Financial Services Bill

Lord Lawson of Blaby Excerpts

Monday 11th June 2012 Lords Chamber

[Lord Lawson of Blaby]

My Lords, the House will have listened with great attention to what the right reverend Prelate has just said with a mixture of expertise and eloquence. It was certainly unusual in one respect; he must be the first speaker from the Bishops’ Bench, certainly in my time in the House, who has come out as a former derivatives trader. This adds great weight to everything he said.

I hope the Minister will pay particular attention to the area on which the right reverend Prelate has focused, as he has on a number of occasions outside this House, of the arrangements and problems associated with payday lending and the people who require and use it. However, I will not follow him further down that route because other things need to be said about this long, highly complex and important Bill, which I warmly welcome.

Before I turn to the measures in the Bill, there is one thing of fundamental importance that cannot be put into it: the relationship between the Chancellor of the Exchequer of the day and the Governor of the Bank of England. Again, this is of fundamental importance. While it cannot be put into a clause of the Bill, that does not mean that it cannot be institutionalised, and I hope that my noble friend the Minister can reassure me that something will be put in place along the lines of what used to happen in the United States, although I do not know whether it still does. There were regular breakfast meetings between the Secretary of the Treasury and the Chairman of the Federal Reserve. The relationship needs to be institutionalised. Just because they get on well is not good enough. In my judgment, that needs to be done.

I approve of the broad lines of the Bill. The regulatory architecture that it introduces is a big improvement on what it replaces. As my noble friend Lord Sassoon has already pointed out, the so-called tripartite system introduced by Mr Gordon Brown in 1997 proved to be a dysfunctional disaster and did not cause, but certainly contributed to, the severity of the UK banking meltdown in 2008. What was particularly perverse about the Brown structure was that it destroyed and replaced the greatly strengthened system of prudential supervision that as Chancellor I put in place in the Banking Act 1987, with the indispensable assistance of the then Economic Secretary to the Treasury, my noble friend Lord Stewartby. I am glad to see that he is in his place and I hope that he will speak later today. I should like to refer to two specific aspects of the 1987 Act later in my remarks. While the new architecture is a great improvement, it may not be right in every respect. It will need to be monitored carefully to see how it works out in practice, and I trust that the Government will be prepared to modify it in the light of experience. That will almost certainly be necessary.

The most fundamental flaw in the tripartite system was not the removal of responsibility for the prudential supervision of the banks from the Bank of England. There is a valid case for that, as I spelt out in my memoirs some 20 years ago. The most fundamental flaw was yoking together in the FSA prudential supervision of the banking system and the conduct of business regulation, in particular consumer protection. Perhaps I may say that I disagree with the noble Lord, Lord Turnbull, on this point, although I agree with some of the other remarks he made. These are two completely separate activities requiring completely different skills, people, cultures and approach. While the intensely detailed, bureaucratic, box-ticking approach may have been appropriate for consumer protection, it was wholly inappropriate for the task of prudential supervision of the banks.

It was also a serious mistake, in my judgment, to separate responsibility for the stability of the banking system as a whole, which was left with the Bank of England, from responsibility for supervising individual banks, which was given to the FSA. While it is true that there is a distinction between the regulatory system as a whole and the day-to-day supervision of individual financial institutions, at the end of the day the system is the sum of the institutions that comprise it, and regulation and supervision need to be intimately linked. Moreover, the grossest excesses of banking imprudence, although economically devastating when they occur, happen probably at most only once in a generation, while consumer abuses such as mis-selling are ever present and politically sensitive. As we saw, they inevitably became the FSA’s principal focus of attention, at the cost of its disastrous neglect of prudential supervision.

The new architecture proposed in this Bill rightly separates these two activities completely, making consumer protection the remit of the new Financial Conduct Authority. However, it is a mistake to give the Bank of England, through the Financial Policy Committee, responsibility for the oversight of the Financial Conduct Authority. It has enough on its plate as it is.

I am also unconvinced by the wisdom of having two separate bodies—the Financial Policy Committee and the new Prudential Regulation Authority—to supervise the system and the individual banks respectively. It is quite true that both these bodies will be within the Bank of England, so there is likely to be constant cross-fertilisation, but the practical effect of having two bodies rather than one will need to be carefully monitored.

The decision to give the Bank of England full responsibility for financial regulation and supervision on top of its responsibility for monetary policy, which may on occasion conflict, places a heavy burden on the Bank in general and the governor in particular. The Government plan to recognise this by having a strong Financial Policy Committee with former practitioners on it and by beefing up the Court of the Bank of England, but I am far from sure that that is enough.

The Banking Act 1987 created inter alia the Board of Banking Supervision, which has already been referred to by the spokesman for the Opposition in this debate. This was charged with supervising the Bank’s conduct of its supervisory responsibilities and was chaired by the governor, but with as part-time members the most effective recently retired bankers that I could find. Moreover, and importantly, if these poachers turned gamekeepers had any concerns about the way in which the Bank was conducting any part of its supervisory responsibilities, they had the power under the Act to insist on a private meeting with the Chancellor, at which they could voice their concerns—a powerful sanction. I urge the Government, even at this late stage, to put in place a body that is more narrowly and expertly focused than the FPC, along the lines of the former Board of Banking Supervision, to supervise the work of the PRA.

