Financial Services Bill

George Mudie Excerpts

Monday 6th February 2012 Commons Chamber

[Mr Osborne]

Yes, I can give that assurance. This is an important point that I want to flag up so that the House understands what we are collectively embarking on. We are seeking to give the Financial Policy Committee the tools to help to dampen down a credit boom or to help in a credit crunch. As my hon. Friend has said, it will be able to alter the maximum loan-to-value ratios in mortgage lending in order to curb an unsustainable rise in house prices. It will also be able to do the reverse, should we face unwanted house price deflation. It will also, potentially, be able to alter capital requirements for banks, in a counter-cyclical way. I should say that these are just possibilities; they are potential tools that the committee might want to use.

One key feature is that the measures will be independently applied, so there will be no political pressure to, say, keep a housing boom stoked up as an election approaches. Another key feature is that the Financial Policy Committee should act symmetrically—that is the intention of Parliament. Its job will be to act not just to moderate a credit boom but to try to alleviate a credit bust. The precise tools that we give the FPC have yet to be determined, as my hon. Friend has just said. We have sought the advice of the interim organisation that we have created, and it will come to us with proposals for the kind of tools that the permanent body will need. We will then seek the approval of both houses of Parliament through the affirmative resolution procedure—which will of course involve a debate—before we pass those tools over.

I freely accept that we are in largely uncharted policy- making territory, here or anywhere in the world. Many other jurisdictions are considering such measures, but we are ahead of most of them. Surely the experiment of making no attempt to moderate the credit cycle—letting the bubbles grow and burst, then cleaning up afterwards—has been an unmitigated disaster, and we would be failing if we did not look for an alternative approach.

[Mr George Mudie (Leeds East) (Lab)]

One suggestion from the Treasury Select Committee was that the Chancellor should not send the proposals to a statutory instrument Committee. That would involve a 90-minute discussion and the proposals would not be amendable. He should instead allow the matters to be debated seriously on the Floor of the House. I wonder why he would think it attractive and helpful to send them upstairs where they cannot be amended; that would suggest a foregone conclusion by the governing party that they would be accepted.

[Mr Osborne]

I would certainly be happy to have a debate about that on the Floor of the House. It is a decision for my colleagues, the usual channels and so forth, but in my opinion the important tools given to this body will have a real impact on our constituents. It will affect the kind of house they are able to afford on their income—the bread and butter of people’s daily lives—and it is important for us all to understand that as we create instruments of policy.

We are seeking to address another flaw in the system by making the Bank of England the single point of accountability when it comes to the prudential regulation of banks, large and complex investment firms, building societies and, as my hon. Friend the Member for Cardiff North (Jonathan Evans) reminded us, significant insurance companies. A new prudential regulation authority will be established within the Bank to perform that major new function.

As the shadow Chancellor pointed out, the Federal Reserve in the US already has responsibility for the prudential regulation of major banks, but not of other financial firms. Let me cite what Ben Bernanke said in what I believe was testimony before Congress:

“The Federal Reserve’s role in banking supervision complements its other responsibilities, especially its role in managing financial crises...During the current crisis, supervisory expertise and information have repeatedly proved invaluable in helping us to address potential systemic risks involving specific financial institutions and markets and to effectively fulfil our role as lender of last resort...The Fed’s prudential supervision benefits, in turn, from the expertise we develop in carrying out other parts of our mission—for example, the knowledge of financial and economic conditions we gather in the formulation of monetary policy.”

I raise this matter because at the heart of the new arrangements we are seeking to establish an understanding that today’s financial markets are so interconnected that the failure of a single firm can bring down the whole system, and risks across the system can bring down many single firms. These feedback loops are what proved so devastating in the crisis.

Some critics of the legislation now accept the need for a macro-prudential Financial Policy Committee, but still doubt whether we should give the Bank responsibility for the micro-prudential regulation of individual firms, too. I would argue that because the interconnections are so great, the FPC could not do its job without knowing what is going on in firms, and a prudential regulator could not do its job without knowing about risks across the system. The best way to combine the insights is to put them both under the aegis of the same institution—the central bank.

