Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Monday 16th December 2013 Lords Chamber

[Lord Flight (Con)]

My Lords, following on from what the noble Lord has just said, I would have thought that recent history suggested that regulators were not particularly good at being the bodies finding out the bad eggs in banking institutions. Most of the staff of the PRA have come from the FSA. They were the regulators for the period during which the banking system in this country took on board the awful problem of a lack of integrity.

There is agreement across the House and the country that the question is: how do we get integrity back into our banking system? I do not see that rules are going to do it. We should have focused more on the role of the shareholders of banks in making sure that their boards and executives are proper people, and on the role of the auditors in this area, but I do not see any sound basis for being of the opinion that the regulators are going to be much good at it.

I broadly support the concept of licensing, although I agree with the point: what is in a word? It seems to me that you can license people in regard to their academic qualifications and job experience but not for integrity. People have either got integrity or they have not. We want to get to a situation where the managers of our banks have got integrity and give key effort to making sure that their banks are run with integrity.

That leads me to the next big area. My view over 40 years in the City has been that the main cause of this trouble has been that an oligopoly was allowed to develop. If one looks at economic history, wherever there have been cartels and oligopolies, there has always been bad practice. One reason that the oligopoly got worse is that there was a mistaken view back in the 1980s after the failure of Johnson Matthey that led to the doctrine that the lender of last resort only stood behind banks that were too big to fail. That led to a shrinkage of the number of banks. Many, because they were not deemed to be covered by the lender-of-last-resort doctrine, were closed down.

I remember having extensive discussions and correspondence with the late Sir Eddie George on just that issue back in the early 1990s. What was allowed to happen was a moral hazard. The oligopoly was there with its ticket that it had lender-of-last-resort support and it took the view, “Make money in any way you like and pay the fines”—they were a natural cost of business if you were in breach. That led to a complete deterioration of the standards of integrity in the banking system. That is the truth of what I observed.

I repeat, I personally do not see the regulator as being a huge force in turning round integrity. Punishing those that basically act immorally is quite an important ingredient, but above all we need to get sound management into banks. Maybe the regulator has some role in helping that process, but bank managers must run their banks on the basis of integrity. How far down does the regulator go if he is responsible for ensuring that staff have integrity? It seems to me that this would not work.

[Lord Tunnicliffe]

I commend the noble Lord, Lord Flight, on his ongoing campaign for small banks and more diversity—not that I dissent from it, but it is consistent. What I have more trouble with is the concept of competence and integrity in the banking system, and the idea that somehow we should more readily trust the banks than the regulator. The banks have not got much of a record over the past three or four years in terms of either competence or, frankly, integrity. There is virtually no major bank that has not shown some errors in terms of integrity or shown some failure in competence or ripped off customers through mis-selling. The poor FSA might not have done brilliantly, but it did investigate these areas and produce perfectly sensible reports. As far as one can see, the FCA has got off to a good start. It is producing good and competent reports. I want to express my belief that the regulator is doing, and will continue to do, a good job.

The amendment is quite rightly interpreted as saying, “The regulator shall do”. If our amendment were to succeed, I could readily see some drawing back from that. My own experience in the airline industry is that the regulator creates the framework and checks the checkers—in other words, checks the senior management—but that the spreading of annual testing and so on goes into the companies in a trusting framework. There are ways of doing it without having thousands of inspectors around. Our general thrust is in the right direction. However, I get a sense from what is happening in the House tonight that the chances of me persuading people on this point are slim, so I will not press this to a Division. I beg leave to withdraw the Motion.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Monday 9th December 2013 Lords Chamber

[Lord Turnbull (CB)]

My Lords, the PCBS always envisaged a two-tier system, one for senior persons where prior registration would be required, and the other for staff below that who are not senior persons but who are nevertheless capable of inflicting damage to the bank, its customers or its shareholders. We felt that the original provisions made for the upper tier were broadly okay, although there were one or two refinements about what a bank is. However, we thought that the provision made for the second tier was too vague. I therefore welcome these amendments, which bring much greater focus to who is covered and what the obligations are.

There are two loose ends in this, which do not need to be concluded this evening. The first is that there are a number of functions in banks for which the APP—the approved persons regime—will be retained, namely the submitters of LIBOR numbers and those who have responsibility for money-laundering. It might be worth considering at some point whether instead of having three schemes for banks—the two new ones and the old one—they can all be consolidated. Finally, there is also the question of whether, in the fullness of time, a decision needs to be made on whether to continue with the old approved persons regime, with all the faults that we identified, in the rest of the financial services sector.

[Lord Flight (Con)]

My Lords, first, I declare an interest as a commissioner of the Guernsey Financial Services Commission. I will raise an issue which relates, as far as possible, to the territory being addressed right now: what will be the position of the banks in Crown dependencies of the UK under the new arrangements for ring-fenced banks? I have made inquiries of the Financial Secretary and got an answer. However, I have some reservations that the answer will not work very well. An issue analogous to the comment about foreign banks in London is that most of the banks in the Crown dependencies are not branches but subsidiaries. The proposal is for branches to be within the ring-fence and not subsidiaries. However, there is little incentive for banks to convert from subsidiaries to branches to come within the ring-fence. At the heart of this is an issue of UK interest in that those banks mostly effectively gather deposits that are lent to London, and are in some senses merely a legal fiction. Therefore if they will be within the ring-fence and will all have to convert to being branches, there is a strong practical case for including them within the UK deposit insurance scheme. If not, the banks in the Crown dependencies will stay as subsidiaries in the main, they will be outside the ring-fence, and there will be a decline in the deposits they upstream to the UK partly for regulatory reasons and partly because they will not be a subsidiary of the ring-fenced entity. I ask the Minister to think again about the precise arrangements regarding ring-fencing for the Crown dependencies.

[Lord Brennan (Lab)]

My Lords, the present amendments fortify Part 4 by creating a comprehensive structure for conduct, standards, licensing and so on. Third Reading is an appropriate time for the Minister to clarify how in this structure directors, including the chairman of a bank, bear responsibility for the fulfilment of Part 4 as regards conduct and standards. Amendment 9 talks about:

“Vetting by relevant authorised persons of candidates for approval”.

The relevant authorised person is the bank. The bank ultimately sets its standards at directorial level, and directors carry a responsibility for it under statute and common law. Therefore I invite the Minister to clarify what, under this system, is the position of the directors and the chairman in terms of the enforcement of this framework for good standards.

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[Lord McFall of Alcluith (Lab)]

My Lords, I support the amendment. In evidence from business people to the Treasury Committee and the parliamentary commission it was said that good and firm regulation is a competition issue. Given that we aspire for London to be maintained as a global centre for financial products, it is important to recognise that dirty money comes in and out. The example was given of HSBC. It acquired a Mexican bank in 2001 in America. From day one the board was told by the compliance officer that no decent compliance functions were available. Notwithstanding that, the situation continued for six or seven years in which drug money was laundered, people died in Mexico as a result, and HSBC was fined almost $4 billion by the US authorities. If that can happen to a UK-based bank, it can be happening elsewhere. It is important that we ensure that regulation in this country is firm.

Mention was made of General Abacha. In 2006 there was an investigation by the FSA that did not go anywhere because the regulator did not have authority. It is therefore important that in this legislation we underline the regulator’s authority. The regulator did not have authority because there was a tension—and there will still be a tension, despite the new architecture—between the financial stability of companies and conduct of business. If we are to make London an attractive global centre, we have to understand the elephant in the room—money-laundering. I am afraid that, if we do not give the regulator an express duty and authority on money-laundering, we could find the problems that happened with Nigeria in 2006 and elsewhere being replicated. That case has still not been investigated authoritatively enough. Having this anti-money-laundering element in the Bill would be extremely important, and I support the amendment.

[Lord Flight]

My Lords, perhaps I may make the point that I made last time this matter came up for debate—a point that is staring at us. The problem is with parts of the world where corruption, drugs and political corruption are rife. Much more demanding anti-money-laundering requirements are needed when accounts are opened for individuals or organisations from such parts of the world.

We already have a factfile that grades different countries around the world according to the extent of their corruption—so there is, if you like, a textbook. If those standards were required, it would, apart from anything else, discourage banks from potentially getting involved. Also, rather than imposing greater demands on everybody—I do not think anyone is suggesting that the average Mr and Mrs Brown from Dorking is engaged in money-laundering—much more demanding standards would be applied when dealing with organisations and individuals from parts of the world where there are the real money-laundering problems.

[Lord Deighton]

My Lords, I think that I can safely say that every Member of this House will agree with the noble Lords, Lord Brennan, Lord Watson of Invergowrie and Lord McFall of Alcluith, about the importance of the fight against money-laundering and other financial crime and about the importance of ensuring that the banks discharge their responsibilities in this area properly—absolutely no question. I hope therefore that the statement that I am making now will reassure them, more than my letters have done, that anti-money-laundering compliance in banks will be fully covered in the new senior managers regime. I can assure noble Lords that anti-money-laundering compliance in a bank will always ultimately fall within the responsibilities of a senior manager in that bank. The FCA will also have extensive powers to ensure that banks are clear about where these responsibilities lie.

First, under the new senior managers regime, the regulator will specify senior management functions in its rules. These will cover such roles as the chief executive and the finance director and may extend to any function that involves an individual managing aspects of a firm’s business that could have serious consequences for the firm or the wider economy. The total number of individuals covered by the new regime is likely to be smaller than those currently performing functions of significant influence in banks. In line with the recommendations of the PCBS, all the senior decision-takers—the most senior people in banks who take important decisions—will be covered by the senior managers regime.

Secondly, under the senior managers regime provisions that are now in the Bill, there will have to be statements of responsibility in respect of each senior manager. The banks will have to supply a statement with each application to the regulator for approval of the appointment of a new senior manager. The bank will have to update a statement whenever there is a significant change in a senior manager’s responsibilities. The regulators will also have the power to set out the form that the statements should take. They will also be able to require banks to verify the information in the statements in a way that they direct. As a result, the regulators will be able to tell who is responsible for anti-money-laundering compliance in a bank. They will also be able to detect any gaps in the responsibilities by comparing the statements of the senior managers in a bank. Senior management is always ultimately responsible for ensuring that the bank complies with all applicable legal requirements, including anti-money-laundering law. It is inconceivable that a senior manager will not be responsible in this area. Beneath senior management level there will, of course, be other staff involved in anti-money-laundering compliance work and these will include money-laundering reporting officers. In addition, the Government have deliberately retained the power for the regulator to pre-approve individuals performing key roles below senior management level, such as money-laundering reporting officers, even if those roles are not senior management functions. I am sure your Lordships would agree that this is a sensible measure.

