Bank of England Act 1998 (Macro-prudential Measures) (Amendment) Order 2021

Baroness Bowles of Berkhamsted Excerpts

Thursday 8th July 2021 Grand Committee

[Baroness Bowles of Berkhamsted (LD) [V]]

My Lords, I thank the Minister for introducing this regulation, which is consequential on the changes to powers laid out in the recent Financial Services Act—which we debated for many days earlier this year. As the Minister said, the matters covered today include the leverage ratio and the application of measures to holding companies.

I have no problem with the regulation but I want to say a few things about the policies which it will be used to put in place. As the Minister said, there are several significant FPC and PRA consultations concerning application of international Basel standards and the leverage ratio, which are made in consultation with HMT. I would like to spend my time on those underlying issues that will be given life through the powers in this instrument.

The leverage ratio presently is utilised essentially as a backstop in case the models used by banks to calculate their risk-weighted capital requirements become too light in their risk assessments. Currently, it is set at 3.5%, and it is the capital buffers that will tend to restrict the banks’ activities, essentially through cost, with the leverage ratio therefore seen as a sort of lower ultimate solvency test. Nevertheless, it effectively functions in a similar way to capital buffers rather than as a different economic tool.

I make that point because I thought that, with the Financial Policy Committee having a bigger role in relation to leverage, there might be an attempt to look at the outcome of the Macmillan committee report produced after the 1929 financial crisis, where it was suggested that, instead of controlling markets simply by interest rates and price, there should be a second leverage control that addressed total volume. So my question to the Minister is on what thought is being given to whether there needs to be a control on volume and money creation other than through price.

Returning to what is actually happening in conjunction with this instrument, and in line with new Basel standards, the leverage ratio framework is being applied to a wider scope of firms, at times to the consolidated or sub-consolidated level, and will extend to internationally active holding companies and firms with non-UK assets over £10 billion, which will cover larger, non-ring-fenced banks and broker dealers such as Goldman Sachs, JP Morgan and Morgan Stanley. I agree that these are all good moves for stability of the banking system in the UK.

Alongside that there is to be tweaking of, and some disapplication of, Basel standards. Schedule 3 of the Financial Services Act 2021, repeated again in this instrument, states that the PRA must have regard to, among other things:

“relevant standards recommended by the Basel Committee on Banking Supervision from time to time … the likely effect of the rules on the relative standing of the United Kingdom as a place for internationally active credit institutions and investment firms to be based or to carry on activities … the likely effect of the rules on the ability of CRR firms to continue to provide finance to businesses and consumers in the United Kingdom on a sustainable basis in the medium and long term … the target in section 1 of the Climate Change Act 2008”,

which is net zero,

“and … any other matter specified by the Treasury”.

As ever, it is “have regard”, so it promises nothing. In the proposed changes around leverage, there are areas where the second point, about the standing of the UK—effectively competitiveness—has prevailed over the first, and the Basel rules are not taken in full. The UK will not be Basel-compliant over its leverage buffer for globally systemically important banks, setting a lower-than-Basel level, and will also not be implementing the disciplinary measures, such as restriction of dividends on breach of a leverage ratio requirement. It is not hard to see the attractiveness of those measures to banks, but is not there a risk that it is saying, “We don’t care that you are getting close to dodgy solvency levels, just go ahead and pay dividends”? Which other jurisdictions are doing this, or is the UK leading the charge?

There are other departures, too, but the Economic Secretary to the Treasury said in the Commons on Monday that the FPC will argue that overall, on an outcomes basis, the UK is equivalent because a stronger measure of what qualifies as capital will be applied. That is a substantial attitudinal departure from international standards. I understand where it is coming from, but it is the UK back to its old tricks of saying it complies when in fact it picks and chooses and jiggles around? It can be the same on an outcomes basis to get to a destination going the wrong way along a one-way street, but it is not advisable and involves breaches of standards. Is not that what the UK is doing—saying that we were well under the speed limit on this road, so now we can take an illegal short-cut down the one-way street?

There is no great glory from being above Basel on capital standards. Basel rules are meant to be a minimum and already have aspects of lowest common agreement, which is in fact how some lower-grade capital gets in there. In my book, the lower standards look like breaches rather than outcomes compliance, and I worry that the UK has possibly started the undermining of Basel and a race to the bottom.

Can the Minister provide, if not now then by letter, calculations that show how the higher quality of capital compensates for lower buffers—for example through loss absorbency in the event of resolution? What was the basis, other than saying, “Come and headquarter here”, for removing the restrictions on dividends for a breach of the leverage ratio? I understand the importance of keeping investors, but what action will the regulator take for fast restoration of capital if dividends are still flowing out? Furthermore, are the differences from Basel in fact things that the UK argued for and lost—perhaps, if you like, giving a warning—or are they new approaches? Will it undermine the future effectiveness of the UK in negotiations if we have the reputation for just doing things our own way anyhow? Will not that remove the incentive for others to see things the same way as the UK?

The regulation will pass, as it is part of the new structure but, despite references in the documents to the “new accountability structure”, it is regrettable that these first, important decisions that I have commented on are happening without more prior reference to Parliament. As we said during the debates on the Financial Services Bill, everything is being front-run and front-loaded. The Government fixed their influence and have, unhappily, left Parliament behind.