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Before we begin, I have a few preliminary announcements. Members may, if they wish, remove their jackets during Committee meetings. Will all Members please ensure that all mobile phones, pagers and other electronic devices are turned off or on to silent mode? If something goes off while on silent mode, I ask Members to switch it off or, if they are going to answer it, to leave the Committee Room.
There is a money resolution and a Ways and Means resolution in connection with the Bill, and copies are available in the room. I remind hon. Members to give adequate notice of amendments. As a general rule, my fellow Chairmen and I do not intend to call starred amendments, including any starred amendments that may be reached during an afternoon sitting of the Committee.
First, the Committee will consider the programme motion on the amendment paper, for which debate is limited to half an hour. We will then proceed to a motion to report written evidence, and then to a motion to permit the Committee to deliberate in private in advance of the oral evidence sessions. I hope that we can deal with that formally.
Assuming that the second motion is agreed to, the Committee will move into private session. Once the Committee has deliberated, the witnesses and members of the public will be invited back into the room and our oral evidence session will commence. If the Committee agrees to the programme motion, it will hear oral evidence this morning and this afternoon. From Thursday, we will revert to the familiar process of clause-by-clause scrutiny of the Bill.
I beg to move,
(1) the Committee shall (in addition to its first meeting at 10.30 a.m. on Tuesday 21st October) meet
(a) at 4.30 p.m. on Tuesday 21st October;
(b) at 9.00 a.m. and 1.00 p.m. on Thursday 23rd October;
(c) at 10.30 a.m. and 4.30 p.m. on Tuesday 28th October;
(d) at 9.00 a.m. and 1.00 p.m. on Thursday 30th October;
(e) at 10.30 a.m. and 4.30 p.m. on Tuesday 4th November;
(f) at 9.00 a.m. and 1.00 p.m. on Thursday 6th November;
(g) at 10.30 a.m. and 4.30 p.m. on Tuesday 11th November;
(h) at 9.00 a.m. and 1.00 p.m. on Thursday 13th November;
(i) at 10.30 a.m. and 4.30 p.m. on Tuesday 18th November;
(2) the Committee shall hear oral evidence in accordance with the following
Tuesday 21st October
Until no later than 12 noon
Tuesday 21st October
Until no later than 1.00 p.m.
Bank of England; Financial;
Services Authority; Financial;
Services Compensation Scheme.
Tuesday 21st October
Until no later than 5.45 p.m.
British Bankers Association;
Building Societies Association;
London Investment Banking Association.
Tuesday 21st October
Until no later than 7.00 p.m.
Association of British Insurers;
Investment Management Association;
Citizens Advice Bureau;
(3) proceedings on consideration of the Bill in Committee shall be taken in the following order: Clauses 155 and 156; Clauses 158 to 233; Clauses 1 to 76; Clause 157; Clauses 77 to 154; Clauses 234 to 240; new Clauses; new Schedules; remaining proceedings on the Bill;
(4) the proceedings shall (so far as not previously concluded) be brought to a conclusion at 7.00 p.m. on Tuesday 18th November.
Thank you for your helpful guidance, Mr. Hood. It is a pleasure to see you presiding over us today. I am sure that all members of the Committee will benefit from your guidance, and that of Mr. Gale, as we proceed through the scrutiny stages of the Bill. We had an encouraging Second Reading, which reflected the widespread support, on both sides of the House, for the principles and much of the content of the Bill. However, I appreciate that there are issues of detail that deserve full consideration, and I look forward to addressing those in Committee.
On 14 October, the House agreed a programme motion that provides for the Committees proceedings to conclude on 18 November. On 16 October the Programming Sub-Committee agreed a programme resolution for the Committee. The resolution provides for oral evidence to be presented in two sittings today. It also provides for discussions of the Bill to take parts 4 to 7 first, minus clause 157, which relates to part 1. We will then take parts 1 to 3that is, clauses 1 to 154 plus 157; and then part 8that is, clause 234 to clause 240, plus any new clauses and schedules.
As I explained at Second Reading, the ordering is primarily to provide additional time to bring forward drafts of some of the key documents, including the code of practice for the special resolution regime, required under clause 5. I hope that hon. Members find the arrangements set out in the resolution satisfactory.
I welcome you to the Chair, Mr. Hood. We look forward to working under your chairmanship, and that of Mr. Gale and, for a brief spell, Mr. Illsley.
As the Minister said in his opening remarks, there was broad support for the Bill at Second Reading. There was also a commitment, on our part, to ensure that the Bill has a smooth passage through the House and the other place, to enable it to reach the statute book before the Banking (Special Provisions) Act 2008 expires in February 2009. We are grateful to the Minister for arranging the reordering of the consideration of the Bill, because we believe it is important that there is time to study the draft code of practice and the principal regulations underlying this Bill prior to the debate on part 1. It would be helpful if the Minister were to indicate when he expects the draft code and regulations to be published, because that would clearly impact on the speed of consideration in Committee.
Despite the broad support for the Bill, there are areas that we will want to probe in detail between now and 18 November. I am sure we can do that and ensure proper scrutiny of the Bill.
Some members of the Committee might be disappointed that the Liberal Democrats are not represented by the sage of Twickenham on this occasion. We will be led by my hon. Friend the Member for South-East Cornwall (Mr. Breed) who is unfortunately out of the country at the moment. He has appreciable experience of both retail and investment banking. We have no objection to or difficulty with the programme motion as this is an important and highly technical bit of legislation.
Many representations made by the banking industry and others recommend a holistic approach. People are concerned about what may be caught up in the code of practice or secondary legislation. I welcome the Ministers assurances that as much as possible will be put before the Committee during its deliberations and as much inkling as possible will be given about the future secondary legislation that follows in its wake.
Ian Pearson: I should like to make a brief introductory statement. The Banking Bill to be scrutinised by the Committee is being brought forward during challenging times for financial markets and economies across the world. The Bill is one important part of a package of action and reform to improve the UK system for ensuring financial stability and protecting depositors. I am encouraged that the Bill received cross-party support on Second Reading. It was disappointing that the Leader of the official Opposition seemed to go back on that in his speech to the City on Friday, which showed a complete lack of judgment and sought to play party politics rather than act in the national interest.
Ian Pearson: The measures in the Bill are designed to form a permanent reform of the UK framework. I want to emphasise that it is the result of a comprehensive process of consultation, which we could discuss in more detail, including three consultation documentations issued jointly by the Treasury, the Bank and the Financial Services Authority. We have consulted with key industry players and experts, many of whom we shall hear from later today. We have had valuable input from the Houses Select Committee on the Treasury. We want to get the reforms right.
I say from the outset that the measures in the Bill represent a proportionate and sound package for reform. However, we shall go into Committee with an open and consultative frame of mind. The Government have made the correct decision in taking the past few months to develop the legislative package, including publishing some of the key clauses in draft, for public debate and scrutiny over the summer. The Bill will provide a sound enhancement to the framework for financial stability and depositor protection. I am happy to take questions on any aspect of the Bill.
Before the first question, I remind Members that the questions should be limited to matters in the scope of the Bill. To assist me and the Committee, both questions and answers should be brief and succinctthen we shall get more questions and answers.
How did the Minister seek to reassure stakeholders in the Bill? How have issues around creditor rights and so on been dealt with, given the pressure to ensure that the Bill is passed quickly but also that legitimate concerns are being answered? How has the Minister sought to reassure interest groups?