We are also introducing, in line with the recommendations of the parliamentary commission, a certification and banking standards regime, applying to all employees of banks. As a result of those changes, the FCA will be able to set standards of conduct for all bank employees who may come into contact with money-laundering or other financial crime. Banks will have to certify annually that people performing particular functions are fit and proper to do them. These are roles in which an individual could do significant harm to the bank or its customers, such as trading or compliance roles or, of course, roles that involve preventing financial crime. The Government’s measures will ensure that senior managers in banks can be held to account for discharging their responsibilities in relation to anti-money-laundering compliance. The regulators will know who has those responsibilities and what those responsibilities are.

No one doubts the importance of the fight against money-laundering and financial crime. The Government’s reforms will ensure that banks and their senior managers will take their responsibilities in this area seriously and will start to discharge them properly. I hope therefore that, in the light of the assurances that I have given, the noble Lord, Lord Watson, will feel able to withdraw his amendment.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Wednesday 27th November 2013 Lords Chamber

I close on a reasonably reassuring note: the sentiment expressed by the Government is that the PSR, and above it the FCA, will do their best to produce the best kind of regulatory activity. We are really here to talk about regulators following principles, not just rules. I hope that the Government, in reply, will seek to satisfy the House that in this particular area of card payments, safety from commerce, high principle and effective regulation will be the order of the day.

[Lord Flight (Con)]

My Lords, I support what the noble Lord, Lord Brennan, had to say about the card payment system. Having looked at it in some detail, it strikes me that it is a classic situation of, “If it ain’t bust, don’t fix it”. There are so many other priorities that I urge the Government to think again about this one.

[Lord Newby]

My Lords, I think the burden of the case of the noble Lord, Lord Brennan, is that the Government are acting disproportionately in seeking to regulate something that is working very well and, in doing so, if they are not careful, they will cause major problems to a system that is currently without major problems. I hope I can reassure him that the principles that he set out at the end of his speech are ones that the Government share. There is no sense in which this regulator is being established with a remit to deal in the heavy-handed way that he fears. Given that we want to cover all payment systems, it would have been remiss to have excluded credit card payment systems. There is, however, no sudden plan to start a new, hugely intensive regime.

The noble Lord made the perfectly valid point that the regulator is slightly unusual in that it not only is a classic regulator but has a function to promote innovation as well. He raised a perfectly valid concern about the staff and whether we will be able to find people with the relevant expertise. We believe that there are people who have the relevant expertise and that it is an extremely interesting area in which innovation can be developed. The FCA will therefore be successful in finding staff who have the expertise and can do the job satisfactorily.

As I say, I am content that we are acting proportionately. We are not going to disrupt a system that is working well and we will be able to find people with the relevant expertise to manage it.

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[Lord Flight]

My Lords, I simply add that there is surely a strong duty of care to the depositors, whose money a bank is lending. The bank has a balancing role of looking after the interests of its depositors and looking after the interests of its loan customers. I also echo the point made by the noble Baroness, Lady Cohen. The “treat your customer fairly” principle has been applied across the financial services sector and I think that, in the main, the investment management industry has put it into practice well. However, it is a nightmare to police. If the individuals are not going to be motivated to act properly, then the law, or whatever is in the regulations, will not necessarily lead to that. We can say that we will pass a law and everything will be wonderful but the question is: will people behave correctly?

[Lord Newby]

My Lords, I am sorry that when we discussed this amendment on a previous occasion, the Government failed to convince the noble Lord, Lord Eatwell, that his amendment was not necessary. I hope that I will have more success this time because I believe that the amendment is neither necessary nor helpful.

We all share the objective of driving up standards in banking and improving the treatment of customers. That is why the Chancellor set up the Parliamentary Commission on Banking Standards and why we have accepted the vast majority of its recommendations. However, we remain unconvinced that the noble Lord’s amendment will add anything meaningful to these reforms.

The regulator’s FSA Principles for Business already includes what is virtually a fiduciary duty. Principle 10 states:

“A firm must arrange adequate protection for clients’ assets when it is responsible for them”.

As other noble Lords have mentioned, these high-level principles also already include the principle that:

“A firm must pay due regard to the interests of its customers and treat them fairly”.

I am not sure how the noble Lord’s amendment would improve standards or help bank customers; nor do I think that he has explained what the new duties on firms really mean. When he spoke in Committee, he said:

“This will increase consumer protection and help to restore confidence of the retail customer in banks. It will raise standards of conduct because banks will know they are responsible for acting according to these duties”. —[Official Report, 23/10/13; col. 1092.]

But my question is: how will it do that? How will it, as he hopes, stop the kind of scandals that we have had in the past? I think that that is an extremely difficult question for the noble Lord to answer in that neither “fiduciary duty” nor “duty of care” in this context describes a specific, precise obligation. As I have explained before, regulators’ rules provide very specific obligations.

I should add that the Official Opposition in the other place seemed to understand this difficulty. When an identical amendment was considered in Committee there, the opposition spokesperson, Cathy Jamieson MP, acknowledged the risk of unintended consequences or lack of clarity. She emphasised that the purpose of the amendment was to ensure that,

“customers are looked after and that banks are clear about their responsibilities and remember the part of the contractual relationship with customers that is about looking after their money”.—[Official Report, Commons, Financial Services (Banking Reform) Bill Committee, 16/4/13; col. 247.]

Of course, that is what we all want. That is why the Government introduced the regulatory reforms and new properly focused regulators. The FCA, in particular, will focus on protecting consumers and maintaining market integrity.

This Bill will take the process further by strengthening the regime of individual accountability and standards for those who work in firms, in line with the recommendations of the Parliamentary Commission on Banking Standards. These rules will be specific. They will be precise. They will set out the responsibilities of banking staff and senior persons to their customers. Moreover, they will be enforceable by the regulator. If they are broken, those people will be punished and could be subject to fines or public censure.

If we were to have the general duty of care or fiduciary duty as set out in the amendment, how would that be enforced? In law a fiduciary duty is enforced by the person to whom the duty is owed taking action in the courts. Does the noble Lord really believe that those people, some of the most vulnerable at the sharp end of bank practices, are likely to pursue their bank through the courts? Instead, the Government’s reforms have established a regulator with real teeth, of whom the banks will genuinely be scared—indeed, I think they are. Bolstered by a clear and binding set of banking standards rules, which specify codes of conduct and personal responsibility through the senior persons regime, this will mean a real change for consumers. The noble Lord referred to the SEC introducing a fiduciary duty in the United States. The proposed fiduciary duty in US securities law is not comparable. The proposal, on which incidentally the SEC itself has not yet taken any clear position, extends only to covering activities that involve giving advice. In any case, in the UK, when a firm provides advice to a customer, a duty of care already exists under the general law. In that respect, the US is simply looking to catch up.

To sum up, attempting to add duties of care or fiduciary duties of the kind proposed in this amendment would add nothing to the existing protections for customers. It is unnecessary and would not add any clarity to existing requirements. I hope, therefore, that the noble Lord will withdraw the amendment.

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[Lord Deighton]

My Lords, I confirm the observation of the noble Lord, Lord Turnbull, that it is of course not our objective simply to make the FCA happy. I will give a slightly longer explanation of why we think that the current situation will work just fine but, to get straight to the point, it is absolutely because we believe that the overriding mission statement is entirely consistent with the vigorous pursuit of the competition objective.

In looking at this from a personal point of view, I am very comfortable with the notion of an overriding mission statement which works in harmony with the operational objectives, can be used to support and enforce them and is very useful when it comes to shades of difference between them. I am very comfortable in this case because the overriding objective of making markets work well is entirely consistent with our mutual objective of ensuring that the FCA is pursing its competition objective with the utmost vigour.

I hope noble Lords have been able to witness that where we have been able to compromise, I have been very keen to compromise, but I am afraid here it is either yes or no, and in this case I ask the noble Lord to withdraw the amendment on the basis of my suggestion that I think it is going to be okay.

[Lord Flight]

My Lords, I have one issue to raise with the Minister. The competitive objective, as I understand it, applies equally to the PRA as to the FCA. As noble Lords may be aware, one of the immediate issues is that the capital requirements for banks of different sizes are dramatically different, such that a small bank’s capital requirement for certain forms of mortgage lending is about 30 times the capital requirement for one of the established clearing banks. The PRA has enthusiastically welcomed changing those arrangements and taking up the challenge to create a more competitive environment, but when I recently asked why the huge difference in capital requirements relating to mortgages had not been addressed, I was told that the PRA could not move until it was able to get agreement from the EU. I am not sure whether that is correct, but it is quite important to know whether meeting the competition objective is not just a question of having our own powers to do it but that EU requirements impinge upon it.

[Lord Deighton]

I shall look into that for my noble friend.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Tuesday 26th November 2013 Lords Chamber

[Lord Deighton]

The central question of full separation is in Amendment 2, which we will address next, and we can go on to discuss it. With respect to the FSA redundancy arrangements, I would be delighted to write to the noble Lord with that information when I have it at my fingertips.

[Lord Flight (Con)]

My Lords, can I ask the Minister for a little clarity on ring-fencing in terms of what is in this pot and what is in the other pot? The point he has made is that the ring-fenced pot will essentially be individual family deposits while commercial deposits would be outside the ring-fence; but what about the other side of the balance sheet in the sense of which part of the loan portfolio is to be in the ring-fence and which part is to be outside it? My previous understanding was that the ring-fence was going to be all deposit-taking and all lending. My reservations, if you like, with regard to the Glass-Steagall solution are that history has shown it is lending and not investment banking that has always caused banks trouble. This time round it was CDO lending and the unwise lending by HBOS and RBS that actually caused the banks trouble. The idea of separating absolutely banking and investment banking as a great protection for the deposits of ordinary citizens is entirely false in terms of economic history.

[Lord Deighton]

The clarification is that the ring-fence effectively operates on the liabilities side, so we are dealing with core deposits. Just to correct the point and make it clear, the most sophisticated investors can be either inside or outside the ring-fence, and they have the choice. However, the asset side of the bank’s balance sheet is unconstrained in the rules.

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[Lord Barnett]

My Lords, the Minister has told us that the Government consulted widely and got agreement. Well, more recently, there were 300 professionals who were consulted in a survey and only 35 of them thought it would work. I do not know who he consulted. He also talked about the robust regulations. Who is going to supervise these robust regulations—the old FSA, now called the FCA? Is he confident that it can? I am certainly not clear myself, nor do many people have a lot of confidence that the old FSA, now the FCA, can do that job. He is confident, however, that it can.

