Financial Services and Markets

Chris Leslie Excerpts

Wednesday 27th February 2013 Commons Chamber

[Greg Clark]

As my hon. Friend knows, that has been a matter of much debate in the Treasury Committee and the Banking Commission, both of which he chairs. It is appropriate to have regard to the international debate on this. There is a difference between the debate on the leverage ratio and the two other tools that we will move on to talk about, the sectoral capital requirements and the counter-cyclical buffer, over which, it has been established internationally, there should be domestic discretion. We are not at that stage with the leverage ratio, as he will know, but I can certainly confirm to the House that the Government’s intention is to provide the FPC with a time-varying leverage ratio by 2018, subject to a review by the European Banking Authority, which is planned for 2017.

[Chris Leslie (Nottingham East) (Lab/Co-op)]

I am intrigued by the Minister’s 2018 commitment, but would it not make good and prudent legislative sense to take the opportunity in the draft Financial Services (Banking Reform) Bill, which will arrive in the House imminently, to insert provisions that would allow the leverage ratio to be triggered sooner if there is a delay in the international discussions?

[Greg Clark]

We do not expect such a delay. The discussions are continuing and are live, as we know, so we do not expect to need that, but of course it is open to the House as it debates the Bill, presumably at some length, to keep that under review as the discussions progress.

The statutory instrument we are debating today relates specifically to the ability to set sectoral capital requirements. I will deal with that tool first before briefly covering the others. The interim FPC recommended that the statutory FPC should have a power of direction to vary financial institutions’ capital requirements against exposures to specific sectors over time. It argued that the over-exuberance that precedes crises often begins in specific sectors before spreading further. The Government agree that this targeted approach would allow these risks to be managed more effectively and proportionately than raising capital requirements more generally. The FPC has stated that it would wish to avoid what it terms an

“overly activist, fine-tuning approach”,

which should limit this risk. However, there may be times when using the tools in a granular way may be necessary, so the Government will keep the use of this tool under review to ensure that it is being used effectively and proportionately. There is also a risk that imposing sector-specific requirements could displace excessive risk into other sectors, so the FPC will need to monitor carefully the impact of any policy interventions using this tool and perhaps consider adjusting more general capital requirements if displacement turns out to be a significant problem.

I should take this opportunity to bring to the House’s attention the one change that the Government have made to the order following the consultation that we undertook on the draft version that was made available for that purpose. The current order excludes investment firms that are not regulated by the PRA from the FPC’s power. This will ensure that systemically important firms are captured while smaller firms that are not systemically important will not be subject to additional requirements.

Let me discuss briefly the other macro-prudential tools that the Government intend to give the FPC: the role of setting the UK’s counter-cyclical capital buffer; and, as we have briefly discussed, the power to intervene to limit leverage ratios. These are not covered by the draft order, but it might be useful if I provide a bit of context to the debate. The counter-cyclical capital buffer is part of the Basel III agreement, and it will be implemented in Europe by the capital requirements directive, commonly known as CRD 4. The directive aims to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. It will be deployed by national jurisdictions when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure that the banking system has a buffer of capital to protect it against future losses. Banks, building societies and larger investment firms will be required to build up capital during upturns. This will help to increase the resilience of the financial system and might also dampen the credit cycle. Unwinding these requirements in the downturn once the threat has passed might help to mitigate contractions in the supply of lending.

It is clear that with its macro-prudential focus, the FPC will be the body best placed to determine the level of the counter-cyclical capital buffer. This was supported by the results of the Government’s consultation. As the counter-cyclical capital buffer is expected to be provided for in CRD 4, on which discussions are continuing, the simplest way to incorporate it into UK law is via regulations made under section 2(2) of the European Communities Act 1972 to transpose into UK law the provisions of CRD 4 which relate to the counter-cyclical capital buffer.

