European Banking Union: EUC Report

Lord Marlesford Excerpts

Thursday 24th January 2013 Lords Chamber

[Lord Davies of Stamford]

My Lords, it has happened more times than I can recall since I have been in this House, nearly two and a half years, that I have had the pleasure of following the noble Lord, Lord Hamilton, or he has had the task of following me. Although I rarely agree with him about very much, it is a great pleasure to debate with him. However, I did agree with two things that he said this afternoon. First, I share his view that the ECB, in practice, is likely to have a dominating and increasing intellectual influence on the EBA. Secondly, I very much agree with his characterisation of the way the European Union makes progress as two steps forward, one step back. Although he probably would not agree, I think that is a very sensible, sound and prudent way of advancing in difficult territory, and I am very content that that has been and continues to be the process. Had he put the order the other way around, I would have very much disagreed with him, but his judgment and mine are very much the same in that way.

I want to add my own word of tribute to the noble Lord, Lord Harrison, and to everyone on the committee for having brought forward a very interesting and timely report. I want to address just two of the issues on which the committee focused in drawing up that report, and then to say a few words about the position of the British Government. First, I recognise that the testimony that the committee received was rather conflicting. A very important and fundamental issue is whether it is right to have the monetary authority—in this case, the European Central Bank—as the supervisory authority for the banking system. It seems to me that it is right. There is often said to be a conflict of interest between financial stability and monetary policy. I see it not so much as a conflict of interest but of objectives. It is not the sort of conflict that can be eased or solved by separation of responsibilities. On the contrary, it is the sort of conflict that can be made a great deal worse by the excessive separation of responsibilities, because if there is a problem and in difficult times the supervisory authority feels it necessary in the interests of financial stability to provide more liquidity to the market, for example, or to support a particular bank by replacing deposits that may be fleeing elsewhere, or otherwise, that decision would immediately have monetary consequences and could be implemented anyway only by the central bank.

The central bank needs to be brought in—inevitably, it must be brought in—and the earlier the better. What is more, the central bank is in a very good position because of its open market operations, because it can see to what extent banks are varying their levels of deposit with itself, and because it knows about any drawings through the back door by banks in its area of responsibility. It is in a very good position to see whether liquidity problems are emerging for institutions in their area. Therefore it seems to me extremely important that the supervisory authority and the central bank should work together anyway. The idea of having two different directorates within one institution—the ECB—responsible for stability and for monetary policy seems to me a very good solution. I personally have the greatest confidence that, if there is a difficult decision to be made—as there will be, inevitably—it should be Mario Draghi, a person in whom I have the greatest confidence, who has the responsibility of making that decision.

The other issue that I want to address, which was dealt with in the committee’s report at some length, is whether it is desirable or acceptable for the banking industry come in in stages. Only the first stage so far has been agreed. Of course, it cannot be certain that there can be any agreement with the second or third stages, the first stage being the supervision regime and the second and third stages being retail deposit insurance and resolution procedure and mechanism. Clearly, it is not ideal; it is not the way one would wish these things to be, but I think it is a reasonably acceptable situation on a temporary basis, and a good deal better than nothing. I am glad that we have the process going.

I have to say that I think the Germans are not being rational. Maybe the Germans, and the Dutch, are resisting a European Union-wide resolution and retail deposit insurance system simply because if there were a problem and a run on the banks in one member state because in that particular context depositors no longer had confidence in the credibility of the retail deposit insurance system, and if that confidence depended entirely on the credibility of the national Government, unsupported elsewhere in the EU, there would inevitably be a systemic crisis. Similarly, if it was necessary for a particular member state to recapitalise the banks, and that task was out of proportion to the financial resources of that particular member state, that would engender immediately a sovereign debt crisis for that country.

What is more, such a crisis would never be limited to one member state. There would be knock-on and systemic effects for the whole of the European Union. If Greece went down, we know that there would be effects elsewhere, or if Portugal went down again there would no doubt be strong effects in Spain. The consequences of that would be that German and Dutch banks—to take the examples of the two countries that are resisting the logic of the banking union, which I think they are—would find that they are making great write-offs of their assets that were exposed to these particular markets and deposits with those banks, and so on. They could be supported only by their own banks, which would have to be recapitalised by their own national Governments.

The cost of such a bailout would be enormous and vastly greater than any credible drawing in respect of one, two or three particular institutions on a retail deposit insurance scheme. I think that the Germans are being quite illogical about this. They are not looking at the matter in the long term or in the round. No doubt intellectually they might agree with me, but they find themselves under political constraints. I hope that with the various events that are in the pipeline in the coming months they will find that it is politically possible to do what I think is the rational thing to do.

