Motion to Take Note

Financial Regulation: EUC Report – in the House of Lords at 7:33 pm on 10 November 2009.

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Moved By Baroness Cohen of Pimlico

That this House takes note of the Report of the European Union Committee on The future of EU financial regulation and supervision (14th Report, HL Paper 106).

Photo of Baroness Cohen of Pimlico Baroness Cohen of Pimlico Labour 7:35, 10 November 2009

My Lords, in opening this debate, I need to thank several people for their help in a long and difficult inquiry in which we took a huge amount of evidence. My thanks and those of the committee are due to our special adviser, Professor Rosa Lastra, without whom I do not think we would have found our way through the complications of the subject, and, as always, to the committee clerk, Rob Whiteway, and our specialist adviser, Laura Bonacorsi-Macleod. We share Laura with another sub-committee but she manages to juggle both of us.

In the particular circumstances of this report I also owe a personal debt of gratitude to my friend and colleague, the noble Lord, Lord Woolmer, who had to oversee and supervise the writing of the report while I lay palely in hospital earlier this year. Little did he know when he sought a place on this committee what it might entail, but I and the committee are truly grateful to him.

I have another and sad acknowledgement to make. Lord Steinberg, a valued member of this committee who made a substantial contribution to this report, died suddenly last week, and is much missed by us all. He was a good man and a good colleague.

In discussing or writing about the complex subject of financial regulation, the committee used the following definitions of supervision and regulation. We took regulation to be the actual rules that are written down and supervision as the application of those rules to a particular firm and making sure that it follows those rules. We have stuck to this throughout.

I will begin with regulation. At the time of the publication of the report in June, the European Commission had brought forward four proposals for the reform of the regulatory system. One was on capital requirements, another on deposit guarantee schemes, a third on the regulation of credit rating agencies and a fourth on the regulation of alternative investment fund managers. The first three of these proposals has been firmed up into European Union law. As Sub-Committee A is in the middle of a detailed inquiry on the fourth, alternative investment, I will not comment on that matter today.

The proposal on deposit guarantee schemes—which, as I am sure all will remember, guarantee bank deposits of up to €50,000, which rises to €100,000 by December 2011—was greeted with general acclaim. The amendments to the capital requirements directive were generally well received by our witnesses, but the directive on credit rating agencies was less so. In general, we identified a need for the Commission to abide by better regulation principles when drafting legislation. Thorough consultation of affected parties must be conducted on all the proposals and rapid action in response to the crisis must not come at the expense of poorly drafted regulation. We urge the Commission, where necessary, to conduct reviews of emergency legislation to ensure its effectiveness.

Further, we found that it was crucial to ensure that all regulation in the European Union was in touch with the global approach. If it was not, it risked damaging the competitiveness of European Union financial institutions. However, we did, and do, welcome the appetite in the European Union for reform of financial regulation, which the crisis proved was so badly needed. Carefully drafted regulations at European Union level can help reduce the level of systemic risk in the financial system and therefore help to prevent future crises. We said at the time that we would welcome more overt countercyclical regulatory measures, both through amendments to the capital requirements directive and the Basel rules.

Subsequent to the publication of our report, the Commission has published further revisions of the capital requirements directive, as well as proposals for the regulation of derivatives markets. We are considering all these items in detail as part of our scrutiny process. After we have completed the enquiry on which we are currently engaged, on alternative investment, we expect to undertake an enquiry on the Commission's proposals to regulate derivatives, which clearly played a huge part in the crisis.

The committee's examination of supervisory reform focused on the report of Jacques de Larosière on the reform of financial supervision within the European Union. His report proposed a more unified system of financial supervision within the European Union, consisting of two main components: a body to examine macro-prudential risk at an EU level and recommend actions to reduce this systemic risk; and a system of European supervisory bodies to co-ordinate national financial supervisors in the task of micro-prudential supervision.

As the implications of the financial crisis became clear, it was recognised that supervisors in the United Kingdom, the European Union and globally had failed to identify the impending meltdown and had failed to take preventive action. Not only did the crisis, very naturally, provoke a flurry of activity to strengthen regulation and supervision of financial services within the European Union, but it has perhaps been inevitable that colleagues in the European Union have tended to lay the blame principally at the doors of US and UK supervisors, Governments and bankers—rather tending to ignore the contribution of their own major banks, which are making the same mistakes and plunging into buying the same derivative products that have become utterly removed from any connection with the underlying assets.

There is a good deal of truth in the perception that it was the Anglo-Saxon capitalist model, carried to extremes, which brought the crisis on all of us. It is for this reason that it has been and remains difficult to make the case for financial innovation and freedom that has enabled world GDP and world trade to grow so substantially since the Second World War. Yet the case must be made. Innovation must not be stifled, or the whole of Europe will turn into a fortress and become markedly less competitive with the rest of the world.

We looked at everything we did against this background and against some considerable opposition and resistance from European colleagues. We supported the institution of a European Union body to assess macro-prudential risks as a welcome step to looking to prevent a future crisis. However, we noted that in order for such a body to reduce systemic risk, there must be structures in place to strengthen the likelihood of macro-prudential risk warnings leading to action from the supervisor at a member-state level.

On the structure of micro-prudential systems, we examined in detail the role of the current Lamfalussy level 3 committees. We agree with Mr de Larosière that, if reformed, they could play an effective role in the co-ordination of supervision at an EU level, linking colleges of supervisors for individual banking institutions, the macro-prudential body and national supervisors. A body playing this role would help link together all supervision within the EU and provide better protection against systemic risk, through information sharing and co-ordinated action.

However, we recognised that while national Governments continue to bail out banks at an EU level, it will be difficult, if not impossible, to provide any micro-prudential body with actual powers of supervision. This was the point made by the FSA, that he who pays the piper inevitably has to call the tune. We also recognise that such a body would have to be instituted within the current European treaty, as there is currently little appetite for further treaty reform beyond Lisbon.

Subsequent to our report, the Commission has published both a communication, in July, and then legislative proposals, in September, based on the communication, to implement the recommendations of the de Larosière report. To summarise the proposals: a European systemic risk board will be constituted to assess macro-prudential systemic risk across the EU; and three new European supervisory authorities will co-ordinate national supervision, implementing a single European rulebook through decisions that will be approved by the Commission. These three new European supervisory authorities cover not only banking but also insurance and pensions, thereby closing, it is hoped, all the gaps through which systemic risk in the financial system might appear.

Not three hours ago, my noble friend the Minister discussed with my committee the different roles of these bodies and the powers that they will have. It is early days, but much is hoped of them. There remains a persistent concern about whether the European supervisory authorities will be able to impose financial conditions. In our report, we also examined the success of the Commission's state-aid policies in relation to the recapitalisation of banks. We found that the flexible, rapid and pragmatic approach of the Commission to the application of the state-aid rules had ensured that member states were allowed to support failing banks, but that risks to the single market have been minimised. However, we also thought that it was important for exit strategies to be devised for these banks to ensure that state intervention and the subsequent competition problems that this poses are kept to a minimum.

The Commission recently published its recommendations on the restructuring programmes of the Royal Bank of Scotland, Northern Rock and the Lloyds Banking Group. These, in effect, will reduce the size of all three banks and create up to three new high street banks, potentially increasing competition in the banking sector. These recommendations, agreed with the United Kingdom, show that appropriate importance has been placed on ensuring that state intervention does not inhibit competition within the banking sector. However, the taxpayer still owns significant parts of all these banks, and delivering viable exit strategies to return these banks—and other banks throughout the European Union—to private ownership must remain a crucial aim. My committee will continue to scrutinise developments in this area to ensure that in the long term this is what happens. Indeed, after we have disposed of derivatives, we will certainly consider an inquiry into state aid. It will be a busy year.

Overall, we agreed that reform of financial supervision and regulation is necessary in the wake of the crisis. As well as installing systems to reduce systemic risk within the EU financial system, greater co-operation among national supervisors will lead to a stronger single market. However, all reforms must be compatible with regulation in other major financial centres to ensure that European Union financial players are not disadvantaged by burdensome and obstructive regulations.

We therefore welcome the Commission's proposals on reform of supervision and the subsequent movement to reach general agreement in the European Council in December as the first steps towards an interconnected system of supervision within the European Union which can help to prevent a future financial crisis. However, there remain some questions which have to be answered. My noble friend Lord Myners has been generous with his time at all stages of our inquiry and has answered all the questions that we have asked. However, I wish formally to put a few questions which I should like him to answer at the end of this debate.

Can my noble friend comment on the rapid speed of reforms at EU level and, in particular, is he happy that better regulation principles have been followed in the drafting of the legislation? Specifically, does he agree with the committee's recommendation that there should be explicit countercyclical provisions within the Basel rules and the capital requirements directive? How are the Government working to ensure that exit strategies are produced for banks that have been recapitalised—again—with taxpayers' money? Within what timeframe does the Minister envisage for the return of these banks to private ownership? Most vitally, given that decisions in the new European supervisory authorities are to be made by qualified majority voting, are these authorities able to force the adoption by the UK regulatory authorities of decisions which our own regulatory authorities voted against? Does he believe that the safeguards in Article 23 provide sufficient assurance that these authorities will not be able to impinge on the United Kingdom's fiscal autonomy? I beg to move.

Photo of Lord MacGregor of Pulham Market Lord MacGregor of Pulham Market Conservative 7:49, 10 November 2009

My Lords, the noble Lord, Lord Vallance, the chairman of the Economic Affairs Committee, cannot be here this evening and sends his apologies. It falls to me, therefore, to introduce our report. I begin by paying tribute to our chairman, who steered us with skill and patience through much evidence, many sessions and a highly complex and topical subject. The Economic Affairs Committee has a broad remit and normally enjoys a wide choice of topics for its inquiries, but in the autumn of 2008 the banking crisis chose itself. We were not, of course, the only parliamentary Select Committee in the field, as is shown by this joint debate tonight. The topic has also been a high-profile focus in the other place.

We did not address directly the Government's action to recapitalise banks and stabilise the banking system. We selected instead banking supervision and regulation as an important area where the committee could bring its knowledge and expertise to bear. The inquiry was launched in December 2008 and the report was published in June this year. We are most grateful to all those who gave evidence, to our committee clerk and staff and especially to our specialist adviser on this occasion, Professor Alan Morrison of the University of Oxford, for his invaluable contribution.

Much has been said, written and analysed about the causes of the crisis and I do not have the time to go over that ground in any detail tonight. With the benefit of hindsight, we can see that the scene for the banking crisis was set by a long period of cheap money, plentiful credit and asset inflation in major western economies and by the explosive growth in debt securitisation and derivative trading. At the same time, the risks of new financial instruments were clearly not well understood. Perhaps, as in previous bubbles, the main players thought that the good times would keep on rolling and failed to see the danger until too late. It is fair to say that the ability of the authorities to respond was constrained because markets are now global, while supervision and regulation remain mainly national, as the noble Baroness pointed out. It is clear that in Britain, as in other countries, the system of regulation failed in its key role to prevent crises or to mitigate their effect.

In our committee, we tried to focus on drawing the right lessons. In particular, we looked at how the regulatory system worked before and during the crisis and at the policy responses that followed. We urged the Government to take the care and time necessary to get the changes right, including, of course, taking account of the vital European and international dimension. However, we welcomed the Government's swift introduction of the Banking Act 2009 and its special resolution regime, which puts in place new insolvency procedures for banks.

The Government produced a lengthy response to our report, for which we are grateful. We made a large number of recommendations over many issues; I can touch on only some of them tonight. I shall list briefly the areas of agreement between us and then focus on a few other matters of importance. My noble friend Lord Forsyth of Drumlean may want to raise others.

On the points of agreement, the Government and our committee both called for better macro-prudential supervision. We both favoured countercyclical measures, setting capital aside in the boom periods to see the banks through the downturns. We called for pre-funding of the Financial Services Compensation Scheme. The Government aim to introduce partial pre-funding, but not before 2012. They accept our observation that pre-funding would have a countercyclical effect. We both agreed that regulation of liquidity should be strengthened, that international macro-prudential supervision should be encouraged, that the Financial Stability Board announced in the G20 communiqué must be sufficiently independent and resourced and that changes in the EU must be aligned with global measures.

I turn to a select few of the issues on which I believe the debate is still open. Time prevents me from dealing with them all—for example, on bank bonuses, I am as incensed as anyone at the rewards for failure and bonuses for immediate returns irrespective of the risks and losses that ensue. There are many important conclusions and recommendations that I have had to leave out, but I turn, first, to the disagreement between the Government and us as to how macro-prudential and micro-prudential supervision should be undertaken in the future. We spent a considerable time discussing the tripartite system; it was perhaps the area to which, in the end, we gave the most thought. We concluded:

"Without a clear executive role, the Bank"— the Bank of England—

"can do no more than talk about financial stability".

We also concluded:

"A clear lesson to be drawn from the recent financial crisis is that the current arrangements failed to recognise the natural affinity between responsibility for financial stability and for macro-prudential supervision of the banking and shadow banking sectors".