I understand that the shadow Chancellor is concerned that our Bill does not create additional lines of communication between the deputy governors of the Bank and the Chancellor, bypassing the Governor, so he might like to explain what he meant. I considered the idea, but rejected it. I think we need to force the Bank of England itself to reconcile its internal differences rather than create additional lines of accountability between the Chancellor and a deputy governor. Perhaps the right hon. Gentleman—[Interruption.] He says, “Dear me”, so perhaps he will explain why he wants to institutionalise a regime in which the No. 2 constantly undermines the No. 1.

The Joint Committee and the Treasury Select Committee have raised what I regard as a far more relevant concern—the accountability of the Bank of England, given its important new responsibilities. We have listened carefully to the recommendations from both Committees and while I do not propose to abolish the court of the Bank of England, I do propose to give it important new powers to hold the executive Bank to account. The Governor and the court of the Bank of England have agreed that a new oversight committee, consisting of the non-executive members of the court, should be created. This group of external independent people will ensure that the Bank discharges its financial oversight responsibilities correctly; it will be able to commission both internal and external reports on the Bank’s policy makers’ handling of particular events and particular periods of policy making. Those reports will be published, with market-sensitive information protected, if necessary.

The Governor is of course, as is the case today, a key figure in the arrangements. It is important that he or she is not only independent of the Government of the day, but seen to be so. The recent experience of reappointing Governors after their first five-year term has expired has not been a very happy one. It has created unnecessary uncertainty and called into question political confidence in the Governor. Although I would hope that this Government would handle the whole thing better than their predecessors did, it makes sense simply to eliminate the possibility of discord entirely, so schedule 2 provides that the next Governor of the Bank of England and his or her successors will serve a single eight-year non-renewable term. That is a sensible reform.

The third flaw in the current arrangements was the fact that the Chancellor of the day felt he did not have the necessary powers to act in the interests of taxpayers. This is another area where the work of the Joint Committee and the Select Committee have proved invaluable. The Bill makes it clear that the day-to-day responsibility for financial stability lies with the Bank of England. We do not want the Treasury second-guessing that work. Beyond setting the parameters for the regulatory system, the Chancellor should become involved only if there is a material risk to public funds. The responsibility in this regard is made clear in the Bill, and in the memorandum of understanding that we have drawn up with the Bank. The Bill makes it clear that the Governor has a responsibility to inform the Treasury immediately as soon as there is a material risk of circumstances arising in which public funds might reasonably be expected to be used.

The Bill is also rightly clear that the use of public funds is entirely a decision for the Chancellor, as he or she is the person accountable to Parliament, and through Parliament to the public. My predecessor is, again, revealing about the limitations of the current arrangements in his book:

“My frustration was that I could not in practice order the Bank to do what I wanted. Only the Bank of England can put the necessary funds into the banking system…I asked Treasury officials if there was a way of forcing the Governor’s hand. The fact that we had given the Bank independence had a downside as well as an upside.”

Of course my predecessor had, as any Chancellor does, the general power of direction over the Bank that the Bank of England Act 1946 provides, but that general power of direction has never been used, so it is a nuclear option that might blow up anyone who tries to use it. That was the conclusion that my predecessor reluctantly came to.

That is unsatisfactory. The Bank must, of course, be protected from politicians who want to use its balance sheet against the wishes of the Governor simply because those politicians want to avoid using the Government’s balance sheet, but the Bank should not be able to use that as an excuse to withhold its services as an agent from a Government prepared to use its own Government balance sheet. Otherwise, in many situations that becomes, in effect, a veto on an elected Government’s fiscal decision making.

The Bill and the memorandum of understanding give the Chancellor of the day not only the right to be informed when there is a material risk to public funds, but the right to ask the Bank to analyse different options that might be available to deal with the risk, and in the newly added clause 57 the Bill gives the Chancellor a defined power of direction to require the Bank to provide liquidity to a particular firm or to put a particular firm into resolution or to provide liquidity to the general system, provided that the Chancellor does so using the Government’s own balance sheet, and makes that clear.

