Bank of England and Financial Services Bill [Lords]

Lord Tyrie Excerpts

Monday 1st February 2016 Commons Chamber

[Harriett Baldwin]

As the hon. Gentleman knows, the measures in the 2013 Act are due to come into force on 7 March this year. The position in relation to the reverse burden of proof is becoming increasingly clear. Andrew Bailey said in his evidence to the Treasury Committee, of which the hon. Gentleman is a member:

“I support the change, because what the change does is it turns the process round and puts the judgment back on to us”

—that is, the regulator.

“I would rather it does that than have us heading down this tick-box regime with legal questions around it over human rights.

I do not want to come back or have one of my successors come back to you in the future and have to say, ‘I am sorry; we could not use this regime in the way that was intended, because it was always a bit doubtful that we could make it stick’. It is far better we come at this point to you and say, ‘I do not think this has a sufficient probability of being effective’.”

I could supply further quotations, from members of the Parliamentary Commission on Banking Standards in the other place, but I must make fairly rapid progress now.

[Mr Andrew Tyrie (Chichester) (Con)]

Will the Minister give way on that point?

[Harriett Baldwin]

I will give way to the Chair of the Select Committee on that point.

[Mr Tyrie]

It surprised a number of members of the Committee when both the Prudential Regulation Authority and the Financial Conduct Authority told us that they supported the removal of the reverse burden of proof. I think that many of us would be in a different place had they not given that evidence.

The Minister has just placed great emphasis on the need for the senior managers and certification regime. Has she asked the regulators for a report on progress in its implementation? If so, will she tell us what it said and put it in the public domain? I have to say, on the basis of what we have heard, that progress is inadequate.

[Harriett Baldwin]

I appreciate my right hon. Friend’s contribution, because he has been examining the issue for longer than most. He will know of the points that were made about this topic in the other place. The regime is due to come into force on 7 March 2016, which is pretty soon. The rolling out of the implementation will focus on the larger organisations first, but the Committee and, I am sure, the Treasury will want it to apply in particular to the large, systemically important firms by 7 March.

The third element of the Bill relates to the extension of the important new freedoms that the Government are granting to allow people to take control of their retirement savings. It will help to ensure that consumers who will be able to sell their annuity incomes through the secondary market in annuities are sufficiently supported. There are two key measures. The first will extend the Pension Wise guidance to those who, from April 2017, will be eligible to sell their annuity incomes through the secondary market in annuities. That will include the offer of guidance to those who have a right to an income under the annuity, such as any dependants and beneficiaries as well as the primary annuity holder.

The second measure will require the FCA to make rules to ensure that specified firms check that individuals with annuities above a threshold value have received appropriate financial advice. On 19 January, the Chancellor set out the Government’s intention to legislate to place a new duty on the FCA to cap excessive early exit charges. I should like to take this opportunity to announce that that new duty will be introduced as a Government amendment in Committee.

--- Later in debate ---

[Mr Andrew Tyrie (Chichester) (Con)]

I fear that I may disappoint you slightly in that regard, Madam Deputy Speaker, but I will do my very best—unless you were giving an instruction from the Chair.

First, I want to find a point of agreement. I strongly agree that there is still widespread mistrust of the banks. A great deal of damage has been done, and it is agreed that there is a lot more work to do to sort it out, but there is a lot more work for the banks to do as well, to demonstrate that they are worthy of trust. The recent conduct scandals and the IT failures are just two examples of how much further we have to go.

Rather than talk in great detail about each clause of the Bill, I thought it might be helpful to take advantage of this Second Reading debate to say something more generally about the progress we have made on regulation. Last time a banking Bill was brought before Parliament—in 2012—it legislated for the ring fence. On behalf of the Treasury Committee, I asked the Government to think again, describing the Bill as “defective”, with parts of it being “virtually useless”. They listened to what the Committee said and changed the Bill, and adequate electrification of the ring fence is now part of the legislation.

This time, there is no need for a fundamental rethink. This Bill goes very much in the right direction. It brings the Bank of England more up to date as an institution, and in doing so it should greatly improve the scope for making it accountable to Parliament and the public. In 2011, the Committee published a report on these matters, and a high proportion of the proposals in this Bill originate or have roots in that report.

This is the sixth piece of legislation the House has been asked to look at in response to the financial crisis. As I said, before examining the specific measures, it is helpful to keep all this in perspective. Banking supervision has been rethought and fundamentally reconstructed three times in the past 30 years—that is a heck of a lot in a historical perspective. The Bank of England initially resisted most of these changes. First, it resisted the creation of the Board of Banking Supervision in the wake of Johnson Matthey. Then, in 1998, it complained that it had not been consulted about the creation of the new supervisory body, the Financial Services Authority. On that occasion, perhaps it was right. Gordon Brown’s creation of the FSA separated banking supervision from central banking and brought in a new “light touch” approach to supervision embodied in the principle, “We’ll make some clear rules, and if you comply with them we won’t interfere.” That all sounded very reasonable, but it left far too much scope for irresponsible buccaneers to pursue reckless business strategies, sometimes egged on by myopic shareholders.