We therefore believed that responsibility for macro-prudential supervision and systemic risk should be given to the Bank of England, which already has macroeconomic expertise. There would be senior representatives from the FSA and the Treasury on that committee. We urged the Government to carefully consider the case for and against giving more micro-prudential supervision to the Bank of England as well. The Government took a different view. I note, however, that it is now official Conservative policy to abolish the FSA—macro-prudential and micro-prudential supervision would switch to the Bank and there would be a new financial policy committee at the Bank including independent members—and to establish a new consumer protection agency, combining the consumer protection functions of the FSA and the OFT.

Without straying into controversial debate tonight—it is my task to report fairly the whole committee's conclusions—and without commenting on the possible outcome of next year's election, I simply observe that there are arguments on both sides of this issue. The present Government's decisions may well not be the end of the matter; they are not set in stone. If there are to be further reconsiderations after the general election, I believe that the discussion in our report will be worth revisiting and taking into account in future deliberations and decisions.

Secondly, we argued that contributions to the Financial Services Compensation Scheme should be at least broadly related to the riskiness of the business in which regulated firms engage. There are some similarities here with the way in which the Pension Protection Fund levy is calculated. There were also particular issues in this connection relating to building societies. The Government rejected this proposal and I would be interested to hear the Minister's response as to why they did so.

Thirdly, we took considerable evidence about the role of credit rating agencies, on whose ratings so many banking decisions relied. This is a complex area, which I personally believe has been much underrated in all the post-mortems on the crisis. There are conflicts-of-interest issues. There is a loss of market confidence in the skills and abilities of the rating agencies. We put forward two tentative recommendations. The Government did not take up one of them, which was to require agencies to make a modest investment in the assets that they assess, and I understand why. We were seeking to strengthen the constraints in the regulation of credit rating agencies. However, the fact that changes are required is in my view indisputable. I welcome the steps that have been taken by G20 leaders and in the EU for a new regulatory regime and greater transparency for these agencies. I note with interest that both points—on regulation and on transparency—were commented on in the European Union Committee's report, in paragraphs 56 and 57. I also note its support for removing the reliance on ratings for regulatory purposes, in conjunction with similar changes to the Basel rules.

Fourthly, on corporate governance, we received much criticism of the role of the non-executives on bank boards. I declare former interests as a non-executive in a number of companies, including one financial institution, albeit not a bank. There is no doubt that big mistakes were made, but such criticisms should, in my view, even more be levelled at senior executives. Did they fully understand all the complex instruments in which they were trading and investing? Yet by and large the non-executives in the major banks were highly skilled, experienced and dedicated people who, by all accounts, devoted considerable time to their role. There has been much discussion about "too big to fail" banking institutions. Is there not an issue sometimes about "too big to manage", particularly from the point of view of part-time non-executives? We put forward several recommendations to assist in dealing with this. Since then, we have had Sir David Walker's review of corporate governance in UK banks and other financial industry entities. I hope that the House will return to this and debate his final report.

We examined the "too big to fail" issue and the possibility of a Glass-Steagall type of solution. We reached no conclusion beyond the rather vague one of,

"a unique opportunity to take stock of the financial system".

The Governor of the Bank of England, who gave evidence on the issue, said that there was a strong argument for legislation that would ensure a diversity of banking institutions. He noted that there were strong arguments both for and against separating commercial banking from the securities business. He went on to say that,

"what I would encourage everyone to do, this Committee and other committees, is to take some time now to think our way through these issues. They are immensely important, we will not get another opportunity to restructure our banking and financial system in a hurry and it is very important that we take this opportunity".

We took his advice and concluded, perhaps because we could not reach an agreed view ourselves, that there should be no rush to write the legislation required to support new structures, and that it was more important to get the details right than to resolve them quickly. The governor, to judge from recent reported remarks, may be reaching towards a solution rather faster than we are.

The report of the Economic Affairs Committee is just one contribution to the debate on the banking system that has raged in the press, boardrooms, Government, Parliament and the country since the banks were bailed out with vast sums of taxpayers' money. Cool, balanced and far-sighted judgment is needed on which of the many reforms put forward are most likely to pave the way for the restoration of a sound and dynamic banking system, which is internationally competitive and above all is able to sustain London's position in world markets.

My committee colleagues and I found this a fascinating and complex inquiry. We gained much insight and help from the many experts and participants who gave evidence that will continue to assist us as we work our way forward. There have been many developments since we published our report, and we welcome them. The severity of the banking crisis and the depth of the recession that has followed call for a thorough review of the options so that decisions on the future of the financial system can be seen to be well grounded. I hope that our report will play a small part in that.

Photo of Lord Renton of Mount Harry Lord Renton of Mount Harry Conservative 8:02, 10 November 2009

My Lords, it is a great privilege for me to follow the speeches that have just been made by the noble Baroness, Lady Cohen of Pimlico, and by my noble friend Lord MacGregor. I have served for the past two years on European Union Sub-Committee A, dealing with finance. It has been a great pleasure to serve under the noble Lord, Lord Woolmer, who acted as our chairman for the report that we are discussing tonight, and also under the chairmanship of the noble Baroness, Lady Cohen.

As my noble friend said, we have been through the worst financial and credit crisis for major banks since the 1930s, and there is no guarantee that these problems will not happen again. It is against that background that, as a member of the Committee, I looked carefully at the regulatory proposals put forward by the European Commission to see if they contained a solution. They read well, but I was not convinced that they went far enough. As the noble Lord, Lord Woolmer, knows, I was not convinced that the de Larosière report, with its college of supervisors, was going to make the changes that were needed. I did not feel that we as a Committee, and the witnesses who came before us, gave enough importance to the probable future strength of the European Central Bank. The reason for this was perhaps not just financial, but also political. It was difficult for us because we were not in the euro. Therefore it was hard to support the European Central Bank in regulating and supervising banks in the 16 euro countries in case the European Central Bank found some reason in the treaty to become more active in the United Kingdom—or in case there was a recovery in the political demand to join the euro.

I will read from paragraph 91 on page 27 of our report, headed "The ECB". It states:

"The role of the European Central Bank in both macro and micro-prudential supervision has also come under discussion. The ECB has promoted the idea that it should play a stronger role in financial supervision. M Trichet, President of the ECB, declared that the ECB 'stands ready' to take on supervision responsibilities ... The ECB has been cited by some as the best-placed organisation to hold macro-prudential supervisory responsibilities ... because of its position as the largest central bank in the EU and the possibility of this happening without Treaty amendment".

That says it all. There was a real fear among some of our witnesses that, if more power was given to the ECB, it would take over prudential and supervisory work for all banks in the European Union.

If one adds to this the national jurisdictional domain of fiscal authorities that raise taxes, one sees that there are significant obstacles to transferring supervisory responsibilities to an EU body. I felt that this was not working well. Noble Lords might look at pages 68 and 69 of our report, where I took the unusual step of suggesting amendments to the text. They will be pleased to hear that I do not propose to read out those suggestions now but I was supported by the noble Lord, Lord Moser, and we had a vote, the result of which was two for and two against. The rules state that the question should be decided in the negative unless there is a majority in favour, so we did not win. I think that our report might have been more effective if we had won, but your Lordships would expect me to say that as they were my suggestions in the first place.

The major development that has occurred since our report came out, to which the noble Baroness, Lady Cohen, referred, is the proposed European Systemic Risk Board, which was announced on 25 September this year. It is a major step forward. This body will be responsible for macro-prudential oversight for the banks, and it is interesting that the word "oversight" is being used rather than "regulation" or "supervision". It is a new word and it seems to me that those who coined the phrase are going to get away with it. As I said, it is potentially a very important step forward, and I know that the Minister, who very kindly talked to us for two hours this evening, supports the principle of the ESRB. He used a rather good phrase: he said that it will have an ability to see adverse weather ahead. Thus, if, for example, banks increased their leverage to a dangerous extent, that would be just the sort of point that the ESRB might cotton on to quickly and point to others to take action on it. So perhaps in the ESRB we will have the right economics and philosophy that are needed for financial stability. There is certainly a little more hope in this suggestion of greater stability ahead.

Finally, on a quite different subject, I turn to the Prime Minister's surprising, to my mind, public support at the G20 meeting a few days ago for a new global tax on financial transactions—that is, the Tobin tax. I regard this as a remarkable step forward. Today, the Guardian in a very interesting article mentioned that a study by the Austrian Government showed that a 0.05 per cent tax imposed on financial trades in Britain would raise about £100 billion a year. If that is so and if it were to happen, it would deal substantially with the debt problem that the banks have caused and might also provide some cash for climate change in poor countries where money is very much needed for this purpose. In any pursuit of this idea, there will of course be many problems ahead. The first is that it has to be a global tax—it cannot allow for any country to be an exception. However, I note that the IMF is waiting for a report on how the tax could be implemented. I think we all await that with very great interest.

I end with a euphoric quote from the article in today's Guardian that I have just mentioned. It says that the Prime Minister's Tobin tax,

"should be a roof-raising, banker-bashing, debt-defying, public-service-saving, rabble-rouser of a political winner".

It is not often that a new tax has those terms applied to it but one could say that, if this tax comes into effect, it will certainly change the picture.

Photo of Lord Skidelsky Lord Skidelsky Crossbench 8:12, 10 November 2009

My Lords, as a recently retired member of the Select Committee on Economic Affairs, I give a warm welcome to its report on banking supervision and regulation. I recognise in its clarity of language and cogency of argument and in the balanced nature of its recommendations the hand of the skilled drafter and expert adviser, as well as the assembled knowledge and wisdom of the committee.

This report, like others that the committee has produced, serves an important educational function: it should be required reading for all those who want to understand the origins of the banking crisis and the steps that might be taken to prevent such events in the future. However, its remit allows it to cover only part of what went wrong and what needs to be put right. Reform of the financial system has to be fitted into a larger framework of reforms covering the conduct of macroeconomic policy, the liquidation of the global imbalances between China and the United States, and, I would argue, the distribution of wealth and income in our society.

The report's discussion of the causes of financial fragility is excellent but, in my view, does not go quite far enough. The reason is that the report remains captive to what I would call the risk modelling paradigm. That is the belief, to quote from the FSA's Turner report that:

"The risk characteristics of financial markets can be inferred from mathematical analysis, delivering robust quantitative measures of trading risk".

If that were so, financial markets would never crash. The fact that they do must be due, therefore, to a failure in the transmission of information somewhere along the line. That leads inevitably to policy recommendations based on devising better methods of risk management.

It is true that the committee has doubts whether mathematical risk models can be applied in all situations. There is an important passage in paragraph 62, which rightly says that statistical models are no substitute for judgment based on analysis. In paragraph 36, the report recognises that mathematical forecasting models rely on parameters which are assumed to be fixed but are actually shifting. In paragraph 39, we are told that supervisors should actively question the assumptions underlying bank risk models. In fact, the chief assumption that needs questioning is that those models can give a robust measure of risk.

The truth is that the risk modelling paradigm makes claims far outside its proper domain. It fails to take seriously Keynes's distinction between risk and uncertainty. That is very important for all clear thinking about both the causes of the crisis and what changes in the structure of the banking system are needed. What will average house prices be in 10 years' time? Is any noble Lord willing to bet on a number? Is any other noble Lord willing to insure him against the bet being wrong? Our risk management models are constantly making the assumption that we can attach precise numbers to those contingencies.

It is for those reasons that George Soros has called for credit default swaps to be banned. The report does not go that far; it simply suggests that the credit default swap market should be made more robust. The main problem is not that those trades are opaque, but that the insurance offered was phoney, because it was not based on actuarial principles. We should not allow firms to offer insurance against uninsurable events. That is a species of fraud.

In their response to the report, the Government wanted more effective stress testing,

"which allows firms to assess the impact of more extreme events ... not captured by traditional risk management models".

However, that also presupposes the possibility of giving numbers to extreme events, and that is just not correct.

Large consequences for bank supervision and regulation follow from taking uncertainty seriously. As noble Lords will know, there is a big debate going on, which finds an echo in this report, on whether countering financial fragility requires the separation of different forms of banking along the lines of the Glass-Steagal Act of 1933, or whether it can be accomplished solely by what is called macro-prudential supervision. The risk management school naturally favours the second. It proposes increasing the buffers of capital and liquidity to guard against high-risk events. Those might include contracyclical capital ratios—the requirement that capital ratios go up in good times and down in bad times.

Of course those measures will do good, they will reduce the fragility in the system, but they are designed to leave the structure of banks untouched and to give them greater capital cover for the same set of activities, without restricting their right to engage in those activities. What is more, they assume that the size of the buffers and the timing of their variants can be measured, whereas uncertainty is unmeasurable.

For example, they assume that the regulators will be able to discover exactly at what point in the cycle they are. Does anyone really believe that? First, it presupposes the existence of the cycle. Secondly, it presupposes knowledge about the length of the cycle. Thirdly, it presupposes knowledge about where we are in the cycle. All that is supposed to be gathered in some central regulatory agency and then instructions issued to the banks on the basis of the figures. That is a completely utopian view. What is more, banks will easily be able to game such regulations. They are very clever at doing that.

