Bank of England and Financial Services Bill [HL]

Lord Carrington of Fulham Excerpts

Wednesday 11th November 2015 Lords Chamber

[Lord Sharkey]

My Lords, Clause 12 abolishes the existing PRA. It defines the Bank as the new PRA, exercising its function through the PRC. The key questions here are why, and what is the benefit? I asked these questions at Second Reading. The Minister, in his letter to me, received last Thursday, answered by saying:

“Bringing micro-prudential regulation more fully into the Bank will support the Bank’s aim of installing a unified culture and flexible and co-ordinated working across its twin aims, aims of monetary and financial stability”.

That is very nearly weapons-grade corporate speak.

I invited the Minister at Second Reading to say what that means in plain English and to give concrete examples of how it would operate. I again invite him to do exactly that. I also invite him, having explained what it means, to say why it is better than what we now have. Andrew Tyrie asked the governor a similar question on 20 October at the Treasury Select Committee. He made the point that the PRA had been successful and asked why this change was needed if the PRA was not “broke”—if it wasn’t broke, why change it? The governor said that no one had made that point to him but he agreed that the PRA had been successful.

Clause 12 brings about a significant change. It brings the PRA directly into the close embrace of the Bank. Despite unevidenced assertions to the contrary, it must reduce the practical and cultural independence of the PRA, and this is absolutely not desirable. Doing all this without a convincing or even intelligible reason is surely the wrong thing to do.

The Treasury briefing paper for the Bill hints at another reason for absorbing the PRA into the Bank—that is, to conform with the governor’s “One Bank” strategy aimed at breaking down barriers within the Bank,

“that could stand in the way of a unified culture and impede flexible and coordinated working across the Bank”.

There are two worrying things about that statement. The first is the “One Bank” strategy itself. As my noble friend Lady Kramer said at Second Reading, the Parliamentary Commission on Banking Standards had many conversations about the importance of ensuring that,

“the Bank was not one single monolith and that there should be an opportunity for real challenge rather than groupthink”.—[Official Report, 26/10/15; col. 1073.]

The “One Bank” strategy appears to be in danger of doing exactly that—moving the Bank back to monolith status, suppressing opportunities for real challenge and recreating the conditions for groupthink.

The second worrying thing about the Treasury briefing note statement is the reference to breaking down,

“barriers that could stand in the way of a unified culture and impede flexible and coordinated working across the Bank”.

Leaving aside the question of whether a unified culture is always desirable, one has to ask, “What are these barriers?”. What barriers have been identified in the workings of the Bank with the PRA?

The position on Clause 12 is that the Government have simply not put forward any compelling reasons for the changes that it produces. We have seen no strong, or even fairly strong, or evidenced argument that either the current situation is unsatisfactory or that the proposed changes would be better. Absorbing the PRA into the Bank is an important and radical step. It should not be taken without strongly evidenced arguments. In the absence of such arguments, we are left with only weakening of the independence of a vital organisation, with no assurance of any real benefit. Like my noble friend Lady Kramer and my former noble friend Lord Flight, I would prefer to see the PRA more independent rather than less. However, if we cannot have a more independent prudential regulator, we can at least try to stop it becoming a less independent prudential regulator.

[Lord Carrington of Fulham (Con)]

My Lords, I refer noble Lords to my interests as declared in the register of interests. It seems to me that these clauses come to the nub of bank regulation in the Bill. The real question that we are looking at is whether it is better to have a stand-alone regulator or one which is integrated into the Bank of England, albeit with Chinese walls, a separate committee structure, independent directors and so on. To answer that question we have to consider why the FSA failed. The FSA was set up very much as a stand-alone organisation with its own rulebook, structures and independence from both the Treasury and the Bank of England, yet it completely failed to identify the problems that were building up in the banking system prior to 2008 and was unable to take action if it did identify those problems. However, there is increasing evidence that it was not even aware that problems were being created.

The noble Lord, Lord Sharkey, suggested that there are no problems with the PRA. That may well be true. Certainly, the PRA has operated well since it was created. I have had personal experience of dealing with people of excellent quality in the PRA and, indeed, of better quality than people in the equivalent posts in the FSA. However, I warn that the PRA has not been tested in the way that the FSA was. There has not been a major financial crisis since 2008. The PRA has not had to face the same problems. Frankly, we do not know whether the PRA would be able to cope with a crisis of the magnitude of 2008 or whether indeed it would suffer from the same problems that the FSA suffered from.

