New Clause 9 — Leverage ratio

Oral Answers to Questions — Communities and Local Government – in the House of Commons at 7:00 pm on 8th July 2013.

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‘(1) The Bank of England Act 1998 is amended as follows.

(2) In Part 1A section 9D(1), for “may”, substitute “shall”.

(3) In Part 1A after section 9D(1) insert—

“(1A) The notice in subsection (1) shall include a target for the overall leverage of the UK’s financial system, to encompass also the activities of foreign financial institutions and non-bank originators of credit.”

(4) After section 9D(3) insert—

“(4) After each three month period, the Financial Policy Committee must respond to the notice of the economic policy of Her Majesty’s Government in subsection (1) by notifying the Treasury of—

(a) any action that the Committee has taken to regulate leverage in the financial system to the identified target in a manner consistent with maintaining adequate credit availability and growth in the economy, or

(b) the Committee’s reasons for not intending to act to regulate leverage in the financial system to the identified target.

(5) Notification under subsection (4) must be given in writing.

(6) The Treasury shall—

(a) publish in such a manner as they think fit any notification received under subsection (4), and

(b) lay a copy of such a notification before Parliament.”.’.—(Chris Leslie.)

Brought up, and read the First time.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I beg to move, That the clause be read a Second time.

It is a delight to see the Leader of the House on the Front Bench to debate with me the question of the leverage ratio—I favour the pronunciation, “leaverage”—and I am happy to give way to him if he has any concerns about it. As the Leader of the House—[Interruption]and, indeed, the Minister will know, a bank’s leverage is the ratio of its assets to equity capital. Its equity capital is equal to the value of its assets, minus the value of its liabilities. Higher leverage rates magnify returns, because any growth in assets will be proportionately greater if equity is thin, but—and this is why it matters—the corollary is that any losses are magnified if leverage is greater. Its equity can be wiped out by a smaller shock than would wipe out the equity of a less leveraged institution.

The Government said that they intended to provide the Financial Policy Committee of the Bank of England with a time-varying leverage ratio tool, but not before 2018, and that that would be subject to a review in 2017 to assess progress internationally. The design of the tool would depend, hon. Members will be glad to hear, on European Union legislation, and will be set out in Britain in due course in secondary legislation. I know that they are keen on that particular process.

The Independent Commission on Banking was clear on this matter, and said that it supported the use of leveraged ratios as a back-stop. It called for a tapering of the requirements when a bank crossed a certain size threshold by increasing the minimum leverage ratio from 3%—the Basel proposal—to over 4% on a sliding scale, as the risk weighting of assets to GDP ratio increased from 1% to 3%. The Opposition believe, as do many commentators—this is a question that came up in the recommendations from the Parliamentary Commission on Banking Standards—that reforms are needed to leverage, as well as the risk weighting of assets. In the aftermath of the global financial crisis, regulators introduced the risk weighting of assets process as an antidote to the high-risk, high-reward culture pervasive in banks. That process, however, has been partial, somewhat self-defined by the banks themselves in some cases, and in the European Union, the zero risk weighting attributed to some palpably risky sovereign debts has brought that system into disrepute.

Leverage ratio powers need to be taken in the Bill, and phased in before the EU plans for the end of the decade. That was one of the main conclusions of the Vickers report. Not legislating for leverage restraint is a significant omission from a Bill that the Chancellor claimed would reset the banking system.

Photo of Stewart Hosie Stewart Hosie SNP Chief Whip, SNP Deputy Leader, Shadow SNP Spokesperson (Treasury) 7:15 pm, 8th July 2013

I am very supportive of the notion of legislating now for the leverage provision, but in his new clause, the hon. Gentleman discusses

“a target for the overall leverage of the…system, to encompass…the activities of foreign financial institutions and non-bank originators of credit”

—or shadow banking. Although that might be taken into consideration in the calculation, the FPC would have no power to implement a leverage ratio in the shadow banking sector, so is there not an unintended consequence that leverage ratios may be too high in the formal banking sector to compensate for what the report found?