Anyone who takes uncertainty seriously is bound to favour some substantial break-up of the banking system into different sectors. The logical line of division should be between commercial banks and investment banks. The noble Lord, Lord MacGregor, quite rightly said that the report states that we should think about these things seriously and not just dismiss them out of hand as being impossible to achieve in a global economy. Many arguments in the report cry out for this kind of separation. For example, conglomerate banks, which are very big banks, have become too complex to manage. Everyone wants better non-executive directors but, as was also said by the noble Lord, Lord MacGregor, the complexity of the business makes it difficult for boards to understand all its aspects. Then let us take pre-funded insurance levied on the size of contributions. That runs up against the difficulty of measuring the riskiness of different classes of loan business. There are many problems with the strategy of simply leaving the structure of the banks unchanged and making them hold more capital and liquidity. This deserves serious thought.

I shall end on this note. The City of London performs a valuable service for the economy in this country. It is also its most powerful economic lobby, and like all lobbies, it tends to rate the value of its services higher than they are worth, a point recently made by the noble Lord, Lord Turner. This is a problem of long standing. It may amuse your Lordships to realise that Keynes wondered, way back in 1913, so before the First World War,

"how long it will be found necessary to pay City men so entirely out of proportion to what other servants of society commonly receive for performing social services not less useful or difficult".

Plus ça change, plus c'est la même chose. At least a time of crisis offers the Government a chance to reform the City in the light of Winston Churchill's remark, made when he was Chancellor of the Exchequer in 1925, that he,

"would rather see finance less proud and industry more content".

Photo of Lord Trimble Lord Trimble Conservative 8:23, 10 November 2009

My Lords, I shall speak to the report of the European Union Select Committee Sub-Committee A, of which I have the pleasure to be a member. I shall not try to go into all the detail of the proposals for financial regulation and all the matters that are spun off from it: the de Larosière report and many other things. There were times when we were looking at this issue when I felt the need for a cold towel around my head in order to try to grasp what was going on, so I am going to keep clear of that detail. I intend to make four points with regard to regulation and will then comment on procedures and state aids.

My first point repeats what was said to us many times by the Government and by other witnesses. It is that regulation has to lie essentially with national regulators as they have the fiscal resources, they are the lender of last resort and only they can do a bail-out. To digress for a moment, I say to my noble friend Lord Renton, who commented on the amendments he proposed and the narrow vote that occurred, that I am very sorry to have to tell him that had I been able to attend that meeting, there would have been no need for the chairman's casting vote. He might have been disappointed by the way I would have voted.

Returning to the necessity for regulation to rest with national regulators, that is why in the Explanatory Memorandum that the Government have produced on the proposed legislation that has now come out, they say that,

"the Government will seek to ensure that no European Supervisory Authority decisions can have a fiscal impact on a Member State".

The Explanatory Memorandum continues, using language such as "seeks to ensure" and,

"some improvements to the fiscal safeguard", but that does not sound as though it emanates from someone drawing a firm red line.

As the legislation stands today, the European Supervisory Authorities could take a decision that impinges on our fiscal authority. As mentioned, we took evidence from the noble Lord, Lord Myners, earlier today, and were told that the Government are not content with this situation and continue to argue against that possibility. However, this matter will be determined by qualified majority voting, and I did not get the sense this afternoon that the Government were confident of the outcome or sufficiently determined to get their way. That is a matter of considerable concern, certainly to me.

My second point relates to the European Systemic Risk Board, which is there to try to avoid a future major crisis but which has no powers other than to make recommendations. I find the constitution of this board rather curious. It will consist of some 61 persons—all the governors of the national banks, national regulators and others—and will look at the weather and try to detect what is coming, as has been said. However, the size of the board militates against the sort of considerations that are necessary.

I am reminded that one of the reasons for the regulatory failure before the credit crunch—there is no doubt that there was regulatory failure before then—was that the FSA took the line that if one company was doing the same as all the other companies, nothing was wrong, even though it turned out that they were all doing foolish things that ended in disaster for some of them. This is the sort of herd instinct that occurs in the more exuberant stages of the boom and helps to contribute to the intensity of the subsequent bust. Is there any reason to believe that the 61 persons who will sit on the European Systemic Risk Board will be immune to that herd instinct? I think they are more likely to share it.

My third point is that although the proposals contain a lot of new structures—the European Systemic Risk Board, the European Supervisory Authorities and all the rest—there is a sense that simply creating new bodies solves the problem. It does not. The question is what they will do, what remedies they will have, what proposals they will bring forward, and what policies they will have to try to prevent or mitigate another crisis.

Our report recommends that there is,

"an overt counter-cyclical capital regime"— namely, that banks should save money in the good times so that it can be used in the bad times. I am sure noble Lords will be familiar with George Osborne's slightly different formulation of that principle. This does not require the structures which the EU proposes. We were told that this counter-cyclical approach was applied by the banks in Spain, which is why they came out of the crisis so well. Before they did this, however, the Spanish Government had to disapply an international accounting standard that limited capital retention to known risks. I have not heard anywhere in the discussion—I may have missed it—whether there has been any change to that accounting standard or how one will bring about a counter-cyclical approach if we have the accounting standards that prevented other banks from building up capital during the good times if they so wished. I hope that the Minister can enlighten us about what will be done to promote a counter-cyclical approach, because everyone seems to be using that phrase and endorsing that approach.

My fourth point relates to a comment in chapter 8 of our report in which we recognise that,

"all regulation must be in coordination with global initiatives".

A double perspective is essential. I rather share the view, to which the noble Lord, Lord Skidelsky, referred, that the basic underlying causes of the crisis were the global imbalances and the huge surpluses that were generated in eastern and far eastern economies but not reinvested in those economies or allowed to feed into higher domestic consumption there. Those surpluses were invested in America and in Europe, thus fuelling the asset price bubbles, the bursting of which triggered the credit crunch. Please note that in that view the so-called sub-prime issue was a symptom of the burst rather than the cause of the crisis.

We are now to have a global Financial Stability Board to work with the IMF, which is welcome. I hope that it can address those imbalances and the undervalued currencies that have helped to create those imbalances, which would be a benefit to the world's economy. I hope that the European Union will work positively with the Financial Stability Board, but I am not encouraged by a comment from a Commission official, who is quoted in paragraph 204. He said that,

"you cannot deliver the global without the European".

That seems to me to have got things around the wrong way. The financial system is global. Europe cannot isolate itself from it. It would be foolish to insist that European solutions come first or to say that you have to modify those global solutions in order to show that you are making a contribution to it or to add wee things to satisfy some localised interest rather than doing what is best from a global perspective.

I am left with the impression that the Commission's procedures were not the best. In paragraph 68, we note,

"significant criticism from our witnesses for", the draft,

"being prepared and agreed at an unnecessary pace without adhering to the principles of Better Regulation".

But worse was to follow. On 29 April, when the noble Lord, Lord Myners, was giving evidence for this report, he anticipated the Commission's proposals for an alternative investment manager's directive which appeared later that day. In that evidence he said:

"I have a fear that we are going to see something coming from Europe later on today which leaps at hedge funds and private equity as a source of instability in a way which is not necessarily as well informed as it should be".

He referred also to the approach as being too speedy and to the dangers of a failure to think through consequences. He supported the view,

"that a proper process, careful consideration, evaluation and broad debate based on a consultation with published responses is the right way to handle this".

On 14 July, while giving evidence on the AIFM directive, the noble Lord returned to this issue. He said that we were lobbying our colleagues in Europe,

"to address prejudice and a lack of understanding".

Later in that evidence he described proposals for private equity funds as perverse.

The noble Lord is usually very measured and restrained in his language, but I thought that those terms, with which I entirely agree, were quite appropriate. But is it not a shocking situation that we were then describing, and are now describing, the procedures of the European Commission in those terms? I hope that we never see that sort of behaviour from the European Commission again.

I have to acknowledge that the Swedish presidency has worked very hard to get some sanity into the process and the Minister here today seemed content that the dragon's teeth have been drawn, although we still have the one-size-fits-all problem. We have also learnt that the European Parliament has now to do an impact assessment. But such an assessment, risk analysis and proper consultation should have preceded publication in order to comply with better regulation. It seems that this was an old proposal, which had been lying around in the Commission for years, and, in the circumstances, was suddenly dusted off and rushed out without anyone bothering to think carefully or clearly about it.

In our final chapter we comment favourably on the operation of state aid in this crisis. The Commission recognised that the emergency justified state aid. It asked for an exit strategy for fundamentally sound banks and a restructuring plan for distressed banks. On the latter point we had evidence, at paragraph 220, which states that,

"restructuring plans are needed to ensure that banks return to 'viability'. This ensures the capacity of a bank to operate profitably ... in some cases the viability of a bank could depend on some degree of retrenchment in certain areas to avoid risks and losses".

We have seen the Commission's requirements on these matters, and they have been touched on in the debate. I am going to comment on some aspects of the Commission's requirements for the Royal Bank of Scotland. In doing so, I should mention that many years ago I was for a while with the Royal Bank of Scotland on an Industry and Parliament Trust attachment, but it was way back in 1995 and I did not complete it because I found myself bound up in other issues at the time. Just in case anyone remembers, I had better mention it, but I do not think that it has influenced my approach to this matter.

There are two aspects of the proposals for RBS that I find curious. It is required to divest itself of its insurance wing and to reduce its overseas operations. These are both highly profitable parts of the bank. If the object of the plan is a return to viability, how do you justify compelling the bank to divest itself of extremely profitable assets? The Government appear to be content with these demands, so I have to ask whether they were consulted in advance. Was there a discussion with the Government about it? If there had not been this process, would the Government through their shareholding have compelled the bank to behave in this way? Were they in favour of breaking up the bank? Press comments have referred to these measures as Europe punishing the bank for the receipt of state aid, but that is not compatible with the Commission's objectives as quoted above, nor is there any sign of this being justified as a competition measure. Indeed, it may not be justified in those terms in any event because what barriers are there to entry into the market? I am not sure that there are any.

I do not want to labour the point, but I feel that we should have a further comment by the Government on this issue. Is there a detailed justification for these measures, and if they are thought to be inappropriate or disproportionate, is there any remedy, or do we end up concluding that this is another case where the terms "prejudice" and "ignorance" would be appropriate?

Photo of Lord Willoughby de Broke Lord Willoughby de Broke UKIP 8:36, 10 November 2009

My Lords, I begin by congratulating the two chairmen and members of both committees for producing these two stimulating reports. What I did not grasp until I started preparing for this debate is that the questions that the reports address are not remotely new. Banking crises have been erupting periodically for centuries. Sovereign default on loans is an everyday hazard for banks, just one example of which was the downfall of the Medici banking family in Florence. The difference now is that the roles are reversed. It is banking default that threatens sovereign structures.

As long ago as 1825, there was a dress rehearsal for the present crisis. The then director of the Bank of England put it thus:

"We lent [money] by every possible means and in modes we had never adopted before; we took in stock on security, we purchased exchequer bills, we made advances on exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the bank ... Seeing the dreadful state in which the public were, we rendered every assistance in our power".

As the noble Lord, Lord Skidelsky, said, plus ça change, plus c'est la même chose. Nothing seems to have changed in the intervening 184 years except that the decimal point has moved a couple of places to the right. Central banks are still taking on collateral whose value remains unquantified. Even credit default swaps, about which the noble Lord was very rude indeed, have an historical precedent. It is no good Citibank or Goldman Sachs congratulating themselves on paying themselves huge sums of money for original thinking. Back in the 12th century, King Baldwin II of Jerusalem secured a loan using his beard as collateral. No doubt he, too, thought he was doing God's work.

Having looked back, let us look forward to find out what can be learnt. Both reports make the central point that there should be no rush to action or quick fix. The report of the noble Baroness, Lady Cohen, concludes by saying:

"But there should be no rush to all-embracing new legislation".

Taking that into account, I should like to touch on two points which I think deserve further consideration. The first is the question of deposit insurance, and I wonder whether this is the right way to go.

Let us take the example of Icesave, which is dealt with in Chapter 7 of the report on EU regulation. Deposit insurance by definition must make depositors risk-insensitive. Why should they care when the taxpayer will pick up the tab? As soon as Icesave went down the tubes, local authority treasurers, charity treasurers and university and college bursars who had placed money with Icesave came bleating to the taxpayer for help.

I had a deposit with Icesave. Icesave was an accident waiting to happen. It was quite clear that that was the case; you had only to read the financial pages early in 2008 to know that it was time to pull for the shore. If a simple peasant could work that out, what were the overpaid council and charity treasurers and college bursars doing with their minds idling in neutral? Depositors should understand that a deposit is nothing more than a loan and thus carries a degree of risk. If depositors want a risk-free deposit they should buy gilts or put their money with NS&I. State protection—or, more accurately, taxpayer protection—for depositors carries a double risk as state support stokes future risk-taking by banks. It is only rational behaviour for banks to double their bets: if the bets come off they win; if they do not, the state guarantees their losses. As Vince Cable pointed out, the gains are privatised and the losses socialised. I hope the Government will look carefully at the danger of taxpayer guarantees.

