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Good afternoon. Welcome to the Committee. I am sure, Angela, that your two colleagues will not mind me paying you a particular welcome. It does not seem as though you have been away, but it is a fair time. Welcome. We will open our session with a question from Mark Hoban.
This question is for both Mrs. Knight and Mr. Taylor. Quite a lot of concerns have been expressed about the proposed changes to creditors rights, particularly in the context of the partial transfer of banks. Have your concerns been satisfactorily addressed in the Bill?
Angela Knight: No. I am sorry, but I do not think that they have. There has been some movement towards recognising some of the issues, but in clauses 42 and 43 we get close to the nub of the problem. Consequent upon those clauses, all the legal netting agreements that banks have are not necessarily going to be honoured. That is the important thing. A range of netting agreements is referred to, but there are more out there. Unless there is a proper agreement that legally binding netting contracts can stand, the concerns remain that effectively contracts will be qualified. You will not then be able to net off. There will not be the certainty of it. In normal business times that means that you will not be able to net off for the purposes of capital. While the degree to which that affects banks will depend upon what business they are doing, about 70 to 80 per cent. of the relevant business is affected. It is a big effect. Even if we get it right in clauses 42 and 43, clause 65 as it stands makes it possible to change everything retrospectively anyway. So those two clauses and clause 65 need to be addressed; otherwise a permanent prejudice will be left.
Jonathan Taylor: I very much agree with Angelas general remarks on that. This is a point that has been raised a lot in our various representations. The Government are clearly trying to move in our direction because they recognise that the issue is a real one. The problem is that, as Angela says, unless legal firms are able to provide a so-called clean, unqualified legal opinion on these detailed netting arrangements, whenever the netting arrangement arises, it will cause a problem for the firms in relation to their regulators. Under the capital requirements directive, the firms will need to show their regulators a clean legal opinion to enable them to net the provisions for their capital purposes. There is a real problem there. That is why it is vital that the problem is addressed properly in the secondary legislation, which we have not yet seen.
This morning, the Minister said that the draft code of practice would be produced next Thursday, and that the principles for the secondary legislation would be ready in time for the debate on clauses 42 and 43. What principles would you like to see in that secondary legislation to address the concerns of your members?
Angela Knight: Our view is that if you have a netting contract that is legalthat would stand a legal testthat needs to be recognised and excluded so that, in effect, that remains unchanged and creditor rights are preserved. I am very glad to hear that we will be able to see the secondary legislation and the code fairly soon, because it is essential that one sees both secondary and primary legislation together. This is a holistic issue that needs to be looked at. Certainly, all the lawyers whom we have consulted, who have no doubt been in touch with various members of this Committee, have raised both the holistic point and the essential need to ensure that we do not inadvertently interfere with creditors rights and end up with a situation in which there is no clean legal opinion, because the consequences thereof would be pretty big. Regarding clause 65, we need to get netting and netting arrangements properly recognised in the clause as being disapplied from the Henry VIII provisions that it contains.
May I go further? On the cost of capital, you have both referred to the impact that it could have through the capital requirements directive. I am intrigued to understand how you think that will work its way through, and what the impact might be. I have spoken to one international bank, which said that if the right safeguards were not in place, it would lead to a situation in which you were counting assets and liabilities on a gross basis, not a net basis. His argument was that that would make London a pretty unattractive place to do business. Do you share that view?
Jonathan Taylor: Yes, that is exactly right. The way in which it would work is that unless you can net off your position for credit risk purposes, your regulator will make you account, on a gross basis, for your capital, against the credit risk, which you take on by being the counterparty of a firm that is based here. That would greatly increase your capital requirement. The result, I am sure, would be that there would be a great deal less business.
Angela Knight: For the purposes of comparison, although there are intervention regimes in a lot of countries, some of which are also being reviewed, there is no intervention regime that we have yet found that would result in the circumstances that could apply if this legislation went through as it stands. That is to say, other peoples intervention regimes do not interfere with creditors rights, and netting agreements are preserved so that there is not the problem of not being able to net off your capital. Certainly, we have been told by a number of our members that if they could not net off, they would no longer be able to do that business here in the UK, so we would see a commensurate loss of a significant amount of business out of London.
Angela Knight: We do not think that this clause should be there at all, I am afraid, the reason being that the special resolution regime should be paid for by the bank that has got into difficulty. When companies up and down the country get into difficulty, the costs of resolving that problem are paid by that company. We are saying that the compensation scheme is there for depositorsor individuals, because it is broader than just deposit protectionand that to broaden it in this way represents a potentially disproportionate burden. Secondly, the responsibilities for resolution should fall on the failing institutions anyway. Thirdly, the clause could be read as a compensation scheme picking up some of the creditor costs of the failing institutions other than those of just the depositors. It is in all ways wrong: to us, it does not seem to work in principlethe principle should be that the resolution is paid for by the entity that got into difficultyor in the content.
Adrian Coles: May I add to that on behalf of the building societies? Small and medium-sized building societies are particularly resentful of this, because the chances of one of them entering the special resolution regime are extremely low, and yet clearly the Bill states that they would have to pay those costs through the FSCS. On this matter, therefore, there is particular resentment among those institutions.
Angela Knight: If a clause of this type must remain, it must be absolutely clear that the compensation scheme kicks in on the SRR only when all other avenues for paying for the resolution have been exhausted. Then, if it must kick in, we must define those costs quite narrowly, because otherwise, in effect, we would be leaving an open door for industry to pay for almost everything regarding a failure, whereas the first responsibility for preventing the failure of an institution is with its management. One must work ones way down a series of questions: Who does what?, Whose are the responsibilities?, Who pays what? and so on. If there must be a last resort, there must be a last resort, although we would argue that that is not right. But if it is necessary, it must happen only if the assets of that institution cannot pay for the costs of the SRR. If an ordinary company is wound up, the liquidator gets paid. It seems to us, therefore, that we have rather moved away from some of the accepted common principles in this area.
