has had significant consequences for how regulation operates in practice. That culture of caution has shaped regulatory behaviours in ways that translate into tangible duties and processes for firms.
Firms describe being inundated with extensive information requests from regulators. Regulators themselves are said to adopt highly cautious approaches to approvals and supervisory decisions. Perhaps most concerningly, the report suggests that the environment has begun to erode trust between regulators and the firms that they supervise. The noble Lord, Lord Pitt-Watson, introduced a wonderful new concept of building a Jenga tower of regulation. He reminded us of the cost of regulatory whack-a-mole and the huge difficulty in opening a bank account in the UK; I have also had experience of this. All of this creates a relationship that is defensive rather than collaborative. Something needs to be done.
The second area that I will therefore address is complexity. The complexity of the regulatory system has developed as a result of the broader culture. It is telling that financial services represent such a large component of GDP—9%, or more if you add legal and other related services—but, as we have heard, their contribution to output and productivity growth has fallen behind the rest of the economy. This growth-sapping complexity has to change.
We have spoken about the “twin peaks” system covering the FCA and the PRA, but there are many other bodies, all with their own acronyms, forming the regulatory landscape that firms have to navigate. We have the Financial Ombudsman Service, the Financial Services Compensation Scheme, the Competition and Markets Authority, the Payment Systems Regulator, the Information Commissioner’s Office and the Financial Reporting Council. All these organisations constantly try to prove the need for their existence, so the report’s finding that there is extensive regulatory overlap is not a surprise.
This is in stark contrast to the helpful concierge service operated in Singapore, which my noble friend Lord Lilley referenced and which my noble friend Lord Johnson has enjoyed. My noble friend Lord Lilley also told us how US banks were freer than UK banks to increase their lending to the real economy. We heard from my noble friend Lord Altrincham that the CEO of Marsh McLennan UK said that UK regulation is the “most expensive” in his wide experience—that was worrying. This has had a marked effect on firms already operating in the UK, which are required to direct capital away from productive investment into filling out forms, sifting through regulations, communicating to these organisations and so on. They are also worried about getting the blame for failure, as my noble friend Lord Lilley emphasised.
The other effect, which is harder to measure, is the chilling effect that this has had on international investment in the UK. Firms operating around the world take one look at the web of regulations and take their business elsewhere. The economy grew by just 0.1% in the final quarter of 2025, and across the whole of 2025 it expanded by 1.3%. The OBR has lowered its 2026 growth forecast to an anaemic 1.1%, as the noble Baroness, Lady Moyo, said. To say that this is growth in any meaningful sense is laughable. Growth must be an important priority for regulators, and the report provides the Government with some useful suggestions: reduce regulatory overlap, strive properly to understand the burden regulation imposes on business and perhaps help them, improve the spread of authorisation processes, and provide simpler rules for smaller domestic banks. My noble friend Lady Noakes was right to point out that the Basel rules applied across the UK are aimed at international banks, so small and medium-sized banks have a hard time here. I know this because I served as a director of Secure Trust Bank, and I therefore welcome the cut in tier 1 capital in December last year from 14% to 13%—that is a good development.
My third area is financial literacy and education. The committee expresses real concern about the chronically low levels of financial literacy and numeracy among adults in the UK. The consequences of this are far-reaching. Too many people lack confidence in financial markets. Many shy away from investing and, as a result, savings often remain concentrated in low-yield products. That means that neither they as savers nor our wider economy benefit from the sort of capital that could be unlocked if people were more confident in investing their money. Traditional advice is often too expensive, and guidance is not always available. Those who stand to gain the most from it are frequently the least able to obtain it and indeed are fearful of financial products—the noble Baroness, Lady Bennett, and I come together on this recommendation, albeit from different perspectives. If we are serious about building a stronger investment culture, financial education cannot begin when people first open a pension or savings account. It must begin in our primary schools. By embedding financial literacy in schools and universities, we can equip future generations with the confidence they need to invest wisely.
There seems to be a degree of agreement that the mandation powers in the Pension Schemes Bill, which could be used from 2030, will have a chilling effect. They could harm growth and deter investment, especially from overseas. As the Official Opposition, we believe that that should be abandoned when the Bill comes to Report next week.