This brings me on to the equally difficult question of how to deal with financial institutions that are too big to fail or, as the noble Lord, Lord MacGregor, said, too difficult to manage. The banking supervision report looks at this problem in some detail, making a number of sensible suggestions to de-risk the taxpayer. I should like to add something different to the mix. I suggest, rather diffidently, that there may be lessons to be learnt on banking structure from the unlikely source of hedge funds. Noble Lords will be aware that hedge funds were the villains of choice as the cause of the banking crisis; subsequent analysis has, however, shown that they had little or nothing to do with it. Why? Because, unlike banking, the hedge fund sector does not consist of a small number of large players but a large number of relatively small players. On the face of it, prudence and hedge funds seem unlikely bedfellows, but please listen to this quotation:

"It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of 'highly-leveraged institutions', most hedge funds today operate with leverage of less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system".

Who wrote that? It was not some financial scribbler in the financial press. No—it was taken from a paper called Banking on the State,written by the Executive Director of Financial Stability at the Bank of England, Andrew Haldane. I leave the thought with the Minister that that paper was written by an adviser at the Bank of England; it deserves careful study.

On the question of EU regulation of our financial services, the committee asked whether the EU is the right area for action, going on to recognise the dangers of over-regulation and a resulting loss of global competitiveness. It also usefully underlined London's pre-eminence in financial services, pointing out that London would lose much more than any other member state from ill thought out regulation. What it did not say, perhaps out of misplaced tact, is that there is an EU bias against London's success. The German Finance Minister, Peer Steinbrück, in an interview with the BBC on 23 September, said:

"There is a clear lobby in London that wants to defend its competitive advantage tooth and claw ... We will deeply change the rules of the game for financial markets".

However, I draw some comfort from the unequivocal statement in paragraph 94 of the report, which says:

"Witnesses told us that giving binding powers to any EU body was not possible under the EC Treaty".

It went on to say,

"no EU body is currently able to make binding decisions over national supervisors".

So far so good, but can the Minister explain how that squares with his Written Answers to the noble Lord, Lord Pearson of Rannoch, on 21 July this year? He asked the Government,

"whether they have power to prevent overall control of the United Kingdom's financial system and its supervision passing to the European Union; and, if so, whether they will exercise that power".

The Government's reply, through the Minister, was:

"The European Commission has indicated its intention to use Article 95 of the EC treaty as the legal basis for its proposals to establish a European System of Financial Supervisors. The European Commission has confirmed that day-to-day supervision of financial institutions should remain at the member state level".—[Hansard, 21/7/09; col. WA365.]

I gather that this proposal, as the noble Lord, Lord Trimble, mentioned, will be subject to qualified majority voting. So it seems that when the debate gets political, the UK can simply be outvoted.

This subservience to the EU's political agenda has recently been cruelly spotlighted by the sorry story of the Royal Bank of Scotland's mugging by the Competition Commissioner, Neelie Kroes. She forced disposals on Stephen Hester, the chief executive of the Royal Bank of Scotland, in discussions that he termed "bruising". He said at his press conference that,

"the settlement with the EU makes recovery harder ... the disposals don't improve competition and don't improve our ability to pay back the taxpayer".

That is a not a very good result, is it? The noble Lord, Lord Trimble, who is not in his place, was absolutely right that the Commission seems to have decided that it wanted a political trophy and the Royal Bank of Scotland fitted the bill. The Treasury did not really seem to understand the damage that this could cause to the bank until too late in the day. In fact, it was behind the game all the way.

Will the Minister tell the House, therefore, what the position is? Will control of our financial system rest with the UK or the EU?

Photo of Lord Desai Lord Desai Labour 8:47, 10 November 2009

My Lords, I join other noble Lords in welcoming these two reports. They are both excellent, and, as the noble Lord, Lord Skidelsky, said, we should make them more widely available to universities, economic analysts and whoever needs to be educated in the details of this matter.

I start my observations on a very different note by saying that crises not only happen, but are a natural part of capitalism. Crises are the way in which capitalism cures its problems. They are not accidents; they are systemic. Therefore, while we must do all that it is possible for us to do to mitigate the effects of crisis, I do not believe that any system of regulation devised by the human brain, either singly or collectively, will be able to prevent the next crisis. It will happen as sure as eggs is eggs and we will again find that the regulatory systems are inadequate and devise new ones. That is because human ingenuity, if there is enough profit incentive behind it, can always outstrip any amount of existing regulation—we at least know that much.

Our first task as we devise these systems is to make quite sure that the costs of the crisis are borne by those who benefit from the boom. Here, we have all failed. We have not been able to separate the goats from the sheep or, I should rather say, the rabbits from the foxes. There is no doubt that the retail depositor of a modest kind—it may up be to €100,000 or £100,000—needs protection, but those who deal with investment banks, hedge funds and other such intricate instruments deserve no pity whatever. Shareholders or bondholders of banks deserve no rescuing. They should be grown-up people; they have taken risks, and they should take the consequences. I, for one, am not at all persuaded by the story told us by the City and Wall Street and all that—that somehow there was a risk of systemic failure. It was a mistake to rescue Bear Stearns; had we not done so, Lehman Brothers would have learnt some lessons and sobered up long before. So Lehman Brothers went, which sadly cost enormous sums to the taxpayer, but I would have liked to see what would have happened in a more robust environment.

The boom was very long—63 quarters, as one report says, of uninterrupted rates of growth of GDP. It was one of the longest booms in recent history, and we had forgotten that all booms come to an end and that in the 1970s we had a banking crisis, as well as a deep recession in the 1980s and another recession in the 1990s. We just did not have a recession around 2000, so we got carried away perhaps. We should get back to the idea that we live in a system that naturally has cycles. It is unstable and cannot be made permanently stable. That is a major virtue of the system; it is not a problem, but a virtue. To the extent that we devise protective institutions, we should protect the retail depositor and perhaps—although it is too late this time—the taxpayer, rather than banks and bankers.

I move to the recommendations of the reports. Clearly the big element is macro-prudential supervision. Unlike the noble Lord, Lord Skidelsky, I am not so against models. I think that I can say without any false modesty that in this Chamber, at least tonight, I have done more modelling in my life than anybody else—econometric modelling, I hasten to add. I see in the evidence from Jon Danielson, whom I know very well, taken by the committee chaired by my noble friend Lady Cohen, that the models that the banks used are fragile because their samples are very small. If your samples are small, it is natural that you have very unrobust parameter estimates. They do not become good just because we call them models, and they are not perfect just because we use mathematics. Aside from the idea that there is uncertainty and not risk, even the risk can be modelled much better than we are doing. We have tolerated extremely bad econometric modelling, which has cost us enormous sums of money.

I should like to see an institution such as the IFS—something independent that would look after financial modelling and macro-prudential modelling. It should not be part of the government or the private sector but funded with sufficient resources that we can rely on its judgment about how the system is modelled. Nobody has even given me a precise definition of what "system stability" means. We are talking about financial system stability, but there are no definitions of it. I could sit down and make a definition, but to incorporate it mathematically would require enormous amounts of data and a very sophisticated technique, in which parameters drift around rather than stay constant and so on, but I think that it can be done. It is our duty, as far as possible, to improve our knowledge base much more than at present. People are getting paid enormous sums for doing bad work and it is our duty to invest in much better knowledge of how the banking system works or does not work.

The best that we can do is not so much prevent crises but improve our mopping-up operations. Importantly, the report talks about the problem of Iceland and the related problem of the EU. When push comes to shove, a bank needs a state behind it to rescue it. Only the state has powers to print enough money to lend to the bank that is bankrupt. Unfortunately, the problem is that the state can only print its own money—it cannot print foreign money—and, in the case of Iceland, the liabilities were in foreign currencies. By the time the bank went bust, the assets were all toxic. The state of Iceland did not have enough dollars, sterling or euros to be able to bail out its own banks.

Even if we had the most sophisticated supervisory system of the type the report recommends, the EU and its fiscal authority has no money. It does not have sufficient money to bail out a really serious big European bank. It would fall to individual European states to take bits and pieces of a large multinational, multibranch bank and rescue it. Although one example is cited in the report in which France and Belgium each rescued part of a bank that was operating in those countries, in a global banking system we would have to devise better rules about who finally pays for the rescue of a bank that is going bust. As I said, I would prefer not to rescue banks at all, but if we are going to rescue them, we need clear rules, especially in the context of the EU, when some are in the eurozone and others are in a different system.

To the extent that we can separate out the rabbits and the foxes to protect the rabbits and shoot the foxes, the hedge fund problem is not serious. People who subscribe to hedge funds are grown-up enough to know what risks they are taking. If they do not, they should not be there. We should leave the hedge funds alone and let them do whatever they do because that is a sector of professional high risk-takers who know what they are doing and are amply rewarded for the risks that they take. We should look after the small person, but more than that we must look out for the taxpayer.

I want to say something about all the structures that have been set up. Despite the FSA and the various other bodies that we have, what has actually worked—here I differ from the noble Lords, Lord Willoughby de Broke and Lord Trimble—is that the European Commissioner for Competition has the best policy about what to do with banks: break them up. Prudential supervision may not work, but if you can enforce rules of competition and see to it that no bank gets too big—whether a pure retail or a mixed bank—we may yet have some insurance against the likely failures and, if they do fail, the cost of rescuing them would be modest and not enormous.

Photo of Lord Forsyth of Drumlean Lord Forsyth of Drumlean Conservative 8:58, 10 November 2009

My Lords, I begin on a sour note by saying that I do not know what the business managers were thinking by putting this debate on at this hour of the night. Here we are discussing the most important issues facing our country, and indeed the world, at nine o'clock at night—an hour after the other place has gone to bed. The chairman of the FSA, the noble Lord, Lord Turner, stayed for all of seven minutes. If Parliament does not take its own committees and reports seriously, how on earth can we expect to restore people's faith in the parliamentary system, which is another major issue facing us this at this time?

I enjoyed being on the committee and was hugely appreciative of the enormous time and effort that people put into giving evidence. I started the inquiry wondering, "How on earth did we get into this mess? How could so many clever people get things so profoundly wrong?". And that is what I would like to focus my remarks on this evening, as well as on Chapter 2 of the report, which deals with the causes of the crisis. My noble friend Lord MacGregor has dealt with the recommendations. I would like to pay the Minister a compliment—he looks shocked, but I very much appreciated the positive way in which the Government responded to so many of the recommendations, and, indeed, the careful way in which the Minister has played the very difficult hand that he was given just over a year ago.

The first thing that we need to get straight, as my noble friend Lord Trimble said, is that this financial crisis was not caused by sub-prime lending in the United States. That has certainly been disastrous but, as my noble friend Lord Trimble said, it is a symptom, not a cause. The global imbalances and the lethal combination of very low interest rates and exceptional amounts of liquidity are the root causes. The Chinese have been saving vast amounts, accumulating about $3 trillion of monetary reserves. Other countries, such as Singapore, Korea, Taiwan and the oil-producing states, have done the same, while here and in the United States we were on a spending binge financed by cheap borrowed money.

The noble Lord, Lord Butler, put it brilliantly in a speech in the debate on the economy back in May:

"Indeed, my view, at the risk of offending both Front Benches, is that the prosperity of the past 15 years owes less to the brilliant management of Governments or the financial authorities than to an extraordinary combination of circumstances; we had a supply of cheap manufactured goods from the Far East, a flow of cheap labour from eastern European countries and an abundance of cheap credit ... The trouble is that the prosperity has been built on major imbalances in the world economy. It has been built on consuming countries, including the United States and the United Kingdom, consuming more than we were earning and living on the credit of the exporting countries".—[Hansard, 7/5/09; col. 679.]

If you want to get to the bottom of a difficult problem, ask a former Cabinet Secretary to summarise it in three paragraphs; that, I believe, does it. Our report echoes those sentiments.

What worries me is that these imbalances, as the noble Lord, Lord Skidelsky, pointed out, have not gone away. Just as banks such as Northern Rock can collapse when their supply of credit vanishes, so can countries. It is pretty unusual for developing countries to be exporters rather than importers of capital. Against that background of cheap money, Alan Greenspan cut interest rates whenever there was a market setback, and Gordon Brown set an inflation target which excluded housing costs and created the conditions for an explosion in house prices, funded by cheap mortgages. As an asset bubble developed, with house prices growing by 25 per cent in one year, the Bank of England did precisely nothing. Gordon Brown had taken away its responsibilities for macro-prudential supervision and given them to the FSA, which was too busy creating bureaucracy to see what was happening in individual banks such as Northern Rock, let alone to take a view on the overall financial picture.

If this sounds like hindsight, look at the debate on the Bank of England Act 1997. The then shadow Chancellor, Peter Lilley, warned:

"With the removal of banking control to the Financial Services Authority ... it is difficult to see how the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse".—[Hansard, Commons, 11/11/97; col. 731.]