Ian Pearson: I want to make two points in response, the first on consultation generally and the second specifically on creditor rights. As I indicated, there has been extensive public consultation: three rounds of formal public consultation, a number of stakeholder workshops and meetings in February, July and August 2008 and the publication of draft clauses for the most complex part of the Billthe special resolution regime. During those consultations, we had more than 200 responses from a mixture of stakeholders, including banks, building societies, insurers and bodies representing citizens, consumers, workers, businesses, legal insurance professionals and credit unions. I believe that the Bill has been consulted on extensively.
With particular reference to creditorsthe hon. Member for Fareham talked about themwe have paid very close attention to stakeholder feedback from the latest round of consultation. For instance, in response to that feedback we have created in the Bill a framework for a range of creditor safeguards to protect set-off and netting arrangements and to protect creditors in the event of a partial transfer. We will continue to engage extensively with stakeholders over the coming months.
I recognise that creditor rights is a very important issue, and that is one of the reasons why I announced on 9 October the establishment of a new expert liaison group to help to prepare the secondary legislation for the special resolution regime. The Committee will be aware that a number of the key elements of the safeguards will come in under secondary legislation. The expert liaison group will be formed from representatives of the banking sector, legal experts and members of the authorities, and I have written to industry experts inviting them to participate in the group. As I have said previously, I hope that we can work effectively together to co-produce the secondary legislation that will be required to ensure that we get it right.
Ian Pearson: We hope to publish the draft code of practice next Thursday, which should be in time for consideration in this Committee the following week. As I have previously indicated, I hope that we will be able to provide the detail in terms of the principles that will guide the secondary legislation, but I do not think that we will be at the stage with the expert liaison group of having written that legislation. That would be premature, but we will intend to make available all the key policy questions and principles behind the legislation.
How will you ensure that those principles are made available before the Committee gets to the relevant stage of the Bill? It is important that there is proper parliamentary scrutiny in this place as well as in the other place, and the earlier we have sight of those principles the better informed the scrutiny process.
Ian Pearson: I will endeavour to get the code published in draft and available by next Thursday, and we will do our best to provide the principles sufficiently in advance of discussing the clauses to which the secondary legislation will relate. I want to emphasise that we see the expert liaison group as playing an important role in helping us to define the secondary legislation, but that that legislation will come before the House in due course and be scrutinised in the usual thorough way.
Ian Pearson: The Chancellor has made it clear that the Government and the authorities need to act generally across the system, as well as having the tools to be able to intervene appropriately in individual cases in order to preserve the financial stability of the system. It is clear that we have been operating under the Act that we passed in February of this year, but a lot of the actions that have taken place have been in the spirit of this Banking Bill.
The Bill provides both general and specific measures to enhance the resilience of the UK financial system for the future, including powers through the special resolution regime for the UK authorities to take decisive action where individual banks are at serious risk of failing. We have seen how that has happened. The Bill will provide a wide range of permanent measures to strengthen the UK framework for financial stability and for depositor protection. That is why it is important to have the Bill on the statute book by the time the Banking (Special Provisions) Act 2008 expires.
Ian Pearson: I do not intend to do that. The five statutory objectives set out in the legislation explain the purpose of the regime. The SRR provides five tools as well, which can be used by the authorities. The objectives provide guidance for the authorities, Parliament and market participants, on how the special resolution regime powers will be used. By putting the powers on the face of the Bill we have ensured that Parliament can hold the authorities to account if they believe that any action has, or has not, been taken in accordance with the statutory objectives. You have to see the objectives as a whole rather than say that one has more importance than the other. They are all important.
Ian Pearson: The objectives are obviously high level and concerned with ensuring the stability of the financial system and the ability to take action. I would not want anything to be said that would detract from the importance of maximising the amount available to creditors in the event of default . But there are wider objectives, in terms of stability of the financial system.
Ian Pearson: We believe that it is potentially an important additional tool. The special resolution regime gives a number of different options. There is the option of transfer through private sector purchase, the option of the bridge bank, and the option of temporary public ownership. We think that there are instances where it might not be possible to transfer assets and property to private sector purchasing, but it might be possible to make a transfer to a bridge bank on a temporary basis, which could then be moved into the private sector at a subsequent date. We think that it gives flexibility to be able to act in the best interests of financial stability to deal with a situation where there is a failing bank or building society.
The nearest analogue to the present situation is Lloyds of London in the 1990s, where toxic assets were reinsured in a kind of spiral, so that nobody quite knew the value of the assets. What Lloyds did was to identify and isolate the toxic assets. Did you think of using such a model?
Ian Pearson: As I understand it, in many ways, what is proposed in this legislation could allow that to happen. It is certainly possible under this legislation to transfer some assets to a bridge bank or through private sector purchase and to retain assets that might be regarded as toxic in a residual company, which would then be subject to the bank insolvency procedure in the legislation. I do not know whether you would like to add anything to that, Emil.
Emil Levendoglu: Just to say that in cases where assets and liabilities had been left behind in the residual company, it would be the bank administration in part 3 rather than the insolvency procedure in part 2. The Minister is absolutely right to point out that the partial transfer possibility allows for a split between good and bad assets.
Ian Pearson: We certainly believe that it is necessary, and part of this answer goes to the last but one question about a bridge bank. We see bank administration procedure as being used when the stabilisation option being used is that of a partial transfer generally to a bridge bank. After the partial transfer, the residual bank is likely to be insolvent, and the bank administration procedure is designed specifically to deal with the insolvent residual bank. It will allow the insolvent residual bank to continue providing essential services to the transferee. The administrator will have statutory objectives to ensure the supply of essential services and facilities to the private sector purchaser or to the bridge bank, and to rescue the residual bank as a going concern or to wind up its affairs. It should be seen as something that will operate at the same time as a partial transfer either to a bridge bank or until a private sector purchase takes place.
Would the use of the administration procedure as you describe it mean that jobs would be lost in the residual bank? Would the administration procedure mean a running down of the residual bank?
Ian Pearson: It is not right to say how the administrator would want to pursue its duties. The administrator would certainly have objectives for ensuring the supply of essential services and either rescue it as an ongoing concern or wind up its affairs. It would normally want to do that in the best possible way. If it can rescue the bank, it will want to do that and, if it is to wind up its affairs, it will want to do that in a responsible and appropriate manner.
Ian Pearson: We made the judgments about Northern Rock at the time and, without getting into party politics, they were not necessarily supported by all political parties. We believed it right that Northern Rock should enter into temporary public ownership. We thought that that decision was in the best interests of all concerned, and we remain of that view. As you will be aware, Northern Rock has paid back more than half of the funding provided to it already and we look to it to continue to do well in the future.
The administration method that you describe sounds similar to what has been done with Bradford & Bingley. Will you say whether that is a fair characterisation so we can understand that, in practice, the Bradford & Bingley model is similar to the administration procedure set out in the Bill? Why did you adopt that approach then, but not with Northern Rock?
It is just that it is helpful for us to understand what it will look like in practice. You would not disagree with the Bradford & Bingley model, with a partial transfer to Abbey of the deposit holding?
It is almost impossible these days not to panic the City. How will you square the circle between having arrangements that are completely transparent, and not causing undue panic as a result of a firms involvement in the special resolution regime? Are you giving serious thought to how news of the special resolution regime will be communicated, both internally and externally?
Ian Pearson: As I said earlier, we are currently at the stage where we believe we have got the general principles of the Bill and the detail of the special resolution regime right, but a lot of the operation of the special resolution regime will depend on secondary legislation. We have been clear in the consultation documents to date about the general principles of the SRR. We have noted stakeholders concerns about it, and that is one of the reasons why we set up the expert liaison group, so there is a great commitment there to working in partnership with those who have interests in the legislation. We want to be as open and transparent as possible, which is one of the reasons why, during the Committee stage next Thursday, we will publish
You do recognise the problem that if a degree of transparency causes panic in the market, to some extent the special resolution regime will not work as perfectly as it might?