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am delighted that the hon. Gentleman has taken the trouble to look at the new clause, because it is our second attempt to cajole or persuade the Government to look at this issue. In Committee, we took a different approach to the question of leverage, and tried to clarify that there was a clear power for the Government to act. I hope in the spirit of consensus and trying to move the arguments forward, the Minister and the House will accept that we have taken a new approach, thinking about leverage as it affects the UK economy as a whole. Leverage—and I shall come on to make this argument—is part and parcel of the way in which an economy works, and in the new clause we have looked at a particular design that would encompass other institutions. I do not want to be misinterpreted: we mention foreign banks, for example, but I do no intend any extra-territorial reference in the new clause. It simply makes it clear that the provision has to encompass effective leverage on the UK financial services sector as a whole.

I have referred to the Vickers commission, and it is important that we do not forget the work that it did, and that we pay tribute to it. It said that

“a leverage cap of thirty-three is too lax for systemically important banks, since it means that a loss of only 3% of such banks’ assets would wipe out their capital.”

The commission recommended a 25:1 ratio—a 4% ratio—but the Chancellor dismissed that concern. It is essential that the ring fence is supported by tougher capital requirements, as well as by a leverage ratio.

The parliamentary commission said that it was not convinced by the Government’s decision to reject the Vickers recommendation to limit leverage in this way. The parliamentary commission said that it

“considers it essential that the ring-fence should be supported by a higher leverage ratio, and would expect the leverage ratio to be set substantially higher than the 3 per cent minimum required under Basel III.Not to do so would reduce the effectiveness of the leverage ratio as a counter-weight to the weaknesses of risk weighting.

Sir Mervyn King, the former Governor of the Bank of England, said that the leverage ratio turned out to be

“a far better predictor of the institutions that failed in the crisis” than measures of risk-weighted assets. I could go on; a great deal of debate has taken place on this issue.

Our new clause seeks a way of ensuring clarity on the powers and what sort of process would take place. We suggest that the powers of the Financial Policy Committee in the Financial Services Act 2012 should be amended to make it clear that a target should be set by the Treasury for the overall leverage of the United Kingdom’s financial system to encompass all the activities of those institutions that are originators of credit.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

May I unpick what the hon. Gentleman is saying? Does he mean a minimum leverage ratio or a target? There is a difference. Perhaps he could clarify that.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

That is a very good question and I am open to debate on that. I believe that looking at that minimum leverage ratio as a target to be set for the leverage of the system as a whole in the UK would be the point of public policy, which is why it needs to be dealt with in a policy-making context by the Treasury, with reference to Parliament if need be. The key point is that it should then be for the regulators to look at the detailed implementation of that on a firm-by-firm basis.

Essentially, there is a parallel to be drawn between the way that the Chancellor of the Exchequer sets an inflation target for the Bank of England and the Monetary Policy Committee is given operational independence to find ways of meeting that target. The purpose of the debate today is to look at the potential parallel to be drawn there, with a target being set and operational independence for the implementation of that target being given to the Financial Policy Committee and the Bank of England. Over every three-month period the FPC should respond by notifying any changes and any actions that it has taken in order to regulate leverage, so that there is a dialogue and a process that is fairly self-explanatory.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

The hon. Gentleman is being very generous in giving way, but I want to be clear about his proposition. A target would imply that a bank that was just 10 times leverage would have to raise its leverage ratio to 25 times if it was a 4% target, whereas if it was a 4% minimum leverage ratio, that would be totally different. The bank that leveraged 10 times would not be in breach of that.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I understand the hon. Gentleman’s point. Let me be clear. The target that should be set would be for the financial system as a whole. It would be for the regulators to make judgments about firm-by-firm leverage arrangements, so it would be on a more sophisticated basis. There is a case to be made for a regulator to look at each individual institution. Some institutions are significantly different from one another. Some of the building societies, for example, have recently been making the point that they have different asset structures and so on, and that exactly the same leverage arrangement across the board for all firms simultaneously would not necessarily be appropriate. In an effort to work towards some way of dealing with the issue, this design is one that I have suggested.