Deposit protection varies slightly; in the past few months the goalposts have been moving all the time. In your view, what is the appropriate level of compensation for deposit protection?
Adrian Coles: We supported the increase in deposit protection from £35,000 to £50,000, which covers 97 per cent. of building society depositors. Building societies believe that that is an appropriate level. To go to an unlimited level of protection would be extremely expensive and open up significant contingent liabilities on behalf of those institutions contributing to the deposit protection scheme. To insure the deposits of 97 per cent. of depositors seems appropriate to us.
You have answered on behalf of the building societies. The point has been made that deposit protection at the moment covers only your net depositnot the gross deposit. In other words, the gross figure is different precisely because you have a huge loan with a building society as well, so you do not get the level of deposit protection that you might think that you will get. Are you happy with that principle?
Adrian Coles: There is a difference between banks and building societies. In the banking sectormy colleagues will correct me if I am wrongthere is an automatic netting off of the position. As far as we can tellthis is a complex legal areain building societies it depends on the terms and conditions of the individual savings and mortgage accounts of the individual building society. So the position is not straightforward in the case of building societies.
To what extent can banks and building societies quickly identify the extent of deposit insurances by individuals given the different brands, multiple accounts and so on? How long would they need to complete an assessment?
Adrian Coles: That would vary hugely between different sizes and types of institutions. For a simple one-brand building society, with perhaps 10,000, 20,000 or 50,000 accounts, that could be a fairly straightforward exercise. My colleagues may be able to comment on how simple it might be for a much larger institution with many millions of accounts.
Angela Knight: Perhaps I can answer for the banks on the two points. First, regarding the depositor protection scheme and the limits, there have been some noticeable changes in the last year. Originally, we put out some information into the public domainthat is, the British Bankers Associationwhich is approximately two years old. That information gave the percentage of individuals who are covered by the £35,000 limit, which was 96 per cent., and at £50,000 it was 98 per cent. In terms of value, of course, it was significantly less.
However, one of the effects of the credit crunch over the past year is that people have moved their money around, to get below the limits. So, in the Bradford & Bingley case you will have noticed that 80 per cent. by value was covered by the £35,000 limit. We must recognise that people have responded to a very strong message, which is, Spread it around underneath the limit, whereas I suspect that the movement is now slowing down. Actions have been taken.
I think that there is a case for special situationsby that, I mean when an individual has sold a house, or there is a lump of money from a will or whatever. We are looking into how we deal with coverage insurance for special situations.
Let us move on to your next point, which is what banks know about the particular positions of their customers. You are right that most systems have been built by brand. Therefore, there are various different types of brands that sit under a bank and usually the systems are built like that. By brand I mean, for example, the NatWest. So it has been done like that. Perceptionally, that is how individuals look at itnot always, of course, but it tends to hypothecate straight up to a banking licence.
So it is very difficult to answer your questionhow can you bring everything together and how long will it take? It is difficult to answer it, not least because there are some other things to consider; there are regulatory requirements and taxation on some issues. There are all those sorts of considerations.
With other issues, we have some consultants examining this area. The consultants report ought to be available relatively shortly. I am afraid that I cannot give an exact date; consultants are as consultants are. However, it should certainly be available before you have finished your deliberations.
Angela Knight: Yes, absolutely. The report delves down into a number of areas, including what is known as single customer view, speed and what can and cannot be done. We felt that that was an important part of this debate and that it would be helpful for us all if we went in with others and commissioned that work.
Adrian Coles: There is one particular aspect that will affect the speed with which you have a single customer view, and that is the extent to which there have been recent mergers between two building societies or two banks. If there has been a recent merger, it will be much more difficult to get a single customer view, because the acquiring organisation will not know the circumstances of the customers of the acquired organisation as well as it knows its own customers.
Angela Knight: May I just come back in, because there was one part of your question that I did not answer? That is what nets off. The view that we have put forward is that what nets off is an overdraft but that is all, and we think that that is probably the right way. I think that we need to work through the legalities of offsets, but again that is something that sits to the side. Netting off the overdraft is the only one that we are really proposing.
Following on from that, we heard in previous evidence that there should be a customer-level test beforehand by the compensation scheme, so that, when a bank goes under, the scheme can, at the press of a button and in a common format, produce the amount of money that needs to be given back to an individual. This issue is very time-sensitive. If someones money is in a bank and that bank has gone bust, they need to access that money.
Listening to your previous argument, it seems that the banks are not very sure how much money each customer has. You have a problem. Do you think that there should be a common format and that customer-level information should be given in advance?
Angela Knight: You are absolutely right about customer information. About 130 million personal accounts are out there. People are using cash machines. They have cheques and direct debits in the system. At any one time, quite a lot of movements are hung up in the system. You are right that we cannot know the precise position at one moment in time. The debate has looked at the matter the wrong way round. We should not be considering a system whereby, if a bank goes bust, the information is passed to the compensation scheme, which cranks up the cheque-printing equipment and sends out 14 million cheques by post. That is probably not how to do it. Even if it can be done quickly, does that really sound right?