I have a number of questions for the Minister, which go beyond the excellent questions from my noble friend Lady Noakes and the noble Lord, Lord Eatwell, although I am less sure about his idea of a new kind of mandation in respect of venture capital—or indeed about the version of the noble Baroness, Lady Kramer, which would be the mandation of a community element. That would mean new rules and new additions to the Jenga tower.
My questions to the Minister are the following. First, it is encouraging to note that the Government appear to acknowledge that regulation of the financial sector has gone too far. Will the Government continue to press for change in the direction advised by the committee? Secondly, will the PRA be asked to consider setting bank capital requirements for SME banks in a more proportionate way, rather than slavishly following Basel III? Thirdly, what concrete steps will the Government take to improve the competitiveness of the City of London, compared to centres such as New York, Milan and Singapore? Fourthly, will the Government think again about benchmarking—perhaps even a one-off benchmarking report—to look at our performance against our competitors overseas? The noble Lord, Lord Vaux, talked about that. It may be difficult, but it must be done, given that competitiveness is a key part of the secondary objective.
The UK faces a real and pressing challenge when it comes to economic growth. Growth, we are told, will be the central pillar of this Government’s economic strategy in the years ahead, and I have welcomed that on many occasions. Although their achievements so far have been disappointing, I encourage them not to give up but to try harder, especially in the financial services sector, which has contributed so much to growth historically. I very much hope that the Government will look carefully at the suggestions contained in this powerful report, and at the further suggestions made today, as they develop their fiscal and economic strategy.
Lord in Waiting/Government Whip (Lord Wilson of Sedgefield) (Lab)
My Lords, I am grateful to the noble Baroness, Lady Noakes, for introducing this report and to the noble Lord, Lord Forsyth, the outgoing chair and now the Lord Speaker. Having been on the receiving end of some of his incisive questions in the Chamber, I can just imagine what he was like as the chair of the committee when it was taking evidence. I also thank all noble Lords for their comments and contributions, which were thorough, thoughtful, instructive and thoroughly knowledgeable.
I reiterate the strong alignment between this committee’s conclusions in the report and the Government’s perspective and actions. The Government are committed to ensuring that the secondary growth and competitiveness objectives are comprehensively embedded in both the PRA and the FCA, and we strongly welcome the thorough and incisive scrutiny of the committee, holding both the Government and the regulators to account.
As the Economic Secretary to the Treasury said in a letter to the committee of 2 September:
“There is strong alignment between your recommendations and the wide-ranging package of reforms announced by the Chancellor”.
The noble Lord, Lord Pitt-Watson, is right that we are on a journey on this—this is not our final destination. Things are going to develop and evolve, and it will be great to continue this dialogue.
A considerable amount of ground has been covered today. I will try to address specific points raised by noble Lords in the time remaining. Before I do, I will speak about the financial services growth and competitiveness strategy and the actions that the Government are taking forward to facilitate the growth of the sector and to ensure that it is supporting growth in the wider economy. I will do my best to answer all the questions but, if I cannot or if there are some that I have not answered, I will write to noble Lords.
Since the launch of the strategy in July 2025, the Government have worked with the regulators to deliver key milestones, including: launching the Office for Investment: Financial Services, a dedicated concierge service for international financial services firms seeking to establish or grow their presence within the UK, which several noble Lords mentioned; launching the joint FCA and PRA scale-up unit, which will make it simpler for scaling firms to get timely responses and expert support; commissioning the Financial Services Skills Commission to produce a report on skills needs; and the FCA approving both the London Stock Exchange and JP Jenkins to operate PISCES platforms. I believe the first trading event will take place by the end of this month.
In addition, the Treasury and financial regulators are working hard to support delivery of the Government’s regulation action plan, where the Government have committed to cut the administrative burden of regulation by 25% by the end of this Parliament. The Treasury is continuing to hold the regulators to account, including through biannual ministerial reviews of the regulators’ performance.
Noble Lords have pressed the Government on the evidence linking growth in financial services to growth in the wider economy. The Government agree on the importance of having a substantial evidence base. That is why, in developing the financial services strategy, the Government took steps to build this evidence base, setting out their analysis and methodology in the strategy’s technical annex.
