Motion to Take Note

Part of Financial Regulation: EUC Report – in the House of Lords at 7:49 pm on 10th November 2009.

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Photo of Lord MacGregor of Pulham Market Lord MacGregor of Pulham Market Conservative 7:49 pm, 10th 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.