Banking Reform

Lord Tyrie Excerpts

Monday 29th November 2010 Commons Chamber

[Mr Meacher]

The hon. Gentleman makes a good point of which we need to take account, but I still think that the credit rating agencies potentially have an important role. They are listened to in the market, are the basis on which financial transactions take place, and should be trusted, but in the present circumstances they are certainly not. However, I am grateful for his question.

On bonuses, there is outrage among not just Opposition Members but, for example, right-wing Governments in Germany, France and Sweden, that a banking system that owes its continued existence to massive Government intervention should pay itself mega salaries and bonuses entirely out of line with the top of business, let alone ordinary taxpayers. There is outrage especially because those gigantic bonuses often drove the recklessness in the first place. The overweening power of the banks attracts almost universal hostility, especially given that 90% of investment bank profits, in an era of austerity, are directed not at strengthening balance sheets, at shareholders through dividends, at customers through lower fees or at taxpayers, but at bonuses.

France, among several others, has demanded a mandatory cap and that there should be no guaranteeing of bonuses, but Whitehall, as usual of course, argues that it would not be practical. However, if the G20 Governments insisted on limits and made continued liquidity provisions dependent on compliance, no bank could refuse. I believe that Her Majesty’s Government should now be taking the lead in the G20 not in succumbing to lobbying from the City of London and the British Bankers Association, but in reining back bonuses on a much greater scale than we have so far seen, and to much lower levels, and in ensuring that they be paid only in exceptional circumstances.

On the broader question of averting future financial crises, attention has so far largely focused on enhancing capital control, but that does not actually have a good record in this regard. At the outset of this latest crisis, virtually all financial institutions across the globe had capital adequacy of between one and two times the minimum Basel regulatory requirements—at least at that level, and in some cases twice as much. Basel III, which has just reached its provisional conclusions, is scarcely any improvement. The core top-tier capital requirement is only 4.5%, and the contingency capital requirement is only 2.5%. Of the EU’s top-50 banks, 45 already meet that standard, and Basel III is actually proposing that the requirement not be introduced until 2019. This is simply nowhere near good enough. A much better possibility might be counter-cyclical capital controls, enforcing different levels of bank capital at different stages in the economic cycle. I can see the point of that, but I suspect that it would leave open the problem of the degree of ratchet and the timing of it. I suspect that that would be far too problematic.

An alternative approach—many have talked about this—is the introduction in Britain of something like the Volcker rule, restricting banks from undertaking certain kinds of speculative trading, notably proprietary trading. Of course that would certainly stop banks doing what they are doing at the moment, which is trading on their own books with the money of depositors. The key point, however, is that it would not overcome the too big to fail problem when applied to investment banks. For example, I do not think it would prevent a repetition of the collapse of Lehman Brothers; neither would it address the interconnectedness—the Chancellor was speaking about this a few moments ago—of today’s banks, with counter-party relationships and exposure between commercial and investment banks, and insurance companies. That is the problem. I say this with regret, but any rule-based reform is almost certain to face the risk of regulatory arbitrage, because financial institutions invent ever more sophisticated products that are simply aimed at getting around regulatory controls. I therefore do not think that what I have described is an adequate answer. For all those reasons, the force of argument and the balance of advantage point strongly towards separating retail from investment banks, in establishing distinct, narrow banks that are conservative, transparent institutions with no financial instruments or incomprehensible balance sheets.

[Mr Andrew Tyrie (Chichester) (Con)]

rose—

[Mr Meacher]

I am being intervened on by someone whom I cannot resist. I am only too glad to give way to the Chairman of the Treasury Select Committee.

[Mr Tyrie]

I am grateful to the right hon. Gentleman. On that point, does he agree that the Government have done the right thing by creating the Vickers review? The review will examine, in depth and carefully, without rushing a reform, whether structural reform of the banks is required, and will give us guidance on how to protect ourselves from the too big to fail problem.

[Mr Meacher]

I entirely agree with that, and I was just about to make the same point myself. I hope I can also take the hon. Gentleman with me when I say that Parliament should have the opportunity to express its views to the Vickers commission before it reports, rather than simply making comments when its work is virtually a fait accompli. Indeed, that is one of the purposes of this debate.

The key advantage claimed for the model that I am describing is that it would remove the implicit taxpayer guarantee—that is, the capacity of the financial conglomerates to use retail deposits, which are implicitly guaranteed by Government, as collateral for proprietary trading; or, as the Treasury Committee put it, I think rather nicely, banks playing

“at a high-stakes casino table with…taxpayers’ chips.”

I have a lot of respect for this model, but the crux of it is that the withdrawal of the taxpayer guarantee would be a sufficient deterrent to prevent investment banks from engaging in highly risky investments that might collapse, with serious and far-reaching consequences for the national economy. The real question—which I do not think enough people have asked—is whether that is likely to be true. The fact is that if a financial institution outside the protected narrow banking boundary threatened systemic contagion, it is difficult to believe that the Government would not attempt some form of bail-out. I therefore have to say, regrettably, that I doubt whether the narrow banking model could, by itself alone, be relied on to overcome the problem of moral hazard and too big to fail.

Does that mean that there is no solution to the too big to fail problem? Not necessarily. There is an alternative to narrow banking as a means of preventing a bank from gambling away other people’s money, which is the recent Kotlikoff proposal in the US. It is a proposal that deserves serious consideration—consideration that I hope the Vickers commission will give it. In the US context, it is proposed that all financial companies become pass-through mutual funds. They would have a 100% equity ratio, to ensure bank solvency, and the payments function of banks would be performed by cash funds that would be 100% reserve—for example, through Treasury bonds. Such banks could, of course, still initiate new mortgages and new loans, but these would not be funded through deposit accounts until they had been sold to a mutual fund. The key point is that the bank would never hold them; in other words, the bank would never have an open position. Banks would not own assets—apart, of course, from their offices and so on—and they would not then be in a position to fail or trigger a bank run. That is a significant proposal.

For those—and there are plenty of them—who want to take greater risks beyond a cash-based mutual fund, there are already hundreds of investment avenues that would continue to be available, such as foreign exchange, derivatives, real estate, hedge funds and all the rest. The key difference with this limited-purpose banking would be that any failure in such investments would be incurred by the investor, not by the bank. That is the crucial point. There would be no problem with the banks being too big to fail or trying to insure the uninsurable risk of financial contagion. Critically, there would be no future claims on the taxpayer.

This reform would overcome a critical market failure without the need for any vast new complex regulation. I say that for the benefit of those on the Government Benches. It is, in effect, a market solution. It is true that it would not necessarily prevent asset bubbles—I do not think that anything can do that, certainly not in this area—but under limited-purpose banking, such bubbles would not threaten the entire financial system. Anyway, there would be nothing to preclude some form of macro-prudential authority from having oversight in this area. I think that that would be a very good idea.

I am not suggesting that this reform would be a panacea, because I do not believe that a panacea exists in this area. It should, however, be thoroughly investigated by the Vickers commission and, I hope, by the Government. I do not think it is an exaggeration to say that at present Britain has the most profoundly dysfunctional banking system of any G7 country. It came nearer to collapse than any other in the autumn of 2008. I believe that we need to break up the mega-banks, with their addiction to mortgage lending. We need smaller banks and, in particular, specialist business banks such as infrastructure banks, housing banks, green banks, creative industries banks and knowledge economy banks. Only that kind of fundamental reform of the banking system, involving all the elements that I have described, can provide the foundation for the economic and social transformation of this country that we all want. I commend the motion to the house.