I now want to say something about the position of the British Government in all this, which seems to be perfectly ludicrous, if I may say so. I understand that they see the banking union as a good thing for others but not for us. That immediately is a slightly suspect argument, and one wonders why it is the case. I looked at the committee report to see what the British Government’s analysis of the national interest was, and why it was not in our interests to join the banking union if it made sense for other people. There is no such explanation in the whole document. I shall read what passes for an explanation to the House. Paragraph 129 states:

“The Government have repeatedly stated that the UK will not participate in the banking union proposals, on the grounds that the measures logically flow from monetary union and are designed to secure the success of the single currency”.

That is a quite unconvincing argument. If someone buys a car, a pharmaceutical product or a piece or electronic gadgetry, he is not worried about who the product was originally designed for; he is worried about whether it is suitable for him, and whether it will work for him. That is the argument that needs to be addressed, but it has not been addressed by the Government at all.

[Lord Marlesford]

Surely what the noble Lord has just been saying is precisely the reason why the British Government do not want to join the banking union. They are saying that there must be mutualisation through the European Central Bank and the banking union of the debt of banks in the euro area. Is he really suggesting that it would be sensible for the British Government to share in that liability, and that if, as he described graphically, there were to be a run on one of the banks in Greece, we, too, should have our share in picking up the pieces?

[Lord Davies of Stamford]

Indeed, I am suggesting exactly that to the noble Lord and to the House. It would be very much in our interests to do so, for the reason that I thought I had explained. Perhaps the noble Lord did not follow my argument, which was that if there were a run on the banks in a member state, left to itself it could engender a systemic crisis that would be far more costly to us, because British banks would write off a very large portion of their assets as a result of collapses elsewhere. In order to restore those banks to financial viability, we would need to recapitalise and support them in ways that would be much more expensive than the likely cost of any contribution to the system. I do not want to detain the House for too long, but I believe that we should have interventions such as this, so I will give way to the noble Lord.

[Lord Marlesford]

In that case, why did the American banks not recapitalise the British banks that went bust?

[Lord Davies of Stamford]

It is obviously necessary, if we are going to get involved in any kind of obligation of this kind, to make sure that we come under the same supervisory authority and that everybody works according to the same rules. That is palpably not the case with us and the United States.

The position of the British Government is clearly that they are not interested in making a dispassionate and functional analysis of the national interest in this area. If they were interested in doing so, it would have been quoted in the report and we would all know about it. They have simply decided that on party political grounds, because of the need to conciliate the Eurosceptics in the Tory party—we know that this is the way the country’s foreign policy is now being run; it is being bear-led by the Eurosceptics—it is impossible to do the rational and sensible thing, so they have simply excluded a priori any possibility of our joining the banking union, even as a participant that is not a member of the euro. A large number of countries will join on that basis—almost certainly a good deal more than the four that have already announced they will. I expect that every east European country other than the Czech Republic to come into that category. As the noble Lord, Lord Kerr, very convincingly argued, that would cause great problems for us. It is absurd for the British Government to say that one of the major difficulties here is the voting system, because the problem would be resolved if we were part of the system, and at least one of a minority of nine or 10.

If we do not join the banking union, there are only three logical possibilities. I do not think that any Member of the House will want to argue with my logic, which is very basic and elementary. The first is that we have a supervisory system that in practice simply tracks that of the ECB; we will do exactly what the ECB does in its area of responsibility, for example in matters of licensing, authorisation, intervention and guidance to banks. That would mean that we were de facto part of the system, with the important difference that we would not be part of the decision-making mechanism and would not have the kind of influence within the system that otherwise we would have had.

The second possibility is that we adopt a supervisory system that is somehow stricter and more severe than that adopted on the continent by, for example, the Republic of Ireland under the ECB. That would mean that banks here would find that they were at a competitive disadvantage doing their business out of London as opposed to doing it out of Paris, Frankfurt or somewhere else. That would not be a very intelligent thing to do.

The third possibility is that we adopt a regime of supervision that is lighter and more complacent than that adopted by the ECB. In the short term, that might attract institutions that do not like the stricter regime on the continent, but in a crisis we would be much more exposed because we would have a lesser degree of credibility. It would be considered that our institutions and banks were less safe and sound than those across the Channel, or indeed across the Irish Sea. That, too, would be a bad day’s work for the country. We would face a situation in which either we would have no advantage at all, but the disadvantage of not having the influence that we ought to have and that is commensurate with the importance of the City, or we would be otherwise disadvantaged either in competitive terms or in our ability to withstand crises. That would be a profoundly bad day’s work for the country—and it is exactly the day’s work that this Government have done. I deprecate it very strongly indeed.