Photo of John Redwood John Redwood Conservative, Wokingham

In the proposal, the hon. Gentleman suggests that the committee has to take into account

“adequate credit availability and growth in the economy” and report to the Treasury. Would the Chancellor and the Treasury have any right of veto or influence over that, or would they have to put up with the Bank’s judgment of what is adequate credit growth? That could be rather important if the problem were one of insufficient growth in the economy.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

That raises the question of the operation of the inflation target. If I draw a parallel between a leverage target and an inflation target, clearly the Chancellor has been setting out his inflation target. It has been missed on a number of occasions—quite a few months and quarters have gone by—so the interplay between the Chancellor and the Bank of England is critical here. I am more than happy to come back to the issue. My point in the new clause today is that we need to start seriously discussing how, from a UK perspective, we are going to deal with the issue of leverage from a home-grown point of view, rather than waiting for the European Union to come along with a set of arrangements which may or may not fit our circumstances.

Photo of Jacob Rees-Mogg Jacob Rees-Mogg Conservative, North East Somerset

There are two points that occur on the hon. Gentleman’s target weighting. One is that it is very arbitrary. If the regulator could set it for each individual bank, that would give a very strong arbitrary power to the bank to meet that overall target. The second is that although people say that their assets are particularly good ones and better than others, that is exactly what they said in the crisis and it turned out not to be reliable.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I agree with the hon. Gentleman, but it would be invidious for us as politicians to try to delve into the specific analysis of bank-by-bank asset or liability, quality and the risk weighting of assets. That is why we have regulators and what their job should be, but it is important that as a body politic, so to speak, we make a judgment about the level of leverage that we should have in the economy as a whole. That is why I raise the issue today.

For us, tackling the leverage question is incredibly important. We should not wait for the European Union to decide these things for us. We sought in Committee to clarify this in part. Rather than put it in the “too difficult to handle” box, as the Government seem to be doing, we should try to move forward constructively. The approach that we have taken is on the amendment paper. First, it is necessary to prevent the banks from over-extending themselves beyond the point of safety.

Ring-fencing does not do that. We think ring-fencing changes should go alongside capital requirements and leverage regulation.

Secondly, we have been hearing arguments recently about the leverage ratio as anathema to bank lending into the real economy. Sometimes it is characterised as one or the other. I do not necessarily agree that there is a seesaw trade-off between the two. Andrew Bailey at the Prudential Regulation Authority has recently made the particularly pertinent argument that capital can be lent onwards in any case, so it should not be a case of one or the other.

For the sake of clarity, in new clause 9 we looked to address this explicitly by framing a leverage target strategy for the system as a whole, which must be constructed in such a manner so as to maintain adequate credit availability to support a growing economy. It is important to recognise that we will always operate with a degree of leverage. That is part and parcel of the way our banking system works, and our constituents rightly want us to focus on getting the economy moving, while preventing excessive risk-taking. In the spirit of constructive engagement, we hope the amendment strikes the right balance.

It is sometimes argued that leverage should be a back-stop rather than a front stop. The argument about what is a back-stop and what is a front-stop can get rather theological. Andy Haldane makes the point in his famous “The Dog and the Frisbee” speech that leverage needs to be brought much further forward as a primary tool for the regulators, and that other capital and risk-weighting issues should be subordinated. The main point is that leverage should be recognised as a key dynamic in our economy and needs to be regulated in a way not dissimilar to the regulation of inflation.