We think that, if a bank has failed, the banks systems should be operated by a third party for the purposes of paying out through cash machines and bank branches in the same way as an individual would be treated now. That does not mean that they all have to queue up outside a bank branch; no, because the general payment system has been used. In effect, that was the case with the Bradford & Bingley. If we consider from where the Billand, indeed, the debatehas come, it would imply that, in a Bradford & Bingley case, the information is passed to the compensation scheme, which then fires up the printing press and sends out all the cheques to people as quickly as possible. Was it not much more appropriate from the customer side that they had a seamless, continuous service?
We should like the Committee to consider an amendment to the Bill that would provide continuity of service, because that is infinitely more likely both to give confidence and give people the experience that they deserve.
That is a very interesting proposal. May I move away from that to the funding of the compensation scheme? In the US and other countries, it is pre-funded, but we really have a pay-as-you-go model. My constituents would be amazed that the banks are opposed to a pre-funded scheme. Some of your member banksnot allhave brought the economy to the verge of disaster. We are going from boom to bust because of irresponsible bankers and, by the way, the bankers do not want to fund the compensation scheme in advance. Is that not a very strange attitude for the banks to take?
Angela Knight: I can put it another way: if you want a system that is pre-funded, it means that you are taking finance out of the banking arrangements at a time when it is not necessarily needed and that will flow through inevitably into costs. Is it not more appropriate to have arrangements that ensure that, if that finance is available, it is made available, instead of having a sum of money sitting in mid-air? I agree that there is a debate to be had. Even the Bill says that it will take a power and think about it. If I were a customer, what I want is my money quickly. If the arrangement behind that ensures that I get my money quickly, that is the important thing.
With due respect, you are missing the point. We all agree that the money has to come quickly. Let us consider the travel industry, and the arrangements of the air travel organisers licence and ABTA. That is effectively paying in during the good years for when something goes wrong. It is rather like an insurance policy. We all want them paid out quickly, but why should the money fall on the taxpayer to do it immediately?
Angela Knight: There are points on both sides. Two years ago, perhaps slightly less, there was a consultation by the FSA at which some of those points were raised. Consultants were asked to look at some of the issues, such as the size of the pots and how they were funded. The conclusion from that consultation was that availability was the important issue. It asked whether arrangements in the UK were such that first, cash was available, should it be required, and secondly, that the cost did not fall on the taxpayer. Those two conditions have been met.
You might say that you want X billion pounds out of the banking industry today. If you do, that is X billion pounds not available for provision for the people of this country. There is a balance. You will know our view because we stated it in our earlier representations. However, in our recent commentary, you will see that equally, we have accepted that a power can be enacted, should there be the will to do so.
It might be a good idea to have a fixed review periodthat is a general comment about a number of issues in the Bill, not only in this area. Such a provision existed in the FSMAthe Financial Services and Markets Act 2000, where it was written into the legislation that a review was to take place in a couple of years. There are many issues herea lot of maybe this and maybe thats and how do interacts take place? Perhaps you would like to take that thought away.
Just to nail the point. Last year, one of the banks that has failed made something like £9 billion profit. None of that moneynone of those billions and billions of pounds made by the bankwas put away in a protection scheme. Do the banks think that is right?
Adrian Coles: I would add from the building society point of view that the profits that building societies make are added to their capital. That capital stands there to protect depositors. There is a choice of whether to put it in the compensation scheme to protect depositors, or whether to keep it in the building society balance sheet. At the margin, if the money is taken out of the building society and put in the compensation scheme, depositors in the building society are slightly less safe by the amount that the building society has given to the compensation scheme. From our point of view, that is moving it around in two buckets, rather than adding to overall depositor safety.
Is there any issue of inequity between a specialist investment bank and an investment bank operation within a deposit-taking bank, in terms of the marketplace for their products? Will a burden be placed on those that have combined functions, as opposed to those that lie outside the legislation?
Angela Knight: Of course it is, and it is a perfectly fair comment for him to make. It is also perfectly fair for me to say that we are not actually quite that sure. Some of the difficulties will end up being not so much with the content of the Bill, but how it is applied by the regulators. Certainly, it is the regulation side where most attention needs to be paid.
Angela Knight: There seems to us to be one main difference, which is that within the Bill it is envisaged that the special resolution regime could be triggered prior to a bank being in default, whereas in other jurisdictions the default process takes place first. The reason the Bill does that is to promote financial stability. It states that we will not get to the point at which there is a default; instead, if we think that will happen the tripartite regulatory system has the right to go in early and take action. In the other jurisdictions of which I have knowledge, that happens after the bank has breached the appropriate default triggers, whatever they may be. That is a difference. It does not make us wrong to do it and them right, or vice versa, but it is one of the reasons why the whole netting thing has come so high up the agenda.
It is noticeable that by putting this legislation through we are in effect codifying practices that not only did we understand could take place prior to Northern Rock, but which the authorities have used since then. We are putting them into place and codifying them. It seems to us that the Bill is doing so far more extensively than the existing procedures in other countries, although I suspect that after the actions that other countries have had to take, which are similar to our own, they too will have to look at and revise their legislation.
To what extent have your members reached a situation where they are confident that they now know the true value of their assets? To what extent are their balance sheets still contaminated by toxic assets? By way of illustration, I think that the nearest analogue to the present situation is Lloyds of London. Lloyds made a point of identifying and isolating the toxic assets in the so-called spiral and then moving on. Are your members at that stage? Are they doing that?
