Committee (3rd Day)

Part of Financial Services (Banking Reform) Bill – in the House of Lords at 5:00 pm on 23 October 2013.

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Photo of Lord Turnbull Lord Turnbull Chair, Audit and Risk Assurance Committee (Lords) 5:00, 23 October 2013

My Lords, I support the amendment and the account given by the noble Lord, Lord Lawson. I shall add a bit of background to this matter. For probably two decades, up to about 2004, the leverage ratio of the British banking system fluctuated between 20% and 25%. It then rose, reaching a peak in 2008 of somewhere over 40%. The Government’s wish that the number of the leverage ratio should not be greater than three implies that the limit of their ambitions is to get this leverage ratio back to 33%, which is still, by historical standards, a very high ratio.

A very interesting chart in the Vickers commission report shows how risky people thought assets were. It shows that they fell—this is the assessment that banks put into their own models—between 2004 and 2008. How can anyone believe that 2008 was a year of greater financial stability? I believe the way this came about was as follows. You said in 2004, “I have a portfolio of commercial property and have not lost a penny on it in the past 10 years, so I will give it a weight of X”. You come to 2008, four or five years later, and say, “I have still not lost any money on this, which tells me that this portfolio is not as risky as I thought it was in 2004, so I will give it a lower risk rating”. What is happening all the time when you have an upswing is that, as the upswing gets riper and riper, the risk weights go down and down, until there is a clash. The whole purpose of having a leverage ratio is to provide a backstop to that. One or two people argue that we should run on basic leverage ratios alone but, in my view, both the leverage ratios—unweighted and risk-weighted—should run in tandem. Each provides a check on the other. Relying solely on risk-weighted assets leads you into the farce of banks marking their own homework and doing the opposite of what they should be doing by marking things as less likely at precisely the moment in the cycle where they become more likely.

Another argument that has come up in relation to 3% and 4% is that we must not get out of step with regulation abroad. However, when it comes to risk-weighted assets, the Government have accepted that they want to impose a higher figure—partly because we have more systemically important banks and it is important for a medium-sized economy running a very large banking sector for that sector to be safe. When you say, “Does that not mean that what we thought was a 3% figure should move pari passu”, the answer is, “Oh no, we can’t do that because we will get out of line with what everyone else is doing”. But if you can do it for one of these measures, why can you not do it for the other? I find that argument completely unconvincing.

There was a view in the commission that higher leverage ratios were a good thing. However, that is not what this amendment is about. Although we thought that, the amendment says that it should be the FPC that makes the judgment. As my noble friend Lord Eatwell has pointed out, the absurdity of hiring this super-duper, global-standard central banker and then not giving him this essential tool until the very point at which his contract ends is beyond belief. It seems an absolutely simple point that the FPC should start this. Elsewhere in the world, other people will be thinking about this and it seems very strange indeed to leave the Bank and the FPC unable to start deploying this measure.

There is an argument that certain kinds of banks, particularly those with low-risk assets, will find that this 4%, or the leverage ratio, becomes the binding ratio. People making that argument cite, principally, various former building societies. You have to look around and ask where the biggest failure in Britain was. It was former building societies thinking that they had a portfolio that was a good deal safer than it really was. Some of them also got into quite a lot of commercial real estate. Northern Rock, for example, would have been well advised to have followed a leverage ratio of this kind. If it turns out that the supply of mortgages is not adequate—although we are doing lots of other things to promote it—you might want to differentiate between one kind of organisation and another. That should be done by the regulator as a derogation from a world in which we are working with higher leverage ratios than the Government currently envisage.