For us, there are three essential elements: set a leverage target for the system as a whole, which is a task for the Government; measure that risk—the threats to whether loans are going to be repaid—more accurately by sector, to determine which sector needs more capital to make it safe if leverage is rising and which could dealt with in a normal way; stress-test to back-test the pressures in those particular institutions to be clear that the choice of the leverage target is correct. The regulator should do that.

New clause 9 would also augment Bank of England independence in relation to operational decisions on monetary policy and take into account the need to supply credit to the wider economy. I am glad that the Building Societies Association and others support it.

I know that other Members wish to speak and so will not take much more time. It is not good enough for the Government simply to leave this out of the Bill completely, to leave the regulators slightly powerless on this point and to leave the EU to deal with it. There are ways of overcoming the impact that leverage questions might have on non-plc institutions, such as those building societies, and having the regulator make those operational judgments is one of them, but we must have the safeguard in place. We must also eradicate once and for all the concept of a bank being “too big to fail.” I think that action on leverage would certainly be one way of doing that.

Photo of John Redwood John Redwood Conservative, Wokingham 7:30 pm, 8th July 2013

I remind the House that I provide investment advice on world markets and world economies, but I am pleased to say that it has nothing to do with banking credit or banking leverage, so I feel quite entitled to comment in this important debate.

I welcome what I hope is a probing new clause from the Opposition. It allows us to discuss something that is at the heart of what regulators need to do to have a strong banking sector and economy and to have the comfort at night of knowing that we will not live through another dreadful crisis like the credit crunch of the previous decade. The new clause goes to the heart of the issue: what action should the Government and regulators take to try to ensure that large banks and other institutions advancing credit that can be a risk to the whole system are kept under sensible control, so that we can be pretty confident that, if something goes wrong or the world economy dips, they have the necessary money to pay the bills and deal with any losses that might arise?

If we look at the tragic history of the previous decade, we can see that the then banking regulator in the United Kingdom—I think that it has now admitted this—got it wrong both ways. It wanted the banks to have too little capital, cash and protection, and in the run-up to the credit crisis in 2008 it allowed the most enormous expansion of leverage, which previous generations of regulators had not permitted. Then, in the ensuing panic, when interest rates had to rise to tackle the problem of inflation, it lurched to wanting very high amounts of capital, but at the time the banks could not generate profit and so found that very difficult. That resulted in the previous Government’s decision, in two of the worst cases, that capital should be forthcoming from the state and taxpayers themselves. I think that we all agree that we do not want to go back around that course or to get to the position again where some Members of this House feel that the only option is for the state to provide taxpayer support for organisations that have been too leveraged.

New clause 9 suggests that it is possible to set a leverage ratio for the system as a whole, and it might be, and that might be desirable, and I look forward to the Minister’s response. Of course, the regulator already does that in a way because it sets individual target ratios or capital requirements for all the major banks in the system, so if we aggregate those we get to its view of the aggregate amount of leverage. As Chris Leslie has rightly said, if that overall leverage were to be set for the system as a whole, the regulator would still need to interpret that bank by bank. Some banks would be super-prudent and some would be straining at the other end of the spectrum and might be under special measures with the regulator to try to get their balance sheets into shape.

My particular worry at the moment is that it is never easy managing the transition. We would all be delighted to wake up tomorrow and discover that all the banks are super-safe, but if the price of getting to that stage too quickly is no growth in the economy or, worse still, the onset of another recession because the banks cannot finance the recovery, that would be a bad idea. Many of us would like to see the banks get to better ratios by writing more profitable business and generating more legitimate and sensible levels of profit, rather than having the regulator run the risk of moving too quickly to demand that they have much better ratios. The banks would then have to achieve those better ratios by not writing any new business and by trying to get old loans back ever more quickly from businesses that might find it difficult to repay them. Some of those banks, not being very profitable, could not trade themselves out of the difficulties that they found themselves in.