Ian Pearson: Let me come on to that point. There is first the point about getting the legislation right, and then how it will be implemented if it is thought right to do so in the future. On that latter secondary point, we have been clear in the legislation that it is the responsibility of the Financial Services Authority to take the decision to initiate the special resolution regime. It is the Bank of Englands responsibility to decide which tool to use, and its implementation of that option must be presented to the markets in a single step. I agree that any period of uncertainty surrounding these processes could undermine the resolution of a failing bank. That is why it is important that the authorities work closely together on this, and why although there are clear roles and responsibilitiesand rightly sothere will be close working between the three authorities.
I want to ask some questions about the regime for depositor protection. To what extent do you think that in setting up the enhanced scheme, the Government have abandoned the idea of moral hazard and consumer responsibility, by diversifying the risk across investments?
Ian Pearson: I do not think that we should abandon the principle of moral hazard, but the actions taken in the past to ensure stability were right. As my hon. Friend will be aware, the FSA recently increased the compensation limit to £50,000. It is currently consulting on reforms to the scheme. We have made it clear that the Government will do whatever it takes to ensure that depositors have confidence in their savings, and that is the right approach in the current circumstances. However, you should not assume that, by saying that, we have completely abandoned the concept of moral hazard, because that would be the wrong thing to do.
When Mervyn King came to see us he said that a scheme like this, if the banks were to pre-fund it, would amount to tens of billions of pounds, which he called non-negligible. Since then, to maintain confidence in the banking system has cost more than thatit has been hundreds of billions. What modelling have you done about how much would actually be needed for the scheme? What kind of bank collapse would it be able to deal with? Could it deal with an HBOS? What size of bank? When will you publish the draft regulationsthere are some in clauses 155 onwards, but I mean more detailed ones?
Ian Pearson: I will let Emil answer the question about regulations, but I will say something about the broader approach. When the Governor of the Bank of England came to speak to you, he did so in slightly different times. Many of us have been living these events day by day, and the unprecedented crisis that we saw in global financial markets meant that we had to take unprecedented action, and rightly so. That is why the Government have said that they will do whatever it takes when it comes to deposits, and that is why we have seen the bank capitalisation programme and the money going in to ensure liquidity and support inter-bank lending. Many other countries have adopted that approach across the world, and it has been the right one to try to bring stability to the financial system.
Emil Levendoglu: Absolutely. As Ministers have made clear, the power to pre-fund the Financial Services Compensation Scheme, in part 4 of the Bill, is taken as a power to be used in the futurethe medium to long term. This would not be the appropriate time to introduce pre-funding, and there is no plan to introduce draft regulations until a decision has been taken as to whether to proceed with pre-funding. That will be at some point in the future when market conditions have changed.
Ian Pearson: Perhaps I can reply to that. The Government will make a decision, in conjunction with the FSA and the Bank of England, as to when the economic and financial circumstances might be appropriate to make progress with pre-funding. As Emil said, we want to make that decision before publishing regulations.
May we go back to depositor protection and the variations in it? When Northern Rock began to have difficulties, the compensation scheme changed and went up to 90 per cent. It went up to £35,000. Recently, protection increased to £50,000 and now offshore depositors in failed Icelandic banks are told that they are totally protected. Can you point to a genuine practical compensation limit, or is it a case-by-case decision being made by the Government?
Ian Pearson: The Financial Services Authority has a £50,000 compensation limit. As you will be aware, it is consulting on possible variations to that limit and that remains our position. In the extraordinary circumstances that we were faced with, we thought it right to say that the Government would do what it takes, and to ensure that no retail depositors of Icelandic banks lost their money. We still think that that was the right decision to ensure public confidence in the banking system in the United Kingdom.
We certainly live in extraordinary times; may I begin by congratulating the Treasury team? I think that you have worked extremely well in amazing circumstances. I thought that the Government had a lot of things to deal with, but we effectively have a strike of capitalism, with the banks refusing to lend money to one another. I hope that the measures we are taking can get them back to work and get them lending the money to businesses again. The SRR that the Government are bringing in is presumably the nuclear option. You would not want to be using that too often. What can you do to prevent us getting to this situation?
Obviously there needs to be some global regulation. A lot of ordinary people feel that there has almost been criminal negligence here. What can we do to prevent these sorts of things happening in the future? We are seeing large amounts of taxpayers money being used to prop up the banking system. It must never be allowed to happen again. I appreciate that we need to act quickly, but we also need to get some responsibility back into the banking system.
Ian Pearson: I think there are a number of different points. First, on what my hon. Friend calls the strike of capitalism, which we tend to call inter-bank lending, the Government have provided £250 billion to support inter-bank lending. We believe that we will make a difference and we are already seeing a reduction in LIBOR rates. So there is an indication that this is working. Clearly, the operation of this special resolution regime only happens in exceptional circumstances. We hope that the legislation that we will discuss in detail in due course will never have to be used, but it is important to have that framework of legislation in place so that we can take decisive action and give a framework of confidence to banks and building societies as well for the future.
The other point that I would want to make is about the enhanced role that we are giving to the Bank with regard to financial stability. We see that as being an important part of the Bill. The Bank has always played a role in financial stability, but the proposals in the Bill build on what is done to date and provide it with a high-level statutory responsibility for contributing to the maintenance of financial stability. We see that as one of the ways in which we can say that we have learnt lessons from recent events and are building a more robust system for the future.
Just so there is no doubt, I think that the Treasury team have been running around like a load of headless chickens. They have been lurching from one set of goalposts to another. So I take a slightly different view from the hon. Lady. May I refer the Minister to the Banking Bill regulatory impact assessment? Paragraph 1.192 says in big red lettering:
Ian Pearson: You say it is open to debate and I know that your leader wants to airbrush out of history the facts of the sub-prime crisis in the United States and that most countries across the world are taking similar action to us because they are in similar situations due to the combination of the credit crunch and high oil and food prices. I do not think there is much debate. I think there is a very small minority opinion that does not accept that there has been and is a global financial crisis.
With regard to what you say about the regulatory impact assessment, I refer you to clause 162, which allows the FSA to make rules allowing it to obtain information that the FSCS may require to carry out its work or prepare for payment of compensation. The FSA is working with the industry to establish how customer-level information can best be provided to the FSCS and on what basis compensation is calculated. The FSAs plan is to consult on new rules in due course and in line with its statutory obligations. This will include a cost-benefit analysis of any new rules. I think that that covers the point that you are making.
Mr. Chairman, I think the Minister said customer-level in that answer. I am trying to understand why that customer information is wanted in advance of a collapse. The nearest comparison I can think of is a collapse of a travel firm where ABTA will, immediately after the collapse, get the information about the customers who are travelling and then refund. Why do you want customer-level information to go to a Government agency before the collapse?
Emil Levendoglu: The FSCS will not necessarily require customer-level information prior to collapse in order to take a view as to what work is needed to prepare for payout. It may need to see the sort of information held by the institution so that it can judge how quickly it can prepare for payout in the event of the firm collapsing. The point about customer-level information relates to the work around ensuring that depositors get fast payout and the question of the single customer view has come up in consultation and also in the Treasury Committees report. The question of how customer-level data are provided in the event of a payout is one that the FSA is working on with the industry to work out the best possible solution. So customer-level data may not be required prior to default.
Finally, Mr. Chairman, we have already touched on it but there is the matter of funding this compensation scheme. I link it again to the travel industry, where the funding is put up by the travel companies and paid into a fund so that it is there for when a company collapses. It is very strange that we are treating bankers with kid gloves and not making them contribute. Last year, one of those banks made £9 billion. Are we talking one thing for bankers and another thing for other companies?