The Government remain committed to building this evidence base and continue to work with industry, academics and other public authorities to do so, including through regulator-led research projects and competitions. It remains a high priority for the Treasury’s Areas of Research Interest, its published list of the main research questions facing the department.
The committee has highlighted specialist lenders and their importance in providing lending to SMEs. The Government share the committee’s ambition regarding the role of the finance sector in funding the real economy. Specialist lending plays a role in supporting competition, resilience and choice. The Government have taken steps to ensure that the regulatory framework supports this, working closely with the Bank to explore further reforms to the ring-fencing regime to make lending to innovative SMEs more commercially viable. Through the Basel III.1 reforms, the Government have also worked closely with the PRA to ensure that overall capital requirements for SME lending do not increase so that the sector can continue to support UK SMEs and help them to grow and be successful.
The Government have a strong relationship with the financial service regulators, and they are working together closely so that the Government can hold them to account for delivering the shared growth mission. Remit letters and ongoing engagement at all levels allow the Government to ensure that the regulators have appropriate regard to the Government’s economic policy, particularly the growth mission. There is a very strong level of engagement and a shared ambition between the Government and the regulators to support growth, and we will continue to work closely together to deliver on this shared ambition.
The Government agree with the committee that it is important to have metrics to monitor the regulators’ impact on growth. The regulators have now published two years’ worth of data against the growth metrics. It is vital that the regulators are held to sufficiently challenging targets for determining authorisation applications while also maintaining robust processes. That is why the Government have proposed new authorisation deadlines and will legislate for them when parliamentary time allows. I am pleased to see that the regulators are already starting to report against these new deadlines, with the FCA doing so in February and the PRA doing so very soon. The UK regulators’ reporting framework is among the most comprehensive in the world. I assure the committee that the Government will continue to scrutinise their performance and how it is changing over time, and I invite Parliament and other stakeholders to do likewise.
I turn to some of the questions that were asked. I will do my best to cover them all, and if I do not, we will write to the relevant noble Lords. The noble Baroness, Lady Noakes, raised the question of productivity and finance. The Government recognise the need to increase the amount of productive lending from the financial services sector to the real economy. Earlier, the noble Baroness cited the Bank of England’s December Financial Stability Report, in which the Financial Policy Committee of the Bank of England provides useful insights in this area. This also notes several actions the Government and regulators have taken to improve the supply of finance for productive purposes, including expansion of the British Business Bank’s financial capacity and reforms to the bank ring-fencing regime. However, I take the broader question around data in this area. I look forward to digesting the report by Positive Money and will write to the committee with further reflections subsequent to this debate.
On SME lending, the Government have increased the British Business Bank’s total financial capacity to £25.6 billion, a two-thirds uplift compared to previous years, and are reducing limitations on this funding, giving the bank more flexibility to address regional and sectoral gaps in SME finance. I think I have already mentioned the concierge service, which everybody in the committee today seems to welcome.
I move on to encouraging informed risk-taking. The UK will always uphold high standards, but a system has been created which at times has sought to eliminate risk-taking completely rather than managing it effectively, and this can hold back economic growth. We can grow only if we enable the UK’s financial services and markets to continue to serve a wide variety of people and firms. At Mansion House in 2024, the Chancellor set out that regulatory changes to eliminate risk after the financial crisis had gone too far and led to unintended consequences.
Metrics was another issue that was raised during the debate. The Government are committed to effective monitoring and evaluation of the strategy. In line with other sector plans that form part of the industrial strategy, the strategy sets out clear indicators focused on how growing the sector will support growth and investment across the UK, delivering security for working people and world-leading financial services to UK businesses and consumers. Because of the time lag in publishing data, the majority of metrics largely cover the period before the last election. However, since then, the Government have delivered a huge package of pensions reform to make sure that people have savings for their retirement and are investing in Britain, with the Pension Schemes Bill now making its way through Parliament.