We also need to be conscious of what is happening globally, because although we should not chase the rest of the world if it has a group of regulators that are being far too generous and wish to re-enact the boom-type crisis of the previous decade—I do not think that we are in that position any more; I think that the regulators of the world are all generally trying to be more cautious—we need to ensure that we do not do anything in Britain that is particularly penal. What we need in order to have a prosperous economy is banks with sufficient profit, reserves and capital to be able to finance a normal recovery. It is very unpopular in this country to speak up for banks making profits at the moment, or indeed at any time, but it is important that they generate reasonable working profits, because that is the best way to make them more solvent.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

Is my right hon. Friend as unconvinced as I am by the relatively arbitrary figure of 4% being preferable to 3% for the leverage ratio? Like him, I believe that, if there is going to be any tightening on capital adequacy or leverage, it should be done when the recovery is more surely under way, and 3% is preferable to the 4% recommended by the Vickers commission and the parliamentary commission.

Photo of John Redwood John Redwood Conservative, Wokingham

I think that I agree with my hon. Friend. What I am suggesting is that I would like to get closer to 4% and further away from 3% by growth, and I think that that could be inferred in Labour’s new clause, because I noticed that the hon. Member for Nottingham East wisely did not pledge himself firmly to 4%. Although he might secretly want 4%, like the rest of us he is probably wise enough to know that, although it might be nice to have 4% in due course, to lurch straight to a target that some big banks could not meet might be very damaging to the economy.

Photo of Neil Parish Neil Parish Conservative, Tiverton and Honiton

One of the problems at the moment, as I know from my constituency, is that some companies are still finding it difficult to get money from banks, so the higher the leverage requirement, the more the banks will say that they have to keep the capital and cannot lend it. I agree with my right hon. Friend entirely that we have to be very careful about how we move from 3% to 4%, because otherwise it is companies and growth that will suffer.

Photo of John Redwood John Redwood Conservative, Wokingham

I think that we have wonderful agreement across the Chamber on this, which might hearten the Minister. We would be happier with 4% than with 3% in general terms, but we do not want to get there too quickly if that means a further jolt to expectations and confidence and further actions by banks to pull back loans, rather than financing the recovery that we clearly need from them.

Photo of Andrew Love Andrew Love Labour, Edmonton

One of the banking commission’s recommendations was that that should be devolved to the regulator to decide and that we should not set a target or a figure. The Government seem to be resisting that, and for the reasons that have been outlined in relation to growth and living standards. What does the right hon. Gentleman think about the proposal to give that to the regulator earlier than the Government suggest?

Photo of John Redwood John Redwood Conservative, Wokingham

I think that a Government have to take responsibility for the big calls on economic policy. They can take very good advice from independent regulators and the Bank of England, and sensible Chancellors take good advice, but ultimately it is the Chancellor of the Exchequer and the Prime Minister of the day who have their names on all that, and the electorate will expect them to be responsible. I think that people believe in independent central banks and independent regulators up to the point where they get it wrong, and then they look to politicians to take the blame. We have just been through a period when the banking regulator, by its own admission, got it very visibly wrong.

Photo of Andrew Love Andrew Love Labour, Edmonton

The Government are suggesting that the regulators will get it wrong in 2018, and the commissions say that they will get it wrong a little sooner. Is this not an argument about timing and when the economy will be out of its current difficulties?

Photo of John Redwood John Redwood Conservative, Wokingham

It is important that we should have proper discussion and informed debate, taking the best advice, so that we can try to get things right for a change. We owe it to all our electors and the economy generally to try to get the matter right.

Time is not generous, so I will be brief. My worry is that, under the previous Labour Government and in the early days of the coalition, we were running a strange policy in which, on the one hand, the Bank of England was trying to depress the vehicle’s accelerator by creating a lot of extra money and saying, “We really need to get some of this money out there to do some good in the economy.” On the other hand, the banking regulator was depressing the vehicle’s brake, saying, “No, you can’t possibly spend that money to create more credit and do more things. The priority is for the banks to sit on the money to have better cash and capital ratios. They probably need to wind down their loan books, which we think are too big.” My observation is that if we try to drive a vehicle with one foot on the accelerator and one on the brake, the brake normally wins.

