European Banking Union: EUC Report

Lord Flight Excerpts

Thursday 24th January 2013 Lords Chamber

[Lord Flight]

My Lords, perhaps I may take the House back to the European banking union proposals and start with my own tribute to the noble Lord, Lord Harrison, as an enormously courteous and conscientious chairman of our committee. At least for me, I allowed myself to go to Brussels, feeling slightly worried as to whether I might be contaminated by doing so. Two things struck me during the visit. The first was that President Van Rompuy is a much more impressive and determined person than I had perceived previously and, to my mind, he will have had considerable influence in persuading Germany at a crucial time that it was not a good idea to allow, encourage or force Greece to leave the euro. Secondly, I cannot resist teasing the noble Lord, Lord Kerr. While we were wandering around the buildings he said to me, “The trouble is that none of the young people in the Foreign Office want to come here any longer because they know we will not be members in five years’ time”. I thought that that was quite an interesting little judgment.

I want to make two further general points. The first is that while the single market sounds wonderful, what we really want, please, is single market free trade. I know from my own commercial career that a great deal of the single market serves the interests of the large players in their sectors and is highly uncompetitive. Wide access is a fair point, but to my mind the single market needs a really good dose of free trade if it is to achieve what it is supposed to achieve. Secondly, I want to make a point about the City of London and its business. It is becoming increasingly global and is not just an adjunct of Europe. The impression I am being given by various European operations in the City is that you would have to have an EU that was very protectionist and was even threatening to impose capital controls for it to be uncomfortable for people in London. If you had an EU which was doing that, I think that people would not want to put money there anyway. I am not complacent about the position of the City of London and I well remember many people warning that if the UK did not join the euro the City of London would collapse. But, of course, nothing like that actually happened.

On the European banking union, the first question to ask is: how important are these proposals, what are they about and what has given rise to them? I have to say that they do not address the real underlying problem, which is that of different levels of competitiveness, or the point made by my noble friend Lord Trimble, the risk of locking less competitive areas into permanent depression, which has happened in the deep south of America as well as in the south of Italy. The solution to that is not necessarily internal devaluation, when that is what I call gold standard austerity. In the big debate about what to do about the competitiveness issue, common banking supervision is somewhat peripheral.

To the extent that banking supervision is important and relevant, I thought it was supposed to be getting banks better regulated, with a view to the ECB managing the extent to which the ESM fund was used to bail out banks where necessary. Now it seems we are being told by Germany that that is not wanted and it has to be sovereign states that bail out their banks when they are in trouble and maybe the sovereign states will be helped by the ESM fund. That is entirely contrary to the principle of trying to separate the problem of the banks and the state rather than compounding the two problems. It is pretty important in terms of the underlying objective as to how this is going to be resolved.

I have two more points about supervision. First, I am not entirely clear how much of the banking system it is going to cover. It looks as if it will be only the large banks. There is a slight danger of moral hazard there. The German Landesbanken, the savings banks that control about €2,500 billion, seem not to be part of it, and lots of other smaller banks will be left to their local central banks. I make the point that I think others have made: Credit Anstalt, which started some rather nasty banking developments in the past, was a small bank. It is almost as important that small banks are regulated well as for large banks to be regulated well.

When it comes to deposit insurance, as Martin Wolf said when we interviewed him, Germany does not want to have to pay a penny more than it absolutely has to. I am rather doubtful that deposit insurance will develop if there is a free-riding risk. You may have similar principles as to how it operates but I think it extremely unlikely that you are going to get a system where each country in the eurozone is there to cover the risks of the others.

What about the UK and banking union? As we were considering the first point, I was struck by how considerably it reminded me of the Financial Services Bill, which we were debating here in Committee, and there was a quite extraordinary similarity between the proposals for the PRA as a sensible supervisor rather than regulator of the banking system and the proposals for what the ECB would be responsible for. Indeed, to whatever extent there was open discussion, it is absolutely clear to me that the two go hand in hand—nothing wrong with that at all—and that the Bank of England will be sensibly collaborating with the ECB, as it has for a long time, in trying to get the best of banking supervision both in London and on a pan-EU basis.