Angela Knight: No. Lloyds put them into Equitas and floated it off as a different vehicleI recall it as well. We would say that they know exactly where they stand. There are still a number of imponderables, however, which are related to the valuation process of illiquid assets. Illiquid assets are not necessarily bad assets, but assets for which there is no market at the moment. The process for how to value them changed from about 10 October, when the US changed its valuation rules and allowed a valuation that included a reflection of the income stream. That meant that one went from having to try to determine the value of a product using mechanisms that were no longer particularly appropriate, to using mechanisms that were appropriate. That has started to clarify the issues very considerably indeed, but the difficulties are not just the result of exposure to particular types of complex US sub-prime, although that is where they start, and undoubtedly there is that exposure around the world. There has also been a loss of confidence in an asset class generallythat is, housingin many jurisdictions, which has fed through to ordinary assets that one would never even remotely call particularly complex. There are many factors involved. On the specific question, the new valuation rules are significant.
This is a question for Adrian. Given that building societies have not had the same track record of failure, are you concerned that this package of reforms might be applied to you although you are not part of the problem?
Adrian Coles: No, we do not believe that we are part of the problem, although I would not claim that building societies will sail through the recession without any difficulties whatever. We have already had announcements of two building society mergers, which were necessary to ensure that the building society sector maintains its record as a safe haven for investors funds.
We are keen that building societies are perceived to be, and are, as safe as banks that are covered by the legislation, so we took an early view that the legislation should cover building societies in exactly the same way as banks. It would be wrong if some of the mechanisms that could be applied to a bank in difficulty were not available to a building society in difficulty and, as a result, some investors somehow got the perception that a building society investment was less safe than one in a bank.
We are supportive of the additional clauses in the legislation that say that the provisions that apply to the banking sector also apply to the building society sector. We think that we would be in a weaker position if they did not.
Adrian Coles: We have already covered one of the most important ones, and that is the FSCS meeting the costs of a bank or building society in the SRR. Most building societies will never go into the SRR but will still have to meet the costs. Also, single customer information must be kept in the way prescribed by the FSA for FSCS payout. That could impose significant costs on small institutions, but the huge likelihood is that a small institution would be taken over by a larger one rather than go through the FSCS procedures. Therefore, the effort of organising affairs in a way that the FSA wants would be wasted for small and medium-sized building societies.
Are you concerned about the pre-funding arrangements, if they come in? Given the benign track record that building societies have had, do you feel that they would be unduly onerous?
Adrian Coles: As I indicated to Mr. Bone, if we moved to pre-funding, it would mean taking a lump of money out of building societies capital, which is there to protect their depositors, and putting it into the compensation scheme. I do not think that is particularly helpful. If there were a requirement to keep capital
But that is a general comment. The point about pre-funding is that, to some extent, the cost has to be related to risk. The risk for the banks could be quite substantial, but you could make a case that the risk for the building societies is slighter, given your track record.
Adrian Coles: Yes, I was going to say that if there were a requirement for pre-funding, and if there were a requirement to keep capital at the current level in building societies, the only place the money could come from is higher mortgage rates or lower saving rates for building society customers.
There is also a strong view among many building societies, which I think the Building Societies Association would now endorse, that there should be some elementwe have not fully worked it outof risk-related premiums. Building societies certainly find it galling that they have to contribute to payments that are being made in respect of institutions that have not been run as prudently as building societies.
Adrian Coles: Clearly the mechanisms by which the SRR is implemented and by which public authorities might take control of a building society will be very different. You cannot buy shares in a building society, for example, but we have not identified particular differences in the overall approach that we would wish to apply to a building society compared to that which we would apply to a bank.
To return to a point that was made earlier, I found the answers that were given to Sir Peters question about the balance sheets of the banks extremely interesting. In the balance sheets of the banks last year, you had some assets that have turned out to be worth much less than had been thought, so the banks have now written those downas I understand you are sayingand have really got to a valuation. What was the change in the valuation rules? Was it a huge write-down?
Angela Knight: First, the new guidance on how to value an illiquid asset held in the trading book, rather than the banking book, only came in on 10 October, so it has not all been done. What it does is to take a different method for assessing a more certain valuation for an illiquid asset, rather than trying to determine what a market valuation would be when you have no market. If you look at what has happened in the States, you will see that there has been a constant spiral-down of assets for which a market could not be found. Although for various reasons there might have been a fire sale price out there, everyone knew that value was probably not relevant, but you had to use it. It is the volatility that mark to market can bring when a market no longer exists.
The new guidance was formulated first in the US under US generally accepted accounting principles, and then the International Accounting Standards Board moved to bring its guidance more or less into lineI have to say more or less because there are bound to be some legal differences. Both the accounting profession and the industry think that enables the much more certain type of valuation and in due course we will see the outcome of that.
Angela Knight: Well, you see that in the public domain daily, as is evidenced through share prices and all sorts of other areas, but where we are with more relevant guidance in place for a current environment will certainly pan out over a period of time. Being able to use the ongoing cash flowfor the various formulae and discounts you will have to ask the auditors for the complex detailsseems a much more sensible way of valuing something that has a value but for which there is no market.
In an early comment by the BBA, you are quoted as saying that your main reservation related to partial transfers of banks, nil-rates and creditors. You made that comment in July. You said that you saw an imperative need for the Government to give further time for consideration of the partial transfer arrangements and that they should be stripped out of primary legislation. Would you like to confirm that that is still your view and elaborate on it?
Angela Knight: If you say where we think the order should be, the first thing is that the regulators regulate and we do not get to the SRR. The second is that, if the SRR is triggered, we would like to see an entire bank movewe hopeinto the hands of a private purchaser. If that has to have stability at some point before the process can take placethe bridge bankthen so be it. Partial transfers come rather a long way down the list. Our preference would be not to have a partial transfer unless there has been a default. If it is the decision of Parliament that a partial transfer must remain as part of the SRR tools before a default is triggered, it is absolutely essential that the creditors rights are not reordered, that the netting is properly taken care of and that the decisions taken at the time cannot be retrospectively changed by clause 65.
