Banking Reform

Baroness Primarolo Excerpts

Thursday 14th June 2012 Commons Chamber

[The Financial Secretary to the Treasury (Mr Mark Hoban)]

With permission, Mr Speaker, I would like to make a statement on banking reform.

The financial crisis exposed a great many flaws in the system. Banks borrowed too much, took risks they did not understand and bought securities that proved to be far from secure. Banking groups became too complex and interconnected to be managed effectively, regulators failed to identify the risks and taxpayers paid the price. Between October 2008 and December 2010, European taxpayers provided almost €300 billion to prop up their banks, with liquidity and lending support in the trillions. In the UK, the bail-out of RBS was the biggest banking bail-out in the world.

Just as the crisis revealed many flaws, there is no single solution. The Government are reforming the substance and structure of the financial architecture, putting the Bank of England in charge of prudential regulation. We have created the Financial Policy Committee to look at risks across the financial system. Our permanent bank levy penalises short-term wholesale funding, and we have introduced the toughest and most transparent pay regime of any major financial centre in the world. We have worked with our international partners to deliver robust, consistent prudential standards for banks and markets.

The White Paper that we are publishing today sets out how we will implement the recommendations of the Independent Commission on Banking. The Government’s reforms will form a key part of our broader programme of reform. In the same way that the action we have taken on the deficit has meant that UK debt is currently seen as a safe-haven asset by investors around the world, we will ensure that British banks will be resilient, stable and competitive, and so attractive to investors at home and abroad.

The eurozone crisis makes reform more, not less important. The link between the strength of a country’s banking sector and that country’s stability could not be clearer. At the same time, our proposals reflect the progress that has been made in European and international regulation since December. The Government welcome the European Commission’s bank recovery and resolution directive, which will improve member states’ ability to resolve cross-border banks without imposing costs on taxpayers. We will also continue to press for full Basel III implementation in Europe.

The goals of today’s White Paper are clear. First, since financial crises rarely repeat the pattern of the past, we must ensure that banks are more resilient to shocks. Secondly, we must make our banks more resolvable, so that if they fail, they do not threaten the provision of vital services to the real economy. Seeing through those two goals will achieve our third—to curb risk-taking in financial markets. It must be clear that investors reap rewards when banks do well, but take the pain if banks fail.

The Government will ring-fence retail deposits from the risks posed by international wholesale and investment banking. A ring-fenced bank will be economically and legally separate from the rest of its group and run by an independent board. The ring fence will not in itself prevent a bank from failing, but it will insulate the deposits of families and businesses, and if a bank does fail those essential parts of the banking system can continue without recourse to the taxpayer.

The deposits and overdrafts of individuals and of small and medium-sized businesses will, in general, be placed in ring-fenced banks. To minimise the risks that a ring-fenced bank is exposed to, it will be prohibited from conducting the vast majority of international wholesale and investment banking. It will not be permitted to carry out activities through branches or subsidiaries outside the European economic area, or, except in limited circumstances, with financial institutions. Beyond that, and within certain constraints, firms may decide what to put inside the ring fence. Ring-fencing will provide customers with flexibility, but not at the cost of financial stability.

The Government also propose to strengthen the ICB’s recommendations by applying strict controls to the use of derivatives by a ring-fenced bank to hedge its balance sheet. That will ensure that a ring-fenced bank does not take excessive risks when managing its own risks, as was the case with J. P. Morgan’s much-publicised trading loss.

Governance of the ring-fenced banks will be important. The Government propose to strengthen the ICB recommendations in that area, establishing separate risk committees and possibly also separate remuneration committees. However, it is important to focus these reforms where they will have the biggest impact, which is on the biggest, too-big-too-fail banks. We therefore propose that smaller banks, with less than £25 billion of mandated deposits, will be exempt from those requirements. Large, systemically important banks gain a competitive advantage from the perceived implicit guarantee. Our targeted reforms will remove that advantage, helping smaller banks and new entrants.

One of the clearest lessons from the crisis is that investors and creditors, not taxpayers, should bear the costs of failure. That is why we have supported Basel III, which increases bank capital to 7%, with a top-up for systemically important banks, and why we have pressed for that to be implemented across Europe, but to protect taxpayers, the Government will go further. The largest UK ring-fenced banks should hold an additional 3% of equity on top of the Basel III minimum numbers. The Government also strongly endorse the introduction of a binding minimum leverage ratio. The White Paper supports the Basel proposal of a 3% leverage ratio for all banks, including UK ring-fenced banks, and we will continue to press for the implementation of the Basel standard through EU law.