Ian Pearson: I understand the point that the hon. Gentleman is making. However, it remains our view that pre-funding at this stage would not be appropriate. We do believe that in different times there should be pre-fundingwe have said so on recordand it is why there are powers to do this in secondary legislation. We do not think it right to go down that road at the moment.
The Bill says that an objective of the Bank should be to
protect and enhance the stability of the financial systems of the United Kingdom.
It is not clear what tools, other than a financial stability committee, it will have to carry out that function. Can you tell us more?
Ian Pearson: I thought you might. I emphasise to the Committee that the Bill gives the Bank of England responsibility for oversight of the payment system. The Bank of England also has responsibility for taking action under the special resolution regime, in the event of a failed bank. I suspect that the hon. Gentleman is probing more on how we prevent getting into a situation in which the SRR has to be introduced
I am probing whether the Bank has the resources to do what is set down in its new objective, which is not to manage the stability, but to contribute to protecting and enhancing our ability to protect stability.
Ian Pearson: The Bank has always played a key role in financial stability. In recent years, its court of directors has sought to engage further with the Bank in overseeing such objectives and their effectiveness. The Bill puts in additional responsibility for financial stability. It is right for a new legislative objective to underpin that. This approach recognises important differences between monetary policy and financial stability, which we shall probably discuss in a moment. It allows the Bank strategy to deal with changing market circumstances. We shall obviously discuss with the Bank how it implements its enhanced responsibilities.
Indeed, that is set down in the Bill. The strategy is co-devised with the Treasury.
There were comparisons on Second Reading to the Monetary Policy Committee, which is an Executive committeeit decides interest rates. The Bill gives a committee the power to make recommendations, to give advice in various areas and to monitor the activities of the Bank at various points. It is not an Executive committeeis that right?
Ian Pearson: There are a number of different potential models. We see the financial stability committee as different from the Monetary Policy Committee; it certainly does not have Executive powers in the same way. That is not to say that there are not executives on it; our proposals are for the financial stability committee to include executives. Equally, we do not see the financial stability committee as like a companys remuneration committee, which would consist completely of non-executives. The Bills hybrid approach, with the committee having both independent members and executives on it, is the right one. In many ways, the analogy is more with how Government might run a Department or Cabinet Committee, rather than with a private sector or Monetary Policy Committee model.
Is there no difficulty having the effective chief executive of the Bank chairing a committee to which the Bill gives the power to monitor his activity? The Governor certainly has Executive functions. Is there no conception of possible conflicts in that? I would have thought that they were obvious.
Even with the excellent Governor that we have. Having a robust conversation about how the powers were exercised is not the role of the committee. Its task is to monitor within the Bill. How can it have that debate with the person or persons who carry out that function actually chairing its deliberations?
Ian Pearson: I do not see the conflicts that you suggest are there. It is more a case of ensuring that we have robust debate within the financial stability committee and that it has responsibilities for contributing to the maintenance of financial stability. It is a sub-committee of the court, and the accountability mechanisms are through the court. I do not see a problem with it being chaired by the Governor of the Bank of England. Indeed, there are many strengths in ensuring that that takes place.
It is not entirely clear within the Bill whether it does always report through the court. You may wish to reflect on the precise wording of clause 216. There are elements when the court is referred to and there is an obligation to report through it, but there are others when it seems to communicate to whoever it feels so inclined to do.
Just to help the Committee, will the Minister look at proposed subsection 2B(2)(a) of clause 216? It refers to a recommendation through the court of directors, but the rest of the clause appears to consign its thoughts into a vacuum of wherever it thinks those functions should be best directed. Where did the idea of the financial stability committee come from? The Select Committee probed that, and no one put up their hand, said that it was their idea and that they thought it was great.
But surely it should be made clear in the Bill, which we shall scrutinise, to the wider public what the Banks remit in respect of financial stability is, rather than relying on the Bank to know the meaning of financial stability, and for it perhaps to emerge from some discussion. Should it not be in the Bill?
Ian Pearson: I do not believe that a detailed definition in the Bill would be helpful. That is a debate that we can hold when we reach that part. Nor do I think that there any difficulties in the Bank of Englands interpreting its responsibilities when it comes to financial stability. I am sure that you can ask it the question.
One of the criticisms levied at the tripartite arrangements was the lack of clarity about who took the lead and who took responsibility for certain issues. Does not leaving a broad description of financial stability out of the Bill give rise to the same sort of challenge in the future?
Ian Pearson: As I said, perhaps you can ask the Governor whether he believes very strongly that there should be a definition in the Bill. We do not feel inclined to have one, and we think that there are good reasons for not going into specific detail about what is meant there. Undoubtedly, one of the purposes of these evidence sessions is to gather evidence, which can help us to form our deliberations when we come to the detailed consideration in Committee.
In relation to financial stability, the Minister referred in his helpful opening statement to the recapitalisation of the banks, which would fit within the framework that we are discussing. There was an injection of £37 billion in shares; have the terms and conditions of those share offerings been determined and when is it likely that the share issues will take place?
Ian Pearson: When I made my introductory remarks, I made it clear that the Banking Bill was part of a range of reforms and actions that we are implementing as a Government. We have taken action with regards to recapitalisation of the banks. The package of measures that was announced included £37 billion for bank recapitalisation, an increase in the special liquidity scheme to £200 billion, and £250 billion for debt guarantees to support inter-bank lending. That is a big package in anybodys book. The details of the individual negotiations are not in the remit of the Bill, but the Government are acting in the usual transparent way in that area.
But the Prime Minister said the opposite yesterday. I thought that it was as the Minister said because I have looked at those documents. However, under questioning yesterday, the Prime Minister said that the terms and conditions had not been finalised, so I am trying to find out whether they have been.
I have a general, simplistic question. Decades ago, regulation of banks took place behind closed doorsthe Governors eyebrow and pressure brought to bearand banks got regulated. Did you, as a Minister, seeing this massive tome, wonder whether it would be possible to make regulation much simpler, and just authorise the Bank of England to do what is necessary to regulate and control, and to ensure the security of the banking system? Were questions asked about whether all this detail was necessary? It is absolutely certain that we will be back in a years time with a banking (amendment) Bill and, I suspect, the following year and the year after.
Ian Pearson: Sometimes people hark back to the days when they knew their bank managerwhen if they ran a business they just had to go to their bank manager and say, I need a bit of money, and it would get sorted out. Perhaps they also hark back to the days when the Bank of England regulated more informally. I think that the world has changed. Modern regulation is very different from the regulatory regimes that were in operation in the 1950s and 60s. The whole worlds financial markets have changed quite dramatically.
The decision we took in 1997 to bring all the different regulators together was the right one. It is interesting to note that many other countries have adopted our approach. I remember working for a company whose members were regulated by FIMBRA, LAUTRO and IMRO. There was a range of different regulatory bodies. Bringing them together in one body covering not just banks and building societies but insurance and other areas is a model that has been copied around the world. I think that it is the right one. I know that there has been debate about this, but I believe it is the right approach to adopt. In the current climate, to suggest that we can rip that up and have light or little regulation is not what people expect. It would not be the responsible thing to do.
May I add a last word about the details of the agreements? I am advised that only very minor details are still to be settled on the agreement between the banks in question and the Government, so the information in the Library contains all the substantive detail involved.
You may not be able to answer this, but do you have any idea how long it will take for the banks to get back to normal and start lending money properly to business and things? Do you think that the recession we could be heading into is caused by the financial situation with the banks?