My noble friend Lord McFall pointed out what Volcker said to that committee: the chairman of a holding company, of which some part got into trouble because of the lack of regulation or whatever—what would he do? I know what he would do. He would seek to save it. These merchant banks may lose money at times—indeed they have done—but most of the time they make a lot of money and do not want to lose it. They want it separated, but under the same roof, with one holding company. That is what they have got and are going to get under the new administration.

I cannot see this regulation working and would like to hear the views of any other Member of the House who has an interest in this.

[Lord Flight]

My Lords, can I ask the Minister whether I am right in thinking that the PRA would be the main regulator of the balance sheets of the two entities under ring-fencing, and not the FCA, which is about protecting customers? Secondly, if there were a Glass-Steagall separation, is the job not exactly the same, in that you would need to look carefully at a separate investment bank and a separate banking bank to make sure that one did not have things in it which ought to be in the other? I would have thought that the job of regulating would be exactly the same as under a ring-fenced structure.

[Lord Deighton]

I agree with my noble friend’s explanation of the roles and responsibilities of the respective regulators in each case.

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[Lord Lawson of Blaby (Con)]

My Lords, this is a very important Bill indeed. We all know the great damage that the banking meltdown in the western world has caused, not least in this country. This Bill seeks to deal with that. There are few more important matters—there may be more important matters in the world but they are not susceptible to legislation. This is a vital matter that we can do something about by legislation, and that is what this Bill is about.

In chronological order, I thank the noble Lord, Lord Barnett, for the kind things he said about points that I had made in earlier debates on this Bill. I agree with much of what he said. I also agree with much of what the noble Lord, Lord Eatwell, has just said. I congratulate the Government on setting up the Vickers commission, on having accepted the recommendations of the Vickers commission and on their amendment endorsing part of the recommendations of the Parliamentary Commission on Banking Standards, of which I was a member. The most reverend Primate the Archbishop of Canterbury was a distinguished member; I hope that he will contribute to our debate. The noble Lords, Lord Turnbull and Lord McFall, whose names are on Amendment 4, were also commissioners. I congratulate them on suggesting that there needs to be a review.

The Government have moved a very long way—and I am delighted—but not quite far enough. That is what we are discussing in this group of amendments. To get to the core of the issue, what the Vickers commission concluded and what the Government have accepted is that there is a problem with the relationship and, indeed, the mixing of commercial and retail banking with investment banking. The Vickers commission accepted that; that is why it introduced the ring-fence. The Government accepted that; that is why they accepted the recommendation of the Vickers commission for the ring-fence.

I have always been in favour of full separation—I came out publicly in favour of it long before the Vickers commission was even set up. We know that this works. It worked in the United States for many, many years under the Glass-Steagall arrangements and it is no accident that serious problems emerged after the Glass-Steagall Act had been repealed. Indeed, the Glass-Steagall Act would have worked for a great deal longer had not successive American Administrations been lobbied by the banks to introduce loopholes in one place and another. Anyhow, that is water under the bridge.

What is the danger? The danger accepted by the Vickers commission and the Government is twofold. First, although my noble friend Lord Flight is absolutely right that ordinary, plain, vanilla banking is a very risky business and often goes wrong, there is one particular range of risks in lending: the bad lending. In investment banking you had a whole new and very complex range of risks. It is not the case that nothing has ever gone wrong there; for example, there have been huge problems with derivatives that are a product of the complexity of investment banking. So there is first the question of whether it is sensible—when straightforward, plain, vanilla banking is risking enough —to add to that a whole new range of risks, a whole new complexity, which can make it more likely that the retail deposit-taking banks will get into difficulties. It must be unwise to do that.

The other problem is about the cultures. The Vickers commission did not talk about this, or think about it; it did not raise the issue of culture. But culture is very important. I was glad that when my right honourable friend the Prime Minister introduced the setting up of the Parliamentary Commission on Banking Standards, he explicitly said that it needed to look at the culture of banking, because something had gone wrong with it.

The culture of retail banking and the culture of investment banking are two quite separate things. One is, or should be, a culture of caution and prudence; the other is a culture of creativeness—which is very desirable—and risk-taking of a totally different order. That is another thing that the Vickers commission did not look at.

Now we come to the question of whether the proposal for a ring-fence will do the trick. We do not know. In the Parliamentary Commission on Banking Standards, we decided that although we had our doubts, it should be given a chance—but that there should be a proper review process, so that if it is proved not to be working, we shall move to something that will work.

Another of the things that the Vickers commission did not consider is the problem of governance. The ring-fence is a curious system, because there is one company with two subsidiaries—the retail bank and the investment bank—and we are told that they are completely separate, yet they are together. There is a real question whether that model of governance is workable. I know of distinguished bankers—at least one of whom is present in the Chamber as I speak—who have grave doubts on this score.

There is also a problem within the law. Boards of directors are responsible to the shareholders, so if there is complete separation it is clear that the board of the retail bank has responsibility to the shareholders of the retail bank and the board of the investment bank has responsibility to its shareholders. But under the ring-fence proposal there are two entities that we are told are completely separate, yet there is a single group of shareholders to whom they are responsible. We do not know whether this will work. We do not know whether there might be cultural contamination across the ring-fence. There is no legislation that can prevent cultural contamination, and that would be a very serious matter.

In the commission, we said that two kinds of review powers were needed. The first would look at individual institutions. If, after a number of years, we find that an institution has found a way round, or has burrowed under, the ring-fence and found a way of evading what the Government and Parliament decided, it should be obliged to separate its retail banking and its investment banking. But we also said that a second kind of review power was vital. The proposed system is a right idea of the Vickers commission. A number of the Vickers commission are friends of mine, they are very clever, and I have nothing against them—but they do not know whether it will work either. It has never been tried anywhere in the world, whereas complete separation has been tried, and it has worked. So it is vital that if the system proves not to do the trick, we move to complete separation.

Therefore, we need two kinds of review. The first is a review of an individual institution behaving in a way that undermines the ring-fence, and the second is a review to consider whether the system itself does the trick. The government amendment accepts in principle the first kind of review, but it does not accept the second kind.

I ask my noble friend to give a firm assurance that, as part of the review, the Government will look at whether the system is working and, therefore, whether full separation will be moved to. With the best will in the world, I know that he will wish to make it work, that the PRA and FCA will wish to make it work, and so will Uncle Tom Cobley and all. But if it is not working, will the Government look at full separation? Unless that undertaking is given here, in this House, I will seek to take the opinion of the House on Amendments 5 and 6, which are linked. Amendment 6 derives from Amendment 5, as noble Lords will know.

Given that the Government have gone so far, which I welcome, I hope that they will be prepared to make this further step and give this clear undertaking to the House.

[Lord Flight]

My Lords, I have broadly been in support of a Glass-Steagall separation of investment and banking banks, but there seems to me something slightly wrong with the concept of having a review and prejudging the outcome of that review. Playing devil’s advocate, I make a point on the other side of the coin. Europe has had universal banking for a long time; that is the banking tradition in continental Europe and there is still a case for universal banking to continue, although it is right out of fashion now. I repeat my point that, to a fair extent, the profits of investment banking have subsidised ordinary banking and benefited ordinary retail customers; the losses have generally come from bad lending. So it is slightly premature to prejudge the review. I cannot see what is wrong with having a review with the understanding that the Government will act on the basis of the recommendation of that review at the time. We will have moved on from the present and other factors may have come to light as well. I do not see what is gained by prejudging the result of the review.

[The Archbishop of Canterbury]

My Lords, as did the noble Lord, Lord Lawson, I begin by expressing my gratitude to the Government that they have listened to the speeches of many noble Lords and my PCBS colleagues on the need for a full and independent review of the ring-fence. I hope that they will realise that the amendments that have been tabled today are the final pieces of the puzzle in this regard. This work, combined with the vast improvements that we have seen to the electrification of the ring-fence—what is officially known as the first reserve power—is most welcome. The noble Lord, Lord Eatwell, put the case very clearly, not only for them but for the second reserve power. The Government’s approach to that is so far disappointing.

The Minister said that he believed that a robust ring-fence will work, and so do we, as the commission. It is just that we do not think that it is robust—that is the problem. The point of the second reserve power is to make the ring-fence sufficiently robust that it will carry the day if the first one is over a period of years overwhelmed.

The swirling floods unleashed in 2008 with the banking collapse continue to cause eddies all over our economy, particularly in the most vulnerable parts, which so many of us on these Benches are so deeply involved in supporting. Both the ICB and the PCBS concluded that the most appropriate way in which to reform the structure of the industry today is to have the ring-fence within a parent company. It is experimental —we hear the arguments, and we know so. This partial structural separation, with the added provision of ring-fence, should create a disincentive for banks to attempt to test the limits or game the ring-fence, but “should” is not sufficient.

The advantage of the second reserve power and the first reserve power together, in addition to the ones that the noble Lord, Lord Eatwell, put so eloquently, is that they give a second shot to the gun. If the first reserve power fails, and a bank or two has been forced into full separation but the whole industry is still gaming the system, then you have still got the second reserve power. It appears that the Government’s policy on this is to have only one shot and then to say, following that, “We’ll do something. As yet, we know not what. But we will do something, and it will be something very, very serious”.

--- Later in debate ---

[Lord Phillips of Sudbury]

My Lords, I support Amendments 21 and 51 as strongly as I can. We all know that the vast majority of people in the City of London and other financial centres are decent people who try to do good rather than bad, but the system of which they are part has been largely stripped of its ethical underpinning. Although you cannot inculcate morality by statute law, you can at least provide support for the forces of good and truth in dealing.

These two amendments are the very minimum required. I wonder whether the wording of Amendment 51, which refers to “rules of conduct”, is ideal. As a lawyer, whenever I see the word “rules”, I slightly draw back, because lawyers spend their time avoiding rules on behalf of their clients.

I would have hoped, and still hope, that if either or both these amendments were incorporated into the Bill, they would be construed in a wide way. There is no shadow of doubt but that too many people arrive in positions of responsibility without regard to these rules. As the most reverend Primate said, you can have a junior dealer who can cause devastating damage to a bank or other firm. So I hope that the Government accept these amendments or agree to come back at Third Reading with something comparable, bearing in mind the astonishing fact that the vast majority of our business schools have no ethical component in their curriculum at all. I do not think that 10% of them do anything in terms of ethics. If anyone says to me that it is a waste of time and a lot of hot air, they need only glance back at where we have come from. As other noble Lords have said, the degree of cynicism manifest in the policies and actions of so many financial institutions is stunning.