Large ring-fenced banks should hold a minimum amount of loss-absorbing capacity—made up of debt or equity—of 17% of risk-weighted assets. Their overseas operations should be exempt from that requirement unless they pose a risk to financial stability. For smaller UK banks, as the ICB recommends, the minimum requirement should be lower.

To deliver those proposals, the authorities need a way to “bail in” bank liabilities so that bondholders, not taxpayers, bear the losses. The Government will work with European partners to ensure that the ICB recommendations on bail-in are credibly and consistently applied across Europe through the recovery and resolution directive. We intend to introduce the principle of depositor preference for insured deposits. Unsecured lenders to banks are better placed to monitor the risks that banks are taking and should take losses ahead of ordinary depositors.

Our proposals on financial stability also improve competition in UK banking. The implicit guarantee to large banks distorts competition; its reduction will help to create a level playing field. However, we want to do more to encourage new entrants and promote competition. We will shortly issue a consultation on reform to the payments system. I welcome the reviews by the Bank of England and the FSA into the prudential and conduct requirements for new entrants to ensure that they are appropriate and not disproportionate. We strongly support the need for a stronger challenger bank to emerge from the Lloyds Banking Group divestment. We are engaged with Lloyds and the European Commission to ensure that the divestment process creates as strong a challenger as possible. A more competitive banking system will work only—[Interruption.]

[Madam Deputy Speaker (Dawn Primarolo)]

Order. Government Members do not need assistance from the Opposition on where they should sit. The Minister is making a serious statement to the House. Perhaps Opposition Members could hear what he has to say.

[Mr Hoban]

That really sums up the Opposition. All they can talk about is who sits where. They have no ideas on how to resolve this banking crisis.

I welcome the reviews by the Bank of England and the Financial Services Authority into the prudential and conduct requirements for new entrants to ensure that they are appropriate and not disproportionate. However, as I have said, a more competitive banking market will work only if consumers are prepared to change banks. The Government are pleased with the progress on the industry-led initiative to make current account switching faster and easier for customers. Providers covering 97% of the current account market have signed up and the scheme is on track to be launched next September. However, to switch, customers need better information, so the Government welcome the fact that the Office of Fair Trading and the Financial Conduct Authority will take forward the ICB recommendation to improve transparency across all retail banking products. Work is already under way on a number of projects, such as making account data available to customers electronically, to enable them to shop around.

Financial stability is a prerequisite for growth. Our analysis suggests that the proposals in the White Paper will cost, in gross domestic product terms, in the region of £0.6 billion to £1.4 billion per annum. However, that should be compared with the estimate that the 2007 to 2009 crisis has already cost the UK economy £140 billion, which is one hundred times the maximum cost estimate of our proposals.

The proposals, although ambitious in scale, are proportionate in impact. They will promote financial stability while supporting sustainable growth and making the UK’s role as the world’s leading international financial centre secure. The reforms we are announcing today, together with the changes we are making to the regulatory architecture, demonstrate that the Government are determined to take action to deliver a stable and sustainable banking sector that underpins rather than undermines economic growth. I commend this statement to the House.

[Ed Balls (Morley and Outwood) (Lab/Co-op)]

Let me begin by thanking the Minister for notice of today’s Treasury statement on the vital issue of banking reform. The reforms are so important that—we read in the newspapers—they are to be the subject of the Chancellor’s Mansion House speech tonight.

The Minister said the statement was serious, and I am sure Opposition Members and Government Members will all be thinking: “Why is the Chancellor not making it?” Should I call him the part-time Chancellor? He was able to spend the afternoon on the Government Bench yesterday to support the embattled Secretary of State for Culture, Olympics, Media and Sport, but he is seemingly unwilling, despite media trails, to come to the House today. What is the Chancellor running scared of? Is he too busy this week on his other duties to be the Chancellor, or is the truth that he is ducking answering the questions because—once again—he is not on top of the details of his brief?

There are questions to answer. Last September, the Opposition welcomed the report by Sir John Vickers and the Independent Commission on Banking, which sets out radically to reshape our banking industry. We urged the Government to implement the reforms without foot-dragging or watering them down, but I fear that watering down is where we are heading. Is not the truth that, having failed to secure international agreement in Brussels and Basel on tougher international banking standards, the Chancellor is now being forced to water down and fudge the Vickers reforms?