At the heart of this UK banking crisis is a regulatory failure and a failure of monetary policy. Gordon Brown is the author of both. He wrecked the supervision of the banking system in our country and encouraged the debt culture by boasting that he had ended boom and bust. By removing the safety barriers he made a serious crash inevitable. Not content with having caused real damage to pension funds by adding to the tax burdens on them with the changes on dividend tax, he is now talking about imposing yet another tax on pension funds and our other financial institutions—which, fortunately, his colleagues, with whom he was helping to save the world, have disengaged from. Of course he and the noble Lord, Lord Myners, now lead the chorus vilifying the bankers, but the Prime Minister, as Chancellor, was all over them once. James Crosby, the CEO of HBOS, was made deputy chairman of the FSA, the body responsible for banking supervision, and given a knighthood. Sir James was later asked to advise and report on sorting out the crisis in the housing market. He was ideally placed as HBOS went down with 40 per cent of its loan book in property, and, amazingly, with equity stakes in some of the companies to which the bank was lending money.

The chairman of HBOS, Dennis Stevenson, was given a peerage and made chairman of the House of Lords Appointments Commission, the body which decides whether people are of sufficient calibre to make a regular and significant contribution to the Lords, as your Lordships know. Since his appointment a decade ago, in 1999, the noble Lord, Lord Stevenson, has spoken three times in this Chamber, and I can find no record of his ever having voted.

Fred Goodwin was invited to advise Gordon on the New Deal and—of all things—on credit unions. He was in and out of Downing Street and knighted for his services to banking. He now, it seems, has been appointed as the prime ministerial lightning conductor. Alan Greenspan, the former chairman of the Federal Reserve who was responsible for cutting interest rates—the so-called Greenspan Put—and for the monetary expansion, was showered with honours and appointed a senior adviser, too. Victor Blank was encouraged to take over HBOS by a prime ministerial promise to ignore the competition consequences. In the end, of course, the Government were shown not to be able to deliver on this, thanks to the intervention of the European Commission. Today, 5,000 people will lose their jobs in the Lloyds Banking Group.

Yes, there have been some spectacular examples of greedy and irresponsible bankers, but it is fatuous to put the systemic collapse of our financial systems down to just bankers and their greed. Some bonus systems undoubtedly encouraged short-term, risky and even reckless behaviour, and the regulator should certainly penalise banks that refuse to reform their compensation arrangements by imposing higher capital requirements on them.

With low interest rates, pension funds and other investors wanted to find a higher return or yield and, as everyone knows, high return equals high risk. Yields are inversely proportional to credit quality. So the cash sought out weaker credit. You can achieve that by finding weaker borrowers or by taking healthy borrowers and lending them so much that they become weak ones. Soon vast amounts were being lent and the loans sliced and diced and mixed together in complex products whose creditworthiness was assessed using computer models and complex probability theory. Because they provided an income stream at a relatively higher interest level they were attractive to investors seeking higher returns. The banks thought as they no longer owned the loans they had eliminated the risk. In fact when the music stopped in this foolish game of pass-the-parcel, it turned out that the banks had been selling these securities to each other.

I bought a new car a few years ago which had a satellite navigation system which I had read was among the best and most sophisticated on the market. My wife and I set off to spend the weekend with some friends in rural Norfolk using this new technology. My wife kept insisting that it was taking us the wrong way. I believed in the technology and ignored her increasingly strident protestations, even though the miles and time-to-destination readings were going up and not down. It was only after we passed the same level crossing for the second time that I abandoned the satnav, applied common sense, followed the road signs and we arrived safely at our destination. It turned out that the satnav had been incorrectly calibrated and thought that we were in Holland. Garbage in, garbage out.

The regulators, the ratings agencies and the banks were all relying on defective models. Amazingly, their non-executive directors, auditors and highly paid managers had failed to do as my wife had done, which was to use their common sense and question their systems. Why? The Governor of the Bank of England, Mervyn King, got it right when he said to our committee:

"It is not easy to persuade people, especially those who are earning vast sums as a result, that what looks successful in the short run is actually highly risky in the long run".

The regulatory requirements which limited investment to products with appropriate ratings were intended to offer security but turned out to be a Maginot line which actually created false confidence and added to systemic weakness. You cannot predict the future from the past, as the noble Lord, Lord Skidelsky, indicated, and in any computer model the results are only as good as the data which go in. It was like trying to drive your car by looking in the rear mirror. A crash was inevitable, and when house prices started falling, mortgage delinquencies and defaults started rising. The banks were not sure what was in the structured products they had bought, confidence vanished, and no one wanted to buy any more. For banks such as Northern Rock, this meant that they could no longer raise funds to lend, and their business was over.

It is important to understand why this crisis is worse than anything since 1929. The most important aspect is its scale. Financial institutions around the world will record losses of trillions of dollars. The capital of some of the biggest banks and lending institutions—names such as RBS, HBOS, Lehman, Citigroup, Goldman Sachs, Morgan Stanley and Merrill Lynch—has been wiped out. Lending froze because banks had to reduce it to fit their capital, which was evaporating. They even stopped lending to each other as the psychological pendulum swung from "every loan is a good loan" to "every loan is a bad one". Allowing the disorderly collapse of Lehman was a major error. It destroyed confidence and created panic. Huge sums were withdrawn from the banks as people began hoarding cash—some $480 billion in 48 hours in the United States alone. The head of the IMF said that the world was on the brink of a systemic meltdown, and he was right.

Now we have entered a brutal recession which will add to mortgage and credit-card default as people lose their jobs and incomes. It will be slow and painful to climb out of. Banks are struggling to lend, despite huge injections of capital and liquidity, because they are trying to shrink and existing borrowers are drawing down on existing facilities. We have previously seen recessions caused by inflation, followed by monetary tightening, but this one is different. This is driven by plummeting asset values which have damaged the balance sheets of the financial sector, households and Governments. We are all poorer than we thought we were and have to cut back.

Even now the Government do not seem to get it. You cannot solve a problem caused by excessive borrowing by borrowing more money. It is like applying for another credit card to pay off the others. In the end, it makes things worse, not better. It might buy you time, perhaps until after a general election, but the pain and costs of addressing the problem will be greater. The era of make do and mend is back. Incomes for most people have remained fairly steady over the past decade, but many folk felt flush because they thought their homes and investments were worth more. It was an illusion. Now things have reversed and it will take years for confidence to recover.

Photo of Baroness Hooper Baroness Hooper Deputy Chairman of Committees, Deputy Speaker (Lords) 9:14, 10 November 2009

My Lords, at this hour, I do not propose to make a lengthy intervention, even if there was anything significant left to say. In any event, the noble Baroness, Lady Cohen, very skilfully set the scene and raised most of the relevant issues for the Minister to answer regarding Sub-Committee A's report. However, I take this opportunity to thank her and, on the occasions of her unavoidable absence, the noble Lord, Lord Woolmer, for their effective chairmanship of this inquiry. It was certainly a challenge for me as a new member of Sub-Committee A, but it was a fascinating experience. The report covers an immensely complicated and detailed area of financial regulation and supervision at a time when urgent action was being demanded on all sides. In case it is deemed necessary, I declare an interest as chairman of the advisory boards of Barclays Private Equity infrastructure funds.

At the outset of our investigations in February of this year, two things concerned me in a general way. They remain matters of concern. The first was the speed at which banks and other financial institutions were able to enter into some of the complicated transactions that led or contributed to the financial crisis, as well as the huge volume of those transactions, all made possible by new technology. This was an important part of the problem and the reason why the crisis, and its extent, seemed to explode on us and take most people by surprise.

The second concern was the need to allow for innovation. After all, it was and still is innovation that has served this country well and enabled the City and our other financial centres to be world leaders. It has been said that six of today's most in-demand jobs did not exist 10 years ago and that in the 21st century we will have to train our children to do jobs that do not yet exist using technology that has not yet been invented. What is true for education is equally true in the finance sector. We have to find a way of ensuring that the new bodies being set up under the proposals before us can cope with developments at ever increasing speed and in ever increasing volume. It was not innovation that let us down; it was the failure of senior management within financial institutions and their regulators, as well as their boards of directors and auditors, to understand it properly and the risks that it brought. That point has been well made by several people who have spoken in this debate, including initially my noble friend Lord MacGregor.

I find it hard to see how the three layers of financial supervision that we are now facing—at national, European and global levels—will deal with these two concerns and avoid stifling innovation while providing effective early warning systems in such a rapidly changing world. The noble Lord, Lord Skidelsky, emphasised this challenge brilliantly. I suppose that we have to start somewhere. However, in doing so, we should bear in mind one of the conclusions of our report, which was, in effect, that there should be lengthy debate on supervision rather than a rush into legislation. I believe that that is still valid and I fully support the remarks made by the noble Baroness, Lady Cohen, on it.

Today's debate is part of that process. It has been very useful to have this joint debate and I trust that not only will this House take note of our report and the report of the Economic Affairs Committee but that the Government and the European Union institutions will take note of and act on them.

Photo of Lord Haskins Lord Haskins Crossbench 9:19, 10 November 2009

My Lords, I declare an interest, with a record—infamous, maybe—on regulation, having been chairman of the Better Regulation Task Force for a number of years. I believe that regulation, like taxation, is a price that we pay for an affluent democracy, but I also believe in the broadest sense that there is a great danger that society expects too much of regulation, so that regulation becomes a substitute for judgment and personal accountability. While both reports concentrate on the need for further regulation, there can be little doubt, in my view, that the real cause of the crisis was not inadequate regulation, however inadequate it might have been, but a combination of catastrophic failures of corporate governance in the banking boardrooms and flawed monetary policies, particularly in the United States and Britain.

Had the boards of most though not all of the big banks in Britain, the United States, Germany, Iceland and the Republic of Ireland done their job properly, they would never have allowed their executives to take such reckless risks with shareholders' money—as exemplified by the RBS takeover of ABN Amro. Nor would they have paid bonuses based on short-term gains of a very dubious nature. They would have drawn much clearer lines between their investment and retail banking activities—these lines became very blurred. They would never have approved trading activities, especially in securitised debt, which they did not understand; and they would never have encouraged their customers to run up absurd levels of debt based on the premise that the property market would never again take a downturn.

As for monetary policy, when the then chairman of the United States Federal Reserve, Alan Greenspan, made his now infamous comment about "irrational exuberance", he did nothing about it, believing that the market would correct itself. The Government and the central bankers were barking up the wrong tree. Their preoccupation with controlling inflation led them grossly to underestimate the dangerous levels of credit being handed out by the banks.

The regulation of financial markets is a nightmare. The banks are too large and too complex to be easily regulated. The markets in which they operate are global, while the responsibility for regulation rests largely with national Governments. This is a particularly big problem in the European single market. The regulatory structures are complex and blur accountability. The three regulatory players in this country—the FSA, the Bank of England and Her Majesty's Treasury—were all uncomfortable about developments in Northern Rock, but nobody blew the whistle until it was too late. Lastly, banks are notoriously secretive about their activities.

There are arguments for urgent, radical regulatory reform in Britain and the EU. The public are clamouring for something to be done—this is always a dangerous situation for a good regulator—especially about bonuses. With the banks on the back foot, it is better to strike while the iron is hot. This relates especially to the Anglo-Saxon bankers of London and New York. However, there is a powerful case for not acting too quickly. Rushing through regulation without proper consultation, and without fully assessing possible unintended consequences, usually results in bad regulation.

The credit rating agencies must carry a lot of responsibility for the debacle. Hired by the people who were trading in securitised debt, they issued triple-A ratings to thousands of transactions, and the banks relied on these assessments instead of carrying out their own due diligence. There have been calls to regulate the agencies tightly, but this would be a mistake for two reasons. First, there would be a danger that the agencies' assessments would swing from being excessively risky to being excessively cautious and risk-averse. Secondly, people would become too reliant on credit agencies for their own good, when instead they should become less reliant on them.

We should return once more to the issue of improving corporate governance. Along with many others, I devoted—and wasted—much time on the issue in the early 1990s in wake of the Maxwell scandals. Sadly, our efforts were in vain. Somehow, we must require boards to be far more diligent about their corporate governance responsibilities, and to stand up to overbearing, ego-driven chief executives. The best way to achieve this is by obliging the obsequious institutional shareholders to be far more positive and long-termist in holding their boards to account. I am always happier when directors invest significantly and on a long-term basis in their companies, because they are risking their own money. Too many modern boards are reluctant to follow this practice.

I turn to my final thoughts about the crisis. Why did the American bank, JP Morgan, which is thought to have invented these securitised debt wheezes, go cool on them several years before disaster struck? And we really must ask the competition authorities to take a much tougher line when looking at wild takeover proposals, such as those made for ABN Amro by Barclays, which had the good fortune to be outbid by the Royal Bank of Scotland. Pre-big bang, the cleverest of our young people tended to go into science, technology and academia, leaving the less bright to run the banks. However, when the brightest were lured into finance, their fertile brains produced all these lethal new products. Perhaps if the old guard were still in charge, these inventions would never have seen the light of day and, if they had, the old-fashioned boards would have viewed them with the great suspicion that they deserved.