This is a question to you, Mr. Taylor. You said earlier that the provisions of the Bill affect stand-alone investment banks only to the extent to which they are counterparties in transactions where there is netting. Are there any tools in the Bill that you think appropriate to be used if a stand-alone investment bank suffered a financial problem, or are you happy with the existing regime for insolvency and administration?
Jonathan Taylor: That is right. My point is that, in particular, the netting arrangements are of direct concern to the investment bank. Indeed, as Andrew was saying, there is a link between that and the partial transfer point. That is one of the reasons why the partial transfer point raises serious questions.
Stephen Haddrill: Given the events of recent weeks, we feel it is right that a resolution regime of some kind is brought forward and we support the greater part of the Bill. Our anxiety is that there is a big national, governmental and taxpayers interest in a bank that has got into this situation being got back into the market, being eventually funded by the institutional shareholders and the City and being got off the states hands. Therefore we are concerned that the regime should generate confidence that a bank will not be put into special resolution unless it is absolutely necessary. We think that there are some things in the Bill that could, perhaps, be strengthened to provide confidence in that respect. If the bank goes into the regime, to the extent that there is value still left in it that should be fairly distributed among the creditors, including the bondholders of the company, if not the shareholders, so that general confidence about investing in banks is preserved as far as possible.
Stephen Haddrill: Ahead of the special resolution regime, as Angela Knight was saying, it is essential that the regulators actually regulate the industry effectively to ensure that the capital is adequate and that the risk of a bank failure is minimised. We would like to see in the Bill a requirement on the FSA to report publicly on why it has not been possible for the regulatory regime to discharge its responsibility in that respect, so that sufficient responsibility is placed on the regulator to keep the bank going, make sure it does not get into that difficulty and avoid going to the SRR. But we accept, now, the case for an SRR in extremis.
Stephen Haddrill: One thing that we do not have is the code of conduct. We certainly want to see that and look at it before fully answering that question. We would like to see an objective to maximise the enterprise value while it remains in the SRR, so that the way that it is managed during that time does not fritter away the existing value in the business. We would like the hierarchy of creditor interest to be respected, so that when compensation is paid the bondholders have the opportunity to get some compensation.
We are also concerned to see as much certainty injected into the Bill as possible. Clause 65, which was mentioned in the previous sitting, creates the opportunity for the Government to completely rewrite the SRR regime. That seems to go much too far in terms of creating uncertainty for the future.
Can I ask a supplementary question? I read your lucid, clear submission carefully. It contains a suggestion that the first port of call might be a shareholders meeting to see if they can divvy up a bit more cash or replace the management, or whatever. Given the speed with which events have been moving in financial markets recently, do you now acknowledge that that is a fairly unrealistic, not a real world, scenario?
Stephen Haddrill: No, I do not acknowledge that. I think that the institutional shareholders are capable of taking a rapid view, because after all if you hold 3, 4, 5 or 6 per cent. of a major institution, which some of the big institutional shareholders do, you know quite a lot about that institution. You saw three of thoseLegal & General, Prudential and Standard Lifecoming together to put more capital into Bradford & Bingley, although, in the event, of course, it was insufficient. That was done alongside some capital injection by the banks and it might have been sufficient; it was not, but it might have been. I think that such an opportunity should be provided.
So it is a real-world scenario when you have a company that is failing but it has a few big institutional investors who can get together and sort it out quickly, but not otherwise.
Stephen Haddrill: Initially, we took that view because we felt that, apart from the responsibility of the bank directors themselves, the responsibility for ensuring that a bank was not going into failure was the FSAs. We were concerned that the FSA would be reluctant to hand over that responsibility to another institution, and that if a special resolution regime or another mechanism were needed, the FSA should be free within its own house to take that view, and then to deal with the consequences of itthe consequences partly having been driven by its own actions in the run-up to thatso that responsibility and power were kept in the same place throughout the process. The Government have clearly taken a different view, but we do not feel strongly enough about it to continue to argue the point.
How do you respond to the view that since 1997, the Bank of England has been more distant from the banking sector as a whole, and that has been an adverse development?
Stephen Haddrill: I think that the Bank brings a great deal to such issues, because it is in the market. It trades on its own account, which gives it a perspective. In retrospect, I believe that it is right that the Bank should be brought much more firmly into the system and given a strong financial stability role within the new tripartite proposals.
We have reservations about the financial stability committee being a sort of subsidiary of the court, because we are not convinced that the court is at the operational heart of the bank. It should be a very senior committee at the top of the Bank and able to take effective decisions. We have not seen the court operating in that way.
Guy Sears: We have called for the introduction of the SRR, and we have resisted getting rid of partial transfers. They are a necessary power, as is the power to interfere with property rights if required. For example, the Icelandic banks and Bradford & Bingley used partial transfers to move £22.2 billion of retail deposits, and that seems to have been an effective use. We have some concernlike the ABI, we are waiting for the secondary legislation to come out and the banking liaison group to workabout what they mean in the other areas, and what will actually happen to the cost of capital. At the moment, there is a range of concerns, such as worry that security will be taken away and you will be left only with liabilities, which is almost certainly unlawful under European directives, but there may be instanceswe had change of bond terms in Bradford & Bingleywhen, if it is not predictable and if we do not understand how the tripartite authorities will use the powers, people will price conservatively, so the cost of capital will go up. If you know which way a bond may be affected by collapse, at least that can be priced in slightly more efficiently. Again, to echo Stephens comments, we await sight of the code and the secondary legislation, which will be critical to the Bill.