Ian Pearson: That is going a bit broader than consideration of the Bill, but let me say a few words on it. That is a real question for many of our constituents. It is very difficult to give a straight answer. There has been a global financial crisis. We know that it started in the United States with problems in sub-prime lending. We know that until recently it has been exacerbated by high oil and food prices. That has produced a challenge for financial institutions and economies right across the world. We have seen the United States taking action. We have seen Germany, France and Italy do so. Only recently we have seen the recapitalisation of ING. We have seen announcements that Sweden is taking action to bring greater stability to its banking system, too. We are all taking action. We are all desperately trying to get bank lending going again. There are some signs that it is working.
Ian Pearson: I am optimistic that we have turned the corner with regard to bringing stability to the financial system as a result of the actions that we have taken, and that others have taken following our lead. We cannot say that we are out of the woods yet, but, as I said on Second Reading, we are on the right path. The fact that others are following a similar path gives us signs for encouragement. There are clearly big concerns about the impact it has had and will have on our economies, which is one reason why the Government are looking at taking a range of actions to support people and businesses through difficult times. The best thing that we can do is to have a Government who are on the side of people and businesses, and trying to take prompt and decisive action to support them.
This is a general question. Clearly, the public are going to have high expectations of the Bill as being able to prevent the kind of catastrophe that we have seen in recent months. What do you say to people who say, Well, actually what happened was down to some dysfunctions in some banks that were not properly regulated or managed by the people who were supposed to be doing so. So, how is the Bill going to make a difference and which particular measures are going to make a difference? What do you say to the public?
Hang on. You say that it is not meant to outlaw sub-prime lending in the US, and obviously it cannot do that, but it is supposed to make the banks here spot when some of that sub-prime lending is bundled up, packed over here and cannot be dealt with. That is where we came in.
Ian Pearson: One of the things that is certainly in the Bill, which we have just been talking about, is an enhanced role for the Bank in ensuring financial stability. Financial stability should take into account some of the things that my hon. Friend is talking about. Clearly one piece of legislation cannot do everything. I hope that I have been very clear that this is one part of a package of reforms and actions that have been taking place. I also want to emphasise the enhanced supervisory framework that the Financial Services Authority has been adopting. We have learned lessons from Northern Rock, and I suspect that there are further lessons that we need to learn as a result of the global financial crisis, but I am confident that the legislation is robust and is needed to ensure that we have a permanent regime in the first place.
The message to all of us is that we need to understand the global nature of international monetary markets better, and to understand that one needs a global response to regulation. The Prime Minister has been pushing for that for the best past of a decade or more. When he was Chancellor of the Exchequer, he said that there needed to be greater co-ordination globally on financial markets and institutions. I do not think that we currently have the institutional arrangements that will be needed, which is one of the reasons for a lot of the interest and activity that has taken place in that area. It is not part of the Bill, but it is part of the learning experience that we have all been going through.
Order. Thank you, Minister and Mr. Levendoglu. I now call the next group of witnesses. We will hear evidence from representatives of the Bank of England, the Financial Services Authority and the Financial Services Compensation Scheme.
Lady and Gentleman, welcome to this mornings meeting. Beginning with the lady, would you introduce yourselves, please?
These questions are addressed to the representatives from the Bank of England. The Governor said that it was more important to get the special resolution regime legislation right, rather than rush it through to a fixed timetable. To what extent are you convinced that the Bill gets it right?
Nigel Jenkinson: As the Governor also said, he thought that by October the Bill would be in a sufficient position to be scrutinised extensively by Parliamenta process that is now under way. We believe that the Bill is in such a state. We strongly support the current Bill and think that it is ready to be taken forward.
Nigel Jenkinson: That is a debate which has taken place in the past; it is not a proposal that is currently in the Bill, where it is clear that the FSA will pull the trigger. But the Bank can, and will, make recommendations in particular cases. That is the debate we have had and a decision has been made. We will wish to operate under the framework that is now in the Bill.
Nigel Jenkinson: Further information will be published. We are working with our colleagues in the FSA and the Treasury in terms of revised memorandums of understanding protocols on how the new arrangements will work. As I have stated, under those arrangements we will be able to make recommendations; there will be good information sharing between the FSA and the Bank of England and we will be in a position to make such recommendations, but it will be the responsibility of the FSA to make the actual decision. I do not know whether Tom wishes to say anything on that.
Dr. Huertas: I very much agree with my colleague from the Bank of Englandboth on the way that the process would work, and that in the Bill there is a provision for the FSA and the Treasury to recommend to the Bank the resolution tool that would be adopted. That is a solution that we heartily endorse.
Under the terms of the Bill, you may lack the legal power to pull the trigger, but do you not have a de facto power to pull the trigger? If a bank came to you, looking for help to enter into liquidity or some other form of financial assistance, the fact that you can refuse would, by necessity, place the bank in the special resolution regime.
Nigel Jenkinson: The particular issue of which the FSA would have to take accountand they will take accountis whether a bank is continuing to fulfil the threshold conditions for regulation and/or the likelihood of being able to improve the position. If a bank came to the Bank of England seeking additional liquidity support and liquidity assistance, that is undoubtedly something that we would be talking to the FSA about, and the Treasury too, in respect of finding the right approach for that particular bank.
Nigel Jenkinson: It depends on the circumstances. Together with the Treasury and the FSA, we would have to make a decision about whether to provide liquidity assistance in those particular circumstances. It is not clear that there would be an issue of liquidity in all cases. For example, there might be a case where a bank had poor capital levels that the FSA was concerned about. That factor might lead the FSA to believe that the bank was failing to meet its threshold conditions and, consequently, could be a candidate for the special resolution regime. Not all cases would necessarily go along the lines that you suggest.
Dr. Huertas: Indeed, some of the considerations that I imagine our colleagues at the Bank have under review are the need to provide liquidity under the conditions outlined in the Red Book revisions, and the wish to avoid the possibility of stigmatising any bank that sought liquidity under those conditions. The question of liquidity provision to banks should be seen generally. It is not always with respect to emergency liquidity assistance.
Nigel Jenkinson: For my interpretation I can do no better than quote the Governor when he was asked that question by the Treasury Committee. We consider a situation of financial stability to be one where the financial intermediation mechanism works normally, where households and corporates can mediate their savings into real investment in the economy at home and abroad, and where the payment system operates normally. It is a situation where intermediation works well, where people have confidence in the system and where the payment system operates well. That is a reasonable working definition, although there are clearly many definitions of financial stability.
Yes, but do you think that it would be helpful to define financial stability in the Bill? Clearly, the Bank will be held to account on its ability to deliver financial stability. At the moment that is a high-level concept, which is undefined in the Bill. How can we hold the Bank to account if there is no definition, even along the lines that you have outlined?
Nigel Jenkinson: I do not personally think that it is necessary to have a definition of financial stability in the Bill. We produce regular reports, with which I hope that you are familiar. For example, we will continue to publish our financial stability report in which we give our assessment of the risks and vulnerabilities to the financial system, state whether we think that there are threats to financial stability or the likelihood of financial instability and discuss what can be done to remedy that position and improve the resilience of the financial system. I do not think that it is necessary to have a definition of financial stability in the legislation, but in terms of a broad working definition, we would subscribe to the one that I have just set out.
You talked about the financial stability report, and your organisation was one of those that pointed out some of the issues that were building up in the economy. What tools do you have to implement your responsibility for financial stability?
Nigel Jenkinson: We have a number of tools. First and foremost is the one that you referred to in terms of the role of the central bank as the ultimate supplier of liquidity in the economy. That is a crucial role for central banks and is very important in determining financial stability. As Tom Huertas has indicated, we have just undertaken a review of that function and put out a new document about how we will conduct our liquidity operations.