It is vital that the FPC’s decisions in relation to the counter-cyclical capital buffer should be subject to comparable procedural and reporting requirements to the FPC’s other tools. Therefore, in addition to the requirements imposed by the EU legislation, the Government intend to ensure that the counter-cyclical capital buffer will be subject to the same transparency requirements as other FPC decisions, with a summary of the FPC’s discussions when taking decisions on the buffer set out in the FPC’s meeting records, and the FPC’s use of the buffer covered in the biannual financial stability report. The Government will make any necessary changes to achieve this in the regulations that incorporate CRD 4 into UK law.

The interim FPC recommended that the statutory FPC should have a power of direction to set and vary a minimum leverage ratio. The Government think that a leverage ratio could indeed be a useful macro-prudential tool for the FPC. The unweighted nature of the measure would guard against risk weights underestimating the true riskiness of assets and provide a directly comparable figure across firms. Firms’ leverage ratios were a useful indicator of failure during the last crisis, and the period immediately preceding the crisis was characterised by sharp increases in leverage. The Government strongly support the inclusion of a backstop leverage ratio in the EU prudential toolkit and consider it an essential measure to ensure that leverage remains at sustainable levels. It is clear that there is some way to go, but the review in 2017 will address that, and it will not be implemented across the EU until 2018, so we have some time to consider it.

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[Chris Leslie (Nottingham East) (Lab/Co-op)]

The jargon in this order may deter not just members of the public but—dare I say it?—hon. Members from rolling up their sleeves and getting involved in this debate. I contend, however, that, in layman’s turns, the order involves an incredibly important set of issues. We are talking about giving the regulators of the unelected Bank of England’s Financial Policy Committee incredible powers that will enable them to tell people the level of deposit required for their home loan purchase and, potentially at a moment’s notice, that minimum repayments on their credit cards will need to rise from, for example, 2% to 5%. They will also be able to tell businesses that loans and overdrafts that they may have already arranged with their banks are no longer feasible. We are talking about the significant potential impacts that macro-prudential policy making could have downstream on the economy and consumers. As we have said many times, although prudential regulatory theory is fine—it is difficult to disagree with the concept—the practical reality and serious questions about how it will work merit consideration.

We support the creation of the FPC at the Bank of England. An important lesson from the global financial crisis is that we need better systemic oversight, not just firm-by-firm regulation. We have to see the wood for the trees. However, as was said last year during the passage of the Financial Services Act 2012, questions linger about the FPC’s accountability and the rationale behind the choices it will make. Asking very clever people to gaze into a crystal ball and predict the economic future is a big thing for Parliament to do. We are asking them to improve their foresight when most people find it easier to draw conclusions in hindsight. There is, therefore, a lot of responsibility on the shoulders of the Bank of England and, of course, this provides a perfect vehicle for it to be landed with the blame by politicians if things go wrong. Members of the FPC will no doubt be well aware of those responsibilities.

As the Minister has said, the order is relatively straightforward. It gives the Prudential Regulation Authority, which is an arm of the Bank of England, the power to make banks and investment firms increase their capital holdings—in other words, their additional own funds—in relation to their exposure to residential property, commercial property or the financial sector. It will also give the PRA the power to make those banks and investment firms treat exposures to other financial services companies, residential property or commercial property as riskier ventures than they might otherwise have done—in other words, to raise the risk weightings on those holdings.

It was interesting to hear the Minister say that, after the consultation, the Government changed things so that the PRA-regulated firms would be those that are systemically important. That throws up a question that has just occurred to me. I had assumed that all residential mortgage loans and commercial transactions would be affected by a turn of the dial by the FPC. As it turns out, the Minister is saying that only transactions undertaken by systemically important organisations or the larger banks will be affected. Will he tell the House what proportion of residential and commercial transactions will not be affected if the FPC decides to adjust the availability of finance in those sectors or the capital requirements affecting those sectors? I assume that the vast majority of the firms in those markets are systemically important, but it would be interesting if the Minister gave a breakdown. If he cannot tonight, I would be happy if his team wrote to me on that issue.