Guy Sears: Yes. It may have been slightly less controversial, although some of my firms would not agree with me. The provision in the transfer order was, from memory, that for the subordinated loans, dated and undated, the bondholders were not allowed to treat the non-payment of principal as an event of default. Essentially, from the Treasurys point of view, it wanted to ensure that subordinated creditors could not hold the new transferor, or the old Bradford & Bingleyit still exists in wind-downto ransom by saying that the transfer had triggered an event of default and that, therefore, they were entitled to full payment now rather than over time.
Guy Sears: A lot of it is that it is almost chance at the moment whether you are a holder at the minute that such things occur. There is no predictability. Over time, we will start to learn how Government will use these measures, and you will therefore know, if you have a subordinated bond, that the terms can be changed. If we are to have those powers, it would be useful to see in the code when that will happen and what might be the circumstances. In other words, perhaps it would say, We will only ever change these provisions in so far as it is necessary to ensure a transfer across, and the provisions we would change are the following, and you would be entitled to compensation, which the Bill does provide. That would start to give certainty to the market, but at the moment, I thinkand certainly last weekBradford and Bingley bonds are trading at almost nothing.
Guy Sears: Yes, but so much of this is about confidence. What we are trying to do is engender confidence in the financial system, and we therefore need to protect depositors, but that comes at a cost. The important thing, we would saycertainly for Stephens members, as our major institutional investors in this country, and my firms as the asset managersis that of course depositors should be protected, but that there is a cost. Pension schemes and the savers of this country are invested in those banks. You cannot have things without cost, and there will be cost. If bond terms are changed and if equity raising is more expensive, that will impact on the pension schemes and other savings vehicles, and that still comes back to taxpayers. The question, therefore, is this: what do we need to do sufficiently to get confidence in depositors, not because depositors are always meritorious, as such, but because we need to secure financial stability? That is not to be against depositors; it is to say that with our other hats on, as the taxpayers, savers and pensioners of this country, they are impacted by the transfer and the loss of value that occurs from that.
Guy Sears: We have done a lot of work, before and during the summer, and the Government have done a lot of work to listen to the whole industry about concerns. There are a couple of points to repeat, one of which Stephen has made. There are fire sale concernsin other words, let us just get rid of the deposit book as quickly as possible to whoever will take it without regard to the value that remains and the damage of that. Fire sale concerns are addressed by some of the provisions on maximising value, but, again, this is about confidence. Do we have confidence in the authorities to do that well enough? There is a concern at the moment regarding those fire sale concerns.
There is also a need for various other safeguards to do with knowing precisely which netting agreements, if any, are going to be affected. That is why, as you might know, we have proposed what has now been announced as the banking liaison group. My suggestion was that, not only would the technicians in the industry work on the secondary legislation, but that we would need to keep it up to date, because it would be very easy to pass the Bill and the secondary legislation and think that we had got it fixed. I assure you of one thing: the markets will exploit any fissure and they will innovate. We therefore need to keep things under review. That is our hope from the banking liaison group.
Stephen Haddrill: I do not think that the Bill does enough on protecting property rights, for some of the reasons that I mentioned earlier. The reference to the Human Rights Act is all very well, but gaining the confidence of the institutional shareholders requires rather more specific protection of what they can reasonably ask for. Some of the things that we have just mentioned are relevant, in terms of maintaining value where possible, not transferring assets through a partial transfer and eradicating the rights and values of bondholders. All those things need to be sorted out, but we do not yet know exactly how that will be done.
A comment was made about the financial stability committee. I heard some implied criticisms, or at least a lack of total enthusiasm. What more would you wish to see of the committee that would enable you to feel much more enthusiastic and confident about it?
Stephen Haddrill: It is an extremely important part of the architecture, and we are glad that it is being established, but it needs to be as important a body within the Bank as the Monetary Policy Committee. However, it does not appear to us that it is being established in that way. It looks to have been established as a sub-committee of the court, and I do not really understand why that should be case.
Guy Sears: No not particularly, Sir Peter. We place more emphasis on the fact that the Banks role, as proposed under the SRR, and ability to exercise the powers, would mean that it would have to resource up and have the people and skills there to fulfil that. Whatever role it did have, therefore, the FSC would have much more weight than you might expect even now.
Mr. Sears, I want to return to your remarks about Bradford & Bingley towards which the Government took an approach different from that taken towards the other banks. Basically, the good bits were got rid of and sent to Santander, and the bondholders were left with a huge loss. Under normal circumstances, would the bondholders have ranked above or level with the deposit takers?
Guy Sears: I think that there is a mix, but that some would have come after the creditors, who of course were the depositors and who rank with other creditors. In terms of the good and bad bits, it is a bit more that if you move a deposit book, as they did, of £14 billion, or £17 billion with the top-up, and move with it the same value of assetsin other words, if it is one for onehow the rump ends up depends on whether it was solvent on an asset and liability basis. If, of course, it was not solvent on that basis, you will necessarily worsen the position, because those people have got pound for pound. But that is the world that we are in at the moment. We need to ensure and secure financial stability. Some say, Should depositors have precedence? My view is that the Government have sought to preserve creditor rights, through compensation for those who are worse off by reason of the transferthere are safeguards in the Bill for thatbut they have in practice ensured depositor precedence. I think that that is quite neat, although it is expensive and tricky to work out the impacts on the Bank. We still have much work to do on thatStephen mentioned the secondary legislation. However, it is a way of securing precedence, at a time of crisis, while ensuring that they rank equally at the moment of a going concern.