The role of payment systems and financial infrastructure is an area of crucial importance to the financial system, and one in which the Bank has particular responsibilities. The Bill goes further in providing it with statutory responsibilities. There will also be responsibilities in the Bill for the functions of the special resolution authority. More broadly, in the financial stability report, we aim to provide an assessment of where we believe there to be risks and vulnerabilities in the financial system, and set out what policies and changes can be adopted to try to improve the resilience of the financial system.
We provide advice to the Financial Services Authority, for example, on some aspects of the prudential regulation framework. We participate in a range of international committees, such as the Basel Committee, the Financial Stability Forum, and the committee on payment and settlement systems, which set standards to try to strengthen the resilience of the financial system. Across a wide range of areas we can exercise the responsibility set out in the Bill, to try to improve financial stability and to strengthen the protection and enhancement of financial stability.
It seems to me that you lack the ability to intervene to maintain our stability. If you go back to the issue that was identified about growing levels of debt in the economy, what tools are at your disposal to affect that?
Nigel Jenkinson: As I have already indicated, we have policies in respect of liquidity, which is absolutely central. It is another area, but clearly the Bank has important monetary policy objectives in terms of the responsibility to set interest rates in line with the inflation target. As regards the regulatory framework, we can and do get involved in some aspects, such as the liquidity framework, in which I am personally involved on an international committee. The pure regulation and supervision of banks, however, is clearly delineated to the FSA, which is fine.
John Footman: It is an immunity that we had when we were supervisor, which the FSA also has as a supervisor. As we are getting the more formal roles in financial stability set out in the Bill, including roles in the special resolution regime and the oversight functions of payment operations, it seemed sensible for us to have the same statutory immunity as the FSA and other regulators. It is not totally unusual in the sense that you mean extraordinary.
I would like the FSA to answer this question: do you think that the public would be surprised, having had the biggest financial crisis for 100 years, with runs on banks and banks nearly going bust and being nationalised, if the regulatory bodies immune themselves from being sued? Would not the public think that rather strange?
Dr Huertas: In terms of the exercise of public duties, with respect to compensation that might be due to shareholders there is provision in the Bill for such compensation. It is in that area that shareholders and other creditors would be able to seek compensation, rather than suing the particular agencies directly for damages.
But do you not think that the public would think that was rather strange? The regulators have obviously failed, because we have got to this situation, but nobody can actually sue the regulator.
Dr. Huertas: It is a separate discussion as to whether the regulators have failed, but there are countries where there is an ability to sue and it constrains quite clearly the ability of the supervisory authorities to take necessary actions and it interferes with the possibility of taking prompt action to correct matters. Although the public might be surprised, an ability to sue the regulator for damages can interfere with the ability of the regulator and the supervisor to take timely action.
The tripartite arrangements left the Bank of England with general responsibility for financial stability, but put the supervision of individual banks upon the FSA. Now the Bank is to be charged with a range of new responsibilities relating to bridge banks, private sector purchaser tools, partial transfer tools and so on. How will it ensure that it has the resources and the expertise that it will need for that duty?
Nigel Jenkinson: In terms of the resources that we will need, obviously we will have to ensure that we have the right staffing in place. We have a strong staff already in place. In some areas we may seek to bring in people with additional skillsfor example, to fulfil some of the tasks in the special resolution authority. It is important that we have a strong working relationship with the FSA. I am very confident that we have such a relationship and that we can continue to strengthen it further. It is important to have access to the information that we need to fulfil that responsibility. I believe that we can and will undertake the responsibilities that we are being granted, should the Bill be passed.
I have put it to the Governor and others that a good regime would have the FSA responsible for regulation, but that when it comes to supervision and action, the Bank should be the supervisor. What steps can you take, short of what has been described as the nuclear option of the special resolution regime? What range of measures do you have available, short of that?
Nigel Jenkinson: I shall ask Tom to comment on that. As you indicate, we very much hope that the use of the special resolution regime will be a last resort prior to institutions getting into a position where they are failing to meet their threshold conditions and it is not very likely that they can remedy that. There is obviously a strong role for supervisors working with the banks to try to remedy that position. When institutions are getting under stress the Bank will be thinking very hard about planning. Should the worst case happen in terms of special resolution, we will be increasingly involved as institutions get under stress. We will be providing advice to the FSA, but I think that Tom should talk about the regulatory tools.
Dr. Huertas: Extensive powers are available to the FSA under the Financial Services and Markets Act 2000 with respect to supervision and with respect to inducing banks to take remedial measures. However, as we have seen over the past year, in a rapidly deteriorating economic environment not all remedial measures can be as successful as we would hope. Institutions may come to the point where a resolution has to be implemented, and the type of co-operation that Nigel has described has been very instrumental there, as well as working with the Financial Services Compensation Scheme to effect a prompt and orderly resolution. We anticipate that the passage of the current Bill would allow that type of situation to continue.
Nigel Jenkinson: We already have close contacts with many financial institutions through our operational role. As the operational arm of Government in respect of the financial system we have an operational framework, which we try to build on, to improve our understanding of what is going on. In terms of financial market developments, we have in recent years significantly enhanced what we call our market intelligence function, which is led by my colleague, Paul Tucker, the markets director. We will need to put additional resources into our analysis and understanding of individual financial institutions, particularly when there are perceptions that those institutions are getting into stress conditions or when financial market conditions, in general, are getting into stress. It is important that we share the information that we collect from our market intelligence and that we share the analysis that we undertake on risks in the financial system and individual institutions with our colleagues in the Financial Services Authority, and that they do the same with us.
It is a matter of making sure that we are working together positively and co-operatively from time to time, and perhaps challenging each other constructively. I am confident that we can build and develop such a relationship, and none the less make it absolutely clear that we are not duplicating the work of the FSA and that the delineation of responsibilities is very clear; the FSA is responsible for implementation, supervision and regulation and the Bank is responsible for the functions set out in the Bill. I believe that we can do that.
I want to ask the FSA, in particular, about the trigger mechanism. There is an argument that there is a risk of regulatory forbearance because, in a sense, triggering the regime would be a sign of regulatory failure. Do you accept that? If so, how would you guard against it?
Dr. Huertas: I do not think that it has been a realistic possibility. In the UK, in particular, the market is a very stern disciplinarian. The market moves quite quickly to bring to everyones attention institutions that have difficulties and to force the hand of the authorities to deal with those institutions. The only way in which forbearance might be exercised is by the provision of very large and extensive amounts of liquidity.
Is the trigger mechanism sufficient? Clause 7 on page 4 sets out two conditions and then there is the consultation process. One condition is whether or not the bank satisfies the threshold and the second condition is a judgment call as to whether the bank might be able to recover. Applying those two conditions, would you have picked up Northern Rock, for example?
Dr. Huertas: I believe that the answer is yes to that. The possibility of preventing a bank run would be greatly enhanced, but I would find it difficult to sit here today and sayindeed, it would be difficult for anyonethat the possibility of preventing a bank run is absolutely banned. The overall prospect of the Bill, which allows us to deal much more promptly with a failing bank situation and to resolve it in a manner that protects depositors and strengthens the ability of the Financial Services Compensation Scheme to pay out to depositors, is a much better place than where we were in September 2007.
Dr Huertas: The judgment is with respect to the interaction with the bank, its capital and liquidity plans and whether they are realistic and capable of execution within the relevant time frame and, as Nigel and others have pointed out, we would also have the benefit of recommendations and consultation with the bank and our colleagues at the Treasury.
