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Clause 1

Banking Bill – in a Public Bill Committee at 10:30 am on 4th November 2008.

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Overview

Question proposed, That the Clause stand part of the Bill.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

It is a pleasure to serve under your chairmanship, Mr. Gale. As you are aware there are good reasons why we have only now reached clause 1, but it is the meat of the Bill in terms of the special resolution regime. I shall take a limited amount of time to set the scene because clause 1 gives us a good overview of the framework of the regime tools.

The clause sets out the broad purpose of the SRR, which is to address a situation in which all or part of the business of a bank has encountered or is likely to encounter financial difficulties. It outlines the tools at the authorities’ disposal under the SRR. The special resolution regime includes the three stabilisation options: transfer to a private sector purchaser, to a bridge bank and to temporary public sector ownership. As the Committee will hear when we consider clauses 13 to 24 and 30 to 38, the stabilisation options are exercised through the stabilisation powers, which effect the transfer of shares and other securities or property, rights and liabilities by operation of law. Those stabilisation powers include the onward and supplemental transfer powers set out in clauses 25 to 29 and 39 to 41.

Clauses 42, 43 and 55 provide for a package of safeguards relating to the exercise of partial property transfer powers, which, as Members are aware, proved of particular interest to stakeholders during the public consultation process. I draw attention to the safeguards here because the Government will be issuing a consultation document on them, as I indicated in my letter to Committee members last week, as well as the draft code of practice, which the Committee has seen, on Thursday of this week.

I have established an expert liaison group of banking sector practitioners, including legal and insolvency experts, to advise the Government on the development of the safeguards. The group held its first meeting last Friday, and the consultation document that we publish on Thursday will reflect its views on the Government’s proposals. It will also have a key role in continuing to  advise the Government through the process of consultation and beyond. Yesterday I tabled a new clause on the position of the liaison group, and we will debate that in due course.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It will be helpful to Committee members if the Minister sets out who the members of the expert liaison group are.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I will circulate the names of the members of the group to the Committee.

Returning to the overview of the SRR, part 1 of the Bill includes provisions on compensation, incidental functions, the role of the Treasury and how the regime applies to building societies. The special resolution regime also includes the bank insolvency procedure and the bank administration procedure, which the Committee will consider when we come to parts 2 and 3. The special resolution regime outlined in clause 1 is at the heart of the Bill; it establishes a permanent and credible framework for authorities to resolve a failing bank. The SRR provides the authorities with the tools to deal with banks in financial difficulty in a manner that supports the public interest in financial stability, confidence in the banking system and depositor protection.

In most situations, normal regulatory interventions or voluntary action by the management of the bank can resolve an individual bank’s difficulties. However, bank failures will sometimes occur and can damage confidence, disrupt financial markets, harm depositors and generate significant costs to businesses and to the economy as a whole. Bearing that in mind, it is worth taking a couple of moments to outline the background to the development of the special resolution regime and the genesis of this part of the Bill.

The recent period of sustained disruption in global financial markets, starting in the United States in the summer of 2007, has had a widespread impact on financial markets, firms and economies across the world. In the UK, the most visible consequence of that has been the financial difficulties faced by a number of financial institutions, including Northern Rock plc.

In summer 2007, Northern Rock found itself unable to finance its activities, due, among other things, to a business model that was heavily reliant on funding from the wholesale money market. In the light of those severe difficulties, the Government took action to maintain financial stability, while protecting consumers and the interests of the taxpayer.

In February 2008, when it became clear that, in the light of prevailing market conditions, no institution was prepared to make an offer to take over Northern Rock that was judged adequate to protect the taxpayer, the Government took the decision to take the bank into temporary public ownership. To that end, legislation to give the Government powers to transfer the shares or property of a failing bank was brought forward in the Banking (Special Provisions) Act 2008, which received Royal Assent on 21 February of this year. The main transfer powers expire, under the terms of that Act, on 20 February 2009. That Act provided the Government with temporary powers should further action be needed while permanent legislation—this Bill—was being prepared and passed.

The prudence of that approach has been demonstrated by events concerning Bradford & Bingley plc. On Monday 29 September the Government used both the share and property transfer powers provided by the 2008 Act to bring the bank into temporary public ownership and then to transfer the deposit book to a private sector purchaser. The special resolution regime outlined in clause 1 replaces the 2008 Act with a permanent framework for the authorities to resolve a failing bank, with objectives that include protecting and enhancing financial stability and confidence in the banking system, and protecting depositors and public funds. Those objectives will be considered under clause 4. By setting out a clear and credible statutory resolution regime to address a failing bank, which removes control from the bank’s management by overriding the powers of shareholders and directors, the regime also provides a strong incentive for banks and their directors to take action to prevent their business from getting into difficulties.

Unlike the 2008 Act, the SRR has been designed as permanent legislation and therefore provides a framework with strict conditions that must be met before the powers are exercised, clear objectives that the authorities must have regard to in exercising those powers, and refined stabilisation powers that are targeted in their effect alongside new tools such as the bank insolvency procedure. Clause 1 also establishes that each of the tripartite authorities—the Bank of England, the Treasury and the Financial Services Authority—has a role in the operation of the special resolution regime. The powers and responsibilities of those bodies are extended by the Bill, in line with each institution’s current mandate and responsibilities, to enhance the UK framework for financial stability and depositor protection. The SRR also provides the authorities with a wide range of tools to meet the above objectives, by resolving a failing bank or facilitating fast payout to depositors. The establishment of the special resolution regime was widely supported by stakeholders throughout the consultation process; I am also grateful for the support from Opposition Members.