The Government set out their vision for regulatory reform through their Regulation Action Plan, announced in March 2025. The RAP commits the Government to cutting the administrative burden of regulation by 25% by the end of the Parliament. The Department for Business and Trade has identified the administrative burden of regulation on businesses to be £22.4 billion each year, which means that the 25% target represents a £5.6 billion annual reduction in the administrative burden.
The relationship between the Government and the regulators was also raised. The Government and the regulators have a strong relationship and are working together to facilitate growth in line with the Government’s economic policy. The remit letters that I mentioned earlier are a key mechanism for the Government to issue strategic steers to the regulators to support the Government’s economic policy and promote competitiveness and growth. The Treasury makes recommendations to the regulators through the remit letters. The letters set out the Government’s economic policy, to which the FCA and the PRA must have regard. The letters must be sent by the Chancellor at least once a Parliament, and the regulators are required to respond to the Chancellor annually.
There was a question on pensions. I will do my best, but I know that we will be debating them on Monday. Why do the Government think that pension funds are so reluctant to invest in UK assets? It seems that the lack of focus on value in the pensions market means that schemes invest only in low-cost asset classes. Cost is an important factor but, ultimately, net returns matter most. Therefore, the Pension Schemes Bill is addressing this by enabling scale in the pension market and through the value-for-money framework, as bigger schemes are able to invest more productively, as we see in Australia and Canada, for example, focusing on asset classes with higher potential long-run returns to investment and growth, such as infrastructure and venture. The noble Lord will probably pick that up in the debate on Monday.
The noble Lord, Lord Eatwell, asked what the Government think about fintech struggling to raise money. The UK has the third-largest VC ecosystem in the world, which raised £23.6 billion in 2025, according to HSBC. We are third behind the USA and China. Although the UK has deep capital pools for start-ups, underpinned by generous tax reliefs, we recognise that there is further to go to support UK companies, including fintechs, to raise domestic scale-up capital. That is why, at the spending review, we increased the total financial capacity of the British Business Bank to £25.6 billion.
As mentioned in the EST’s letter to the noble Lord, Lord Forsyth, in December, the FCA has undertaken several projects to improve the evidence base on how the financial sector regulations can support growth. In particular, it is consulting academics on how the financial sector hubs across the UK can support regional innovation.
There was a point raised about AI and inward investment. The Government are committed to realising the investment opportunities from AI. In January last year, the Government announced that investment in UK data centres infrastructure has reached £39 billion. Since then, the Government have designated five AI growth zones across Great Britain, including two in Wales and one in Scotland, generating £28.2 billion in investment. In 2025 alone, UK AI firms have raised £4.8 billion.
On the regulation of cryptocurrency, which was raised by my noble friend Lord Eatwell, the Government recognise the transformative potential of digital assets. In February, we introduced an SI underpinning the regime that we want to see; the consultation on the rules and requirements laid out in the SI is at an advanced stage. The SI defines which crypto assets will be part of regulation—the qualifying crypto assets—and the new regulated activities. It also creates a definition for qualifying stablecoin as a subcategory of qualifying crypto assets.
I have mentioned the regulatory metrics before, but there were other issues raised. Now that the regulators have published two years’ worth of data against their secondary objectives, the Government, industry and Parliament can begin to meaningfully scrutinise the regulators’ performance and how it is changing over time, as well as assess the appropriateness of the metrics themselves. As part of the 2025-30 strategy, the FCA is revising what growth metrics it will publish with more granular metrics, if appropriate. The PRA noted in its second report into the competitiveness and growth objective in 2025 that it would keep its metrics up to date and ensure that they remain “world leading”.
This leads us to international comparisons. The Government agree with the committee that there is a benefit to making international comparisons where possible. The Government’s aim is to ensure that the UK is a competitive jurisdiction for international financial services business. The regulatory environment plays an important part in that. We accept that there is more to do on this, and the Government remain committed to reducing the complexity and burden of regulation on business, including reducing the admin burden by 25%.
Another question from my noble friend Lord Eatwell was on what the Government think about the inadequacies of macroprudential regulations to address systemic crises. The Bank of England Financial Policy Committee is the UK’s dedicated macroprudential authority responsible for the health of the financial system as a whole. The International Monetary Fund has described the FPC as world class. It is equipped with an extensive set of macroprudential tools—for example, loan-to-income ratio controls in mortgage lending.