You will have some criteria you will look at. In terms of the public, suppose something goes wrong again and it comes back to a Select Committee, which can say, What were the objective criteria? and What factors did you take into account in condition 2? People would see that. The staff would be trained in that, as well.
May I follow up the issue that Sally raised about potential bank runs and panic? Clearly a balance needs to be struck between transparency regarding the special resolution regime and not inducing panic among the public. Could I ask the FSA in particularI will be grateful for the thoughts of the Bank of England, toowhat your communication strategy will be regarding measures taken under the special resolution regime? How are you going to avoid panic?
Dr. Huertas: It is very important that the decision about whether the trigger should be pulled is closely co-ordinated with the solution that is to be adopted, and that a communication strategy be developed at the same time, so that all three things are done together as a piece. Unfortunately, we have had the opportunity for a good deal of practice in that regard. The importance of that overall co-ordinated approach has been very much driven home and that is something we expect to continue.
The most striking thing about the last 13 months or so, about the various developments in this crisis, has been that practically every interesting bit of information has been revealed by Robert Peston on the BBC News. To what extent has that been a major difficulty for the FSA and the Bank of Englandthat control of the story appears to be in the hands of Robert Peston rather than the authorities? Is there anything in this regime that will prevent that happening again?
Do you identify it as a problemwhether with existing powers or under these new powersthat every story seems to be breaking not through official channels but through leaks to a particular journalist? Is that an issue for financial stability?
You were sitting at the back when the earlier questions were asked, so I can run through them briefly. It is clear from the Bill that the financial stability committee is not an executive committee. It has a hybrid scrutiny and advisory role. Is that your understanding?
John Footman: Yes, it is a committee of the court. I shall go back a stage: if functions are given to the Bank, as the Bill does, they are initially exercised by the court of directors or the board of directors, and it is likely that the court in any circumstances would have wanted to create a sub-committee. There is already an informal one at the Bank called the financial stability board. The financial stability committee would be a natural thing for the court itself to create to help it carry out the functions. The financial stability functions are significantly different in how they affect the Bank from the monetary policy functions.
The monetary policy functions take monetary stability and deal with that quite separately. Just dealing with the risk-free interest rate does not affect a lot of the activities of the Bank. Monetary stability is much broader.
John Footman: The Governor said that to the Treasury Committee. But it does affect the way in which the functions are managed. It goes to the balance sheet. It goes to risks, and it goes to controls. It also goes to decisions that the court will have to takefor example, about the lender of last resort, transactions outside the normal course of business, collateral swaps that would not be within the normal delegations to the Governor and the executive. The court would need to be consulted and to decide on them. That is why a financial stability committee is something that the court would create, and give executive functions.
Good. I have that. The Bill, as I explored earlier, is not absolutely clear about the relationship between the financial stability committee and the court. It is in certain respects, but not in other aspects. Would you welcome a clarification of the clear subsidiarity of the financial stability committee or do you feel that allowing it to float free to some extent is desirableas appears to be the intent of the Bill, as drafted?
John Footman: The Bill requires the court to create the committee. It does not completely flow free. A clause enables the court to delegate functions to it. It is very likely that the court would want to delegate, for example, short-run immediate transaction decisions to it. There is already a transactions committee at the court, so they could be rolled together. The functions in the Bill are to recommend financial stability strategy to court, which will decide and then advise.
You heard the exploration as to the role of the Governor. He is designated as the chair of the financial stability committee, yet part of the committees function is to scrutinise the Banks executive role for which he is responsible. That is an unusual combination of roles, is it not?
It may help if I quote the Bill. It says
to monitor the Banks use of the stabilisation powers.
I interpret that as a scrutiny function normally carried out by non-executives, but the committee would be chaired by the main executive responsible for the delivery of those functions.
John Footman: That is, in a sense, why I wanted to stress that the function is given to the Bank. Typically, the court delegates to the Governor, as the executive, a range of functions, but reserves certain decisions to itself. It is reasonable for the committee to advise the executive and also to exercise some of the functions that the court reserves to itself, and it would do so. It is also likely that there would be oversight within the committee. The fundamental oversight processthis goes back to the 1998 Actis the court, or the non-executive of the court in what is called NedCo, which reviews the Banks performance in delivering its various activities, with the exception of monetary policy.
There is an implicit suggestion that a somewhat different character of membership might be required to carry out this role, which it has now been given rather more explicitly than in the past.
John Footman: At least four of the non-executive members would be members of the financial stability committee, and would require the skills, abilities and knowledge to exercise that function. The remaining nine membersor eight if you take out the chairman of the FSA, who is usually on the committeewould review the performance of the Bank in its financial stability role. You are right: expertise and ability would be needed in that as well.
There is a reference in the Bill to co-opting other non-voting members. I hope that is a means of recruiting those who are not necessarily UK citizens, but have valuable experience of financial stability issues. Of course, the Bank already has someone from the Scandinavian banking system who, even before this happened, advised it on stability issues, presumably based on the experience of nearly 20 years ago. Is that the kind of model that is envisaged regarding the use of that power?
I should like to kick off with some questions on depositor protection. The Governor of the Bank of England banged on about moral hazard many times on television. I think I understood what he meantwe do not want irresponsible lending and we have to bear the consequences of the risks we take. On the other hand, although we have talked about a £50,000 limit to depositor protection, we all know that it is effectively 100 per cent. We have seen that with Northern Rock and the Icelandic Banks. Politically, the Government do not dare allow depositors to lose money in banks.
Was the Governor saying moral hazard for soundbite purposes, or was he serious? If he was serious, what is he saying to the Government regarding their actions in giving, in effect, 100 per cent. protection?
Nigel Jenkinson: The question of moral hazard is important in the design of financial regulation and the operation of the financial authorities. The Governor is right. It is important to look hard at what incentives the systems of regulation and supervision entail with regard to the behaviour of participants in the financial system. On the specific issue of deposit insurance, the Bank view is that there is merit in a risk-based, pre-funded system of deposit insurance. The opportunity and the powers to implement it are clearly set out in the Bill, should the Government decide to do so. However, given current financial circumstances, the decision has been taken not to adopt that measure now, and it will be a decision for Government in the future. It is important to think hard about the respective incentives in terms of how the system is designed. It is important to think about moral hazard issues.
I am not quite clear. Let me give an example. Were the Government right to protect all retail depositors with the Icelandic banks? At that time, the scheme said that deposits of up to £35,000 were protected. That is where it should have come in. People who had money above that amount should have lost it. That is the moral hazard aspectpeople who went to an Icelandic bank that gave a higher rate of return were taking a moral risk. That is not what happened; the Government rushed in and said that we must protect everyone. There might be somebody who is very rich and had £5 million in an Icelandic bank. Such a person is protected the same as somebody with only £35,000. Does that not drive a coach and horses through the idea of moral hazard?
Nigel Jenkinson: The Government took the decision last week and that was a decision for Government. You raise an important question about whether there is a hard limit in the longer run. In the current stressed circumstances and conditions where people do not have much confidence in the financial system, a strong case can be made that it is important to retain and protect depositor confidence. That is the decision that the Government took last week. In other circumstances, under more normal financial market conditions, where suddenly a bank gets into particular difficulties on its own, it is possible to make a different decision. In terms of financial stability, it is important to look at the conditions of the time. That was a factor behind the Governments decision last week.
Nobody 13 or 14 months ago would have expected a bank to fail. No one anticipated that the Financial Services Compensation Scheme would have to step in to repay depositors. Will Ms Minghella set out what lessons the FSCS has learned over the last year and what changes it needs to make to adjust to the new financial climate?