At the same time, the Bank decided to define its role much more narrowly and concentrate on its new responsibility for monetary policy. In doing so, it was seduced by the benign economic conditions at the time, which it called “the great moderation”. Just as bad, it was reassured by the audited but nevertheless misleading and, in some cases, useless accounts of the big banks. The Treasury Committee is trying to do something about inadequate auditing right now. The Bank neglected its financial stability responsibilities right through the period up until 2007, and it failed to rise to the challenge when liquidity seized up in that year.

Perhaps worst of all, the statutory responsibilities of the FSA and the Bank created a large supervisory gap. Nobody paid enough attention to the banking system as a whole, even when it was known, for example, that the banks were becoming excessively reliant on wholesale deposits for funding. In principle, the gap was to be filled by the so-called tripartite, backed by a memorandum of understanding. In practice, the tripartite was considered an irrelevant backwater by all three parties involved, and we later learned that the heads of the three bodies never met prior to the crisis. Parliament was largely asleep on the job; we were all looking through a glass darkly. Some raised voices of concern, including Vince Cable, who is no longer a Member, and, on several occasions, my right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley). For what it is worth, I argued vigorously that the tripartite was an accident waiting to happen and that the Government were neglecting systemic risk. Those were all partial warnings; there was nobody with a comprehensive picture.

The multiple failures of 2007-08 were not just the result of bad supervisory arrangements aggravated by a complacent Government and a sleepy Parliament. Nearly everybody who had responsibility in the field failed—and to some degree, in my view, they are still failing—including directors, managers, credit risk analysts and auditors. Shareholder discipline, in particular, was and is still lacking.

Limited liability brings a limited sense of responsibility, but it implies an unlimited liability for taxpayers, and the bail-outs have added to moral hazard. They have made it essential that the objectives and organisation of banking supervision be fundamentally rethought. Hence we have got to where we are now—twin peaks. Put crudely, supervision is back with the banks, and the FCA is responsible for conduct. Twin peaks, and particularly ring-fencing with electrification, is and remains an experiment. Experiments need particular care, and that means a particular responsibility for Parliament to keep an eye on it.

A number of issues already present themselves for attention. For example, it is becoming clear that prudential risk management is about not just adequate capital on the balance sheet, but proper conduct of business. The shocking treatment meted out to customers has triggered massive fines. UK banks have paid about £30 billion in fines in redress since 2009. In theory, those fines should be enough to wake up even the sleepiest shareholder, but so far they have not done so, or certainly not enough. The systemic implications of conduct risk also make it essential that the Bank of England and the FCA be better co-ordinated than they were in the days of the calamitous tripartite. Parliament needs to keep a close eye on that.

Most important of all, the Bank has huge new powers, some of which are enhanced by the Bill. How it runs itself can no longer be left to the Bank; it is a matter of considerable public importance. That is why the Treasury Committee has been pressing for years that the Bank should abandon the style of governance that Alistair Darling memorably characterised, whether fairly or not, as the

“court of The Sun King.”

It needs a modern board, one fit for the 21st century.

That is where the Bill comes in: it does a good deal of the statutory heavy lifting required to enable a modern board to be created. Its main effect is to rationalise the demarcation between the Bank court and the Bank executives, which previously contained some curious anomalies that were created after 2007-08 by on-the-hoof policy making by both Governments.

The Prudential Regulation Authority will no longer be a subsidiary of the Bank, but part of the Bank. The Financial Policy Committee will no longer be a sub-committee of court, and the oversight of the executive will be the responsibility of the court itself, rather than a sub-committee. Even though it was not called a sub-committee, it was, in fact, a sub-committee, and a weaker committee than the court.

The Bill also provides for the appointment of another deputy governor. I would say in passing that, over the 300 years that the Bank has been around, it has managed to rub along quite well with one deputy governor. In 1998, it acquired a second one, then the Financial Services Act 2012 gave it a third, and now we are told that it needs a fourth. I just wonder how many this old lady really needs.

It is greatly to the credit of the current Governor and deputy governors that they have grasped the importance of being required to explain themselves in greater depth before Parliament. The Bank’s initial resistance to the Treasury Committee’s 2011 proposals, now embodied in the Bill, have largely evaporated. It has grasped the fact that with accountability can come enhanced authority. Far from weakening the Bank’s effectiveness, scrutiny and explanation can enhance it.