That is one area in which the Opposition would not welcome a U-turn from the Chancellor. The Minister will say in his response that I am wrong, and that there is no U-turn, just as Ministers said we were wrong to spot U-turns on pasties, caravans, churches, charities and skips, but a pattern is emerging with this Chancellor. He declares, “This Chancellor is not for turning,” and then sends along a hapless junior Minister to do the job for him. We can ask the Exchequer Secretary all about that.

If the Chancellor is not watering down Vickers, why will he not agree to the Opposition’s request to ask the Vickers commission to come back this autumn and publish an independent report on progress in implementing its reforms in the past 12 months? The Chancellor could publish that report alongside the autumn statement, when he will have to come to the House to explain why his failing economic plan has plunged our economy back into recession. That is one area where a U-turn would be warmly welcome.

On progress against the three tests for banking reform, first, to protect taxpayers, the Opposition support the Vickers conclusion that banking services should be safeguarded and ring-fenced. In November 2006, the Minister told the House that

“light-touch…regulation is in the interests of the”

financial

“sector globally.”—[Official Report, 28 November 2006; Vol. 453, c. 995.]

May I ask this champion of light-touch regulation to explain why, contrary to Vickers, it is right to allow retail banks inside the ring fence to trade in derivatives and hedging products, which are among the controversial interest rate swap products that many small firms complain they were mis-sold in recent years? I have said many times that the previous Government got bank regulation wrong. Those on the Government Front Bench also got it wrong, but they are getting it wrong again. The Chancellor should be careful about leaving the door too wide open.

The Opposition agree with the Vickers view that we need a minimum leverage ratio and higher equity requirements for larger ring-fenced banks, but will the Minister confirm that the Chancellor is setting a lower minimum leverage ratio than the Vickers commission recommended, and that he is departing from the recommendation that larger banks should have tougher rules?

The Chancellor implied in December that he would mandate those services specifically within the ring fence to provide clarity and certainty. Can the Minister explain why the Chancellor is now delegating that detailed task to the Bank of England—the regulator—and not putting it in primary legislation? Will the Chancellor—or, on his behalf, the Minister—commit to inserting in the Bill the requirement that large UK retail banks should have equity capital of at least 10%? Is not the real problem that the Chancellor is not in the driving seat on this agenda?

That takes me to our second test, on international agreements. In December, I asked the Chancellor whether he was confident that he would get the necessary international and EU-wide agreements to implement Vickers. The answer is that he has not succeeded in delivering that. The Chancellor himself said at last month’s ECOFIN, when he refused to agree to an EU statement on capital requirements, that they would

“make me look like an idiot”—

a muttering idiot perhaps! Two weeks later, though, he signed up to exactly the same deal. The problem is that there remains the risk that he will be overruled by the EU.

There is a wider problem. We agree with the Chancellor that the UK should not contribute to a eurozone-wide deposit insurance scheme, but the Commission’s proposals go much wider and are said to be intended to apply to the 27. The Chancellor gives the impression that he has a veto on the plans, so that they would apply only to the 17. Will the Minister tell us, then, whether the proposals for Europe-wide banking supervision will be subject to qualified majority voting under existing treaties, and will he tell us how the Chancellor is doing in building alliances across the EU to ensure that British interests are properly protected and that Vickers is implemented?

That brings me to my final test: the impact on growth and the wider economy.

[Madam Deputy Speaker (Dawn Primarolo)]

Order. I hope that the shadow Chancellor will be brief, given how much of the time allocation he has already taken.

[Ed Balls]

I shall put my questions briefly, Madam Deputy Speaker. I only regret that I cannot put these questions to the Chancellor because he has not turned up.

We have consistently urged the Chancellor to take a swifter approach to competition and to have a growth objective for the new Financial Policy Committee. We and the CBI agree on that, but the Chancellor will not listen. The problem is that in those circumstances Vickers implementation could lead to a continuing impact on business lending at the expense of small businesses.

To conclude, we set three tests for Vickers, but on each one the Government are failing, causing uncertainty where we need confidence, lending and growth. They are failing to take the lead on reforms in the EU, and fudging and watering down proper taxpayer protection. We need a Chancellor who can do the economics, grip the detail and work full time on the job—someone who at least turns up in the House and answers questions on this vital issue.