Loretta Minghella: I would start by saying that it has been very clear over the last 13 months how important it is for people to know what compensation will be available to them and to be confident that that can be paid quickly. The FSCS has always dealt promptly with the failure of smaller credit unions and deposit takers. We have the experience of dealing with about 35 of those and an MP thanked me the other day for dealing with his claim very quickly. He is joined by many thousands of people who have had that benefit.
Over the last year we have also been able to participate, thanks to the Banking (Special Provisions) Act 2008, in much larger-scale rescues. For example, in the case of Bradford & Bingley, we paid £14 million overnight so that 2.5 million people went to bed on 28 September banking with Bradford & Bingley and woke up on 29 September banking with Abbey. That was a tremendous result in terms of consumer protection. That was only possible because of the provisions of the 2008 Act, which is why it is terribly important to us that the Bill goes through. It will allow that kind of thing to happen in the future.
That is not the only kind of scenario that we will face. There will be circumstances in which payouts will be necessary for larger numbers of people than is contemplated in smaller credit union failures. We must be able to speed up payment. Eight measures must be taken to help speed up payment. Four are delivered by the Bill and four can be delivered by changes to be made to FSA rules, which Tom might want to comment on.
I will speak about the measures contained in the Bill. Those are allowing us early access to information about firms before they fail, assistance from the liquidator in the event of a failure to prioritise the payout of depositors, a streamlined process that will not need all the forms that go backwards and forwards between us and the claimantsin other words, no forms and deemed assignment of rightsand immediate access to the liquidity that we need to pay people promptly. Those are the four changes that the Bill will deliver. We have realised how important they are in delivering consumer confidence.
There are four sets of changes under the Bill that will also help us: simplifying the eligibility criteria, ensuring that banks have the data that we can use immediately to pay out showing a single view of each customer and what they are owed, the need not to set off peoples loans against their deposits before they are paid out and streamlined arrangements for people to open new accounts with other banks, so that they can pay their compensation cheques into them if necessary. We have learned over this past year how important all those things are, and that is why we support the Bill.
You talked about how you were able to transfer money overnight to Abbey, straight from Bradford & Bingley. How long do you think it is right for customers to wait until they can access their accounts, if the situation is not that a banks assets are being transferred to another bank, but that a bank is going insolvent? Is it one week, two weeks, or longer?
Loretta Minghella: Tom may wish to comment on that, because the FSA has been running some research about consumerswhat they need, and what they believe will give them the confidence that they need. I think a period of a week or two is what we are looking at, which is why we are aiming for a seven-day payout for the majority of what people are owed, with the balance, if necessary, to follow a few days later. Obviously, there will be some cases of hardship even so, but we think that is realistic and would meet the needs of the majority of people.
Loretta Minghella: I have set out the eight things that need to change, and I would say that missing out one or two of them would probably defeat the whole object, so we commend to Parliament the list of changes as a whole. One of the key things will be having the right data from banks at the point of failure and knowing that those data are reliable, which is why we need to be in earlier. Part of the reason why the Federal Deposit Insurance Corporation can pay out quickly is that three months beforehand, it starts the preparations towards payout. The FDIC works with the firms datait runs through them, it tests them, it explores them and it does dummy payment runsto make sure that when the button is pressed and it goes into payout mode, the process will be reliable.
The data have to be there, they have to be tested and reliable and they have to fit the compensation scheme rules as they currently stand. If we have to pay out everybody except so-and-so, we must be able to identify who that so-and-so might be. If we have to set off loans, we need to know what to set off; if we do not have to, all well and good. The data are crucial and we have been working with the FSA and consultants to examine the whole business of the speed of payout, to see how it can be delivered most efficiently. Tom may want to say more about that.
Dr. Huertos: We are very much working on that. There is a trade-off between speed and accuracy. On balance, for the broad number of depositors there should be much more emphasis on speed. It may involve a bit of overpayment, but with respect to the broader social objective of ensuring that the depositors get access to their money quickly, we would come down on the side of taking the risk that there is a bit of inaccuracy and potential overpayment, in order to get the speed in place.
Just going back to Ms Minghellas comment about the FDIC in the States going in three months before the button is pressed to make the payments, how would that work in the context of the regime we are talking about? If a bank was to go into the amber zone of heightened supervision, would you expect the FSCS to become involved in that situation, to prepare the ground in case a bank goes into the special resolution regime?
Dr. Huertos: There is a trade-off between the time required and the type of indication and one would have to make that judgment in the broad area of heightened supervision. More generally, we are looking at what aspect of the data banks need to keep with respect to insured deposits, and at the need for banks to inform their customers on a fairly regular basis as to what is and is not insured.
Loretta Minghella: It shows how terribly important it is for the FSCS and the tripartite authorities to work closely together in relation to particular firms. That is something that we want to see enshrined in the code of practice: that we will work together as we have done in recent times and that that will always be a feature of the way in which the arrangements operate.
I understand why you require the banks to hold the information in a certain format. I have no understanding of why you need that information in advanceof particular customers. When the button is pushed, the deposits of each customer will have varied from the earlier information. Why on earth do you need that information in advance? In the travel industry, the information is not required in advanceit is required in a format, so that it can be immediately had and acted on. Why do customers details have to be with you in advance of a failure?
Loretta Minghella: It is not that we are particularly interested in whether Ms Minghella or Dr. Huertas have any particular amountswe are not interested in individuals from that point of view, but in making sure that the process works smoothly from day one. It is going to be one of the jobs of the FSCS to give advice on whether the payout could be activated speedily enough, or whether it would not, because of the status of the system, and some other special resolution tool might need to be chosen. That is what the FDIC doesit works with the particular systems of the institution, testing them to make sure that they will work effectively on the day and that the data that should be there are there in the right form. It is not a prurient interest in any individuals account, but more to do with the issues of that system.
I wanted to ask about the pre-funding, which is not popular with banks. The Governor talked about the need to build up such a fund, but if there was a decision to go with that, it would take some years to provide the level of funding needed. What are your views on that and on how the Bill provides for a reserve power to be used at some future date?
Dr. Huertas: With respect to the fund, it is important to remember that the deposit guarantee promise needs to be backed by the full faith and credit of the Government. If it ever got to the point that the deposit guarantee promise was limited to the size of the fund, the exhaustion of the fund and the removal of any type of deposit guarantee for the remaining depositors would be a severe threat to financial stability.
Dr. Huertas: Without a Government backstop, the fund alone is not sufficient. The Government backstop is what gives ultimate security. Anywhere they have tried to limit the deposit guarantee promise to the size of the fund, inevitably there have been problems. It caused problems in the United States and in other jurisdictions.
Loretta Minghella: We agree that the crucial thing is that the compensation scheme always has enough money to pay depositors when necessary. That is why the national loans fund part of the Bill is so crucial, from our point of view. Whether or not there is a pre-fundwe welcome the debatethe crucial thing is that there is always that backstop and that people can be confident that the Government will always be there for the scheme.
Some of our constituents might think that the idea of having a pre-funding scheme is to move some of the risk of failure away from the Government and on to the banks. But are you saying that, whether that happens or not, the Government still have to underwrite it?
To be precise about this, what you are saying is that a pre-funding arrangement is not sufficient. To be very specific, would you say that it is necessary, or desirable?
May I ask the Bank of England about clause 66, which relates to international obligations and says:
The Bank of England may not exercise a stabilisation power in respect of a bank if the Treasury notify the Bank that the exercise would be likely to contravene an international obligation of the United Kingdom.?
Will this mean that, essentially, the Bank of England will not need to take a view on international obligations and that it will proceed as if there are no issues with international obligations unless the Treasury says otherwise?