Adrian Coles: Yes. A compensation order is to be made, but I do not think that it has been tabled yet. However, the Government say that an order is to be made, as they did on Northern Rock. Again, that throws us back to confidence in the valuationwhen will it come in? There is another difficulty. If you are a bondholder and you expect to receive compensationmaybe it comes in a years timewhat if that bond is underlying a pension scheme that is paying out annuities and all that in the meanwhile? So there are lots of real effects for the investors and savers.
Stephen Haddrill: It is clearly possible to have a pre-funded scheme. We are nervous about it in relation to banking, for the reasons that were largely given at the previous session, and we totally reject it in relation to insurance. Of course, the FSCS at the moment operates a single scheme, with cross-subsidy between different types of sector. We are worried about it being introduced in banking and it then being applied in some way to insurance.
The reason that we do not like a pre-funded scheme in relation to insurance is that you do not need it in insurance, because the payments you make are spread over a very long period, as people make claims. You do not get a run with a queue outside the insurance company as the annuities fall due, and so on and so on. So you do not need to prepare in advance for it. I think that it should be clear in the Bill that, if there is pre-funding, it should be limited to bank deposit protection and not applied across the other parts of the financial services sector.
We have seen the FSCS compensation limit go to £50,000, and the European Commissioner has been talking about a minimum of €100,000. Moral hazard has been discussed quite extensively in the run-up to this legislation and there are two possible moral hazards here. One is moral hazard among the providers, on the basis that there is a collective insurance here in which there may be an incentive for poor practice by one of the providers, because they will not have to bear the total consequence of their foolishness. The other is among depositors, which assumes that people race to the best offer without proper regard for any risk analysis. However, that of course is based on an assumption that people have the tools to work out these things for themselves anyway.
We have not heard from the two wingers in this four-man formation. Can we hear a little bit from them, particularly on the second possible hazard, which is the hazard of depositors racing to the top rates?
Teresa Perchard: This is the main area of the Bill where both Which? and Citizens Advice might have some input. However, it needs to be looked at in the context of the introduction of a special resolution regime, because, as I understand it, that is designed to ensure that calls on the FSCS rarely happen, as it is designed to ensure that somebody takes on the business, rather than letting it go down, so that people have to queue up to get their money back on a cheque and open an account with somebody else. That would be the nightmare scenario.
So one might look at things like pre-funding in the context of having a special resolution regime. We have not expressed any view on the pre-funding proposition, but we are interested in what happens with the compensation scheme. The appearance of unlimited compensation for Icelandic savers, with varying limits across Europe, means that we now need to rethink the £50,000 limit, although very few citizens advice bureau clients will have more than £50,000.
As you suggested, it is quite brave to assume that consumers go shopping for somewhere to put their savings safely, taking with them the sheet I have before me from the Martin Lewis site, which shows exactly who owns who. The £50,000 limit applies to a single registered institution. There is a nice little string of the AA, the Bank of Scotland, Birmingham Midshires, Saga, Halifax and Intelligent Finance, which are all in one group and have now been swept up into another conglomerate. You might have safely tucked away little bits of money up to the £50,000 limit in different institutions and find that while you thought you were doing the right thing, you were actually trading with just one entity. The practice of having a limit works only if institutions that are taking peoples savings say, Oh, youve exceeded the protected limit. We suggest that you put the excess with another institution that is not in our group.
Teresa Perchard: Absolutely. There has been a lot of debate about whether the consumer should take some risk. It has been said that consumers who simply want somewhere safe to put their accumulated savings should take some risk. If no one will tell them where they can keep their money safely, other than under the bed, it is difficult to operate a limit. That is particularly true when limits vary across Europe. It has become confusing for consumers.
Doug Taylor: I am not convinced that moral hazard really applies in the area of consumers putting money into simple personal accounts or savings products. In reality, the different interest rates on savings accounts are not dramatic. Individual consumers are chasing the best that they can get. I do not think that they are being reckless in placing their money in savings accounts. Indeed, prior to recent events with Northern Rock, it would have been hard to find a consumer who did not think that in putting money into a high street savings account, they were putting it into something absolutely solid. I do not think that moral hazard issues that apply in areas of investment apply to personal accounts and savings. I do not think that consumers have acted recklessly in this area.
On the ability of consumers to navigate through the system and decide on a high street bank, I do not think they are in a position to carry out due diligence in terms of the liquidity and solvency of the big names. They assume that the regulatory system will do that for them. When that fails, a problem arises. At the end of the day the consumer will meet the bill, either as customer or taxpayer. I hope that I have answered your question on moral hazard.
There was the other element of the moral hazard among providers. If you have a comprehensive insurance scheme paid for not on a risk basis, but simply on volume activity, it can encourage poor behaviour among some providers.
Guy Sears: That is an interesting point whether you support pre-funding or not. Perhaps pre-funding is one of those things that should be axiomatic. It is seen as a cost of doing business. At the moment, the compensation scheme is the cost of someone else doing business. The point you make about the risk basis for collecting the money is very interesting. Finding the right proxy for banks to reflect that, whether it is pre or post-default, is an interesting issue.