There are other macro-prudential tools. The Minister mentioned the counter-cyclical capital buffer. That is part of the Basel III requirements which will be implemented through European directives and so forth. I want to ask him about some of the other macro-prudential tools that were discussed in a long document by the FPC.

I am pretty sure that the Minister is saying that, by and large, the sectoral capital requirements are those that are dealt with in the order, but I am not entirely clear about that. If one wanted to be very theoretical about macro-prudential policy, one could argue that history shows, whether through the South Sea bubble or the tulip boom, what has happened to various sectors that nobody predicted would become overheated. I do not necessarily see all sectors coming under the potential purview of the FPC. I assume that the Government would simply vest the FPC with other sectoral issues if they felt that there were emerging pressures or credit bubbles in other sectors. It does not seem that the Minister is today allowing the FPC to intervene across the whole landscape.

The hon. Member for Chichester (Mr Tyrie), who chairs the Treasury Committee, rightly asked about the leverage ratio. I am surprised that the Minister wants to wait until 2018 for that. He says that he hopes there will not be slippage, but he has been around the European policy-making circuit for long enough to realise that a commitment to do something in 2018 means that it may well not materialise until 2022 or even later. One just has to look at the solvency II discussions, which seem to be generational. I regret that the Government seem reluctant to take a British approach to regulating on the leverage ratio. I do not think that we should simply wait for Europe to determine such matters for us. It would be better if the Minister gave a commitment that he would at least consider including in the Financial Services (Banking Reform) Bill the recommendations of the Parliamentary Commission on Banking Standards on giving the FPC the right to get into some of the leverage ratio questions.

I have a number of other points that I want to ask the Minister about briefly. On the enforcement of prudential regulation, will he elaborate on the penalties or disciplinary steps that the regulator will have at its disposal if an investment firm or bank contravenes the imposed requirements of the FPC? If we have a body that is making policy, we must ask how it will be enforced. So far, a lot of the penalties in the Financial Services (Banking Reform) Bill seem to involve an individual seeking redress through the civil courts, which seems quite weak. What will happen if a bank steps across a line?

Members will recall the debate that we had during the passage of the Financial Services Act 2012 on the stability rules that the Government originally proposed to give to the Bank of England. They wanted to emphasise stability, which of course is vital, but they left out the importance of getting the economy growing and creating jobs, especially when times are tough or when there is a deflationary environment. Eventually, the Chancellor of the Exchequer was forced to relent and an amendment was inserted in the House of Lords to ensure that the FPC has regard to the economic objectives of Government policy.

Are we in danger of repeating the same lopsidedness in the regulations, or of an asymmetrical approach to attempts to control the heat of the economy? The measures in the order specify that banks must hold “additional” funds if lending to households or businesses, with a view to slowing things down and taking the heat out of the economy. That, of course, is a necessary part of the toolkit, but what happens if things slow down too much and the economy needs more lending to businesses and households, or more inter-bank and financial services mutual investment? The order does not seem to contain corresponding or parallel powers to dial things down, relieve capital requirements or remove “additional own funds” provisions if they prove in retrospect to have gone too far. Is that a problem with the order? Should not the power be symmetrical? I would be grateful if the Minister would consider that point.

On enforcement, are there dangers and risks of gaming in sectoral capital requirements? If we draw up operational targets that focus on the means rather than the ends, will the Minister assure the House that some of the specific requirements on residential or commercial investment cannot be evaded by twisting definitions, deliberate misinterpretation or gaming? I gather that that point came up at the Treasury Committee last year and there are important concerns.

Will the Minister update the House on the latest information about who will make decisions on the loan-to-value and loan-to-income ratios on mortgages? There was a bit of pass the parcel between the FPC Committee and the Treasury last year when it came to mortgage regulation. The Treasury wanted the Bank of England to do the deed, but the Bank said it was a political decision and wanted Ministers to make decisions restricting LTV ratios. Will the Minister say where things currently stand, because such things do matter? As Adrian Coles from the Building Societies Association has rightly said, a change to the loan-to-value ratio may not matter much to those wanting to get a foot on the property ladder who have already got access to deep pockets or the bank of mum and dad, as it is known, but rapid decisions to increase the amount of deposit a home buyer needs will hit the least well off in society. Who will decide those things—the Treasury or the FPC?