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[Mr George Mudie (Leeds East) (Lab)]

May I first align myself with the remarks that my right hon. Friend the Member for Newcastle upon Tyne East (Mr Brown) made about the Chairman of the Joint Committee on the Bill, the right hon. Member for Hitchin and Harpenden (Mr Lilley)? The fact that I was still on the Committee at the end of its sittings shows that he was indeed tolerant and patient. I would like also to put on record my admiration for, and thanks to, the Chairman of the Treasury Committee, who is in China at the moment. We have had an arduous 18 months on the Committee going through the regulations. The fact that there are three members of the Committee here today is nothing to do with our being unable to get on the plane to China; it is more that we are so dedicated to regulation that we chose to be here.

I want quickly to raise three matters. I welcome the Chancellor’s open-mindedness—it was not a U-turn; that was an unfair description—in accepting the point about secondary legislation being inappropriate for the macro-economic tools. I hope that he will show the same open-mindedness on the three matters that I will raise, because so far the Government have not accepted the Joint Committee’s or the Treasury Committee’s views on them.

The first issue is the objective of the Financial Policy Committee, which is to ensure the financial stability of the financial sector. One difficulty raised by many of the witnesses before the Treasury Committee and the Joint Committee was that no one can come up with a definition of “financial stability”. That clearly presents those responsible for oversight of the FPC with obvious difficulties. On what basis do they judge the committee’s activities and performance? Is the issue stability alone? As the Chancellor himself stated in evidence, we should not be seeking the “stability of the graveyard”. I think of the unfortunate individual in hospital who is seriously ill in the high-dependency unit, but whose relatives are assured that he is in a stable condition. Just as in that example, stability in economic terms does not equal a healthy economy.

Arising from that—and equally important—the relevant question for all sectors to emerge from our witnesses was: in exercising its power to seek financial stability in the financial sector, will the Financial Policy Committee ignore the effect that that might have on the other sectors, in the real economy? To be fair, the original suggestion that the Government advanced was that the Financial Policy Committee could not take decisions to achieve financial stability if it believed that those decisions risked medium to long-term economic growth. An interesting and important point is that it was originally left to the FPC to make that judgement itself, with no mechanism for the Chancellor to have his say. The negativity of that formulation led HSBC, the British Bankers Association and several other witnesses to the Joint Committee to suggest that the relevant clause be redrafted, to give the FPC a positive duty to support economic growth.

I would like to put on record what was said by Stuart Gulliver of HSBC and Bob Diamond, neither of whom would immediately be recognised as friends of mine, or otherwise. Stuart Gulliver said:

“the…Treasury should be setting out what the Government’s goals are for growth, employment and job creation and saying to the FPC, ‘Use your macro-prudential tools to ensure that you achieve the Treasury’s goals.’”

Just as interestingly, both he and Bob Diamond cited the experience of the Pacific economies that actively manage the flow of credit and even its sectoral allocation, using a variety of macro-prudential tools. The people in small businesses and medium-sized enterprises would be very interested in that. The Joint Committee agreed a recommendation that the Bill be redrafted so that, like the MPC, the FPC must have regard to the Government’s growth objectives and other economic objectives. The Government have responded to the Joint Committee’s points on other related items in this area, but have not responded in favour of the more positive and widely supported suggestion that the FPC should be given a brief to have regard to the Government’s growth and economic policies. That is a real worry, and I hope that the Government will approach it with an open mind in Committee.

[Mr Ruffley]

I am following the hon. Gentleman’s argument closely. Does he agree that it is imperative for the Governor of the Bank of England to return to Parliament to explain in detail the indicators that he thinks should be used in the attempt to get a handle on the definition of financial stability, and that we need a full and frank debate on what those indicators should be?

[Mr Mudie]

That is an important point. I think that it was Charles Goodhart who raised the question of indicators. They are certainly interesting, but on a wider scale, I think it more important to establish that, given that the Monetary Policy Committee is linked to a target of 2% inflation, the Financial Policy Committee should be linked to growth employment measures that ensure that there is no “safety low level” of stability, and be forced to have a look at the problems of the real world out there.

[Steve Baker (Wycombe) (Con)]

The hon. Gentleman’s speech seems to allude to a search for an equilibrium that never exists in the real world. Does he think that that disconnection between the reality of life as a dynamic process and the search for stability is at the heart of the inability to define financial sustainability?