I agree with the points that have been raised on financial inclusion and education. The Government are putting more focus on helping young people to build strong financial skills and prepare for key money decisions in life. As part of the financial inclusion strategy, the Government committed to making financial education compulsory in primary schools in England through a new statutory requirement to teach citizenship. Alongside this, the Department for Education and the Treasury have committed to working closely together to improve the quality and reach of financial education in England. There will be a public consultation on the updated curriculum in 2026, with the changes in place for the first teaching in 2028.
The consumer duty was, I think, first mentioned by the noble Lord, Lord Johnson. The FCA wrote to the Chancellor in September with the results of its review into the application of the consumer duty, and it is updating its approach. The Chancellor asked the FCA to report back to her on how it plans to address concerns about the application of the consumer duty for firms primarily engaged in wholesale activity. The FCA has already committed to taking a number of actions, including refreshing some of the supervisory expectations and consulting on changes to the rules that help firms to distinguish between retail and professional clients.
I may not have covered all the questions, but I will write to noble Lords if I have not. I conclude by saying, in the time I have left—about 20 seconds—that we need to be optimistic as well. We have to bear in mind, and it is worth repeating, that the UK remains a top global financial centre and our regulators have an excellent reputation. The UK is the largest global net exporter of financial services, totalling £102.2 billion in 2025, which represents half of the UK’s services export surplus. The Global Financial Centres Index of 2025 ranks London in second place in terms of financial centre competitiveness, with Edinburgh and Glasgow also inside the top 40. The Government are committed to building on those strengths.
To conclude, I express the Government’s and my appreciation for the committee’s ongoing engagement. The Government will provide a further update in the summer of 2026, and we are committed to continuing this dialogue.
Baroness Noakes (Con)
My Lords, I start with an apology to the Committee, because I failed to declare my interests at the outset of the debate. I declare shares in listed financial services companies, as on the register and in the report. I apologise for not declaring those interests earlier.
I will keep my remarks short, because the Minister is on his feet in the Chamber and we do not want to break and come back again to hear my conclusions. I thank all noble Lords who have spoken in this important debate and the Minister for his reply. I do not have time to draw out all noble Lords’ points, but I am particularly grateful to those who picked out some of the things that I did not cover in my summary of the report—in particular an important point that I had largely forgotten about the way in which some in the financial services sector are basically too frightened to say in public what they will happily and quite freely say to us in private. That is an indication of something that is not working well that is therefore not in the national interest.
Most people have agreed today that the competitiveness and growth secondary objectives could be an important stimulus to growth in the financial services sector. The problem is that while there are now lots of initiatives, actions and planned actions in play, at the moment we lack the evidence for whether we will get growth either in the financial services sector or in the economy overall. That is one of the things we have to keep a focus on in order to ensure that regulators are accountable for delivering to us on those objectives. I was pleased to hear the Minister confirm that we would be getting a report this summer. I am sure that my committee will look forward to examining that and possibly engaging with the Government on it.
As noble Lords have said, there has been a significant increase in regulation since the global financial crisis. This has weighed on financial services firms in very many ways, and can act as a deterrent to inward investment in financial services in the UK as well as within the financial services sector, reducing the capacity to lend into the productive economy.
One lesson is that regulation has a real-world impact. I hope that the regulators increasingly understand that what they do has real-world consequences, and that they are committed to modifying the behaviours that are leading to burdens on the industry. I hope that the Government will continue to accept their important role in getting better data, setting better metrics and continuing to apply pressure on the regulators to deliver.
Whether the regulators can change their risk-averse culture and become organisations that more creatively balance risks against opportunities in a proportionate way is an open question. I think we have to keep that in constant view. Both the regulators and the Government need to move away from the comfort blanket of operational efficiency. The real issues are much deeper than whether we process paperwork on authorisations in a certain number of days.
Because this is all so important to the UK’s economic success, the Government and Parliament have to keep the regulators in full view and ensure that their impact is kept under scrutiny. My committee is fully up to the task of playing its part in that; I am sure that we will return to that in due course.