My final two points are on geographical regulation and business lending. Will the sectoral powers be available for the Bank of England to use area by area, region by region, and locality by locality? In other words, will the Bank be able, or is it seeking, to take heat out of certain geographical housing markets and not others? I do not advocate this, but if it so wished could the Bank use these powers to make it harder to buy a house in London than in Cornwall, or vice versa? Will the Minister clarify how specific—or area-specific—the Bank can be with these powers?

Lending to small and medium-sized enterprises has fallen off and is still doing so. The funding for lending scheme was supposed to change that but its rules are skewed towards residential lending rather than business lending. Is the order to be seen in parallel with that scheme, and can the scheme be reformed to favour business lending? Will the Chancellor consider those issues in the Budget?

Transparency and the openness of the FPC must be considered and many, including the Council of Mortgage Lenders, have said that we need proper analysis by the FPC about what it is doing and an explanation of why it is using its powers. A narrative requirement on the FPC is a reasonable request, so will the Minister explain why that is not in the order?

The Opposition support these general powers but we hope for refinements and improved accountability in the enactment of some of these tools. We want Parliament to have better scrutiny of these measures and for the Treasury to ensure that when the tools are granted, whether or not that is in the next wave or regulations or legislation, the Treasury Committee and others will have a better opportunity for proper oversight of how the Bank of England is exercising these considerable powers.

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[Greg Clark]

Let me go on to describe some of the other elements involved. I said that we had committed to bringing to the House particular measures that could be debated. The hon. Gentleman has anticipated one such possibility. He was correct in suggesting that, if we had been proposing a power over the loan-to-value rate, the House would have been substantially more occupied than it is at the moment, that such a matter would engage Members and that there would have been a fuller debate on the matter. However, this is not the only mechanism by which scrutiny can take place.

The secondary objective of the Financial Policy Committee has been mentioned. Through the scrutiny of the House and of the hon. Gentleman’s Committee, that objective has been set up, and it means that the FPC’s duty to support the court of the Bank of England in achieving its financial stability objective is subject to supporting the policy of Her Majesty’s Government, including their objectives for growth and employment. That is significant. That power is there for a reason, and we expect it to be used. It requires the Chancellor of the day to write annually to the FPC to set out what he expects it to have regard to in making its decisions. The House will have the ability through that mechanism to scrutinise and take a view on whether Ministers—in this case, the Chancellor—are giving the right directions to the Committee in terms of what it should understand the Government’s economic objectives to be. I believe that the mention of growth and employment will address one of the concerns that has been raised.

It is worth noting that the measures we are talking about relate to peacetime; they are not for use in a crisis. The Chancellor will retain the ability to give directions to the Bank in a time of financial crisis, for example, when that is in the public interest. The measures before us are for use in the normal course of events.

There will also be a requirement on the FPC to account for its decisions. It will appear before the Treasury Committee after it has held its meetings and published its reports, and it will have to explain the basis of its recommendations and directions. It has made a commitment to setting out in advance the types of indicators that it will bring to bear on those questions, so there will be no arbitrary use of discretionary powers. The committee will seek to be predictable in regard to the types of instrument that it will use.

On the format of statutory instruments, the parliamentary Delegated Powers and Regulatory Reform Committee will take a view on whether the choice of procedure is appropriate. I think that the hon. Gentleman will approve of the fact that the affirmative resolution procedure is to be used in these circumstances.

Let me address the hon. Gentleman’s point about residential property, which is of course a matter of interest to our constituents. It has been pointed out that all these matters have a bearing on our constituents. I think he would acknowledge that any review of the recent financial crisis—and, indeed, of financial crises around the world—would note that housing bubbles are often associated with the kind of over-exuberance and excess that contributes to financial instability, which the arrangements that we have in place are designed to address. It is appropriate for the powers to be there. These sectors have been debated at the European level, and this is one of a limited number of sectors for which it is anticipated that the national regulators should have a sectoral power.