--- Later in debate ---

[Mr Mudie]

I think that it is more an indication of the way in which the banks have moved away from the real world into the investment world, computer schemes, and making money by using money, rather than funding the small and medium-sized enterprises on which we depend for a rebalanced economy.

This is a very similar—Madam Deputy Speaker, I think that I have thrown away my speech. However, the second issue that I want to raise is that of accountability. I want to draw the Chancellor’s attention to the danger of giving great powers to unelected officials, which can have a significant effect. One of the witnesses drew a parallel with the responsibility given in the sphere of health to the National Institute for Health and Clinical Excellence. NICE determines the availability of drugs and treatment, and when a particular decision is made, elected politicians are under great pressure to reverse it. It does not wash with most constituents to tell them that the decision is one for the regulator. They may understand that politicians have given up the power, but they rarely accept that we do not retain the ability to alter a decision that is painful to them—and why should they?

That is very similar to what will happen when powers are given to the Bank of England and the Financial Policy Committee. The Chancellor is handing power to the Bank on matters that will inevitably extend beyond the financial sector to the real economy. One example is interpretation of the financial stability objective. The Chancellor is given the opportunity to set an annual remit for the FPC, but to ensure the Bank’s independence, the Bill accepts that the FPC may refuse to accept the Chancellor’s remit. The Joint Committee recommended that the Treasury, not the Financial Policy Committee, should have the final say on the interpretation of the remit. It did suggest, however, that the FPC should make public its objections to the annual remit, and should alert the Treasury Committee. Giving evidence to the Joint Committee, Lord Burns said:

“if there is any part of this set of proposals that concerns me, it is probably to do with the governance of the FPC in relation both to its accountability to Parliament through the Treasury and the extent to which it can be defined as ‘independent’.”

That is a stark reminder of how much is being conceded by the Chancellor. His annual remit on how the Financial Policy Committee should interpret and pursue the financial stability objective can be disregarded by the committee. To illustrate the importance of that, I cannot do better than to read out the words of the Joint Committee:

“The tools available to the FPC could allow a reversion to a level of central intervention in credit flows that has not been practised in the UK since the period of ‘Competition and Credit Control’ in the early 1970s. Such interventions would, for example, often affect mortgage availability and loans to households and companies. Given the wide range of possible interventions, and absence of any quantifiable target for financial stability corresponding to the inflation target for monetary stability, the FPC’s decisions will be more politically controversial than those of the MPC.”

Bizarrely, the Government have not accepted that when there is a difference, the FPC must accept the will of the elected Government, but have accepted that the FPC may make its defiance public. The Chancellor is not only allowing the FPC to defy him, but encouraging those unelected officials to tell the world that they have done so. That strikes me as a very strange working method.

The third issue that I wish to raise concerns a different aspect of a matter that has been discussed by those on the Front Benches. Who is in charge in a crisis? That is the question that was asked by Lord McFall at the time of the Northern Rock crisis. It shook the regulators, and it voiced the thoughts of the general public. There is a genuine wish to prevent such a situation from arising again. The accepted answer is that the Chancellor is responsible, and that therefore he should be in charge when there is a crisis. That seems sensible and straightforward to most people, but not to the territorially sensitive Bank of England. Nigel Lawson heard about the Johnson Matthey crisis, and the need for him to commit Government money, on the morning when it broke. He was understandably upset. Before the resort of using public money is accepted, the Chancellor should be made aware of the difficulties.

I shall now depart from my script, because I have only a minute left. We in the Joint Committee and in the Treasury Committee were trying to be helpful to the Chancellor. We made a recommendation, which the Chancellor accepted, that when a crisis arose or he was warned of one, he should take direct command. The memorandum of understanding—this is a different point from the one raised by the shadow Chancellor—has been nicely arranged, by the Bank, I presume, to ensure that even in those circumstances he does not have direct control. The Bank remains operationally in control, and the Chancellor can speak only about matters relating to the public funds to be used to deal with the crisis. We wanted to give him the opportunity to make a full range of decisions to avoid the use of public funds, and I hope that the Minister will consider that.