I hope that, if these amendments are brought into the Bill, they are construed widely by those who have to implement them. I am particularly happy that Amendment 51 would require any breach of standards of conduct to be reported to the relevant authority, because that is a real deterrent. People would be anxious about that. This proposal must be the absolute rock-bottom minimum to provide some underpinning for the future of financial services.

[Lord Flight]

My Lords, I come down to a very practical issue. In the territory that we are discussing, pre-approval is absolutely necessary for dealing with staff and anti-money-laundering requirements.

[Baroness Warnock (CB)]

My Lords, I support this amendment, which we have heard is really at the heart of the disasters of 2008. I have felt a creeping horror since the 1980s, when I was head of a college. People would frequently come up to me and say, “I’ve changed my mind, I’m not going to go on to a further degree or teach classics—I have had an offer that I can’t refuse”. This would be a young man or woman of about 21. You could see that their ethical standards had dropped away; they did not exist anymore. That was a shock to me then and it has been a shock to me ever since, so I very strongly support the amendment.

--- Later in debate ---

[The Archbishop of Canterbury]

I want briefly to add my support to the amendment of the noble Lord, Lord Brennan. Money laundering affects not only the areas that have been mentioned, but in my 10 years’ experience of dealing with conflict management and mitigation work in Africa, it was particularly significant in the ways in which illegal regimes or militias managed to fund and supply themselves. My experience, particularly in some parts of Africa, has shown that London, over time, as one of the deepest and most liquid financial markets on earth has, contrary to the impression given by many senior bankers, played a significant role—not through their collusion in any way at all, but because of its size and the complexity of preventing it. I believe that this amendment and the suggestions put forward by the noble Lord, Lord Eatwell, will contribute extensively to restricting that.

[Lord Flight]

My Lords, all Members of this House are what is known as PEPs for the purposes of anti-money-laundering. This means that any bank has to pay extra-special attention to any of our transactions. It is perfectly justified. The thought crossed my mind—and I have great sympathy with the noble Lord’s aspirations—that money laundering for corrupt purposes, for armaments, for terrorism and the rest of it, does not particularly come from an ordinary British family living in a suburb. It comes very much from parts of the world where such things are more prevalent. There is a case for requiring a more judicious anti-money-laundering regime for any form of transfer that comes from such parts of the world in an analogous fashion to a PEP if we really want to get to grips with the horrific money-laundering that can come from some parts of the world, causing misery to citizens there. As arrangements presently stand, there is no difference between an evil regime somewhere and an ordinary British citizen living in Birmingham.

[Lord Harris of Haringey (Lab)]

As I understand it, the money-laundering regulations specifically exclude British citizens, including parliamentarians, from their scope. What has happened is that the banks, as a matter of policy, following what they expect to be European directives on this subject, treat British parliamentarians as though they are politically exposed persons. The actual regulations do not.

[Lord Flight]

I think the noble Lord may be right, but in practice, we are thus treated as a more dangerous category. I was merely using that as an example of how the more obvious areas of money-laundering offences might be more carefully policed.

--- Later in debate ---

[Lord Flight]

My Lords, these amendments have the support of the Law Society of England and Wales as well as that of Scotland—certainly for Amendment 27. The issue is pretty clear. The objective is to ensure that the provision of legal advice is not to be construed as taking decisions or participating in the taking of decisions, and for situations where solicitors or other legally qualified professionals frequently give advice on decisions which a bank or other institution may take. They do not make the decisions, but purely advise on legal issues where the Bill is currently unclear as to whether advising would be included in,

“participating in the taking of decisions”.

Amendment 27 seeks to clarify the position.

There is an irony here in that, as I understand it, Clause 15 creates a broad definition of a senior management function, and the term,

“participating in the taking of decisions”,

as currently drafted will capture legal advice. This could have some perverse results and disproportionate consequences, and a danger that all legal advice is considered as participating in decision-making. If that were to be the case, all banks’ lawyers might need authorisation from the Financial Conduct Authority to give legal advice, whereas of course they are already regulated through the Solicitors Regulation Authority.

[Lord Newby]

My Lords, I understand the concern of the noble and learned Lord and that of the Law Society about the position of lawyers under the new regime, and I hope very much to be able to reassure him.

Amendment 27 would amend Clause 15, which inserts new Section 59ZA into FiSMA, which provides the definition of a senior management function. A person becomes a senior manager only if they perform a function which has been designated by a regulator as a senior management function and have been approved to perform that function by the appropriate regulator on the application of the authorised person; that is, the firm concerned. A senior management function is one that will,

“require the person performing it to be responsible for managing one or more aspects of the authorised person’s affairs”,

and that,

“those aspects involve, or might involve, a risk of serious consequences—

(i) for the authorised person, or

(ii) for business or other interests in the United Kingdom”.

It is therefore highly unlikely that the regulators would designate being a legal adviser as a senior management function simply because giving advice does not constitute management as set out in the definition of senior management.

Clause 22 inserts new Section 64A into FiSMA, which allows the regulators to make rules of conduct for approved persons, including senior managers, and for bank employees. This implements the Parliamentary Commission on Banking Standards recommendation regarding the introduction of a “licensing regime”. This broadens the population who can be subject to the regulators’ rules, which could for example now apply to an in-house legal adviser in the capacity of an employee. In addition, the regulators already have a broad power to require firms to provide information, as set out in Section 165 of FiSMA. However, the regulators cannot make rules which would trump the protection of legal privilege. Section 413 of FiSMA provides expressly that no power under the Act can be used to require the disclosure of “protected items”. These are defined in terms which are materially identical to the definition of items subject to legal professional privilege in Section 10 of the Police and Criminal Evidence Act 1984. Consequently, FiSMA already prevents the regulator from obtaining legally privileged material.

The noble and learned Lord’s amendment would also introduce a protection against the disclosure to the regulator of “excluded materials” as defined in Section 11 of the Police and Criminal Evidence Act 1984. This includes personal records generated in the course of business and held in confidence, human tissue and journalistic material held in confidence. Clearly, the regulators would not request some of the categories of material included in this section. However, in relation to confidential information such as that compiled during the course of business, it might be appropriate, and indeed sometimes essential, for the regulators to receive it. However, FiSMA itself provides strong protection for confidential information received by the regulators when carrying out their regulatory functions. Section 348 of FiSMA prevents any such information being disclosed to a third party except for very narrow purposes. Further, where any such information constitutes personal data, it would be subject to the Data Protection Act.

The noble and learned Lord asked whether Section 413 of FiSMA covers communications as well as documents. I can give him that assurance. The section is not limited to documents, so regulators cannot require the disclosure of privileged communications. With those reassurances, I hope that the noble and learned Lord will feel able to withdraw his amendment.

Banking: Co-operative Bank

Lord Flight Excerpts

Wednesday 30th October 2013 Lords Chamber

[Lord Newby]

My Lords, the banking Bill incorporates many of the proposals of the Parliamentary Commission on Banking Standards. On switching, a new seven-day switching service was introduced last month. In its first month, there has been an 11% increase compared with the previous year in the number of people who switched their bank accounts. One would expect that number to increase as the service becomes better known. This year the big change in terms of new entrants to the market is that the regulators have greatly reduced the time that it takes to become a new bank and greatly reduced the amount of money it takes to establish a new bank. Those are key drivers for getting new competitors into the market.

[Lord Flight (Con)]

My Lords, as the noble Lord, Lord Sharkey, has pointed out, it is perhaps somewhat of an irony that the Co-op Bank should being bailed out by hedge funds. The crucial point is that the Government have made clear that the time of taxpayers bailing out banks is over. Bluntly, if a bank cannot organise its own financial affairs, the resolution mechanism is the only alternative.

[Lord Newby]

My Lords, one of the key purposes of the Financial Services (Banking Reform) Bill is to provide, in ring-fenced retail banks, relatively risk-free places for ordinary customers to put their money. Beyond that, the key thing is that the Bill’s resolution provisions will require banks to put in place mechanisms to be activated if they got into financial difficulties, such that they would not need to come to government in those circumstances.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Wednesday 23rd October 2013 Lords Chamber

[Lord McFall of Alcluith (Lab)]

My Lords, I support the noble Lord’s amendment enthusiastically because the auditors were the weak link in the financial crisis. In terms of profits, the banks booked expected profits and then found out they were not there. So the question is: where were the auditors in that situation?

I was chair in 2007 when the Treasury Committee looked at Northern Rock. There were no meetings between the regulators and the auditors. The auditors of Northern Rock received more income from consultancy for Northern Rock than they did from audits. If I remember correctly, the auditors wrote 10 letters on behalf of Northern Rock, from which they gained £800,000. That is £80,000 a letter: not bad for a day’s work. Again, if I remember correctly, there were about seven meetings between the regulators and Northern Rock. At the time the mentality in the Financial Services Authority was the bigger the bank, the bigger the risk; the smaller the bank, the smaller the risk. Of these seven meetings, four were conducted by phone. Three were face-to-face, with no minutes taken. If you were the secretary of your local community council or your golf club and came up with such practice, you probably would not be the secretary at the end of the year. The regulator, however, kept on swanning along. That practice was a terrible practice—the voice of the auditor was missing.

The Treasury Committee report was clear. We said that within the limits of what they are required to do, perhaps the auditors did an adequate job. However, if they did an adequate job in terms of what they were required to do, the question remains: what is the point of an audit? That question continues to haunt the audit profession and it has not started to answer it.

The Government say there is talk about a code of practice, but in 2011 in a letter to the Economic Affairs Committee, Andrew Bailey of the Bank of England was very clear that,

“the working relationship between external auditor and the prudential supervisors had broken down in the period prior to the financial crises”.

So the code of practice does not work. The aim of this amendment is to ensure that there is a statutory basis so that no one can come along in future and say “That aspect was overlooked”. There has to be a serious duty on individuals to look at that.

From an accounting and disclosure perspective, RBS, Halifax and Northern Rock went down because of factors such as huge wholesale funding and property exposures. It was clear from the accounts two to three years previously exactly what the risks were, but nobody took heed. That is why the voice of the auditors has to be that much stronger. At the time, RBS shareholders approved the ABN AMRO deal by 95% to 5%, but that was just months before it collapsed.

