Bank Resolution (Recapitalisation) Bill [HL]

Lord Vaux of Harrowden Excerpts

2nd reading
Tuesday 30th July 2024 Lords Chamber

[Lord Vaux of Harrowden (CB)]

My Lords, it is always a pleasure to follow the noble Lord, Lord Eatwell, with his in-depth analysis and huge knowledge of this area. I feel I will probably fall short after that, but I will give it my best go.

This Bill provides the Bank of England with slightly greater flexibility to find a resolution to a bank failure other than insolvency, at a cost to the rest of the banking industry. As we have heard, it follows on from the lessons learned from the insolvency of Silicon Valley Bank. As such, I think that, like everybody else, I am generally supportive of it. But it does beg some questions, so, rather than making points about its merits or demerits, I will ask the Minister a number of questions about how it will operate in practice and some of the potential impacts.

First, the Special Resolution Regime effectively splits the banking industry into two tiers: those larger banks whose failure might create systemic risk, which are required to maintain excess debt and equity over the minimum capital requirements, known as MREL, and smaller banks whose failure would not be expected to create systemic risk, which do not hold MREL. SVB was a small bank whose failure was none the less considered to create some systemic risk because of the nature and concentration of its customer base. The Bank of England therefore decided to follow a resolution procedure, which it felt was better than allowing SVB to go into insolvency, which would have restricted its customers’ access to their funds, which I think the noble Lord, Lord Moylan, referred to. SVB was then rapidly transferred to HSBC for £1—a good result all round, I think. Customers retained continuity of access to funds and did not lose any of their deposits and HSBC gained a subsidiary that it said would accelerate its strategic plan by two or three years.

However, this begs the question as to whether we have the classification right for which banks are required to hold MREL. It is currently based primarily on size. Should the PRA be required to do more to ensure systemic risk has been identified before failure? SVB seems to have come as something of a surprise, and its risk profile does not seem to have been recognised in advance, so it appears to me that the current classification should be reviewed and that we should at least consider extending the MREL regime to small banks whose failure would none the less create some systemic risk. I would welcome the Minister’s thoughts on that.

Secondly, and this goes to a point that the noble Lord, Lord Eatwell, raised, the letter that the Minister kindly sent explaining the Bill states in the first paragraph:

“The Bill enhances the UK’s resolution regime, providing the Bank of England with a more flexible toolkit to respond to the failure of small banks”.


The Minister said that in his opening words as well, so could he explain why the Bill applies to all banks, including those inside the MREL regime?

Under the Bill, any costs of putting a bank into a resolution procedure, either by transferring it to a private sector purchaser, as happened with SVB, or by transferring it to a bridge bank with a view to ultimately transferring to a private sector purchaser or insolvency, will be met by funds provided by the industry via the FSCS. The Government indicate that in most cases they expect the costs to be lower than putting the bank into insolvency because it should avoid compensating depositors up to £85,000 each. The costs that the FSCS would cover would include the costs of recapitalising the failed bank, the operating costs of the bridge bank, and any costs in relation to the resolution, including legal and other professional expenses, costs of valuation and other associated costs incurred by both the Treasury and the Bank of England.

That raises a number of questions. What cap or limitation is there on the costs? While the Government say that they expect costs generally to be lower than insolvency, and they are probably right, that is not guaranteed. The bridge bank could be run for up to two years, and that is extendable in certain circumstances, so this could become quite a large, open-ended cost. Who controls the level of costs during the period? I think the noble Lord, Lord Macpherson, talked about this. It is not those who are going to be paying for it, so there is no direct incentive to keep the costs as low as possible. How is that going to be scrutinised? What input will those who ultimately pick up the costs have?

Under an insolvency process, there is a de facto cap on the liability to the FSCS, and therefore the industry, which is the amount of the deposit protection. Is it right that the wider industry will potentially be on the hook for paying more than that de facto cap? As I understand it, this process will be used only—and I think the Minister mentioned this—if it is in the public interest to do so, where a small bank failure turns out to create systemic risk. That would reflect a failure by the PRA to identify a systemic risk, as I mentioned earlier. If the resolution decision is driven by a public interest test, surely it should be the public purse that pays the excess rather than the banks which have no part in this. As a matter of principle, it is shareholders, lenders and other creditors who should bear the primary risk before the industry is asked to contribute. The industry should not be underwriting any debt or equity or even supplier risk. What is the mechanism for ensuring that the resolution process will not unfairly benefit share- holders or other creditors?

Related to that, if a bank is transferred to a bridge bank and two or even more years later goes into insolvency, where will the FSCS money that has been poured into the bank in the meantime rank in the hierarchy of debts? It should presumably rank above all debts that existed on the day the bank was transferred to the bridge. Is there a mechanism for returning money to the FSCS and to industry if it can be recovered either in insolvency or a sale? To go further than that, any sale to a private sector purchaser in these circumstances is typically under fire sale conditions, so they usually happen at below market price. SVB UK was transferred to HSBC for £1, as I mentioned, and HSBC is widely seen as having got rather a bargain because the failure of SVB was not caused by the UK entity; there was nothing wrong with the UK entity. SVB UK had loans of around £5.5 billion and deposits of around £6.7 billion and in the previous financial year had recorded a profit before tax of £88 million. Its tangible equity was around £1.4 billion, so quite a bargain at £1.

Will there be or should there be a mechanism for clawing back any excess profits made by the private sector purchaser to be refunded to the FSCS if the FSCS has provided the resolution financing? What happens if the failed bank is a subsidiary of an overseas entity? What mechanisms do we have for ensuring that the parent company pays for the costs of such a failure and not the FSCS? Why should the UK banking industry pick up the costs if there is a viable overseas entity? I realise that was not the case with SVB, but there could be a situation where an overseas bank sets up a UK subsidiary that does not go very well so it just walks away from it. It should pick up those costs. Is there a process for clawing back management bonuses and dividends paid prior to the failure?

As a general principle, bad or failing businesses should be allowed to fail, and that may mean that creditors, including depositors beyond the protection cap, lose money. There is a risk that this mechanism could be used to avoid negative headlines or for political or reputational expediency. After all, as was said before, the costs of taking the action will not fall on those making the decisions. Ultimately, the costs will be borne by consumers as the banks pass them on in low savings rates, higher lending rates or higher charges. What safeguards are in place to ensure that the mechanism is used only in appropriate circumstances? I am broadly supportive, but I have a lot of questions and look forward to hearing from the Minister.