Banking Reform

Mark Hoban Excerpts

Monday 29th November 2010 Commons Chamber

[The Financial Secretary to the Treasury (Mr Mark Hoban)]

It is a pleasure to take part in this debate, and I congratulate the right hon. Member for Oldham West and Royton (Mr Meacher) on securing it. I would like to pick up on one point that was raised by the hon. Member for Nottingham East (Chris Leslie) when he talked about the Government showing leadership. If I remember rightly, it was his party that said before the election that we could not introduce a banking levy on a unilateral basis. This Government have introduced such a banking levy, and it will raise £2.5 billion in a full year. That is what leadership is about. All that we have heard from the Opposition is that there is more disagreement on policy among the Front Benchers than among the Back Benchers. The problem is that the debate showed that those Back Benchers had more policy than the hon. Gentleman. Nothing in the 15 minutes for which he spoke told us anything about the future direction of the Labour party on the regulation of the financial services sector, other than his vague attempt to justify their decision not to vote for the motion. The right hon. Member for Oldham West and Royton has been hung out to dry yet again by his Front Bench.

It is vital that we learn and act upon—[Interruption.] I ask the hon. Member for Streatham (Mr Umunna) to let me continue. He will have his chance tomorrow in the Treasury Committee. It is good to see that the Leader of the Opposition’s Parliamentary Private Secretary is already revving up for that experience.

It is right for us to learn the lessons of the financial crisis, and to act on them. We must think very carefully about the range of interventions that we make. It was clear from everything that was said today that a range of measures was needed. The hon. Member for Streatham himself said that there was no magic bullet, and that is true. We need to take a range of measures domestically, in Europe, and at G20 level, if we are to learn those lessons of the financial crisis.

Let us begin with what we should be doing at home. We know that the regulatory architecture introduced by the last Prime Minister was fundamentally flawed. As my hon. Friend the Member for West Suffolk (Matthew Hancock) pointed out, he took away the Bank of England’s responsibilities for the regulation of banks. The Bank had the ability to spot threats to financial stability, but it lacked the power to tackle them. The last Prime Minister gave the FSA a dual mandate, which focused on the conduct of business to the detriment of prudential supervision.

Unlike the last Government, we have decided to reform the architecture and the approach to financial regulation, and to implement a structure that works. Before I outline the institutional reforms, let me set out the new approach that we want regulators to adopt. We believe that whether the problem is a threat to financial stability, a flawed business model or the mis-selling of financial products, regulators should intervene decisively and early to minimise its impact on our economy, on financial stability, or on consumer outcomes. The regulators will be required to demonstrate judgment and discretion, which represents a big change in attitude and approach.

However, we do not think that it is enough simply to change the approach; we want the architecture to change as well. We will establish a financial policy committee in the Bank of England with a dedicated focus on macro-prudential analysis and action, to ensure that risks that develop across the financial system as a whole are identified and responded to when that did not previously happen. The FPC will have a strong mandate to protect financial stability, with credible and knowledgeable external membership. It will be able to challenge the prevailing consensus, and to ensure that potential risks are identified, monitored and addressed rather than being ignored, as they were under the last regime.

The new architecture will also ensure that macro-prudential regulation of the financial system is co-ordinated effectively with the prudential regulation of individual firms, and that a new, more judgment-focused approach to regulation of firms is adopted so that business models can be challenged, risks can be identified, and action can be taken to preserve stability. That will be the responsibility of the new prudential regulation authority, which will be an independent subsidiary of the Bank of England.

However, it is not just a question of prudential stability. As a number of Members pointed out today, we also need to reform the way in which we look after the interests of consumers. We will set up a consumer protection and markets authority with a primary statutory responsibility to promote confidence in financial services and markets. Regulation and conduct within the financial system, including the conduct of firms towards their retail customers and the conduct of participants in wholesale financial markets, should be carried out by a dedicated, specialist body with focused and clear statutory objectives and regulatory functions.

As I said earlier, it is also not just a question of regulation. We need to think about the structure of the banking system. It was the last Government who closed down the debate about whether the activities of universal banks should be divided between investment and retail banking. We had the courage to open that debate, which is why we have established an Independent Commission on Banking, led by Sir John Vickers, to examine the structure of banking in the United Kingdom, the state of competition in the industry, and how customers and taxpayers can be sure of the best deal. The commission will consider issues of systemic risk and moral hazard, and will examine the complex issue of separating retail and investment banking functions, which was raised by Members on both sides of the House. It is due to deliver its report to the Cabinet Committee on Banking Reform by the end of September 2011, and its findings will help to shape the UK’s banking sector for decades to come.