Photo of David Ruffley David Ruffley Conservative, Bury St Edmunds

As has been mentioned already, some in the Bank, including Sir Mervyn King, argued that insufficient lending is a consequence of insufficient capital. I put that to Mr Bailey a few days ago in the Treasury Committee. I asked him about the net new lending level now compared with when funding for lending began last August, and he said that it was flat. Is that not evidence for his proposition that we cannot have tighter adequacy requirements on capital and lots more new lending? The figures show that lending is flat.

Photo of John Redwood John Redwood Conservative, Wokingham

Indeed. That point also shows that we need banks to be profitable—particularly RBS, which is still largely state owned. Until the bank is making profits, its capital ratios will not improve quickly enough and it will then not be in a position to lend the money that the Government would like it to. The taxpayer would be grateful if it could be more profitable, because our shares would be worth more, which would be in the general interest.

I conclude by making the same point to the Minister. Yes, I want us to get to stronger banks with tighter ratios, but I want us to get there through growth and growth in bank profits—particularly for HBOS and RBS, in which we have a large state stake and whose results have been disappointing for a number of years. If we can get to that happy position, we can have a bit of growth and some more profitability and then the regulator will have to have a sensible conversation with the banks; it will say that some of the money has to be put into cash and capital so that they are stronger. We will be the better for that.

Photo of Pat McFadden Pat McFadden Labour, Wolverhampton South East

I will not detain the Chamber for long; I just want to make a few points.

The argument is really about complexity versus simplicity in how banks are regulated. One of the points that my hon. Friend Chris Leslie is trying to bring out is the inadequacy of the over-complex Basel regulations, which have allowed banks to game the system and say they had hugely different capital ratios on similar classes of assets in different institutions. The truth is that the Basel system is so complex that it does not give confidence about the safety of our banks. That is why this debate about leverage is so important.

In all the debate about ring-fencing, separation and so on, what has perhaps been under-discussed is the fact that not enough attention has been paid to leverage—a basic measure of banks’ safety or resilience against future risks and very important in respect of banks’ ability to absorb losses. One of the features consistently pointed out, both to the Treasury Committee and the Parliamentary Commission on Banking Standards, was that in the run-up to the crisis banks were hugely over-leveraged. That meant that their capacity to absorb and deal with problems when they came was minimal.

Our banks still have very high gearing today. The banks lobby hard on the issue. I counsel caution on the basic trade-off that has been raised about lending and leverage. There are other ways for banks to improve their capital ratios than simply by reducing lending. They could, for example, look at the proportion that they give out in remuneration every year; that could make a difference to their capital ratios. Over the past decade or two, vast amounts of money have been paid out in remuneration that could have improved capital ratios without having any effect at all on lending. Let us not fall for the argument that we can either have banks that lend, or safe banks, but we cannot have both. It would be wrong of us to fall into that false dichotomy. We should aim for banks that are both safe and have the ability to lend.

There is also the international dimension. Part of the rationale for the Government’s current position on the 3% leverage ratio—or a leverage ratio of 33:1, if we want to put it that way—is that it is part of the new Basel regime. However, we have a particular issue in the UK. We are a global—some would say the main global—financial centre, but in a medium-sized economy. That gives us many great strengths, to which the hon. Member for Wyre Forest (Mark Garnier) alluded in the earlier debate. There are the associated services of law, consultancy and the rest of it. That is true. Those provide good employment and tax revenue and make Britain an attractive place to do business. However, we must not be so blinded by that that we do not take the necessary measures to insulate the rest of our economy from the risks.

We know that those risks are real, because we are still living with the consequences of them following the crisis. The leverage ratio is absolutely at the heart of that, so there is an important British reason why we should think twice about simply going along with minimum international requirements.