When he was on the Economic Affairs Committee the noble Lord, Lord Lawson, asked John Connolly of Deloitte a pertinent question about auditing. The answer was that perhaps Deloitte would have had a different interpretation of “going concern” if it had realised that the Government were not standing behind the banks at the time. How flexible and flimsy is this focus on auditing from the auditors themselves?

There is a long way to go on audit, not just with regard to a statutory basis. There has to be a look at what auditing uncovers and what information it gives. I suggest that the Government look at three key features of an early warning system, having said that the auditors knew what the risks were before. First, there has to be a duty on auditors to raise these issues early with the supervisor. They knew what lay ahead if the reckless approach continued. Secondly, and very importantly, the auditors need to become more professional and sift large numbers of high-impact, low-probability events so that the regulator can understand what the risks are. Remember that the regulator was operating on the basis of business models—the profit and loss accounts of companies—which had nothing to do with the regulator, so they never looked at that. That is why we ended up with such huge scandals as PPI, interest rate swaps and whatever else. Business models are crucial to the regulator, as they should be to the auditors, so it is crucial to sift that large number of high-impact, low-probability events.

Given the point I made earlier about nobody taking heed, there needs to be an increase in credibility to ensure that all stakeholders pay attention to what auditors are saying. In terms of auditors and auditing and the link between auditors and the regulator, there has to be a less compliance-driven and more comprehensive approach. There has to be an enhanced role for the auditor as an independent expert to check and challenge all the trivial and complex issues that banks present. There has to be clear and unequivocal communication from the auditor to the company, and it is important that the regulator is aware of that information. From the auditors there has to be an insight into the company’s risk management system. More than anything, there has to be a universally consistent interpretation and application of standards. Given that we have to increase the confidence of the stakeholders by auditors, financial reporting needs to ensure that investors understand what is happening in a company.

The Government’s response to the commission’s report is totally inadequate. They said that they are,

“not convinced of the need to define the frequency of this dialogue in statute”.

The Bank of England has also said:

“The PRA has published a code of practice on the relationship between an external auditor and the supervisor”.

That code of practice, by the way, was ignored and jettisoned in the past. The FSA, given its culpability in Northern Rock, Halifax and the Royal Bank of Scotland, has the cheek to say that it supports an open dialogue with external auditors.

Andrew Bailey’s letter states quite clearly that the code of practice does not work. The empirical evidence states quite clearly that the auditors and regulators did not do their job in the past. If all we have is an exhortation to the financial community, auditors and regulators, to do things better, we will be back here in a few years. I therefore ask the Minister and the Government to look at this issue very seriously, and if they cannot give us a full answer today, to ensure that when we come back on Report and have had adequate time to look and present our amendments on that, at least we can have a positive way forward.

[Lord Flight (Con)]

My Lords, I strongly support these two amendments and the points made by the noble Lords, Lord Lawson and Lord McFall. I will add only the point that IFRS renders accounts virtually impenetrable, and fund managers have to convert them into a more understandable form of accounting to understand what on earth is going on within the organisation. I have been critical of IFRS for more than 10 years. The point was made to me initially that this was not a matter for Parliament but for the profession. It is of crucial importance to Parliament, because if it leads to things such as the banking mess, the nation at large is responsible. Secondly, as the noble Lord, Lord Lawson, pointed out, not only did it exaggerate profits in good times and create fictitious profits on the back of which excessive bonuses were paid, but it also exaggerates the other way in bad times, and therefore arguably can lead to an underappreciation of a bank’s strength. I had thought that France and Germany had some sympathy with this view and, notwithstanding other criticisms, I had been hopeful that the EU was looking to address this issue. I am disappointed that, to date, nothing seems to have happened.

I also make the point that, going back 20 years, Switzerland actually put a legal obligation on the auditors to do the compliance regulatory checking. The auditors were then liable if they had not done their job properly. I think it is a pity that Switzerland changed from that practice because I thought that it worked extremely well. I am not necessarily recommending it for this country but it was a novel idea, and the auditors ought to know what is going on within a bank if they have done their duty in auditing that bank properly. Switzerland has since changed its approach. Indeed, it was after it did so that Switzerland, too, encountered problems.

When the crisis broke in 2007-08, I asked myself: where were the auditors? Since then, candidly, there has been justified criticism of the regulators, but the issue of what the auditors were doing and why, and why bank accounts were so unsatisfactory, has not been adequately examined. I believe that the Treasury Select Committee has looked at this, but I am not sure whether it has done so in any detail. It is still quite an important issue and I believe that this Government should exercise pressure to effect reform of IFRS. In addition to the havoc it caused in the banking industry, it has also been significantly responsible for massive damage to our pension systems by overestimating the liabilities, especially when bond interest rates are artificially low. That has led to massive closure of justifiable defined benefit schemes. It really is a problem and it needs addressing.

[Lord Barnett (Lab)]

My Lords, I strongly support the amendment moved by the noble Lord, Lord Lawson. I declare what I suppose is a former interest, as many years ago I was a senior partner in an accountancy firm of modest size—I say “modest size” by comparison with the three or four firms that audit banks or, indeed, any of the FTSE 100 companies. That firm became bigger since I retired, because it merged with a fairly large international group, but at the moment it is not one of the likely auditors of any bank, whether small or large.

The noble Lord who just spoke asked where the auditors were. That question arose constantly, and understandably. If a bank gets into that kind of trouble, what were the auditors doing over the years? Never mind dialogue with the regulators; what about a dialogue with themselves or with the banks? Something serious will have to be done by the Government or by the profession about there being only three or four firms which audit all banks or, as I said, any FTSE 100 company. It is a serious matter and will obviously have to be addressed. It has been broadly spoken about for years, but nothing has ever been done about it.

Amendments 92 and 104D relate to some extent to leverage, which is what Amendment 93 concerns, and to whether banks have adequate capital to do the job of being a normal bank. This clearly is a serious issue, which nobody has properly addressed. How do we get to the situation where other major banks can be called on to have some kind of competition for who does that auditing job? When a firm knows that it will have that job permanently, the likelihood is that it does not do the job as well as it could or should. That has been happening all the time.

I hope that the Government will listen very carefully to what the noble Lord, Lord Lawson, my noble friend Lord McFall and others said, and what previous Select Committees said. This is an all-party issue, as the noble Lord, Lord Deighton, knows. I hope that he will be able to tell us that the Government will seriously consider what has been said today. If they cannot accept the amendment because the drafting is not quite as it should be—which I would understand—I hope that they broadly agree with it and will come back on Report with an amendment that does the job. We cannot just leave this; something will need to be done. I hope that the Government will listen very carefully today.

--- Later in debate ---

[Lord Flight]

My Lords, as the noble Lord, Lord Eatwell, pointed out, this is crucially important territory. However, I am not certain that the amendment gives the right answer.

I recollect that when I was studying economics at Cambridge 40-something years ago, a capital base of 8% and a gearing ratio of 12.5% was viewed as the prudent formula for a bank. Things have changed a great deal since then. Who was it that allowed banking ratios to get to such ludicrously low levels in this country? It was the regulator. Although we have a change of regulator organisation, there are still, to some extent, the same people and I am not sure that I necessarily trust the regulator in its new name as being sound in overseeing such things.

Look what has happened, I repeat, in the past 10 or 15 years. I think it was the noble Lord, Lord Lawson, who made the point that risk-weighted asset formulae are somewhat discredited. Again I agree and, having had some recent experience of it, I have little confidence going forward.

I also note in terms of ratios permitted that the regulator for some extraordinary reason—at least until the recent present—had ridiculous differences between the capital ratios required for large, too-big-to-fail banks and smaller and new banks. The ratio for mortgage lending was something like 20 times as much for a small bank as for a large bank. So, again, how come the regulator allowed crackpot different capital ratio requirements to creep in in a way that was thoroughly anti-competitive?

I am not sure that the Treasury may not be the safer party to ultimately have the power to determine capital ratios. As has been pointed out, the amendment states:

“The direction above may specify the leverage ratio to be used”.

The direction is given by the Treasury and so the amendment ultimately gives the last-call power to the Treasury and not to the PRA.

So where are we? I do not think the issue is resolved. It certainly needs addressing.

[Viscount Trenchard (Con)]

My Lords, I agree with much of what my noble friend Lord Flight has said. I also agree with a great deal or all of what my noble friends Lord Blackwell and Lady Noakes have said. I was also impressed by the way in which the noble Lord, Lord Turnbull, stated that he believed that the straightforward, unweighted leverage ratios should operate in tandem with a risk-weighted ratio.

I noticed that noble Lords opposite smiled when my noble friend Lord Blackwell pointed out that if the absolute ratio bites first and becomes effectively a frontstop rather than a backstop, it will lead banks to concentrate more heavily on risky assets, on lending on assets which they think will give them higher returns. I am convinced that that is correct. It is therefore important that the absolute ratio should be a backstop rather than a frontstop.

I am confused by the difference in responsibility between the FPC and the PRA. The amendment suggests that the Treasury should enable the FPC of the Bank of England to determine what the leverage ratio should be. However, as noble Lords have pointed out, the FSA had already become more involved in interfering with and providing advice, exercising influence over banks’ lending policies and questioning their formula and the basis on which they applied certain leverage to certain categories of asset class.

I am not sure where the writ of the FPC stops and where that of the PRA starts. I know that they are both part of the Bank of England and this is confusing. I would welcome clarification from the Minister.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Tuesday 15th October 2013 Lords Chamber

[Lord Eatwell (Lab)]

It would probably be helpful if I spoke now, and also introduced the amendment which is grouped with this one. I am grateful to the noble Lord, Lord Sharkey, for mentioning the comments that I made at Second Reading, but I feel that his amendment, while it raises a series of valuable issues, conflates some of them in a way which is not entirely helpful.

The first point is the one that he also made, which is that there has been no fundamental thinking at all about the structure of banking in this country. The whole discussion about ring-fencing which occupied us last week is a modification of the existing structures of ownership, rather than encouragement to develop an entirely different and more competitive banking structure. That is a key issue which underlies the amendment in the name of the noble Lord, Lord Sharkey, and the one that is in my name and that of my noble friend Lord Tunnicliffe. Where the issue has been conflated is that regional banking, to which he referred, should be separated from the issue of competition. Either or both can be promoted, but they have to be seen as separate entities. For example, the chief executive of Santander has recently written in the Financial Times that she would like to see a significant increase in regionalisation in its activities. That, of course, is not necessarily an increase in competition, but is a more regional focus of the single entity.