The point has been made, but it is important, about the extent to which the Government did a good deal in terms of the voting powers for the EBA. It is the EBA that lays down the rules so it is pretty important. I think it is probably reasonable. We have to have only four countries left that are not participating, which is fairly unlikely, and three have already indicated that they are unlikely to participate.

Others have made the point—in particular, the noble Lord, Lord Hamilton—about the lack of ECB accountability, which is crucial in a world of gold standard austerity. Rather cynically I make the point that when people in southern Europe find that the funds from Germany are not flowing in transfer payments in the way that is expected as the quid pro quo, that is going to become extremely difficult politically. The ECB will have to make a real effort to make itself accountable. Then you have the big issue as to whether it is going to be accountable to national parliaments or to the European Parliament. I think that citizens still look much more to their national parliaments.

I have not got a grain of criticism of the proposals, which seem pretty sensible in the main. I see them, in the future, rowing quite sensibly and practically—not negatively—in tandem with what we hope will be much better banking supervision by the Bank of England than we have had from the FSA. However, the real underlying purpose does not look as if it is being addressed. It should provide a mechanism for managing bailout funds from the ESM for the banking system but it does not look as if that is going to be on the agenda.

--- Later in debate ---

[Lord Liddle]

My Lords, I begin with two personal points. First, I declare an interest in that the think tank that I chair, Policy Network, has in the past received support from the City of London Corporation. Secondly, it is a pleasure to welcome the noble Lord, my brother-in-law, to the Front Bench opposite. Therefore, there will not be an excess of partisanship on this occasion on my part.

As always, it has been an interesting debate, not least because of the final contribution from my noble friend Lord Desai, which I am still trying to absorb. My noble friend Lord Harrison began the debate with an admirable summary of his report. As usual, one wishes that the country was governed by the committees of your Lordships’ House rather than by the prejudices of its Executive, because we would be much better governed. It is an admirable report.

An interesting, rather off-the-wall point was made by the noble Baroness, Lady Falkner. It is something on which I have long reflected: why is discussion of Europe such a male-dominated subject? That is not something that we should discuss at length today, but we have to take it very seriously if the pro-Europeans want any chance of winning a referendum, so thank you to the noble Baroness for raising that issue.

I want to make three points. First, on the state of the euro itself, I believe that adjustment is on the way. Things are a lot better than they were. The question is whether what is occurring is socially and politically sustainable. I do not think that it will be without more fiscal flexibility. Nor do I think that it will be sustainable without considerable debt write-offs, particularly after the German elections in September. There will have to be an element of a transfer union to make the position of the mezzogiorno of the south, which the noble Lord, Lord Trimble, mentioned, sustainable. That will require further steps towards banking union, particularly in the case of Spain, because there is such an obvious link between bank debts and the sovereign debt position.

My second point is on the Britain in Europe debate. Banking union is the fourth major institutional development since the euro crisis started from which the United Kingdom has stood aside. There was the European stability mechanism, the euro-plus pact, the fiscal compact and now the banking union, which was agreed in principle in June 2012, and which the British urged the eurozone to get on with. Indeed, I think George Osborne first recommended it as long ago as January 2011. He was very foresighted about that, but it is something from which we have chosen to stand aside.

If you read what this is about, while in the British debate it is presented as a measure to rescue the single currency, in the continental debate it is about the creation of what is called a financial market union. I think the noble Lord, Lord Kerr, pointed that out. In the British Government’s view, this is all part of a clear narrative in which the eurozone is integrating and we have to establish a new kind of settlement and relationship with the members outside it; that is the British Government's narrative. However, the real question is: to whom does this narrative apply, other than the United Kingdom? How many other euro-outs share this conception of the British narrative? I might ask the Government what their view of that is.

That is a crucial point, first, in informing a view about the sustainability of the safeguards that the Government obtained on the banking union in the December 2012 summit. Secondly, it is fundamental to whether David Cameron’s essential assertion in his speech yesterday—that the core of Europe is the single market—is right. For most members, however, will it actually be the single currency? This point is fundamental because it is a question of whether we are going along with the support of other euro-outs, to try to negotiate a balanced relationship between outs and ins, or whether we are just making a case for special treatment for Britain, which will be far more difficult to negotiate.