It is incumbent on us as policy makers in this House, and on regulators who have responsibility for the issue, to look at Britain’s specific circumstances as a global financial centre with a medium-sized economy, so that we keep the strengths that that entails without the rest of the economy, taxpayers or the Government being held to ransom.

Photo of Greg Clark Greg Clark The Financial Secretary to the Treasury 7:45 pm, 8th July 2013

It is a pleasure to respond to this important debate. First, I should like to correct a grievous omission in my previous remarks. During my paean of praise to the members of the parliamentary commission, I neglected to include my hon. Friend Mark Garnier, who was behind me and therefore was invisible to me. He has been in the Chamber throughout this debate and his contribution is no less sterling and distinguished than those of the other parliamentary commission members whom I did mention. I apologise.

The new clause requires the Treasury to set a leverage target for the

“overall leverage of the…financial system”.

I welcome what I think is the spirit of the new clause. Problems with risk weights clearly contributed to the financial crisis; Mr McFadden made that point. Those problems must be addressed if risk weights are to have a place in the regulatory regime of the future.

I also share the concerns raised by the parliamentary commission about the importance of having a robust minimum leverage ratio required by the regulator. As my right hon. Friend Mr Redwood said, there is clearly support among Members on both sides of the House for that notion. We have consistently argued for a binding minimum leverage ratio to be implemented internationally, to supplement the risk-weighting requirements.

As has been said, the Basel III standard of 3% will come into force in 2018, following an observation period beforehand and a final calibration of the leverage ratio in 2017. Of course, national supervisors must be equipped to respond to new risks as they emerge in banks and financial markets. The PRA, in this country, is empowered to ensure that banks’ risk models are appropriately conservative and, where necessary, to set higher capital requirements.

As every hon. Member will be aware, the PRA has recently announced that major UK banks need to set out and implement plans to improve their leverage ratios and so to migrate further towards the new Basel III standard even now. The FPC has already been given a number of directive powers, including a counter-cyclical capital buffer and the power to set time-varying sectoral capital requirements. The Government have also made clear their intention to give the FPC the power to vary through time the baseline leverage ratio requirement, always subject to its never being below the requirement determined by Basel III.

Let me address the new clause, in whose support Chris Leslie spoke. The first thing to say is that it requires the Treasury to give the Bank of England a target for the overall leverage of the UK’s financial system; I think I understand the hon. Gentleman correctly when I see an allusion to the inflation target perhaps given to the Bank of England. I have to say, though, that that pulls in the opposite direction to the parliamentary commission’s recommendation, which calls for the FPC—in other words, the Bank of England—to be given the power to determine leverage ratios. In its first and final reports, it noted that

“the leverage ratio is a complex and technical decision best made by the regulator and it certainly should not be made by politicians.”

The new clause cuts across the views of the parliamentary commission, if delivering that recommendation were its intention.

Moreover, the new clause would require a target for the overall leverage of the UK’s financial system. Again, this is not quite the right approach. Banks should certainly be subject to individual leverage requirements to ensure that they have sufficient capital to absorb losses, but an average leverage ratio for the entire financial sector could serve to conceal the risks in particular institutions. It would seem perverse to require the Treasury to set a target for overall leverage and so create an onus on the FPC to allow some banks to remain highly leveraged as long as this is offset by smaller or more conservative institutions running with less leverage. A system-wide average, or net, leverage ratio might be of little value in tackling excesses of leverage, and it could be positively counter-productive.

Another feature of the new clause would be dangerous. The proposal for a target requires the FPC to pursue action to meet the target. It is suggested that the FPC take action to increase leverage in the system when it is less than the target level that the Government are required to set. I am not clear how or why the FPC would want to do that. The target approach seems to me to be wrong. Financial stability is not like price stability; it cannot be boiled down to a single, symmetrical target. As a recent Bank of England paper concluded:

“No single set of indicators can ever provide a perfect guide to systemic risks, or to the appropriate policy responses…Judgement will, therefore, play a material role in all FPC decisions and policy will not be mechanically tied to any specific set of indicators.”