It is, however, encouraging, with respect to the regional issue, that the Governor of the Bank of England argued in Leeds a couple of weeks ago that he was very much in favour of an increase in regionalism in British banking, and I wonder whether the Government agree with him in this respect. The key issue underlying this is not regionalism so much. After all, if we look across Europe, it was the small regional banks which failed in their dozens, particularly of course in Germany. The issue is of relationship banking, and the return to a close relationship between the lending entity—which used to be the manager of the bank—and the community in which he or she is located. For example, that was an important force in the development of the science park in Cambridge. At that time, Barclays Bank played an important role in the funding of the science park. The manager, who took something of a punt in this respect, was of course then promptly moved on, because it was felt that he had overstretched his remit. I am very sympathetic to the idea of regionalism, but we have to see it in the context of a secure structure, without creating the rather weak structures which collapsed in other countries. We have to focus especially on the issue of relationship banking.

I now turn to the amendment in my name and the name of my noble friend Lord Tunnicliffe. This amendment seeks to look in particular at competition, with which the noble Lord, Lord Sharkey, began his discussion. As he pointed out, while at the beginning of the financial crisis it was argued that banks were too big to fail, they are now much bigger than they were then as a proportion of the overall UK market. The “too big to fail” issue is even more important today than it has been in the past.

There is no doubt whatever that the regulatory system itself—as well as various other aspects of banks’ activity, including the payments system, to which we will return later—has been a very effective barrier to entry. Only one significant deposit-taking bank—Metro Bank—has been introduced into the UK system over the last five or six years. We need to tackle this issue of competition. It was striking that the banking commission argued in the second volume of its report that,

“a market study of the retail and SME banking sector, with a full public consultation on the extent of competition and its impact on consumers”,

should be commenced immediately. It continued:

“We make this recommendation to ensure that the market study is completed on a timetable consistent with making a market investigation reference”,

to the competition authority,

“should it so decide, before the end of 2015”.

The Government’s response to the parliamentary commission on this point does not state that they reject this recommendation. Instead, they imply that they will fulfil it. However, what has happened? Nothing; absolutely nothing. They are bringing forward the OFT market review of small business banking, but this was not talking about small business banking. They are not putting in place a market review of the retail banking sector as a whole. Why on earth not? That is what is necessary, and what this amendment calls for.

The Government say that they are in discussions and that they are engaging with the problem. We would like to see some evidence of that. It is just not enough; it is too piecemeal, and not transparent. A proper review of competition in the banking sector is required. This amendment would secure that review in the manner which the commission recommended.

[Lord Flight (Con)]

My Lords, I declare an interest as a director of Metro Bank. I support Amendment 102, in the name of the noble Lord, Lord Eatwell. The Government are now well aware of the competition issue, but no particular policy has been formulated for how to deal with it. This legislation offers the opportunity to require that that should be prescribed. I will say more about competition in a minute.

While I support the principle behind the amendment in the name of the noble Lord, Lord Sharkey, I have strong reservations about regional banks. I remind noble Lords that, going back to the second half of the 19th century, when an industry got into trouble the regional bank failed and the whole region became depressed, often for a decade or more. The principle at that time, led by individuals such as Walter Bagehot, was to create national banks to spread the risk. Therefore, I am not sure that regional banks are particularly the answer.

Government policy has been anti-competition going back to at least Barings. I remember more than 10 years ago having an extensive debate with the late Sir Eddy George when he was Governor of the Bank of England, because it was stated policy that lender of last resort facilities would apply only to banks that were too big to fail. It seemed to me completely the wrong way round in that it gave smaller banks a disadvantage in terms of what they had to pay for deposits. Lots of them, such as Hambros, closed down. It created the great risk, for which we subsequently paid the price with the banking crisis. Elements of uncompetitive measures have been the big—very much higher—capital ratios that smaller banks have been obliged to have in relation to mortgage lending; the costs of the payment system; and the difficulty of getting a banking licence. If I may boast, I think that Metro Bank is the first new high street bank to have been set up in 120 years.

However, I therefore have some sympathy with the second part of the amendment of the noble Lord, Lord Sharkey. What he is saying, in my language, is that we want high street banks that will get dug into their communities and will naturally get involved with sponsoring activities in those communities. That is exactly what Metro Bank is doing. It is very good business to do it and very popular. When we open branches, there are queues of people waiting to come in and open accounts because they are so fed up with the appalling service that they have had from the banking oligopoly for the past few years. It was, indeed, very much an oligopoly. I think it was Lloyds that first decided that you could cut all service and just leave people with telephone numbers to dial. The other banks all followed, with a very substantial boost to profits as a result. For customers, however, it has been one of the biggest factors in making the large banks so unpopular.

I think the outlook is encouraging. Metro Bank plans to have something like 6% of the nation’s deposit base by 2020, which is not that far away. There are other new banks coming up. I believe that the face of the banking scene, even if the Government do not do much about it, will look very different in some 10 years’ time. One of the issues is that the big banks are simply too big to manage. The have archaic silo systems, which are an enormous problem to them. Their activities are simply too large. The requirement for increases in capital will lead to them shrinking their balance sheets and, rather like the old-fashioned huge department stores in the US, it is inevitable that business pressures will lead to their decline.

I attended an interesting meeting that was addressed by Andrew Bailey, the head of the PRA, this morning. He made the point that perhaps the regulator had been wrong to require small new banks to have much higher capital ratios against certain forms of lending. The logic for that was that new banks were more risky—fair dice—but its net effect simply increased the oligopoly strength of the existing large banks. The PRA is looking constructively at making capital ratios, as far as possible, the same across the board, whether banks are large or small. So the PRA is very much on to the need for more banking competition and for it to be supportive and helpful to new banks, as opposed to having rules that hinder them.

The Government, too, have seen the point and are keen on more banking competition. It seems to me, however, that they have not thought about it adequately and have not made up their mind about what more should be done, other than expressing a wish for more competition. That is why a requirement to look into the subject would be no bad thing. However, as I said, while I fully support the principle of more high street banks doing the things that high street banks always did, I am less comfortable with the amendment of the noble Lord, Lord Sharkey, which I think is overprescriptive.

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[Lord Flight]

My Lords, I ask the noble Lord to look at the other side of the balance sheet. I could not find the extract, but it is from a key government website and says that most organisations within the public sector are obliged to bank with either RBS or Citibank. This means that new banks cannot solicit their business. I am not clear how that came about or whether it is even in accordance with EU requirements, but a large part of the economy in the public sector is simply being dictated to on who it can bank with.

[Lord Higgins]

My Lords, my noble friend says that people have been very slow in the past, but he is now telling us that the OFT will decide whether to make a referral—not actually do anything, just make a referral—by 2015. Does it really take from now to 2015 to decide whether the banks need to be referred?

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[Lord Turnbull]

My Lords, these clauses exemplify the maxim, “be careful what you wish for”. The commission recommended that the UK Government should prepare a UK version of the bail-in scheme being negotiated in the EU as a precaution against the possibility that the EU scheme could be delayed. One only has to look at the Solvency II directive to know how long these things can take. We have a slightly different explanation today, which is that we are sufficiently close to finalising the EU scheme that it is safe to proceed to legislate for it. In other words, that implies that this is a substantive scheme, not an interim scheme that might in due course be replaced by an EU scheme. I wonder if the Minister could clarify this.

My only other remark is to say that I very much support the remarks that the noble Lord, Lord Eatwell, has made about people who, once or twice in a lifetime, have a very large sum in their accounts. The other example that could have been quoted is people who sell a business before they retire.

[Lord Flight]

My Lords, I can see something like a bail-in scheme working satisfactorily with regard to a bank the size of the Co-op Bank, for example, and indeed the proposals to bondholders are effectively a do-it-yourself bail-in scheme. However, in the unlikely event that it was necessary, if a bank as large as Lloyds Bank were in trouble, I find it difficult to believe that the situation could be resolved by a bail-in scheme. This is in part for the reasons that others have given, that the knock-on effects to the rest of the banking system are too large. So while the bail-in system makes great sense, I do not think it can be a sort of universal solvent to the possible need for taxpayer money to be used when huge banks are in trouble, or for so long as we have huge banks.

[Lord Blackwell (Con)]

My Lords, in asking Parliament to approve these powers, I wonder if my noble friend could set out what protection he believes is built into this legislation for the inappropriate use of these powers. I understand why having a regime in place that allows a speedy resolution to be enacted is desirable. If that is to come about, it needs to happen very quickly and efficiently when the circumstances call for it. The draft legislation sets out the conditions under which those powers might be exercised. The new Section 8A of Schedule 2 talks about appropriate conditions protecting,

“the stability of the financial systems … the maintenance of public confidence … the protection of depositors … the protection of client assets”,

but those conditions are obviously subject to judgment and interpretation, and it would be helpful to understand those parties who might be affected by the exercise of those powers, not least of course shareholders and bondholders, and whether there is any protection for them against the inappropriate use of those powers without getting into some lengthy and time-delaying process of judicial review.

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[Lord Flight]

My Lords, I support the points made by the noble Viscount, Lord Trenchard. It is entirely understandable that people in this country are furious when they see individuals whom they blame for the system blowing up getting off scot free. On that front there are two points. First, if monetary policy is too lax for a long time, it will almost inevitably lead to bad lending by banks because, in some sense, banks are an automatic conduit of money. That really is what happened in the UK—because of the 2% inflation target, the Bank of England did not acknowledge that there was much higher inflation here off-set by imported deflation. We had easy money for far too long that filtered its way through into bad lending by banks. I remind the House that it was not investment banks but one or other form of bad lending—old-fashioned bad lending such as HBOS or buying CDO instruments from the US. It is not just individuals when a banking system blows up but the background as well.

Secondly, I blame greatly the useless and negligent regulators as well. Why did they not spot the problem? Why should they get off scot free as well? They have a job. Their task is to keep an eye on and make sure that the banking system is safe. If they fail completely in the discharging of that, to some extent they are as guilty as reckless people running banks badly. There is certainly an argument for saying that it would be desirable to bring in draconian powers against the executives of banks, harmonised internationally. I would be more comfortable if the same sort of measures applied in the US, Hong Kong and continental Europe.

I want also to raise a slightly quirky point relating to anti money-laundering since anti money-laundering amendments have arisen. It seems to me that in some ways anti money-laundering has gone slightly over the top. Noble Lords may be aware that, following the large fine given by the US authorities to HSBC, HSBC has simply fired all its US clients in the UK. It has closed their accounts. It has said it no longer wants the risk of dealing with Americans. This has caused huge inconvenience to lots of Americans living in London. Going forward, I can see if other dangers present themselves to other banks, they may decide that it is not worth having a particular category of client.