I think it important to note that the power to make recommendations and give directions is available to the FPC, but that there is no requirement that it should get in the business of micro-managing these sectors. It seems to make sense, on the basis of history, for this initial set of sectors to be included. The powers are there, as I say, but there has been some debate about whether they should be more specific in respect of loan-to-value powers, which is not part of the proposals. It is no part of the Government’s purpose, as the hon. Gentleman rightly anticipates, to prevent what we hope will be an increase in home ownership and house building as a result of the order.

Let me deal with some points raised by the hon. Member for Nottingham East. He forcefully made the point that we need an explanation from the Financial Policy Committee of why it is using its powers. This should not take place in a vacuum or in secret. I completely agree, and this is provided for in the Financial Services Act, as the hon. Gentleman, a veteran of the Committee, knows. Section 9S requires the FPC to give an explanation of the reasons for its use of direction powers, and the explanation needs to be published in the financial stability report and it needs to account to Parliament for its use of the powers.

Let me pick up one of the hon. Gentleman’s earlier points, which was not quite right. He mentioned credit card repayments, for example. The powers provided for in the statutory instrument do not go into that level of detail, and the FPC will not have those powers and they are certainly not in this order—and neither are the loan-to-value powers available.

The secondary objective addresses the hon. Gentleman’s point about the necessary symmetry of these arrangements. Macro-prudential regulation is certainly about damping down excessive exuberance when it takes place, but on the other side of the cycle, by retreating from some of the provisions by varying requirements downwards, it also has the power to reverse the dampening of those sectors.

[Chris Leslie]

I am sorry, but as I read the order, I note that it says that UK firms can be required to maintain “additional” funds, but there seems to be no provision to dial it down the other way. Have I misread the order?

[Greg Clark]

What I am referring to is the fact that if the requirements have been dialled up, they can be dialled down. That will be required. The fact that they are time varying precisely reflects the different conditions that will apply from time to time.

The hon. Gentleman mentioned the exemption for small firms, and he was quite right to raise the issue of what proportion of mortgages might be covered. To be clear— when he sees my remarks, he will be clear—the exemption applies to small investment firms. It is still the case that all deposit takers and banks, including building societies, will be within the scope of the power. That contribution will be recognised.

As to whether we should take the power—either through the order or, more likely, through the Banking Reform Bill or previous legislation on the leverage ratio, which is a live issue—it is already possible by order under the Financial Services Act to make provisions to vary the leverage ratio. Such an order would, of course, be subject to prior parliamentary approval. There is no requirement for additional primary legislation; the powers will be there at the time we expect to bring the provisions into force.

The hon. Gentleman asked about the penalties for contravening the views of the Financial Policy Committee. The committee makes recommendations to the regulators, and it is the regulators—the PRA and the FCA—who are responsible for implementing them. The hon. Gentleman will know—again, from the Financial Services Act—that considerable powers are available to the FCA and the PRA, in the form of regulatory sanctions, constrictions on firms’ activities, and unlimited fines. That is why the sector regulators have the powers of direction.

The hon. Gentleman raised a geographical point, asking whether the sectoral powers could be used to specify a particular area. The answer is that they could, if there were evidence of a particular problem in a particular area. However, as he will recall, there is a general requirement for the FPC to act proportionately, and one of the principles that has been agreed is that it should not become involved in the micro-management of these matters or in close detail. I consider it unlikely that it would make recommendations on a narrow geographical basis.

I hope that I have responded adequately to the points that have been made this evening. I gather from the Whips that I may have done so to the satisfaction of the House, and I hope that it will agree to the recommendations.

Question put and agreed to.

Resolved,

That the draft Bank of England Act 1998 (Macro-prudential Measures) Order 2013, which was laid before this House on 24 January, be approved.