Another innovation introduced by the 1987 Act was dialogue between bank supervisors and bank auditors. Until that time, it was illegal for there to be a dialogue between the auditors and the supervisors, as that would have constituted a breach of the auditors’ commitment to client confidentiality. The 1987 Act not only changed that but stated that there had to be a dialogue. Given the extreme and understandable reluctance of auditors publicly to qualify a bank’s accounts as they might qualify the accounts of any ordinary company when they discover something amiss, for fear of causing a run on the bank, it is particularly important that they should privately tip off the supervisory authority. Equally, if the Bank of England has a concern, it is important that it should share it, privately, with the auditors of the bank or banks involved, and ask them to look into it more closely. Regrettably, with the Brown changes, the dialogue demanded by the 1987 Act fell into desuetude.

I am pleased that the Bank of England and the Government have decided to do something about this, and to introduce a code of practice designed to reinstate the dialogue. The Economic Affairs Committee of your Lordships’ House, under the excellent chairmanship of my noble friend Lord MacGregor, looked into this in its report on auditors of March last year. I declare an interest as a member of that committee, which unanimously concluded that in the light of experience a code of practice was not good enough and there should be a statutory requirement for the dialogue to take place. That must be right, and I urge the Government to look at it again.

I will raise two other matters before I leave the subject of bank auditing, which is so important to the task of bank supervision. First, I mentioned the reluctance of auditors to use the nuclear weapon of qualifying a bank’s accounts, which may be one reason why they did nothing at all about major banks, which, in the event, turned out to be insolvent and had to be bailed out at great expense to the taxpayer and at massive economic cost. It might be worth considering a system in which, instead of the present all or nothing system, bank accounts are graded in the way in which the ratings agencies grade financial instruments.

Secondly, it is clear that the change in accounting standards from UK GAAP, which I admit was not perfect, to IFRS is a change from prudence to box-ticking, which has been particularly malign in the case of the banks. This is true not least when it comes to provisioning. Linked with that, IFRS has also enabled banks to this very day to conceal substantial bad debts, the failure to face up to which is a significant cause of their reluctance to lend to small businesses, which badly need it at present. To accept IFRS blindly, with all its faults, simply because other countries do, is not good enough.

The Bill before us today is not, of course, the only Bill this Session to implement the lessons of the disastrous banking meltdown of 2008. As my noble friend Lord Sassoon has reminded us, we have also been promised a banking reform bill to implement the recommendations of the Vickers commission and in particular to enforce the separation of investment banking from retail banking by the so-called ring-fence. I welcome this, which I have long called for.

However, one reason why we need this split has not perhaps been sufficiently recognised: that is, that bank supervision is an extremely difficult and complex task, given the unprecedented complexity of modem banking. A system in which the failure of an investment bank does not threaten the core banking system means that the regulators and supervisors can concentrate on the health of the core banking system, a less complex and more practical task. My fear, however, is that the ring-fence will not prove impermeable or wholly effective. Bankers, despite the greed and folly that many of them evinced during the Goodwin-Brown era, are clever people, and they will find ways round it. Moreover, what we are talking about here is, at bottom, a matter of banking culture.

Earlier this year, the FSA published a report on HBOS—Halifax Bank of Scotland—which has not received the attention that it merited. Finding that the bank was “guilty of serious misconduct”, it ascribes this to a culture,

“of optimism at the expense of prudence”.

That is a nice euphemism for reckless gambling.

Culture matters and the plain fact is that the prudent culture of retail bankers and the adventurous culture of investment bankers are diametrically opposed. With the best will in the world, it is hard to see how two quite different and opposed cultures can co-exist within the same corporate entity. There needs to be complete structural separation, not just a ring-fence.

Finally, I turn briefly from the structure to the content of bank regulation and supervision. Progress is being made on the subject of capital ratios and capital adequacy—indeed, with the economy in its present condition, there is an overwhelming case for allowing the banks to go more slowly towards achieving the desired higher capital ratios. Here, I entirely agree with the noble Lord, Lord Turnbull.

However, there has been no comparable progress in dealing with the problem, which is at least as important, of bank leverage.

[Baroness Garden of Frognal]

My Lords, I apologise for intervening on my noble friend—

[Lord Lucas]

My Lords, this is a Second Reading. We are a self-regulating House. Whips have no business telling us what to do. We are listening to my noble friend with great fascination and I hope that he takes another 10 minutes.

[Lord Lawson of Blaby]

My Lords, I am grateful for that. This is a very important and complex Bill, and we should be able to speak if we are not waffling—and I hope that I have not been waffling—at adequate length. However, I assure the House that I shall not take another 10 minutes.

No banking system is likely to be stable if it is financed by a mountain of loan capital on an exiguous equity base. Yet that is what we now have. I suspect that this is unlikely to change unless there are two supporting changes.

First, the bank regulators and supervisors should at least strongly discourage if not actually forbid the remuneration of bankers on the basis of the rate of return on bank equity. Secondly, there needs to be a fundamental change in the tax system as it applies to banks, or at least banks that conduct ring-fenced activities, à la Vickers. At present, a bank that finances itself by raising loan capital finds that the interest paid on that capital is tax-deductible, whereas the dividends paid on equity capital are not, so there is a clear tax incentive in the system for the banks to capitalise themselves on the smallest possible sliver of equity—the very reverse of what is needed in the interests of stability. That should be changed. Interest on the bank’s loan capital should no longer be tax-deductible. The quid pro quo might well be the abolition of the blunt instrument of the bank levy.

In conclusion, I warmly welcome the Bill, but there is much still to be done.