FATF, which as far as I can see is an unaccountable body laying down anti money-laundering rules, decided to blacklist a number of countries it felt were not practising anti money-laundering measures adequately. This led to some 30 embassies in the UK finding their bank accounts were likewise closed by HSBC. Some of the embassies found it virtually impossible to obtain a new bank account. If there was a branch of a bank from their country in this country they could go there but most other banks would not take them on as a client because they had been blacklisted by FATF. That again seemed slightly to fly in the face of embassies being approved by the Foreign and Commonwealth Office. Its reaction to this matter, I gather, was to express regret but not to do anything. I raised this with Andrew Bailey from the PRA. He felt it was extremely wrong and was quite surprised it had happened. This is a slightly different issue from where we are in the Bill but I would just say to the Minister that the Treasury needs to keep a little watch on what is going on in the anti money-laundering territory and its knock-on effects. I certainly think it is time that FATF, which is the top body laying down all this, were accountable to somebody. Both the Treasury and the Foreign and Commonwealth Office effectively said to me that they could not interfere with FATF—whatever it says goes.

[Lord Brennan (Lab)]

My Lords, I speak to the amendments in my name and in those of the noble Lords, Lord McFall and Lord Watson. I declare an interest as chairman of Global Financial Integrity. It is a Washington-based think tank whose purpose is to promote measures designed to limit and eventually eradicate illicit financial flows around the world, in particular those from developing countries, which presently run into hundreds of millions of dollars. It is thought that they exceed the amount of aid that developed countries contribute to the countries out of which that money comes. I have experience as non-executive director of a banking operation and have advised banks professionally.

Money-laundering, the proceeds of crime and the results of fraud represent a composite picture of international dishonesty, which has been and will continue to be practised wherever those responsible can find a banking system through which to channel the money. This is a fact of life. Many of our banks have such an international scope that they are a ready target for people wanting to use them for these illicit activities.

I invite the noble Lord, Lord Flight, if he has not already read it, to look at the congressional report on HSBC. The chairman of HSBC described it as a very sobering read and concluded that bankers had lost the right to self-determination on such issues. When we come to the part of the Bill that controls how and what people in banks do so that this kind of dishonesty is not furthered, we should err on the side of authority. I invite those advising the Minister to avoid the legislative naivety I dealt with at Second Reading, or in months to come the Bill will result in many hours of detailed inquiry and comment by lawyers advising banks. The first rule the lawyers will pick up is that that which is not stated in this Bill was neither meant nor intended. The Bill, if it is to restore public trust and avoid the kind of risks I have described in dishonest money transfers, should err on the side of authority.

The amendments I am about to speak to were produced by independent counsel, invited to produce amendments that sought to meet the concerns I and my noble friends have. We played no part in the drafting of these amendments, so let us have a care. If a professional advising us as to the amendments produces this level of authority as being required, what do you think those seeking to protect themselves against it will do in terms of legal expense and inquiry?

My final point before I turn to the amendments in detail is by way of introduction. The noble Lord, Lord Flight, in his usual reserved manner, said, “What about the reckless disregard of regulators in the past of their responsibilities?”. I do not think that we are entitled to repose into the hands of future regulators a degree of confidence that past experience shows would be misplaced. They should be told the scope of how they are to do things and what they are to do because we are talking about bank involvement in criminality.

Amendments 46A and 46B go to the question of strengthening the senior management function—the senior person’s regime—so as to include, with precision and clarity, an obligation on the banking system specifically to deal with the risk of money-laundering and of dealing with the proceeds of crime or the results of fraud. There should be no legislative fault in precision and clarity when dealing with criminality.

The amendments seek to ensure that the definition of “senior management function” should be seen to include those areas that I have just mentioned in terms of compliance. Those in banking must comply and must avoid the risk of non-compliance. The FCA, in specifying senior management functions, will require them to do things, including a minimum threshold for sums to be regulated. Is this too much? It was not thought to be too much in the United States, which has a far bigger banking system than ours. Would it run a risk of damaging our banks? It has not in the United States. It is ours that have suffered the penalties, not theirs. These amendments seek to establish a norm—not some Anglo-Saxon aberration—for proper cross-border behaviour in the banking world.

Your Lordships will note that Amendment 46A uses the words, in proposed new paragraph (b)(iii),

“related to or resulting from”.

In other words, it gives a broad reach to responsibility. Amendment 46B makes specific reference to the statutes that have to be borne in mind. It is hardly a criticism to be met to say that people must obey the criminal law—of course they must. This statute—the Bill and the amendment—remind people in statutory wording of their civic obligation, as well as their professional obligation, to obey the law. It is designed to stop the defence of, “Nobody told me. It was not my job”. The two amendments are straightforward and build on the Government’s well deserved intention to improve the law.

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[Lord Flight]

I clearly did not make my point correctly. I was simply trying to say that I have seen reactions to anti money-laundering arrangements, namely HSBC sacking all its US clients and 26 embassies in the UK being blacklisted by the FATF and having problems getting bank accounts. By the way, 10 of those embassies belonged to members of the EU. It is right to focus on anti money-laundering for the reasons which noble Lords correctly pointed to, but people do not take account of the other side of the coin. What is happening, as I described—and it will increasingly happen—is that people who come from countries that have been FATF-blacklisted will find it impossible to get a bank account, although they may be completely innocent.

[Lord Eatwell]

My Lords, I have an amendment in this group and it may be for the convenience of the Committee if I speak to it now. Before doing so, I would like to make two comments about the discussion that has gone on so far. First, Amendment 55 in the name of the noble Lord, Lord Deighton, which includes the meaning of what is a bank, requires very careful exposition by the Minister, because if it says what it appears to say then it seriously undermines the whole discussion about the senior persons regime that we have been having up until now.

Secondly, on the amendments tabled by my noble friend Lord Brennan and his colleagues, it seems that it is incumbent on the Treasury between now and Report to produce a written report demonstrating the noble Lord’s claim that these amendments are unnecessary; showing that the current regime is fully in accord with the latest FATF principles; and therefore providing the comfort which my noble friend might seek if his amendments are indeed unnecessary. Perhaps the noble Lord could also take in some of the points made by the noble Baroness, Lady Noakes, as there are areas that the noble Baroness wants to be sure are equally well covered. Particularly with respect to the issues raised about anti money-laundering and prevention of terrorism principles, it is crucial, as those principles are conveyed into legislation, that we are absolutely clear—and the legislation is clear and explicit—on this matter.

Amendment 100, which is in my name and that of my noble friend Lord Tunnicliffe, proposes to introduce a licensing regime to apply to all approved persons. The noble Lord, Lord Newby, made the extraordinary remark that this would weaken what was elsewhere in the regime as set out in the Government’s amendments. However, I was heartened to hear the noble Lord, Lord Turnbull, use the word licence as I did, and to hear him quote almost word for word the specification of,

“minimum thresholds of competence … integrity, professional qualifications, continuous professional development”,

and so on, which is included in our amendment.

Amendment 100 would significantly strengthen the requirement for approved persons to be suitably qualified in this country, to be licensed and to face the possibility of having the licence removed. Doctors, teachers and lawyers all require some form of professional licence, so why not approved persons in banking? If the noble Lord really undertook to understand this amendment he would realise that it fits precisely with the goals of the commission and would significantly strengthen the quality of regulation and approval of those working in the banking sector in this country.

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[Lord Newby]

The definition relates to deposit-taking, retail and wholesale.

[Lord Flight]

Could I add my support? It seems to me that it is in investment banking territory where there is the greatest scope and where there has been the most inappropriate behaviour. It was Lehmans that nearly brought the whole system down. Part of the intent of the ring-fence is that what is in it is much simpler banking. The whole argument does not stand up unless investment banks are very much covered by the new regime.

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[Lord Turnbull]

My Lords, this is another example of where we should be careful what we wish for. The Treasury committee and the parliamentary commission both welcomed the Government’s damascene conversion —that was what it was called in our report—announced in the Budget last year to create a payments regulator. However, this has been done in a quite extraordinary way with some 40 pages of amendments having been produced only two or three days before we were due to examine them. Although the new clauses were published following a process of consultation, there does not seem to be time for anyone in Parliament or anyone affected by them to scrutinise them. How can we tell whether what has been drafted is workable, reflects the views expressed in the consultation or will deliver what the Government want? From a procedure point of view, the usual channels might consider whether the gap between Committee and Report might be rather longer than normal so that we get a chance to look at not just this but also at the bail-in provisions as we have only had a small amount of time to consider them.

Through much of the consideration in Committee my view has been pretty close to that of the noble Lord, Lord Eatwell. However, as regards whether this body should be independent or part of the FCA, I am in the other camp. One of the key features here is that there is doubt about whether competition comes high enough up the FCA’s priorities. We shall come to later amendments whereby the parliamentary commission wanted to push competition higher up the FCA’s priorities. The proposal before us serves the interests of competition better than by making the body under discussion another department within the FCA, so there is another side to the case.

[Lord Flight]

I support these amendments. The biggest part of the Bill is concerned with creating competition in the banking industry. The thought had crossed my mind that we are proliferating yet another regulator but I am persuaded by the argument advanced by the noble Lord, Lord Turnbull, that it might get lost within the FCA which has many other things to focus than competition. However, I make the small point that in the past year the Payments Council has done a good job in bringing in the ability to transfer a bank account within seven days. Although the new body will be more representative, the Payments Council should not be overcriticised for what it has achieved while it has existed.

[Lord Higgins]

Those of us who have been through many legislative processes may be a little appalled to find that it takes 40 pages of amendments to establish a payments regulator. I wish to ask one or two simple questions. On whom will the cost of this regulation fall? Have we an estimate of what it is likely to be? The Minister referred to what I believe was the lamentable attempt to get rid of the cheque system. Will this proposal stand up if the cheque system is changed? As far as international transactions are concerned, will the regulator be concerned with payments which are made internationally?

Bank of England: Monetary Policy Committee

Lord Flight Excerpts

Monday 14th October 2013 Lords Chamber

[Lord Newby]

My Lords, I am sure that the noble Lord welcomes the fact that, for the first time, the Bank of England is looking at the employment rate as a way of deciding on the speed at which interest rates might change. I am sure he would agree, as Keynes probably would, that the quickest way to bring the rate of unemployment down is to get the growth rate moving more quickly. I am sure that he will be pleased that all the projections of growth are now being revised rapidly upwards. The IMF, for example, last week revised upwards its growth rate for this year from 0.09% to 1.4% and for next year from 1.5% to 1.9%.

