Financial Services Bill

Steve Baker Excerpts

Monday 6th February 2012 Commons Chamber

[Mr Mudie]

That is an important point. I think that it was Charles Goodhart who raised the question of indicators. They are certainly interesting, but on a wider scale, I think it more important to establish that, given that the Monetary Policy Committee is linked to a target of 2% inflation, the Financial Policy Committee should be linked to growth employment measures that ensure that there is no “safety low level” of stability, and be forced to have a look at the problems of the real world out there.

[Steve Baker (Wycombe) (Con)]

The hon. Gentleman’s speech seems to allude to a search for an equilibrium that never exists in the real world. Does he think that that disconnection between the reality of life as a dynamic process and the search for stability is at the heart of the inability to define financial sustainability?

--- Later in debate ---

[Matthew Hancock]

That is absolutely right, and I should also pay tribute to my hon. and learned Friend’s profession outside this House, because, as in the common law, every successful system of oversight that has stood the test of time allows room for both rules and judgment. The common law is an example of a system that has built up over time and that understands the complexities of human behaviour. It has strict rules in some regards, but it also allows the exercise of judgment in order to be able to adapt to modernity and circumstances. If we move entirely towards rules and away from the exercise of any judgment, we take away that ability to adapt.

[Steve Baker]

My hon. Friend makes an interesting point in comparing the approach under discussion to the common law. Does he agree that a key difference is that whereas in the common law anybody can look at previous judgments and know how the law will respond to their behaviour today, under this proposal to have flexible forward-looking, judgment-based regulation we cannot necessarily be sure today how the state will treat our current actions at some point in the future?

[Matthew Hancock]

It would be better if we had an embedded and long-standing system in which there were those precedents, but as we do not have about 800 years to put it in place it is better to have a forward-looking system. If my hon. Friend has a suggestion as to how we can use precedent built up over time, given that we are starting from a system that catastrophically failed, I would be very interested to hear it.

[Steve Baker]

I hope that my hon. Friend will stay for my speech.

[Matthew Hancock]

As I said, this pendulum swung too far, but why do we need to allow the authorities to exercise discretion? It is because the world we face is as we find it, not as it is written in the rulebook. Indeed, the very complexity of the system calls for simple rules, because the more complex the rules applied to a complex system, the more likely somebody is to try to game it and, therefore, the more complex the set of rules that will need to be imposed again on the system to try to account for that behaviour. We see the same thing in respect of other areas of Government policy, not least the tax system, where complexity has led to avoidance activity, which has led in turn to complexity, and so we now have the longest tax code in the world. This attitude towards regulation and oversight makes no sense in the modern world of complexity. Complex systems need simple rules.

Complexity also adds cost to businesses not targeted initially. Worse still, the complexity leads to a moral abdication, because the rules become a substitute for personal responsibility. Just as we need to allow for the exercise of discretion by regulators, we also need, within a system that promotes responsibility, to allow for the discretion of management. That is why I have concluded that we need to ensure, especially in such a high-paying business, that the sanctions for failure and for irresponsibility are strong. It is not a good enough sanction for someone simply to lose their job in an industry where it is easy to move into another one.

In the first instance, we need to move to a system where the debarring of directors is made easier, not least because when a bank is rescued it technically does not go through the current debarring rules. The FSA is right to regulate pay and introduce claw-back, but we also need, in extremis, to introduce a measure to ensure that for recklessness at the helm of a systemically important bank there is a stronger and, if necessary, criminal sanction. I hope that such a measure would never be used but, as with other areas of life where these measures are hardly ever used, it greatly concentrates the mind to know that a deep sanction exists for reckless and deeply irresponsible negligence. I hope that such a measure would be a check on hubris and would last the test of time so that it would be in existence next time there is a boom and the associated hubris.

I hope that that change, the changes in this Bill and other changes will allow those of us who support the free market, enterprise and innovation to support, unabashedly and with enthusiasm, the wealth creators, who make our prosperity possible.

--- Later in debate ---

[Steve Baker (Wycombe) (Con)]

Thank you, Mr Speaker. I refer the House to my interest in Cobden Partners, which has been established to help nations solve their banking crises.

I very much welcome the Bill, which I hope and believe will prove to be the zenith of contemporary thought on bank reform. With due deference to my right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley), I wish to talk about three potential elephants in the room. First, I wish to make some remarks about accounting, then I wish to discuss the conduct of individuals and liability, and finally I wish to talk about financial stability.

I know that the Minister has heard my views on the international financial reporting standard, but I draw his attention to a letter in yesterday’s Financial Times by Lord Lawson, under the headline “Forget Fred and focus on the real banking scandal”. He stated:

“The auditing of banks’ accounts, however, is fundamentally flawed in itself. The IFRS accounting system itself has proved to be damagingly pro-cyclical, and the ability to pay genuine (and genuinely large) bonuses out of purely paper profits, which are never subsequently realised, is at the heart of both the bonuses that cause such public and political outrage, and the reason why bank management consistently does so well when bank shareholders do so badly.”

Andy Haldane, the executive director for financial stability at the Bank of England, gave a speech in December. I shall not read out all the remarks that I meant to cover, but he concluded by saying that

“if we are to restore investor faith in banking sector balance sheets, nothing less than a radical rethink may be required.”

He was referring, entirely, to accounting standards. I therefore refer the Government to my private Member’s Bill introduced on 13 May 2011, which seeks to introduce parallel prudent accounting for banks. It is a couple of pages long and I hope that it can be added to this Bill.

I also refer the Government to “The Law of Opposites”, a paper produced by the Adam Smith Institute and written by my colleague Gordon Kerr, who has spent 25 years “gaming accounting rules”, as he would perhaps say, in order to make a profit. The banking system is in a far worse state than is generally believed. I do not see how either the Financial Policy Committee or the Prudential Regulation Authority can operate without a true and fair view of the state of financial institutions, and I do not believe for a moment that the international financial reporting standards give that to us.

On the conduct of individuals, we fail too often to think about the pattern of regulation in which we have engaged. It seems that the first thing that legislation does is damage the incentives and disciplines of the market. Having thereby created moral hazard, regulators come along to try to mitigate the consequences of that moral hazard. A banking licence today is a licence to lend money into existence, at interest, with the risk socialised. When we look at central banking, deposit insurance and limited liability, we find that moral hazard is absolutely rife in the banking industry, even before we consider investment banking. I suggest to the Government that it is time to increase the liability of banks’ directors. There should be strict liability for them, and bonuses should be held in a pool and treated as capital for at least five years. I will introduce a private Member’s Bill to that effect on 29 February.

We have talked about financial stability and the difficulty of defining it. There has been a sense that there is some kind of equilibrium economy—an evenly rotating one—in which there could be a sustainable and stable quantity of credit. Indeed, on pages 14 to 16 of the Joint Committee’s report there is an interesting discussion about the need to regulate credit.

To leave time for my hon. Friend the Member for North East Somerset (Jacob Rees-Mogg), I will just say that if we were talking about any other commodity and were discussing adding to a failed regime of price control a regime of quantity control, we would certainly reject the idea out of hand. In Lord George’s testimony to the Treasury Committee before the crisis, he made it absolutely clear that the Bank of England had created a credit bubble to avoid falling into recession, yet we are going to give the Bank even more powers, more tools, more risk of ruin and more big-player effects and distortions of economic expectations.

I congratulate the Government on introducing the Bill, and I sincerely hope that it represents the absolute zenith of contemporary thinking on interventionist bank reform.