Banking Reform

Lord Eatwell Excerpts

Thursday 14th June 2012 Lords Chamber

[Lord Eatwell]

My Lords, having read the Statement, I am most grateful to the noble Lord for not repeating it. He has rescued the House from some tedium. However, I am concerned that the new procedures are having the unintended consequence of shielding the Minister from embarrassment, particularly the embarrassment of having watered down the Vickers proposals, and from a number of serious ambiguities in the Statement. I have not had the opportunity to read the White Paper. I hope it will provide a better vision of the future of UK banking than does the Statement.

We on this side of the House welcomed the Vickers report as a positive step along the road to making Britain’s retail banking system safer, in particular protecting households and small and medium-sized firms from the instability that, as we have seen to our cost, may well be generated in wholesale financial markets, by banks’ proprietary trading and by the complex interconnections that characterise today’s global banking.

The Statement suggests that one of the Government’s goals is,

“to curb risk-taking in financial markets”.

Can the Minister elaborate a little on this? As many have commented, a financial market without risk is the market of the grave. If Britain is ever to return to boisterous growth—something which under this coalition must be in increasingly serious doubt—financial institutions will need to take risks. Indeed, the expansion of credit is vital to recovery.

How does the Treasury intend to monitor the risk that is generated within the ring-fence system? What is the Treasury’s definition of “acceptable” levels of risk? What is the Treasury’s estimate of the impact of these measures on the supply of credit to households and to small and medium-sized firms? For example, what will be the impact on the supply of credit of the severe limitations on wholesale funding of the balance sheet, given the important role that wholesale funding has played in the British banking system over the past decade? What will be the impact of the new leverage collar on the supply of credit? All these issues refer directly to the ability of British industry to receive the funding that it needs for recovery.

What is the Government’s intention with respect to the substantial flow of liquidity into the UK economy from the Crown dependencies? Since large companies will be outside the ring-fence and the failure of those companies would impose unacceptable costs on the UK economy, is it not clear that the Government’s proposal has failed to deal with the issue of “too big to fail”? How would the Government deal with the failure of a non-ring-fenced bank that imposed destructive instability on large UK companies?

The Statement also reads:

“The deposits of individuals and their overdrafts, and the deposits and overdrafts of small and medium-sized businesses will, in general, be placed in ring-fenced banks”.

How can the Government be sure of this? What compels a saver to commit their savings to ring-fenced banks if those banks offer a lower rate of return than non-ring-fenced operations? Are the Government simply planning to force UK households to accept lower rates of return to secure the stability of institutions within the ring-fence?

The Statement also declares that,

“within certain constraints, firms may decide what to put inside the ring-fence”.

I presume, therefore, that they may decide what to put outside. What do the Government have in mind here? Why are they abdicating their responsibility to determine the boundary of the ring-fence?

We are told that the Government have decided that ring-fenced banks should be required to hold 10% capital against risk-weighted assets. Whence do the Government derive the belief that moving to a 10% capital-to-risk-weighted asset ratio will provide the resilience that the banking sector requires to head off a serious crisis? This belief is without empirical foundation. A little investigation would reveal that Allied Irish Bank, the collapse of which devastated the Irish economy, always had a capital-to risk-weighted asset that was higher than that which the Government now propose as the basis of security of ring-fenced banks.

More generally, it is well known that the outcome of regulatory actions—that they stimulate a creative response from the banks, creative in the sense that they work out ways to circumvent or evade the regulations—reduces the impact of regulatory innovation over time. How do the Government intend to keep the operations of the ring-fence under review? Would it not be appropriate to keep the Independent Commission on Banking in being and charge it with the task of reviewing regularly the performance of the ring-fence? Why not ask Sir John Vickers and his team to return to the issue—let us say—12 months after the ring-fence has been introduced?

What is to be done on the timing of this legislation? We have before the House a Financial Services Bill the structure of which, as has been recognised by the Government and throughout the House, is seriously deficient. Would it not be better for the Government to withdraw that Bill, go back and rewrite it in a way which corrects its deficiencies, and incorporate the new measures from the Vickers report and the White Paper in that revised Bill? The House would then have the opportunity of assessing in its entirety the new framework for financial services in this country, rather than this hotchpotch of measures being introduced one after the other without clarity as to the way in which they relate to one another.

[Lord Sassoon]

My Lords, I am sorry that the noble Lord, Lord Eatwell, has not yet had a chance to read the very detailed White Paper because, when he does, he will see that a lot of his detailed questions have been addressed.

I find it disappointing that the noble Lord comes here and takes such a picky attitude towards this fundamentally important reform being introduced by the Government. The previous Government had two years in which to act on the collapse of Northern Rock and then on the failures of RBS and Lloyds and did absolutely nothing about them. Did it not occur to them that there might be a problem with the structure of banking in this country? It seems not. For two years, they sat on their hands, asked no questions and did nothing. When this Government came into office, we established within weeks the Independent Commission on Banking under the chairmanship of Sir John Vickers. It has come up with a very fine report to government. We have considered it very carefully and have published our final response today. What we have before us is one of the most radical reforms of banking that I suggest the world has ever seen.

Why have we done that? We have done that because we face in this country something which my right honourable friend the Chancellor has characterised as the British dilemma: how do we continue to host a world-class financial services sector, a sector in which our banks are able to go out to compete vigorously, as they do, around the world with the best and biggest that the rest of the world has, without putting the UK taxpayer at excessive risk? That is what is encapsulated by our response to the Vickers commission, a response that picks up the essence of what Vickers recommended but which interprets it in a way that is appropriate, flexible, forward-looking and balances those key interests of ensuring that we have a world-class but safe banking system.