The Bill also provides for the Comptroller and Auditor General to have, for the first time, a role in the audit of the Bank’s accounts. That sounds sensible at first blush, and it was an easy win for the Chancellor on Budget day, but I think it flatters to deceive and we certainly should not expect too much of it. The National Audit Office lacks the expertise to do that kind of work, and I think it is already trying to rectify that by hiring some people, so there is an extra public expenditure cost involved.

I am sure the NAO can learn the skills, but there is a bigger risk: it is essential that the Comptroller and Auditor General should not be induced, whether by accident or design, to bring pressure on the Bank in a way that could adversely affect the decision making of the three policy making committees, or their funding. That is not an idle concern. After 1997, I am told, with the changes that had been made and the transfer of supervision to the FSA, the Bank was encouraged by the Treasury to save money. Foolishly, the Bank cut back the amount that it spent on financial stability, and lost some of its institutional experience of financial crashes—high-quality people—as a result. An idea that might have looked like good value for money at the time turned out, in retrospect, to be a big mistake. I hope that the NAO treads carefully, strong value-for-money man though I am.

There is a risk that the over-mighty Governor problem will be reinforced by the removal of the PRA’s subsidiary status. The independence of the PRA—or the Prudential Regulation Committee, as it will now be—is essential. A single point of systemic risk, in the Governor, has been created and will remain. Parliament will need to keep alert to protect the PRA’s independence.

On that score, I believe that more transparency could help. I have a proposal off my own bat, not on behalf of the Committee; I have not yet discussed it with Committee colleagues. The PRA could consider making more of its rulings available, not only to the managers of companies affected but to shareholders—they are the people who are supposed to be responsible for these companies’ affairs. That would mean making that information public. At the same time, it would reveal, and provide an opportunity to challenge, the PRA’s reasons for its rulings. I have said that that should be considered; there is a lot more to think through before it can be done.

In the meantime, the PRA appears to be accepting a related and more modest proposal from the Treasury Committee, which relates to banking competition. It is well known that challenger banks, which are new in the market, can be impeded by onerous capital requirements. A few weeks ago, I wrote to the chief executive of the PRA to suggest that the average of capital requirements of established banks be published, together with the average of capital requirements of challengers, so that a comparison could be made between the two. I am pleased to say that the PRA is looking into that.

At the heart of the Bill is the strengthening of the court. A strong board is needed to ensure that the policy committees are doing what they should be doing, and it will need to be forthcoming when the Treasury Committee asks for technical and other support for our scrutiny work. When we need information, reports and, occasionally, investigations, we will expect the court to be co-operative.

Before I sum up, I will raise one relatively minor issue that has not been touched on. The court, despite our request, has not been renamed the board of the Bank of England. That is a mistake. What is in a name? I am a strong supporter of most traditions, except when they get in the way of good outcomes, and this one is on the cusp, at best. Perhaps the Chancellor, who likes 18th-century history, has been too swept up in 18th-century court politics and cannot bear to lose the name, but I think that it is time it went.

With six relatively new pieces of legislation to implement, some time should pass to allow their effectiveness to be established. A lot of legwork will be required from supervisors and regulators to implement them all. A couple of quick examples will suffice. First, regulators have not reached the point where they can allow a bank to fail, and they have told us as much in evidence. What does that mean? It means that the taxpayer could still be at risk. Secondly, several banks still seem too big to manage. That poses a threat to financial stability and increases the risk of misconduct. The proposals of the banking commission were designed to address that problem directly. Detailed implementation towards certification, in particular, has been pretty sluggish so far. I am concerned that the Minister is not pressing more vigorously to make sure that certification and the senior managers regime will be fully implemented and to time.

I would like to end with a broad observation. With all this legislation, we are making some huge demands on the Bank and the FCA, and we may be close to the point of regulatory and supervisory overload. By that, I mean that the Government and Parliament could be raising expectations of what they can achieve to a point where they will never be perceived to have succeeded. We need to ask just how much national regulation can achieve in an open financial world. The truth is: perhaps not that much, and certainly less than many people think. We probably cannot stop the next financial crisis. The best we can hope for is to delay it, to reduce its impact by developing somewhat stronger institutions, including financial institutions, and to give us a better prospect that regulators are a bit more alert and prepared than they were in 2007-08.

In the long run, competition must take more of the regulatory strain. In markets for most products and services, customers can vote with their feet and barriers to market entry are tolerably low. Businesses with weak balance sheets or poor customer standards go to the wall. Neither of those is yet the case in banking. We are a long way from the point where competition can be a full substitute even for conduct regulation in banks, and the contagion risk inherent in the banking system would make supervisory withdrawal and reliance on market disciplines even more hazardous. Until competition is much stronger and market discipline more of a restraint, there will be no substitute for a strong and sometimes interventionist Bank of England and an effective conduct regulator.

Overall, although with some weaknesses, the Bill takes a step in the right direction—the direction of strengthening that framework—which is why I will vote for it on Second Reading.

[Several hon. Members rose—]