The third point I want to make is about the position of the City of London. These are not just intellectual exercises; we are talking about something that is fundamental to our national interests. I have long believed that the UK is overdependent on financial services and I support the whole concept of rebalancing the economy towards manufacturing. My noble friend Lord Mandelson’s comment was right; there has been too much financial engineering and not enough real engineering. I agree with all that. However, the City is a crucial national interest and the financial centre of the single market. I also agree with the noble Lord, Lord Flight, that it is global and very resilient but it has benefited a lot from the single market in Europe—particularly from the opening-up of the financial single market, a lot of which occurred under the previous Labour Government.

Of course, no one worried about this at the time because it was the era of light-touch regulation. No one worried about the financial imbalances that were building up between countries and the lack of cross-border regulation. Well, the banking crisis changed all that and the Government recognised the need for regulation at EU level. It was a good thing that the Conservative Government, including Chancellor Osborne, accepted when they came in what Chancellor Darling had already agreed to: the establishment of European regulatory agencies.

[Lord Flight]

Could I just make this point to the noble Lord? The investment management industry, in which I spent 40 years of my career, has still failed to penetrate the EU. There are a variety of cultural and other barriers, but a lot of American firms came over thinking that Europe was like America and that all they had to do was have offices. If one looks at how much money the London retail funds business has got from the EU, it is still pitifully small.

[Lord Liddle]

I agree that things vary from sector to sector but one of the reasons why so many foreign-based banks are in London is because it is the financial centre of the single market.

The point is that the banking crisis has changed the way that we thought about the City. It has made regulation absolutely essential. The euro crisis has made banking union essential in order to break the link between sovereign debt and the fact that nation states have had to underwrite their banks. It raises difficult issues for us in the UK. As long as we see ourselves as being outside the single currency, the centre of the European financial market will be remote from the core of the banking union. There is also the block vote problem: if regulation is concentrated through the ECB, we could be outvoted.

The UK made a disastrous attempt in 2011 to try to tackle this problem of what to do. This was at that year’s December summit, where a paper was circulated late at night without prior consultation with anyone. Full of complex detail, it had at the top the horrible word “unanimity”. Basically it was asking for unanimity on questions of financial services. Not only was this tactically maladroit, it was strategically misguided. If the sincere wish of the British Government is to deepen the single market in the European Union, we cannot go around demanding unanimity on a specific UK interest, because every other member state will demand unanimity on an interest specific to it.

That is why the proposals of, for instance, the Fresh Start group are extremely worrying. They do not demand unanimity but in cases of financial services they do demand use of the Luxembourg compromise and they talk about emergency brakes. If you believe in the single market, you cannot put forward such things in the European Union. I should like to hear from the Government that they have no intention of pressing for the Luxembourg compromise or emergency brakes in this area. This would be so damaging to Britain’s interests in pressing forward to the single market.

However, the Government achieved a notable success in December with the acceptance of the double majority principle. I agree with my noble friend Lord Davies of Stamford that, for protecting our position, this is a lot better than nothing. Yet I also agree with the noble Lord, Lord Kerr, who asks how robust this is and whether it will last.

First, this double majority applies only to the banking agency, which is about the implementing regulations, and not to ECOFIN, which draws up the legislation. So we do not have a special position there. Secondly, the noble Lord, Lord Hamilton, is right that the ECB will be the big player in this and the EBA a weakly staffed and resourced organisation. How do the Government intend to deal with that? Thirdly, there is the question of time limitation. How many euro-outs, which are actually banking union-ins, will there be? If there are a significant number of euro-outs who will be banking union-ins, how long do we think that this special double majority arrangement will last?

There are alternatives. I am not saying that this is what the Labour Party would propose but, as my noble friend Lord Davies said, we have not had from the Government a proper cost-benefit analysis of what the alternatives might be. Did they look at how, as a euro-out, we might be a member of the banking union and whether it could be made to work? Could we have built on the model of the European Systemic Risk Board, of which the president of the European Central Bank is chair and the Governor of the Bank of England is vice-chair? Could we have used that as an umbrella? The Government have a duty to look at all the possible alternatives here because this is an issue of such vital importance to the future of the City. The fear that a lot of us have is that for reasons of ideology and prejudice, the UK has opted for very much a second-best, possibly a third-best, solution that would be gravely damaging to our interests in the long run. I will be grateful to the Minister if he can deal with some of these points.