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[Baroness Kramer (LD)]

My Lords, in response to the noble Lord, Lord Carrington, of course the FSA failed in its task as the problem developed over the several years leading up to the financial crisis of 2007-08. But I think it is very wrong to claim that the Bank of England did not also fail during this period, despite its access, as he reasonably said, to very extensive market intelligence. One of the frustrations of this House was that although the FSA recognised its failure, I am not sure that even up to this day the Bank of England has ever accepted that it played its role in an inadequate way during that period. Indeed, that has been part of the problem in putting remedies in place because, as many have said, a change in culture is an essential part of that process.

[Lord Carrington of Fulham]

The noble Baroness is failing to understand that there was a strict separation between the role of the Bank of England and the FSA, and there was no communication between them at the level which ought to have allowed that information to be passed. That was part of the problem. There was a great separation between the two. If the Bank of England understood what was going on, it did not see it as its job. If the FSA knew there was a problem but did not have the information, it could not communicate with the Bank of England. Bringing the two together—bringing the regulator together with the central bank and, I emphasise, with the Treasury as well—will find a solution.

[Baroness Kramer]

My Lords, I find it extraordinary that there is an argument that the Bank of England knew what was going wrong but sullenly kept its mouth shut because the constraints gave the key responsibilities to the FSA. We have to break away from that sort of cultural notion that one observes only the very narrowest interpretation of responsibility when we are talking about an organisation such as the Bank of England. I agree that that culture tends to continue. That is one of the frustrations and concerns that we have, particularly with the removal of the oversight committee, which is the one challenge to that ongoing attitude. Let us set that aside for the moment, although I find it a constant frustration not to recognise that the Bank of England did not act when it certainly had an opportunity to lay on the table the many problems it now says it saw with such clarity.

I go back to the underlying issue, which is that the PRA has been a success. The PRA has been absolutely key in establishing the kinds of regulations that have made the Bank safer for the future, setting standards for regulatory capital being an important part of that. In addition, in the period before we had the PRA, it was virtually impossible to get a new bank licensed in this country. We have had Metro Bank but essentially no new bank for 150 years. People had to find an existing banking licence, buy it and go for some sort of change of purpose. The PRA was a leader in changing that whole culture and recognising the importance of bringing in challengers and new players. Had it stayed tightly within the existing Bank family, which had resisted that approach over and over again, I very much doubt that we would have seen that kind of change. So the experience we have had since setting up a PRA which has some distance from the Bank—a small distance, I fully acknowledge, but separate responsibilities governed under company law—has been that it has brought forward change in a way that is not part of the history of the Bank. I am very concerned at the potential for losing that.

The noble Lord, Lord Carrington, also suggested that if we changed the existing structure it would not allow a proper flow of information from the Bank of England to the PRA. But look at the membership of the PRA: we have crossovers in deputy governors, and I believe that the Governor of the Bank of England is the formal chair of the PRA. If these individuals are unable to remember the meetings that they were exposed to and the memos that they read when they wore one hat, and bring that information into the meetings they have when they play their role within the PRA, I frankly find that extraordinary. As far as I understand it, there is no problem of information flow—and if there is, we would very much like to hear from the Minister what the instances are, where there has been that kind of breakdown, and why an individual involved in discussions in one particular part of his or her job has been unable to remember those discussions when participating in another part of it. Those are quite serious allegations. I would like to hear from the Minister where this communication has so badly broken down when it is quite frequently the same individuals who are involved.

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[Lord Carrington of Fulham]

My Lords, I had not intended to intervene on this amendment, and before I speak, perhaps I had better remind the Committee of my interests as set out in the register. I think that everything has been said about the natural justice and injustice of the reverse burden of proof, particularly on this side by the right reverend Prelate the Bishop of Southwark. I do not want to take that line because the argument is clear; rather, I want to add two practical thoughts. The first is that if there has been wrongdoing in a financial institution, I do not think that anyone in this House would support the guilty parties getting away with it, however senior they are in the organisation. The question is not whether they should get away with it but whether the powers exist to enable the regulators, and then the proper prosecuting authorities, to take appropriate action. I remind the Committee that the PRA has very extensive powers. If the authority considers that there has been malfeasance in a financial institution, it is able to go in and trawl through the records of that institution in great detail, to the extent of looking at email trails.