The noble Lord, Lord Eatwell, talked about risk-taking in the financial markets. The critical thing is that we want to make sure that the parts of the banks within the ring-fence, the parts of the banks in which the savings of the men, women and children of this country go, are properly ring-fenced and protected—the parts of the banks which service the SMEs of this country. We want to ensure that there is not inappropriate risk-taking within that ring-fence. The noble Lord asked how that is to be monitored. It is not for Her Majesty’s Treasury to monitor it; it will be up to the Financial Policy Committee to look at the system as a whole—as it already is in interim form—and it will be for the Prudential Regulation Authority, under the Bank of England, to supervise individual firms in future.

The noble Lord then talked about curbs on growth. That area is very important, because the flow of credit must go on, particularly at this time of challenge in the economy. That is precisely one reason why Sir John Vickers and the commission recommended that the implementation of the recommendations should be concluded by 2019, a recommendation that we have accepted. The numbers are set out in the document, but I suggest that the costs of implementation over that period and beyond on a running basis are very modest in relation to both the cost of the banking crisis over which the previous Government presided and the size of the UK economy.

The noble Lord then referred to the flow of funds in from Crown dependencies. He is clearly an expert on this subject. I believe that he is on the regulatory body of the States of Jersey. I am aware, as he is, that significant deposits flow from that and other Crown dependencies into the UK wholesale markets. That plays an important part of the funding of the wholesale markets and should continue.

The noble Lord, Lord Eatwell, then asked: what compels a saver to deposit his or her money in a ring-fenced bank? The fact is that 87%, or thereabouts, of deposits in the banking system at the moment are within banks that will be subject to the ring-fence. It is highly implausible to suggest that it would be wrong to protect 90% of the deposits of the British public but not to say that there are other places that are not ring-fenced that are accessible. What the noble Lord presents is not a realistic picture. Sir John Vickers and his commission raised the question of a de minimis limit and we set a limit that the ring-fence should not operate for banks with deposits below £25 billion. I suggest to the noble Lord that one thing on which we might agree is that we need more diversity, more competition and more new entrants in the banking sector. It is entirely appropriate, we believe, that the ring-fence should operate for only the biggest of our banks—those which account for some 90% of deposits.

The noble Lord then asked a number of technical questions about the way that the ring-fence will operate. I refer him to the details in the White Paper. If he has further questions that it does not answer, I should of course be happy to write on any supplementary questions that he may put, but there is a very full analysis there.

As to the capital ratios proposed here, the noble Lord talked about the Government proposing them but of course what analysis there was underpinning them was all the ICB’s analysis. The Government have done one thing in this area today, which is to put out a 3% rather than a 4% ratio against total unweighted assets. That is to create a level playing field with what is proposed in Europe. We want this measure to be not a front-stop but a back-stop, in line with what the ICB proposed, and we want to make sure that our banks have every opportunity to compete on a level playing field.

The noble Lord then asked whether we should ask the ICB to return to the operation of the ring-fence by keeping it under review and coming back to it one year after it comes into operation. Given that the implementation date is set by Sir John Vickers at 2019, it might be a little unreasonable to Sir John and his commission, who have done tremendous work on this, to keep them on the hook until 2020, or later, to ask them to come back to these issues. I am sure that there will be other ways of looking at the impact of these measures in due course.

Lastly, the noble Lord asked whether we should put these measures into one Bill with those in the Financial Services Bill, which is already before your Lordships’ House. This is to misunderstand the different nature of what is being addressed here. On the one hand, the Financial Services Bill deals with the structure of regulation and, on the other, the measures that we are talking about today relate to the structure of banking. I accept of course that the two things taken together are the measures that, combined, will make sure that this country has a world-class financial services sector and will not put UK taxpayers excessively at risk. However, they are two sets of distinct measures. Your Lordships will now have them in front of them so that they, can read across from one to another, but any suggestion of delaying the legislative process, which the noble Lord and others have constantly urged us to get on with, would be wholly inappropriate.

[Lord Eatwell]

Before the noble Lord sits down, I would like to press him on a question on which I am genuinely puzzled. The Statement refers to the idea that UK households will place their deposits in ring-fenced banks. Why should they do that if the rate of return is higher on non-ring-fenced banks than it is on ring-fenced banks, and why should not an innovative financial sector create devices whereby households can take advantage of a higher rate of return in non-ring-fenced financial institutions? We are not planning—or are we?—to reintroduce Regulation Q as it was in the United States, where there was a limitation on the return that households could receive on their deposits to force those deposits into the commercial banking system.

[Lord Sassoon]

My Lords, at the moment depositors have freedom as to where they place their deposits. It is certainly not the case that the vast majority of deposits go to the outliers, as there always are, in offering returns. When it comes to the future arrangements, I would anticipate that the vast majority of deposits will stay where they are. For better or worse, that is the system with a number of very large incumbent banks, which will all be ring-fenced. It will be very clear to people what the difference is between ring-fenced and non-ring-fenced banks. The Statement made by my right honourable friend was merely a clear statement of observed behaviour and likely behaviour into the future—not a Statement saying that people “must” or “are compelled to”, or that they do not have any choice. Of course they will have choice, but 90% of the deposits are where they are today and I anticipate that that is not somehow going to be magically changed overnight.