One of the issues that has been a focus of international debate is linked to the work of the independent banking commission. Recent interventions have reinforced perceptions that some institutions in particular are too big or too important to fail: the so-called systemically important financial institutions, or SIFIs. They pose a much greater risk to taxpayers and to the efficient working of markets. We believe that it is vital for us to eliminate that source of moral hazard, and to ensure that it is possible to resolve failing firms without triggering a systemic crisis or requiring support from taxpayers. The Government are taking an active role in the G20 and in the Financial Stability Board’s work on the development of a robust, internationally consistent policy framework to address SIFIs and the risks that they pose. We fully support the principle that they should be required to have a higher loss-absorbency capacity than other institutions.

That is just one sphere in which international co-operation is needed. We recognise that financial stability cannot be achieved by any one country operating in isolation. The UK has a commanding position in international financial services, and the industry is global in character. It is therefore vital that we co-ordinate our actions with our international partners to ensure that we have effective means for dealing with threats as they arise. We have consistently argued for strengthened international financial regulation to address the failings that were laid bare by the crisis, and huge progress has been made in strengthening international regulatory standards. Getting these reforms right is vital for financial stability, but it is also vital for the future of our global financial services sector.

Capital was mentioned frequently during the debate. During the crisis, we learned that the banking system lacked the capital that was needed to absorb losses, or the liquidity that would enable it to survive when markets closed. We have been a vocal supporter of the G20’s endorsement of the Basel committee’s reforms to strengthen international capital and liquidity standards. Banks will be required to hold more capital to withstand losses, with the buffer of 2% core tier 1 required under Basel II being replaced by a buffer of at least 7% by 2019. I think that the long transition period gets the balance right. It strengthens the banks’ capital position, but at the same time ensures that banks are able to lend and continue to sustain economic recovery. I believe that this crucial set of reforms will strengthen the resilience of the banking system to the long-term benefit of the economy.

The motion refers to derivatives. I think that the hon. Member for Nottingham East and I agree on one point. I believe that neither of us will support the motion, but we have learnt through the crisis that over-the-counter derivatives in particular lacked transparency and created a complex web of interdependence between the bilateral contract parties, which made it difficult to identify the nature and level of risks involved. The financial crisis has demonstrated how those characteristics increased uncertainty in markets in times of stress, and posed risks to financial stability.

Notwithstanding the comments made by the hon. Gentleman, the UK has shown strong leadership in reforming the derivatives markets. We have continually called for more transparency and central clearing of OTC derivatives. Internationally through the G20 and the Financial Stability Board, and in Europe through the European market infrastructure regulation, we are implementing vital reforms that will address the shortcomings evidenced by the crisis in the derivative markets.

The right hon. Member for Oldham West and Royton has proposed that the Government should establish a clearing house for approval of all financial derivatives. However, in the crisis, the private sector clearing houses successfully unwound the positions of defaulting members. Their prudent risk management meant that they did not need assistance from the public sector, despite being directly exposed to failing institutions such as Lehman Brothers. We therefore believe that clearing houses as private sector entities are able to manage risk effectively, but we also believe that central counter-parties should be bound by high standards given their systemic importance, and that those standards should be harmonised on an international basis. The Government are committed to ensuring that that happens.

The main aim of our reform should be the reduction of systemic risk in the financial sector. It should cover derivatives only when central clearing will indeed bring a reduction in systemic risk. Corporate end-users that trade derivatives purely for the purposes of hedging, as opposed to speculation, will be exempt from the clearing obligation. That will reduce the cost that will be passed on to their customers. I reject the arguments in the motion.

The motion tabled by the right hon. Member for Oldham West and Royton fails to recognise the action that we have taken to reform financial regulation at home and abroad. We have done more in the past seven months than our predecessors did. We are building a new financial regulatory architecture and approach. Banks will hold higher amounts of capital so that their shareholders, and not taxpayers, will bear the losses when the next crisis comes. International reforms must strengthen financial stability, but they should be proportionate and should not choke off economic recovery.

Over the past few months, this Government have led the debate on financial reforms both at home and abroad. We are taking the action that is required to create a much more sustainable and stable financial system, and if the motion is put to a vote, I will urge my hon. Friends to oppose it.