Photo of Lord Leach of Fairford Lord Leach of Fairford Conservative 9:25, 10 November 2009

My Lords, I should declare two possible interests. I am a director of a bank that has not taken assistance from any Government and a director of an untroubled insurance business.

Despite all its disasters, the financial services industry is still a formidable asset to this country. Your Lordships' Economic Affairs Committee's measured recommendations on reform of the tripartite system have led to a very constructive dialogue to which I shall not contribute tonight—there have been too many excellent contributions already for me to add to them. The committee's recommendations were all about putting our own house in order. They presupposed national responsibility and multilateral co-ordination. The EU's proposals to transfer regulatory powers from London to Brussels are on a fundamentally different tack. The City is at the centre of a worldwide, not a European, network. It cannot be wise to agree to proposals whose horizon is regional and whose regulatory purpose is not co-ordination but transfer.

We saw from the financial services action plan and more recently the alternative investment fund managers directive the result of conceding financial authority to the EU. What emerges is a set of measures drafted by people with no knowledge of wholesale financial markets and not always, as my noble friend Lord Willoughby sadly reminded us, with friendly intentions towards the City. Some of these measures stem from the inexperience of countries that do not have a sophisticated financial industry; others reflect a hope that financial activity will fragment, allowing a shift from London to Frankfurt and Paris; others come from visceral antipathy to organisations such as private equity and hedge funds, although, as de Larosière himself said, they had nothing to do with the crisis.

For those who think that way, the troubles of the City represent an opportunity, but our own dismay at the City should not lead us to accept the EU's analysis or its solutions. There is no reason to think that supranational regulation will be in any way superior to the national regulation that, as some noble Lords have remarked, has stood Spain, and has also stood Canada and Australia, in such good stead.

The FSA has said that the Commission goes too far in proposing that EU bodies should be able to overrule national supervisors. Last year the Treasury, too, said that the most appropriate form of supervision was at member state level—an opinion implicitly shared by your Lordships' Economic Affairs Committee in its emphasis on domestic reform and its suggestion of national regulatory capital for branches of multinational banks.

Given those unambiguous statements from the supervisors of the unquestioned powerhouse of financial expertise in the European time zone, one has to ask why these EU proposals were not strangled at birth. Why are we always left trying to mitigate ill-thought-out proposals when it is too late to prevent them? If the common agricultural policy or the car industry were threatened in this way, France or Germany would not have let the proposals see the light of day. Can the Minister say just when these plans—the AIFM directive and the broader EU plans—first came to the Government's attention and what steps they took at the very outset? Did the Government press the case for subsidiarity? Did they insist on widespread previous industry consultation?

The Commission's proposals envisage three new authorities with combined budgets of €68 million. It will be mandated to take action in emergency cases. Does the Minister believe that the Commission will be more competent than a reformed FSA to take a technical decision, such as banning short selling? If the new EU authorities get things wrong—which, as the noble Lord, Lord Skidelsky, said, is a racing certainty—who will hold them to account, who will change them?

As the noble Lord, Lord Myners, has said, if the financial crisis has shown us one thing it is that Finance Ministers and regulators must be held accountable. Some important decisions on enforcement and implementation in the new regime will be taken by simple majority, on the basis of one state, one vote. That means that the UK, which has far more to lose or gain than any other member state, will have the same voting power as Latvia or Malta.

If you look at the history of European finance with a sense of perspective, you see the formation, at first embryonic, but now more and more clear, of a comprehensive US-style regulatory system, with a budding SEC in the shape of the European Securities Markets Authority. As President Sarkozy has said, that is just the point of departure.

In two or three years' time, it is likely that the City will again be seen as a success. That is not certain, but it is likely. The FSA, within whatever overarching structure it eventually sits, will recover from its failures and be seen as an effective regulator again. The Bank of England's initial response to the crisis has been much criticised, and it suffered from the misguided tripartite system, but its international reputation remains as high as ever. The Takeover Panel is a widely admired model. That deep pool of operating and supervisory experience and legal and professional support was responsible for the migration of international finance from Wall Street to London 40 years ago. We should not even contemplate handing its regulation over to the lowest common denominator of 26 legislatures and three or four unaccountable EU bodies with vague powers that can only grow.

Finally, it is an old chestnut, but we must ask whether the proposals have a sound legal basis. The grant of binding powers requires a treaty amendment. In evidence to your Lordships' EU Committee, a witness from the ECB gave the opinion that the creation of the new agencies crossed the line of what is permissible under internal market legislation. The Commission argues, as it always does, that the new authorities can be created under the notoriously permissive Article 95, and surely the least that we can do is to challenge the legality of this unwelcome new regime in the highest court of law. Will the Minister assure us that Her Majesty's Government will follow that course?

Photo of Lord Newby Lord Newby Spokesperson for the Treasury 9:33, 10 November 2009

My Lords, it is a pleasure to be able to debate these two reports this evening, although my enthusiasm is slightly tempered—as the noble Lord, Lord Forsyth, commented—by the lateness of the hour. I retain some enthusiasm, not least because the two reports are grappling with a common problem: how to develop the existing regulatory framework for financial services in a manner that minimises the possibility of the kind of crisis through which we have just lived occurring again while, at the same time, neither stifling innovation nor putting the UK or the EU at a competitive disadvantage.

In doing so, both reports necessarily grapple with the roles which a variety of regulatory and supervisory bodies should play. The reports have been produced against the backdrop of a continuing sense of popular unease that the banks have somehow got away with it. That unease will have been strengthened by the size of Barclays' profits that have been announced today. There is also a growing realisation that while the large international banks can and do operate very flexibly on a global scale, shamelessly playing one Government and regulatory system off against another, politicians still find it extremely difficult to come up with an effective international decision-making structure. The example over this weekend of the Prime Minister's ill-fated attempt to fly the kite of a Tobin tax demonstrates this. It is inconceivable within a Cabinet, for example, that a Minister would float an idea that his most senior Cabinet colleagues would immediately disown, yet in the absence of a proper G20 or international decision-making framework, it is quite difficult to see how else you make proposals. One hopes that when the noble Baroness, Lady Vadera, gets stuck into the organisation of the G20, that might change, but I suspect it will be a long job.

On the substance of the Tobin tax, in principle, it has much to recommend it. There are a number of outstanding difficulties, of which getting international agreement is only part. Bearing in mind that one of the original intentions of the Tobin tax was to introduce some grit into the system to reduce the amount of speculation, as he saw it, the projections of what the tax would raise, based, as they are, on assumptions that trading volumes would stay the same, are misplaced. While it might be a useful contributor to a variety of causes, and there are lots jostling to spend any money raised, the quantum raised might well be less than the headline figures have so far suggested.

The extremely clear and thoughtful report by the committee chaired by the noble Baroness, Lady Cohen, demonstrates time and again how difficult it is, for a variety of legal, political and administrative reasons, to make progress at a European level. There are a number of points in the report, and a number of noble Lords have referred to them. There is an extent to which what might seem to be sensible progress—to me, at any rate—is blocked by the need for a treaty change, and a treaty change is virtually impossible. One of the main challenges for the EU is how it makes progress in areas where there may be a consensus for change, yet the treaty makes that very difficult. I completely disagree with the concept that you can deal with these problems largely at national level. I have some sympathy with the noble Lord, Lord Trimble, about it being preferable to deal with it all at a global level, but we know that if you try to do that, on many issues, you will be waiting a very long time, despite the progress that has been made in recent months in terms of making the G20 a more effective body.

Turning to the specific proposals in the report, I agree with the need for dynamic provisioning and a major redrawing of the basis of the Basel rules. This is obviously something that, as the noble Lord, Lord Skidelsky, said, has its limitations, but to have countercyclical rules must surely make no sense whatever. It obviously makes sense to have a common deposit guarantee level across the EU. There are some wrinkles to sort out in that area in terms of whether one is talking about a guarantee that applies to a brand or a bank, but the principle of having a common level makes great sense, as we saw when the Icelandic and other banks got into such difficulties. It would be extremely difficult to see how one could establish an EU body with micro-prudential supervisory roles as long as national Governments bail out financial institutions, and no one is suggesting that. But there is a real challenge if we believe—I do not know whether some noble Lords do believe—that we should have within Europe some of the world's largest banks. If we do, the problem that we are faced with is that there is no single nation state in Europe that is big enough to bail them out if they get into serious problems. The view of the chief executives of some of our largest banks is that the choice is between having some of the world's largest banks in Europe with some sort of European guarantee and not having them at all. We will come back to that debate.

The most interesting contribution to our debate on the macro-prudential systemic risks and the ESRB was that of the noble Lord, Lord Renton of Mount Harry. A simplistic response, which I cannot help giving, to the question of how you reduce the paranoia about the potential growing strength of the ECB is that if we were part of the euro, perhaps we would be somewhat less concerned about it. I realise, however, that not everyone will become less paranoid at that suggestion.

On state aid rules, the noble Lord, Lord Willoughby de Broke, pointed out that Stephen Hester did not like his bank being split up. Well, he wouldn't, would he? Has a single banker so far volunteered their bank to be reduced in size and complexity and regulated more systematically? Of course not; bankers are the last people to look to to support that kind of activity. Our criticism of the changes that have been made is not that they go too far or that profitable bits are being hived off—how, incidentally, could you hive off non-profitable bits; who would buy them?—but simply that they do not deal with the question, which a number of noble Lords have raised, of whether one goes down the route of having a Glass-Steagall type of separation.

As for the alternative investment fund directive, yes, the first draft was poor but it was not, as the noble Lord, Lord Trimble, said, pulled out a bottom drawer, having sat there for a long time; it was the product of a single politician who had an ideological view and was temporarily in a position to push that view forward. I seek to reassure the noble Lord, Lord Leach of Fairford, only that the committee at the European Parliament that is dealing with this is chaired by my colleague Sharon Bowles, who I am sure will ensure that we get a sensible outcome. Interestingly, I do not think that a single noble Lord has pointed out in our debate on Europe that the European Parliament plays a major role in decisions on all this financial stuff. This is not just a question of what happens in the Council. The European Parliament is very open and transparent and, as we are seeing with regard to this directive, is capable of forcing through change to what many people thought was a poor Commission first draft.

The biggest question with which the Economic Affairs Committee report deals is who is responsible for the stability of the financial system. There is now agreement that the Bank of England should have a decisive role in macro-prudential supervision. At the moment, macro-prudential supervision is in a muddle. Three committees—one of the Bank, one of the FSA, and one of the Treasury—are charged with financial stability, which is clearly nonsensical. I disagree with some of the proposals on the table at the moment in that I do not believe that micro-prudential regulation should follow macro-prudential regulation to the Bank. I do not believe that the Bank is temperamentally cut out for it. It would cause a whole new range of boundary issues, and spending two years changing the nameplates on the doors and rearranging structures at this point makes absolutely no sense.

I strongly agree with everything that the noble Lord, Lord Haskins, said about corporate governance, with one caveat; if you have a very strong and domineering chief executive, as the RBS did, it is quite difficult as a non-executive constantly to challenge that person effectively. I declare an interest as a former non-executive of a small privately owned company that had a dynamic and charismatic chairman. I challenged particular things that he was doing with which I disagreed, but after a while that became a mere irritant to him and was not effective. That may have been a lack of eloquence on my part, but I do not think it was entirely that. I agree with the noble Lord, Lord Haskins, that the role of the institutional shareholders should be more effectively exercised. They are the people who really get chief executives and chairmen worried if they think that they are being effectively challenged. They should play a larger role in the future.

I particularly enjoyed the speech made by the noble Lord, Lord Skidelsky. I have just finished reading The Black Swan: The Impact of the Highly Improbable, which deals with these issues in a slightly different way. His essential point that you cannot simply predict the future by looking in the rear-view mirror is extremely important and, as bankers now tweak their models rather than change the concepts on which they base their decisions, it has yet to be fully appreciated in the banking sector.

The hour is late and, although there are many other issues which one could happily spend a long time debating, I will finish. It is clear that in the months ahead we will grapple with all these issues time and again. At this point, we are extremely fortunate to have the two reports before us to help inform our thinking.

Photo of Lord Trimble Lord Trimble Conservative

As the noble Lord made reference to my comments on the origins of the AIFM, it may be that the rumour I heard was incorrect. I heard that the origin of the concept was Oskar Lafontaine many years ago. But if the noble Lord is correct that some other ideologue produced it more recently, that underlines the failure of the Commission to keep a grip of what it was doing.

Photo of Lord Newby Lord Newby Spokesperson for the Treasury

My Lords, what matters is the outcome, and my view is that the outcome will be sensible.

Photo of Baroness Noakes Baroness Noakes - Shadow Minister, Shadow Minister 9:47, 10 November 2009

My Lords, I join other noble Lords in congratulating the Economic Affairs Committee and the EU Committee on their reports. I pay tribute to all members of the committees, particularly those who have come to take part in this debate. I echo the comments made by my noble friend Lord Forsyth on the timing of this debate. It is a pity that it has taken until the dying hours of this Session for the reports to be given debating time. They were timely and relevant when they were published in the early summer. Subsequent developments mean that they have continuing relevance, which is why today's debate has some real point, but they should have been debated earlier.