[Lord Flight (Con)]

In the discussions that the Minister is having with the Chancellor and the Governor of the Bank of England, are they focusing on what the extent is of imported inflation or deflation compared to domestic inflation? It was largely a failure to understand that domestic inflation was far higher than the mixed bag that led monetary policy under the previous Government to go off the rails.

[Lord Newby]

My Lords, in recent years, there has been a very different mix of imported and domestic inflation, and we have not seen any significant degree of domestically generated inflation. That remains pretty much the same today. Fortunately, we are a very long way from the 1970s and 1980s, when domestically generated inflation was the single biggest problem of macroeconomic management.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Tuesday 8th October 2013 Lords Chamber

[Lord Flight (Con)]

My Lords, I rise very much in agreement with the noble Lord, Lord Lawson. The particular point that I should like to make is that if we look at events over the past five years, it was not derivatives or standard investment banking activity which got the banks into trouble but unwise forms of large-scale lending. It was the purchase of blind CDO instruments from the US without knowing what was in them and the banking practices in particular of HBOS. These were the areas in which huge amounts of money were lost and which nearly brought down two of the main banks of this country.

Looking at the ring-fence model, it seems rather strange that all that sort of activity will be in the same box as good old-fashioned high-street banking, as I understand it. I repeat my interest as a director of Metro Bank, which is an old-fashioned high-street bank in essence. But if the high-risk areas of banking generally are going to be in the same box as the lower-risk activities of high-street banking, that does not seem to make much sense. The delineation of what is investment banking and what is commercial, high-street banking is not a particularly good one if your objective is to protect the ordinary citizens’ banking activities.

[Baroness Cohen of Pimlico (Lab)]

My Lords, like many in the House I did not manage to speak at Second Reading either, but I have spent a miserable summer concluding that Vickers got it wrong. This is a horrible thing to say to my good friends in the Parliamentary Commission, but they got it wrong too about separation. I come from a long career in merchant banking. I was pulled out of the Civil Service to be a merchant banker and I understand very well how ingenious they are. We had a wonderful concept in my youth called the Chinese wall. All I can say is that ivy grew over that Chinese wall and ear trumpets went through it because we are an ingenious lot.

The very complication of the debate that we are having, the horrible complication of the legislation and the very real difficulty of the amendments all stem from the fact that we are trying to do something impossible. Ring-fencing will not work. It does not matter how many people you place in charge of it, you need institutional separation. As my noble friend Lord Barnett says, we are going to have to come up against this one of these days.

I am also fairly horrified to hear Members of this House describing ring-fencing as an experiment. What are we doing experimenting with the banking system? We have experimented with it before and we should not. We should be sticking to what we actually know will work.

I am in entire sympathy with the points made by the noble Lord, Lord Forsyth. I think that his diagnosis is absolutely accurate, but I differ on the conclusion.

Financial Services (Banking Reform) Bill

Lord Flight Excerpts

Wednesday 24th July 2013 Lords Chamber

[Lord Flight]

My Lords, I first declare my interests as set out in the register, in particular as a co-founder and director of the new retail bank, Metro Bank. I agree very much with what the noble Lord, Lord Lawson, had to say about the separation of high street and investment banking. It is accepted that the ring-fencing regime is a compromise to see how it goes but it seems to me, above all, that these huge institutions have become unmanageable. They are just too large to manage effectively. I also note that investors, many of them pension funds, are still investing in a mixture of the two businesses, so it really is not much help to them.

The ring-fencing brings a lot of problems in terms of which services can or cannot be sold to retail clients. It is very complex but, to go only slightly in the other direction, one should not forget that it was essentially bad lending that led to the banking disasters. The noble Lord, Lord Lawson, made that point. There was bad lending of all sorts, including the buying of foolish CDO instruments. It was not particularly the derivatives or the investment banking side. It is important to remember that. I hope that a separation of the two sides of banking, should it come about in the future, may leave the banking sector to return to more reliable lending practices. That would go a long way to help address the issue of remuneration. In the past there was never any justification for huge remuneration. It was very much a carry-over from the investment banking world.

I, too, pay tribute to the Parliamentary Commission on Banking Standards and to Andrew Tyrie’s excellent leadership. I support the new senior person responsibility regime, but with the proviso that we should continue to have the principle that one is innocent until proven guilty. Some of the proposals seem to point in the other direction.

I want particularly to talk about competition. I used to think that competition was not so hugely important. The more that I focus on it, however, the more I consider it the one thing that could completely change banking in this country within as short a period as a decade. I will start by commenting on the Payments Council arrangements to enable seven-day current account switching, which come into operation this September, and on the debate about whether bank account number portability will be feasible in the foreseeable future. First, sort code account portability will not be feasible until banks have common sort code number systems. There is a lot of work to be done to standardise sort codes, which will be expensive. My second comment concerns a point that I raised at the time of the Financial Services Bill, to which there has been no reply. The anti-money laundering, or AML, “know your customer” requirement means that another two weeks or so is added to the time that it will take people to move their bank accounts. Banks will not accept a new customer’s account until they have satisfied themselves with an AML check. We all know that that goes on for ever; people have to see lawyers, get passports signed and goodness knows what. I would not mind if it was sensible—if there was a single body that did all AML “know your customer” analysis that was acceptable to all banks and which could be kept up to date. That would save a lot of duplication. With my Metro Bank hat on, we find that just by using a driving licence we can access all the data that we want and open an account within 10 minutes.

On the point about the essence of competition, until the latter part of the 19th century we were like America, with many regional banks. When local banks went down they caused 10-year depressions in parts of the country, which led the great Walter Bagehot to argue that if banks were consolidated, that would spread the risk. Certainly, one could argue that, in the 1930s, a Midland bank that had a very rough time in the north-west was sustained, in part, because of its spread of business all over the country.

Inevitably, things swing too far in the wrong direction. I would argue that in this country the amalgamation to reduce risk spread virtually to a cartelised banking system. When one of the large four banks decided to cut massively the services that it provided to customers, everyone else copied it. By and large, the big four have behaved in a similar way for a long time. When we have a cartel situation we tend to get problems and bad behaviour. Therefore, there is a sound case to be made for a significant revival of new banks in this country, which might take as much as half the total banking business—certainly the high street business—over the next 10 years or so.

Yesterday Metro had its third birthday. We have opened 19 branches, we have a balance sheet of nearly £1.5 billion, and we have about 210,000 account holders. That has all been built from scratch. If we can do it, why cannot everyone else do it? It is not that difficult. I am pleased to say that Vernon Hill, the American backer, considers this to be a more welcoming country than America in which to grow a bank. Although we may have our complaints about regulation, the multitude of American regulation is more exhausting than it is here. He is a great advocate of doing banking business in this country.

However, there are four areas in which we see scope to improve competitiveness. None of them is absolutely huge, but all are important. The first concerns the need to have a level playing field with regard to capital and liquidity requirements. The second concerns the payments system. The Minister commented on that in terms of the Government’s commitment. Thirdly, our antiquated high street planning rules tend to make it difficult for new banks to open up in good retail spots. The final point concerns the guidance to all government departments on doing business with new banks. As everyone knows, not so long ago the advice was to place money where one got the highest interest rate. Then came the Iceland banks crisis and the advice swung the other way: “You mustn’t go to any bank unless it’s got a credit rating”. We have all seen how useful credit ratings are.

On the first point, it is unacceptable that small banks—not even just new banks—often have four to five times the capital ratio requirements for SME and mortgage lending as do large banks. Clearly, a set of common industry standards for both liquidity and capital requirements is needed. I accept that both requirements should be higher in the early years of a new bank. There are high risks in setting up a bank and it is appropriate that there should be protection. However, the regulator should know what is going on and after three or four years it should be able gradually to phase in the capital and liquidity requirements to be broadly the same for all sizes of bank. I am hopeful that the PRA will use the occasion of Basel III and the EU’s CRD IV proposals, which come in at the beginning of next year, to move in that direction. I cannot see why we are where we are today and why the PRA should not get more of a move on.

On the payments system, new and smaller banks are dependent, as everyone knows, on large competitors to provide them with agency banking services, for which they invariably are significantly over-charged. It would be best to remove the payments system completely from banks’ internal mechanisms and to create an independently run licensed payments platform that would provide the service to all banks. The US clearing house inter-bank payments system is effectively that. It services several thousand banks within the United States quite satisfactorily. I cannot think why we might not think of copying the US in that direction.

On planning, we have classes A1 and A2 planning designations where banks are treated as A2 and therefore do not qualify for A1 retail sites. If a bank wants to open an operation in a shopping mall in an area where there is a lot of retail custom, it is not allowed to have that site. If the bank thinks it worth the effort, it has to go through substantial expense and time-consuming activity in seeking to get a change of use from A1 to A2 before it can take on such a site. Needless to say, landlords do not like that much, given that there is a delay in the period in which they are likely to earn their rental. The costs of dealing with planning add about £100,000 per site. The sensible solution might be to amend class orders to reclassify banks that keep retail hours, have retail customers and provide retail services as being suitable for A1 and A2.

Finally, on doing business with local authorities, it is clear that what is needed—whether it is guidance from DCLG or local authorities themselves—is to take a wider view of rating banks. Indeed, it is an insult to the PRA, which is supposed to ensure the creditworthiness, security and liquidity of all size of bank, to assume that credit agencies are better and that the smaller, newer bank is automatically less secure. Quite often it is, in fact, the other way round. The guidelines ought to be amended inviting government bodies to make their own judgments and potentially to place deposits on a more pro rata basis to the capital of different banks.

There are two other issues I shall address briefly which are somewhat indirect. One is that the EFG small business loan guarantee scheme is working poorly in this country, particularly in comparison with the small company loan scheme in the United States. The banks do not like it as it is a nuisance and a hassle. However, in the United States, there is effectively full security cover because the lenders, including the Government as guarantor, take a charge over the entrepreneur’s residence whereas over here that is not permitted. In the United States, that makes such loans more easily on-sellable, so the banks can go on making more.

Finally, as noble Lords will have noticed, UK banks in America have now been fined many billions for breaches of various regulations. I am very mindful that America has reduced its international indebtedness by about $1,000 billion as a result of the mis-selling of CDOs and that has been substantially paid for by our banking system. I wonder whether the Treasury has looked at whether the mis-selling of CDOs is a regulatory offence for which we might look at levying some compensating US fines.

We have a lot of work to do on this Bill. It is very important, but my sit-down message is that I feel that all efforts need to be made to make this country have a much more competitive banking system.