We need to apply caution in any consideration of enshrining in law a system that focuses on one target for systematic financial stability. Goodhart’s law is relevant in these circumstances:

“When a measure becomes a target, it ceases to be a good measure.”

I therefore hope that on reflection the hon. Gentleman will withdraw his new clause.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I am grateful for the quality of the debate that has taken place in the short time we have had.

I am glad that we tabled this new clause on leverage, because otherwise we would not have had the opportunity to start to focus on the issue. I understand what Mr Redwood said about getting the balance right and the care and caution that is needed as we move towards what we want, which is a better, safer level of leverage within the overall system. It is worth reiterating that we want to do this only to make sure that banks do not over-extend themselves and become so lopsided that when they topple over they are not able to absorb the losses should things take a turn for the worse.

I am particularly grateful for the contribution by my right hon. Friend Mr McFadden, who rightly pointed out that saying that we need action either on leverage or on getting lending going into the real economy does not represent alternative poles of the argument. It is not as clear as that. Some are arguing not only that the extra capital could be lent out but, as he said, that compensation ratios, as they are sometimes known—the remuneration levels within banks—could also be tackled. Given that we are the major financial centre worldwide, we should not just be leaving this to international regulators. We certainly should not be leaving it to the European Union completely to decide these things for us. We have a duty in the UK to make sure that we think these things through properly and spend much more time on them.

Photo of Mark Garnier Mark Garnier Conservative, Wyre Forest

The hon. Gentleman proposes that the individual leverage ratios of the banks be published, but if that information were in the public domain it could have implications for a bank’s funding costs. If the regulator deems that a particular institution has a greater risk, and therefore looks at a lower leverage, that will clearly have implications for the business.

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

I would tend to err on the side of publication and transparency. It is long overdue that we have better insight into banks’ balance sheets and the quality of their assets generally.

If we are to have this architecture, it could be a useful dynamic to have a leverage target set by policy makers—by Government. I slightly take issue with the parliamentary commission on this. There is a systemic aspect that ought to rest in the hands of politicians. Ultimately, the buck stops with us and Parliament is sovereign; the arguments about that are well known. However, as the commission said, the operational decisions taken institution by institution have to be left to the regulator. It would be invidious for that to be in the hands of the Treasury.

Photo of John Redwood John Redwood Conservative, Wokingham

RBS, against the wishes of some of us, had been allowed to grow to a colossal size and to gear excessively. At the point when it got into trouble, it had a balance sheet of £2.2 trillion —almost four times the tax revenue of the state—and if it lost 2% of its asset value it lost the equivalent of the defence budget for a whole year. Is not that of interest to those conducting government?

Photo of Chris Leslie Chris Leslie Shadow Minister (Treasury)

There is a rare consensus across the Chamber in some respects. We have to agree that the UK economy, whether it is mid-sized or not, is potentially adversely affected by our vast financial sector.

I offered new clause 9 in the spirit of consensus to try to get some engagement from the Government. I am disappointed by the Minister’s attitude of saying, “We’ll just leave this and do it internationally. We’ll come to it in 2018 through the normal conveyor belt on when these things happen.” The Government must address this issue far more constructively and engage with it far more seriously, because it really does matter. We need action on leverage and it is important that we put on record the essential characteristics that it could and should have within our economy as a whole. I am afraid that I therefore wish to test the view of the House.

Question put, That the clause be read a Second time.

The House divided:

Ayes 211, Noes 271.

Division number 47 Communities and Local Government — New Clause 9 — Leverage ratio

Aye: 211 MPs

No: 271 MPs

Ayes: A-Z by last name

Tellers

Nos: A-Z by last name

Tellers

Question accordingly negatived.