[Baroness Kramer]

I believe that the noble Lord, Lord Carrington, is referring to the FCA, but regardless of that, he has mentioned email trails. Is he aware that the absence of email trails was a fundamental part of the regulator’s decision that it was not able to pursue a single case to senior management level? There was an absence not only of email trails but of any other record which would enable pursuit of a trail from the bottom upwards. The evidence for that is very clear in the transcripts of the Parliamentary Commission on Banking Standards.

[Lord Carrington of Fulham]

I have not read those transcripts, but I have some experience of both the PRA and the FCA, and I can tell the noble Baroness that those powers exist for both bodies. If they do not, or if they need enhancing, I would be the first to say that that should happen

[Baroness Kramer]

I am sorry to keep bobbing up and down, but the point that was made was that those in charge are very careful that there is no email trail and no written trail. That is one of the points about the reverse burden of proof: in effect it requires senior managers to allow an email trail to exist, or indeed some sort of audit trail, because they would be in a position where they would be required to demonstrate that they had taken reasonable steps. When the burden shifts back to the regulator, the regulator is completely stymied at the point where all conversations and exchanges take place in an environment where there are no minutes, no emails, no memos and no existing trail.

[Lord Carrington of Fulham]

I will come on to that in a moment; that is the second point I wish to make. The first point is that the power does exist for the PRA—and, indeed, the FCA—to be able to go and investigate what has happened inside a financial institution in very great depth and in very great detail.

The consequence of the reverse burden of proof would be to make the situation to which the noble Baroness referred even worse. An organisation which knows that there is individual liability where they have to prove that they did no wrong will have lawyers crawling all over them to make certain that at every move, nothing is recorded, nothing is said and nothing is minuted which would put them in a position where they could do anything other than deny all culpability. That is what would happen—and to some extent does happen. But I can reassure the House that destroying email trails is extraordinarily difficult. In most institutions, email trails survive through even the greatest attempts to wipe the hard drives clean. I can assure the noble Baroness that if the PRA wishes to find evidence and has the resources, the determination and the suspicion, it will find the evidence to bring the prosecutions it needs.

[Lord Davies of Oldham]

My Lords, this has been an excellent debate and the Minister has a great deal to which he needs to respond. It is little surprise that we have been exercised with these amendments, because they go to the very heart of people’s trust and confidence in the financial services industry.

I would suggest that perhaps one reason why this change has been effected by the Government is because of the lack of transparency in the government proceedings. That is why the controversy has arisen. None of us has been privy to the process whereby the Government produced this significant change to the senior managers and certification regime. Clearly, decisions have been taken behind the scenes and without consultation. I do not think that there is much of an email trail on either of those factors.

The fact is that the Government did not even consider that this might be much of a problem, and today’s debate identifies just why that is. I hope, therefore, that the Minister will be able to demonstrate the thought processes behind these changes. The age-old argument that it is not working in practice scarcely holds, because the SM&CR never had a chance to work in practice—so the Government will have to come out with a better argument than that. What advice did they get that convinced them that these changes were the best approach? Did an event occasion the change? Are the meetings that the Minister had on such a significant issue as these proposed changes on the public record?

We also need to consider the role of the regulators and how we can ensure that they are bold enough to spot when misconduct takes place. Has their job not been made harder by the fact that there will no longer be a duty on firms if they suspect wrongdoing? Can the Minister please go into some detail about how the Government propose to ensure that the regulators will be able to rule out ineffective management? We have had a refresher course today in just what ineffective management—and, indeed, corrupt management—has done in terms of damage to so many people’s lives. We ought not to forget that.

I hope that the Minister will be able to address these points in some detail. Of course, he has to take into context just what this debate has demonstrated: how difficult the issue is, but how fundamental it is to the welfare of our society. I expect the Minister to give a detailed response.