The majority of my remarks will be focused around some aspects of the EU Committee's report. That does not imply that I regard the Economic Affairs Committee's report as of less importance—far from it—but the world has moved on further as far as domestic supervision and regulation are concerned, and there is much still to play for in Europe.

We agree with the analysis in the Economic Affairs Committee's report that, in addition to the global financial imbalances to which several noble Lords have referred, there was a failure of regulation and supervision, a failure of the tripartite authorities, a lack of attention to macro-prudential supervision, and the dominance of conduct-of-business supervision to the detriment of micro-prudential supervision. In July, the Government's White Paper, Reforming Financial Markets, refused to acknowledge the fact that the tripartite arrangements, which were designed by the Prime Minister, were a part of the problem. Instead, they proposed yet another committee, the Council for Financial Stability, to paper over the cracks.

As my noble friend Lord MacGregor pointed out, this summer, my party issued its own policy proposals in a White Paper. Our solution is not for yet another committee. We have set out a more decisive approach based on transferring prudential supervision from the FSA to the Bank of England so that macro- and micro-prudential supervision can be properly united. I hear the reservations of the noble Lord, Lord Newby, but it is something we believe is worth the effort to achieve. Furthermore, we will separate conduct-of-business regulation into a consumer protection authority, thus implementing the twin-peaks approach that the Economic Affairs Committee urged the Government to examine. I will say no more about domestic supervision and regulation at this stage, save that we will work constructively on those parts of any financial services Bill in the next Session that deal with real issues, but we will not ease the passage of legislation which merely rearranges the deck-chairs.

I turn to the European dimension because that worries us greatly and because the actions or otherwise of the Government over the next few months are very important to the UK. In my first observation I may well display my ignorance of the workings of the EU Committee and its sub-committees, and I stand ready to be corrected. In the introductory pages of reports from the EU Committee, there is the following statement:

"The European Union Committee ... considers EU documents and other matters relating to the EU in advance of decisions being taken on them in Brussels. It does this in order to influence the Government's position in negotiations, and to hold them to account for their actions at EU level".

That seems an entirely sensible approach but the report before us today, which I think is similar to other EU Committee reports, directs several of its conclusions to the Commission rather than the Government. Our role in Parliament is to hold the UK Government to account but, with many of the recommendations being directed other than to the Government, they themselves have had to reply formally to only four of them. I would have preferred all recommendations to be framed in such a way that the Government have to do things, even if only in terms of influencing the Commission. At the end of the day, a failure to achieve a good outcome for the UK must be laid squarely at the door of the Government, and it is they who we must hold accountable for it.

This links to an issue that is not dealt with directly in the EU Committee's report, namely the effectiveness of the Government in arguing the UK's case in Europe. A constant complaint from the financial services industry over recent years is that the Government have been too little engaged in the detailed processes of EU policy formulation. I know that the Minister has of late been engaged in the alternative investment funds directive, but I am less clear, for example, about ministerial involvement in the current reshaping of the architecture of financial regulation and supervision. As I understand it, a Minister is not leading those negotiations, which are being left to UKREP—that is, to Brussels-based civil servants. Can the Minister enlighten the House on the level of involvement of the Government in these important negotiations? My own party's proposals include a significant increase in ministerial commitment to Europe, including a Treasury Minister with specific responsibility for financial issues. That Minister would not be tied down by other significant responsibilities and will devote as much time in Brussels, and indeed with other member states, as is necessary to achieve the right outcome for the UK.

A number of noble Lords have referred to the alternative investment funds directive, which has not had a good press. The better regulation principles, as has been referred to, have largely been thrown out of the window. The draft seems to show a misunderstanding of the range of companies that will be affected and it is not based on any empirical evidence about the causes of the financial crisis, as the EU Committee pointed out. The directive, if implemented, would have a particular impact on the UK because of the nature of the financial services companies operating here.

The Government's rather weak response to the committee merely talked about working with the affected firms with the aim of a full understanding of the impact of the draft directive and to draft alternative proposals. My noble friend Lord Trimble referred to the fact that there have been more recent changes in relation to the draft, and I hope that the Minister will update the House on the latest state of play. Can he assure the House today that the Government will achieve a result that eliminates the harmful parts of the draft directive in terms of protectionism, in terms of cost to the industry, and in terms of the restriction of investment choice for EU investors?

The de Larosière proposals to change the architecture of financial regulation are even more worrying. The EU Committee was right to flag this as an area on which the Government need to do more work. There have been movements since the committee's report, but not for the better. The Minister described the proposals as having a "chilling consequence" for the financial services industry in the UK when he gave evidence to the Treasury Select Committee in another place last week. He said that the Commission had gone further than the European Council had contemplated. That, of course, is what the Commission does whenever it gets half a chance.

The key issue here is the new supervisory authorities, which will be created out of the existing level 3 committees, and their potential impact on the UK's financial services sector, which, as other noble Lords have pointed out, is much larger than those in other parts of the EU. Other member states have less at stake and can also, unfortunately, see an opportunity to cut the UK down to size. This is particularly the case for the proposed Securities and Markets Authority, where the UK has an overwhelmingly large share of the securities market and where industry players regard the UK as at particular risk from this aspect of the new proposals.

We have no problem with the new authorities acting as the focal point for the development of micro-prudential standards within the EU, provided that they remember that the global dimension is even more important than EU standardisation. My noble friends Lord Trimble and Lord Leach reminded us of this. However, there are problems with the ability of the new authorities to issue binding technical standards. As currently drafted, the powers for the Commission to alter those standards on a unilateral basis, or to have the final say in disputes between national regulators, are not acceptable.

We have major problems with the proposed powers in relation to individual institutions in the so-called "emergency situations". We support the Government's line that the authorities should not act if that impinges on the UK's fiscal responsibilities, but the current draft does not achieve that. An ex-post appeal to the Council, which is then determined by qualified majority voting, is several steps too far. Will the Government set out clearly where their red lines are? My noble friend Lord Trimble has already pressed the Minister on this point.

The EU Committee also pressed the Government to clarify their thinking on the proposed European Systemic Risk Board. We have no problem at all with an EU body which can survey financial stability and contribute to the macro-prudential work of national regulators and, indeed, at a global level. There is no reason to believe that such a body would have prevented the financial crisis but, equally, no harm can come from co-ordinating views on emerging financial stability issues across Europe.

However, we have concerns if that body expects to do more. As a non-eurozone country—I hope for many years to come, if not indefinitely, I say to the noble Lord, Lord Newby—the ECB seems an odd home for the European Systemic Risk Board. I probably part company with my noble friend Lord Renton on this. This is exacerbated by rumours that the UK will not automatically be represented on the ESRB steering committee, which is where all the important things will be discussed, and probably decided, given, as has already been pointed out, that the ESRB will total an unwieldy 61 members. Do the Government have any red lines on the ESRB, and where do they draw them?

The two reports have given the House a valuable opportunity to debate important issues. I look forward to the Minister's response because it will give the Government an opportunity to explain in detail how they will protect the UK's interests over the next few months. I hope the Minister will lay out clearly what the Government intend to achieve and, just as importantly, the things that they will not tolerate in any final proposals.

Photo of Lord Myners Lord Myners Parliamentary Secretary, HM Treasury 10:00, 10 November 2009

My Lords, I thank the noble Baroness, Lady Cohen of Pimlico, and the noble Lord, Lord MacGregor of Pulham Market, for allowing us to have such a timely and excellent debate. I also thank all noble Lords for their informed and, at times, challenging interventions. I congratulate the European Union and Economic Affairs Committees on their insightful and extremely well argued reports.

As your Lordships are aware, the Government strongly support moves to improve the quality and consistency of supervision, ensure more effective rule-making and enforcement and better identify risks in the financial system. That is why we support the proposals to establish the three new ESAs and to give them strong rule-making roles, a leading role in enforcing rules, responsibility for peer review and the ability to settle disagreements between supervisors. Such moves will improve the quality and consistency of supervision and are supported by the City and cross-border institutions represented in London.

However, as the Government have made clear a number of times, we need to ensure that day-to-day supervision and crisis management arrangements remain national, as it is only national Governments who can provide the necessary fiscal support to firms. As the noble Lord, Lord Trimble, said, they are a necessity for that function. As my noble friend Lord Desai observed, there is a need for resource, and I have yet to see a credible burden-sharing agreement that could allow that responsibility to rest with the EU as opposed to national Governments. I therefore reassure the noble Baroness, Lady Noakes, immediately that a red line exists as far as we are concerned. That is why the Heads of Government agreed at the June meeting of the European Council that the new framework should not impinge on member states' fiscal responsibilities and, therefore, that day-to-day supervision should and must remain national. As a result, it is clear that there can be no direct crisis management powers over firms or other direct powers that undermine such national supervision. That is another red line that I would draw to the noble Baroness's attention in responding to her concluding remarks.

The Government also agreed in June that the new European supervisory authorities could directly supervise credit rating agencies—on which I shall say a little more in a moment—given that their failure would not result in a fiscal obligation for national Governments. So there is a consistency of approach on this point.

This is an agreement on fiscal responsibility with which we must and will stick. In some areas, the Commission's proposals do not respect the Council's agreement as articulated in June and repeated by ECOFIN in October, in particular where it proposes European powers over firms and European crisis management powers. Here, we will need to bring the proposals back into line.

There are also, as the noble Lord, Lord Leach of Fairford, said, legal issues in the proposals of which the Government are well aware. I shall not go into the detail, but let me be clear: regardless of the technicalities, the Government's overriding objective is that the framework must be able to withstand legal challenge. We cannot have legal uncertainty and challenges before the courts. That would undermine confidence and financial stability. We are therefore working closely with other member states of like mind and the Council's legal service to ensure that the new bodies are on a sound legal footing and, in particular, comply with the Meroni principles. These areas are problematic, but I believe that they can be resolved.

Let us not forget, however, that while there are outstanding issues and questions, this is a positive agenda for reform which the Government strongly support. We are putting in place a new framework that will improve the quality of supervision and regulation. Such a framework will better protect consumers, help prevent financial crisis and improve efficiency for firms.

Finally, we need to ensure that this is a better and more effective regulation and therefore is based on strong evidence, thorough consultation and robust impact assessments, as my noble friend Lord Haskins reminded us.

I know that many noble Lords have questions about the fiscal safeguard clause in the proposals. I have said before that this is a mechanism that in practice should never be used. The ESA is required to ensure that it does not impinge on member state fiscal responsibilities. However, alongside this is a process set out in legislation. We need to ensure that this process is not open to abuse but provides the right protections. I am not convinced that the balance is currently right; we are working with EU member states, many of whom share our concerns to improve the safeguards clause. This is a proposal that, in the main, must be agreed with a QMV in council, meaning that a majority of countries with a two-thirds majority of votes and roughly two-thirds majority of population must approve the measures. Clearly that means that we cannot stop a proposal on that basis alone. However, I am confident that I we can ensure that we achieve a solution that meets our concerns. I remind noble Lords that there are elements of the package on which unanimity is required.

I understand the concerns expressed by the noble Baroness, Lady Cohen, about the speed of reforms at EU level and better regulation principles. It is, of course, important to respond swiftly to the crisis. However, I agree that the desire to act swiftly should not be at the expense of high-quality regulation. It is more important than ever to ensure that our response is evidence-based and will achieve the desired ends. Clearly there was an absence of evidence base in the alternative investment management directive, to which I shall return in a moment. Having a high-quality evidence base will also maximise the influence of the EU on the international stage with our international partners, and better enable the EU to attain international regulatory convergence.

I turn to the Economic Affairs Committee report on Banking Supervision and Regulation.As noble Lords will be aware, in July this year the Government published the Reforming financial markets White Paper. This document presented the Government's strategy for the reform of regulation and supervision of financial markets, and particularly the banking sector. The document consults on a wide range of questions relating to this reform agenda, including proposals for primary legislation.

While financial services organisations, their managers and owners must take responsibility for their part in the economic crisis, it is clear that the Government need to take action, too. We announced that we would legislate to establish a new Council for Financial Stability to analyse emerging risks to the financial stability of the UK's economy and co-ordinate appropriate responses. We will enhance the FSA's regulatory powers to support its new, strengthened and more systemic approach to regulation and supervision. We will strengthen the objectives of the FSA, including providing the FSA with an explicit financial stability objective; making clear that the FSA should consider both the wider economic and fiscal costs of instability and the potential impact on economic growth of stability-enhancing measures; and creating an explicit duty for the FSA to have regard to the need to work internationally.

Sir David Walker is due to report later this month on the governance landscape in the banking sector. The noble Lords, Lord MacGregor of Pulham Market and Lord Haskins, among others, spoke on that issue and about whether banks were conceivably too big to manage. The noble Lord, Lord Willoughby de Broke, also mentioned that. That is an issue not only of concern for the regulators but for the owners and boards of directors. Frankly, some of those directors did not understand what the companies on whose boards they sat were doing. The shareholders certainly did not understand—or, if they did, they did not engage properly. There is a need for everybody to raise the standard of their game here, and I do not exclude the Government or regulatory structures from that imperative.