May I clarify what you have said? In connection with Citizens Advice and Which? we are talking about small depositors because those are the people whom those organisations characteristically see when they have a problem. Two different concepts have emerged so far. We were told by the banks in this mornings sitting that people are moving their accounts around quite cleverly. We were told that they are trying to guess the market and put their savings in safe places and are consulting the internet and looking at charts such as the one you brandished a few moments ago. There is the other perception that they are completely baffled by the system and that they are likely to use products in Iceland, particularly when ratings agencies say that it is perfectly safe to do so. Those are two diametric images of the small depositor. Which do you think is the most appropriate for legislators to take into account?
Teresa Perchard: Most of the policy is played out in the regulations on the scheme, and the legislation is changing the scheme to provide more flexibility around what it does, what the compensation is used for, to fund the special resolution regime or to invest it partly and have flows of money in and out of the Bank of England. It seems that we can make changes to the compensation limit quite easily without legislation.
Teresa Perchard: Well, most CAB clients would be astonished to have savings of £50,000, while some would be astonished to have £500. The changes to the scheme protect many of the people whom my organisation works with, but we are struck by the fact that many people are now quite anxious about getting it right. Much media coverage over the past year has created such high anxiety even about putting money into a simple savings account that people are unsure what to do.
The issue is really about who owes who and when the limit actually kicks in. If there is a limit, and it applies to a business, not an individual brand with which a customer thinks they are trading, the brands that are trading with their customers need to tell them when they have exceeded the protected limit. I am not aware of financial institutions doing that as a matter of course. Caveat emptor. The consumers cannot know what they are not being told by the supplier.
But is it not worse than that? Even when the bank is taken into the safe hands of the state, the small investor is often the last person to find out exactly what has happened. I was contacted by constituents who were Lloyds TSB customers, so dutifully I went on to the Lloyds TSB website to see what it was saying, the gist of which was, Watch this space. I did not think that that was wholly satisfactory. A pensioner depending on a limited amount of interest from a savings account at Lloyds TSB would presumably take a similar view that, whatever arrangements were made when taking banks into partial state control or whatever salvation is offered to banks, the small investor needs to be told up front.
Teresa Perchard: In our response to the Treasury consultation, we highlighted the need for good communication with people who rely on tax credit payments and benefit payments into their bank accounts. Those people rely on a very small amount of income coming in, so they have to budget weekly. If they have to open a new account elsewhere, disruption to that income flow will cause debts. In any situation in which a bank is failing and people can no longer gain access to their money, it is those people on the lowest incomes who are drawing on it frequently who will be hit very hard.
The whole compensation scheme needs to be geared around not just a leisurely way to send out cheques to people, but a way to maintain payments in and out of the account. That is why the special resolution regime is actually capable of offering consumers in that situation more stability than a beefed-up Financial Services Compensation Scheme. It looks to ensure that banking continues by taking control of the bank services, so that customers accounts are not disrupted. Making sure that it does not happen or that bank account services are managed is in the better interests of consumers than fixing up a compensation scheme, although that is needed as an absolute backdrop.
Doug Taylor: May I preface my remarks by referring to a point that was raised earlier?
In terms of the financial capability of consumers in the UK, we can look no further than the FSAs baseline study, which showed that 40 per cent. of consumers with an equity ISA did not realise that it would be affected by movements in stocks and shares, and 16 per cent. of people with a cash ISA thought that it could be affected by movements in stocks and shares. I make that point simply to illustrate that, to establish something that consumers can understand, we need to start from where consumers are rather than where we might like them to be. Indeed, we would like to see consumers more active in using the market to get a better deal and to create a highly competitive financial services world but, where we stand at the moment, the level of understanding is perhaps lower than we would like it to be.
Doug Taylor: The FSA is now doing a considerable amount of work on the issue of financial capability, and the Thoresen review, which reported recently and which dealt with the creation of an advice network to help people on the first rung of understanding, is important. Work is being done in schools by organisations such as the Personal Finance Education Group. A whole series of actions can take place, and I think that the answer to the question is that it is the responsibility of a large number of people to try to improve capability.
We should understand that it will take some considerable time before peoples capability moves up significantly. Therefore, in the short to medium term, we need to do whatever we can to make information and the way that people interact with it as simple as possible.
We have raised a number of issues that we think would help the compensation scheme. One of them, which has already been referred to by Teresa, is the question of whether the scheme works on the basis of a brand or a licence. It is difficult to believe that consumers can navigate their way through to where an individual limit will end, given that a number of what they might see as separate brands operate under the same licence. Teresa illustrated that with the example of AA, Saga and HBOS, which are all part of the same stable. Issues around consumers understanding need to be addressed, and we strongly believe that any limit should be related to brand. That would allow consumers at least to have a view, if they were getting to the limit, of where it was.
There is also an issue related to temporary high balances. For example, if someone were to sell a house or receive a legacy, they could have a sum of money in an account for a short time, and it would be unfortunate if that happened to coincide with a bank failure. Something needs to be done in that area. We have advocated that institutions should look to the wholesale market to secure insurance, and that the FSA should create a rule so that that happens for particular areas such as temporary balances.
The third issue is to do with whether payments should be gross or net. We strongly believe that it is better to make payments gross rather than net. A net payment could potentially wipe out the liquidity of the consumer immediately. That would mean that if they had planned anything from a home improvement to paying university fees, they would find themselves bereft of cash. I listened to the session this morning, and I concur that paying gross would also help in speeding up any compensation payments. It would make it simpler for financial institutions to calculate the amount.
The fourth and final issue is that of banks that are passported into the UK system, and what should be done about them. We believe that any bank not currently authorised and regulated in the UK should be, so that consumers can have confidence that the system operates across the board in the UK. Indeed, that might require consideration of whether that part of the scheme should be pre-funded so that any default would not eventually fall on the UK taxpayer.