Sir David Walker will make recommendations for far-reaching changes to strengthen board challenge and shareholder oversight, and improve the quality and independence of risk management. Last week, the Chancellor announced the intention to legislate to enable the Government to implement Sir David's recommendations. In parallel, the FRC is reviewing the combined code and considering which of Walker's preliminary recommendations have application beyond the banking sector. I think that many of his recommendations will be judged to be non-sector specific and to have a broader applicability than financial institutions alone. The FSA is implementing remuneration principles, designed to ensure that remuneration practices no longer incentivise excessive risk-taking but run in parallel with, and are supportive of, effective risk management.

The noble Baroness, Lady Noakes, asked about the alternative investment fund managers directive. We have worked on that assiduously. It has taken a considerable amount of ministerial and official time. The original draft was exiguous and poor in both evidence and understanding of the industry, but I am much encouraged by the progress that has been made. We are likely to end up with a directive that is broadly satisfactory from the point of view of investors in the United Kingdom, those who operate their businesses from the UK and, importantly, as far as financial stability is concerned. The noble Lord, Lord Newby, mentioned the work of Miss Sharon Bowles in the European Parliament. I echo that: I think Miss Bowles is doing an excellent job.

The noble Baroness, Lady Cohen, asked a number of questions. I should immediately say to noble Lords that at this late hour I will not be able to answer all the questions that were asked without the noble Baroness's eyebrows disappearing into her forehead, but I will try to respect the amount of time that noble Lords have set aside for me to speak and cover as many questions as I can.

My noble friend asked whether I agreed that there should be explicit countercyclical capital requirements. I answer that question burdened by the observations of the noble Lord, Lord Skidelsky. Certainly, there is a consensus around the G20, the FSB and the FSA—and indeed the Government in our Reforming Financial Markets White Paper—that capital structures now need to bear down on cycles rather than enhance them as has been the case in the past. My noble friend also asked about the return of the banks in which the taxpayer currently has a shareholding. I can only repeat that it is our wish to see these banks returned to private ownership as soon as possible, consistent with achieving value for the taxpayer, contributing to competition and enhancing financial stability. Many months ago, I said in answer to a question from the noble Lord, Lord Forsyth of Drumlean, that I believed taxpayers would earn a good return on the support that they have provided to the banking system and I remain as strongly of that view as I have ever been. As we all know, it is necessary to be patient at times.

The noble Lord, Lord MacGregor of Pulham Market, noted many points of agreement with the Government on macroprudential issues and on liquidity. He also observed that bonuses were unpalatable to him in some respects and I will return to that subject later on. There is clearly a role for the Bank of England in terms of financial stability, but I respectfully do not agree for a number of reasons with the case made for the Bank taking back microprudential responsibilities. First, it is far from clear that the Bank would want to be responsible for the microsupervision of the Shepton Mallet building society. Secondly, there is a logical integrity to having responsibility for monetary decisions and responsibility for regulatory decisions resting in different entities because there are situations in which a decision could conflict with those two objectives. One might want to increase interest rates, for instance, because of a judgment about the economy, but at the same time one might be concerned about the stability of financial institutions and not want to increase interest rates.

I also observe—correctly, I think—that the Bank is inclined to be an academic institution. It is modest in size but huge in terms of intellect. It is not well suited to managing an organisation employing nearly 4,000 people, as is the case for the FSA. I wonder whether the choice of governor might not be influenced in future if these two organisations were combined. You would need very different skill sets.

We are very fortunate in having a governor of such excellence. However, he is a governor drawn from an intellectual, academic background and is not necessarily somebody whose career would have inclined him towards wanting to manage a huge organisation on the scale of the FSA. There are plausible arguments but I am not going to suggest that there is one superior model of regulation and supervision. We know, effectively, that all models fail to a greater or lesser extent. It does not make sense to disturb the current architecture.

The noble Lord, Lord MacGregor, raised issues about the Financial Services Compensation Scheme. The FSA is currently consulting on that and no doubt it will look at whether a risk-based mechanism is suitable. I also agree with the noble Lord's observations about credit rating agencies. The noble Lord first—and other Members later—raised the issue of Glass-Steagall, which dates back, as the noble Lord, Lord Skidelsky, said, to 1933. I believe that the model that we are proposing achieves the goals of a Glass-Steagall outcome without the disruption, disturbance and practical difficulties. We place great emphasis on capital. The noble Lord, Lord Skidelsky is right to say that this requires judgment—and judgment, to some extent, from people whose judgment has, in the recent past, not proved to be absolutely perfect in forecasting. However, I come to life as an optimist, always believing the best of people and hoping that we learn from our experiences.

A Glass-Steagall model is difficult to achieve. The distinction between retail and investment banking is far from clear. Even if it was feasible, it is not necessarily the case that one would separate the risk of contagion from the two separate constituencies. Those who speak in favour of Glass-Steagall imply that all the risk lies in investment banking, but global experience suggests that that is not the case. Some quite narrow institutions failed.

Instead, we see the combination of increased capital requirements and the living will. I emphasise here that the significantly increased capital requirements are for the most risky activities—those which were transferred, perhaps because of accounting conventions, to trading books. The living wills are the recovery and resolution plans which will ensure that, if part of a banking institution gets into extreme difficulty, it can be separated from the rest of the bank without doing damage to the rest of the institution or the system. I have no doubt that there will be very substantial resistance from the banking industry to the concept of the living will, but I am equally clear about the Government's determination, as will be reflected in forthcoming legislation, to ensure that we introduce living wills in this country, and to advance the case for living wills to the G20.

The noble Lord, Lord Renton of Mount Harry, has served the committee with distinction; I am sad to hear that he will be leaving it. He asked about the European Systemic Risk Board, and suggested that it could be an important step forward. I also believe that it could be. It certainly has the components of the right economics and philosophy to give rise, I hope, to greater confidence in financial stability in the future. I think it will act, as I explained to the committee this afternoon, as a good warning system for inclement weather coming towards us.

The noble Lord, Lord Renton, raised the issue of the Tobin tax, as did the noble Lord, Lord Newby. The Prime Minister laid down at the G20 Finance Ministers' meeting in St Andrews a very clear marker that we need to search out institutionalised solutions to the problems that we have experienced, including the fact that the build-up of leverage through wholesale funding meant that, ultimately, that risk came back to the taxpayer. There is an implicit guarantee in the banking system for which no premium is being paid. We managed to get quite a nice premium out of Lloyds for the implicit guarantee that it had under the APS. The Prime Minister was saying that we need debate about this. It could take the form of a liability insurance premium, a Tobin tax or a couple of other ideas that he floated, which I cannot immediately remember. They were all incredibly good; I remember thinking that the minute I heard them. He is going to make sure that we develop an international consensus through the G20.

The noble Lord, Lord Skidelsky, talked about the sources of the problems. To me this has been a bit like a Russian doll in that whenever I got to where I thought the problem lay—it was rather convenient for a while for us to think that it all stopped with sub-prime in America—there were further Russian dolls in there. This core issue of imbalances across the world is undoubtedly one that the IMF and the G20 will need to address, or, if they do not, they need to recognise that they are themselves a critical potential contributor to financial instability in the future, and therefore an early chapter for the FSB and the ESRB to address. I noted with great interest the noble Lord's comments on the great deception of spurious accuracy that came from statistical risk modelling. I defer to my noble friend Lord Desai, whose reputation as a model is so well known to all in the House. I was fascinated by the 1913 quotation from JM Keynes. I shall certainly look to use that in the future.

The noble Lord, Lord Trimble, spoke about the possibility of an impingement on national fiscal resource. I hope that I have answered that. He also referred to the conciliatory tone of some of our language on these issues. I hope that will be interpreted not as a wavering in our determination but rather as an approach to getting consensus in Europe; however, I have been very clear that these are red-line issues. The meetings of the systemic risk board will involve 61 people but there will be only 27 voting members. That still seems to me quite a large number, although less than the membership of the shadow Cabinet. Importantly, the decisions on the day-to-day issues that we have discussed this afternoon will lie with committees, expert groups and the secretariat.

The noble Lord, Lord Trimble, raised questions about RBS and state aid. It was very clear to Lloyds, Northern Rock and RBS that state aid would require remedies and that there would be consequences of failure. We cannot have a system in which institutions that fail do not bear any consequences at all. The companies and their shareholders must bear the costs, as indeed must the subordinated debt holders, as we have agreed with the EU. We were consulted and we did negotiate with Neelie Kroes on this. I and others spent many hours talking with the Commissioner and her staff on these issues. It is absolutely critical in my view that the Royal Bank of Scotland reduces its complexity and gets back to a point where it is more manageable and, in so doing, if we can get an outcome which encourages new entrants—which we believe this outcome could do—that is another plus. The noble Lord, Lord Willoughby de Broke, reminded us that Mr Hester had described the experience as bruising. The noble Lord, Lord Newby, reminded us that it was pretty obvious why he would do so. I have been negotiating with Mr Hester for 12 months and he is a bruiser himself. I have no doubt that Mr Hester is perfectly capable of standing up for the interests of the shareholders of Royal Bank of Scotland. If he does not like this outcome, he can go to a phase 2 review. He has clearly chosen not to do so, so his conclusion must be that this is in the best interests of the Royal Bank of Scotland.

The noble Lord, Lord Willoughby de Broke, quoted Mr Haldane. Of course, Mr Haldane would no doubt have given this space and gone on to explain that hedge funds do not take deposits and do not operate funds transfer systems, and therefore clearly can be run to very different standards from banks. Deposit insurance does not cover all deposits.

I apologise to those whose comments I have not covered, to whom I shall write. I shall try to wind up at this point.

The noble Lord, Lord Willoughby, asked about the EU's ability to supervise our institutions. This is so important because many noble Lords raised this point. It is not proposed to move the supervision of financial institutions to the EU level. However, it includes issues such as emergency powers and direct powers over firms that could undermine national supervision and have a fiscal impact. We need to correct this. These proposals will be decided using QMV. This means that we cannot block them alone. However, I say to the noble Lord, Lord Willoughby de Broke, that many member states share our concerns on these matters and I am confident that we can work with the grain of good argument to convince others that the position taken by the Council in June was correct and should hold.

I disagree with my noble friend Lord Desai on Bear Stearns; I agree with my noble friend—or rather, the noble Lord, Lord Forsyth; he was so kind to me earlier that I almost felt that I had to call him my noble friend. My noble friend Lord Desai emphasised the importance of judgment. I am grateful to the noble Lord, Lord Forsyth, for his kind words; I shall pass over his less kind observations about one or two other people. However, I agree with him that there will need to be economic adjustment involving reduction in debt levels—at the individual level and the government level—and that will take time; but it needs to take place at the right time. However, I do not disagree with the noble Lord that that is the direction in which we need to travel.

The noble Baroness, Lady Hooper, spoke about innovation. Keynes said that all financial innovation was about leverage, and the capability of managing innovation will be a big concern. It is clear that the chairman and board of directors of the Royal Bank of Scotland had very little idea of what was going on in major parts of that bank. It was absolutely shocking, but it is the shareholders who should be holding them to account. I continue to urge the shareholders, as the noble Lord, Lord Haskins, said: step up to your responsibilities; you are there as fiduciary owners. These institutions require active and engaged owners.

I think that I have answered most questions of noble Lords. The Government feel that they are being held to account by these committees. We are fortunate to be informed in our deliberations by such a wise and experienced group in the work of these committees. My thinking on some of these issues has moved on—of which the committee somewhat rudely reminded me. However, I am not ashamed of that; I benefit from the wise advice we receive.

My final point is that there is senior ministerial involvement in negotiation with the EU on the architecture of the new supervisory boards. The Chancellor is very involved in this issue at ECOFIN meetings, as is the Prime Minster at European Council meetings. The Chancellor and I regularly discuss this; and other Treasury Ministers and I work with our opposite numbers in Europe. The proposals are being negotiated at attaché—official working group—level but they will come back to ministerial-negotiation level before final agreement on the new architecture. Ultimately, they will need to be agreed by the European Council as being consistent with the framework set out in June.

I apologise for taking a long time, but I can only pay tribute to the quality of input from the House. I agree with the noble Lord, Lord Forsyth, that it is a shame that this debate is being held late in the evening. This has been an extraordinarily good debate, comprising outstandingly well informed and challenging observations. I thank noble Lords for their part in it.

Photo of Baroness Cohen of Pimlico Baroness Cohen of Pimlico Labour 10:28, 10 November 2009

It has been a great pleasure and very illuminating to share a debate with another committee engaged in another version of the subject and attacking it from another angle. It has been a worthwhile innovation and I suggest that we do it again. Indeed, we may have to do it again in order to support my noble friend the Minister in his efforts to ensure beyond peradventure that the new European supervisory authorities cannot make regulations that impinge on the UK's financial sovereignty. I thank all who have taken part in the debate and the Minister for his long efforts with both committees and in summing up this difficult debate.

Motion agreed.