As I have said, clause 1 clearly sets out the framework for the whole package of SRR tools—we will debate the tools later—giving the authorities the full range of options for dealing with a bank that is experiencing difficulties. I appreciate that the Committee will wish to discuss many of the provisions that the clause summarises, and which I have just briefly run through. I am looking forward to debating the provisions in detail over the remaining sittings. However, I propose that detailed consideration of those provisions be reserved until we reach the corresponding clauses. I will be guided on that by you, Mr. Gale. Given that clause 1 is a broad summary clause, intended to provide users of the Bill with a clear understanding of its contents, I urge that the clause stand part of the Bill.

Photo of Roger Gale Roger Gale Conservative, North Thanet

The clause is fairly wide-ranging—as the Minister has indicated—and it is up to the Committee to decide how broad it wishes the clause stand part debate to be, bearing in mind that we need to try to avoid covering too much ground that will be touched on under other clauses. If it becomes necessary to embrace other arguments and discussions prior to further clauses being reached, I shall bear that in mind. As the issue is complex, I am acutely conscious of the need to have a fairly wide-ranging debate now. The decision is in the hands of the Committee.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It is a pleasure to serve under your chairmanship, Mr. Gale, for this ninth sitting, which by my reckoning takes us to about halfway through the Committee’s proceedings. I am not sure that we have broken the back of it yet, but the end is in sight. I take note of your comments, Mr. Gale, about guiding our debate. I recognise the challenge in trying to restrict remarks. One could make a speech that lasted for both sittings today and well into Thursday, but it would not be in my interests or those of the Committee to go down that route—

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

—although my hon. Friend might tempt me to do so if he is not careful. I want to give a sense of where we are coming from over part 1 and to set the backdrop for our debate on it.

As the Minister said, clause 1 sets the scene for part 1. I share his recognition that one of the learning points from the crisis over the last year is the lack of a decent toolkit for dealing with the problems of a failing bank. That came out particularly clearly from the debate on the future of Northern Rock and the time it took to resolve that situation suggests that we did not have the right tools available. I suspect that if the tools that were initially developed in the Banking (Special Provisions) Act 2008 and have been fleshed out in this Bill, had been deployed in respect of Northern Rock they would have produced a different outcome. We do not know what that outcome might have been, but we have seen how Bradford & Bingley was tackled and in some respects it was not dissimilar to Northern Rock in its problems. A very different solution was found for Bradford & Bingley compared with Northern Rock.

It is in a way disappointing that the Government have not listened to the warnings that they were given prior to this crisis about the adequacy of the framework for dealing with a failing bank. At the end of one of the scenario-planning exercises that the tripartite authorities undertook and which looked at this issue in about 2005, both the Governor and the then chairman of the FSA, Sir Callum McCarthy, highlighted the need for a review of the tools that were available. They recognised that the framework that was in place was not sufficient to deal with the consequences of a failing bank.

The Bill provides a set of tools, the stabilisation options in part 1, the insolvency procedure in part 2 and the administration procedure in part 3. When considering those stabilisation options and the transfer to a private sector purchaser and to a bridge bank and temporary public ownership, we need to bear it in mind that this part of the Bill invests significant powers in the tripartite authorities. Those powers enable them to make important decisions affecting the function of the banking system and the wider financial sector, as well as affecting the outcomes for individual institutions and their creditors. The framework for the exercise of these powers is set in clauses 4 and 5, and we will talk about them in more detail later on.

Clause 4 sets out the objectives of the special resolution regime. The Committee will note from the range of amendments tabled on clause 4 that there is a question  about the completeness and adequacy of the framework which we would want to probe in that debate. Clause 5 talks about the code of practice. We are grateful for the early sight of the code last Thursday, but as the Minister wrote in his covering letter, it is very much a work in progress. It makes it a little difficult in the context of the debate on clause 5 to understand just what the safeguards will be over the exercise of the power by the Bank, the FSA and the Treasury, given the amount of work that still needs to go into the code. It would be helpful for the Committee if, in his summing up of this stand part debate, the Minister would outline how he envisages the process of consultation on development of the code working, in parallel with the passage of the Bill.

For my part, I would want to see before Report in this place a more detailed code that is much closer to completion—I accept it might not be finalised—than the one that was circulated to us on Thursday, so that we can be sure that a robust framework is in place that will govern the use of these powers. I am sure that when we reach clause 5 we will have a long discussion about the nature of the code.

The concern I have—also expressed in the response to the stakeholders’ consultation—is to ensure that there is a proper framework in place so that these powers are exercised in a predictable way: that people know the circumstances in which they will be exercised. That is what we are lacking at the moment. We will try to tease out how we shall know the circumstances in which the powers will be exercised. That requires further elaboration in the code and I hope that today’s debate helps us establish more detail.

In talking through this part of the Bill, it might help the Committee if the Minister were able to use recent examples of how the powers in the special provisions Act have been used, to illustrate how they will be exercised in the framework in this Bill and to explain the points of difference between the special provisions Act and the Bill before us. The Minister referred to how Bradford & Bingley was dealt with in the context of temporary public ownership and the transfer of shares and property. We also had the situation with Heritable where the FSA determined that the threshold conditions had been breached and that led to deposits being transferred to ING Direct and the rest of Heritable being placed into administration; there was a similar pattern with Kaupthing. These are powers that we would expect to see in this Bill.

However, one element of the Icelandic banking system fell outside the powers of the special provisions Act and it would be helpful for the Committee to understand how the Bill would deal with Landsbanki’s branch in the UK. A different set of powers was used to tackle the problems faced by Landsbanki. We need to understand how the Bill would tackle a situation where a bank’s branch based in the UK faced significant financial problems. A relatively large number of banks based in the UK operate through a branch system rather than through a UK subsidiary. We will come to that in clause 2, when I will probe it in more detail. That important issue needs to be resolved.

We want to ensure there is some predictability in the way that these powers are used. That will require us to probe some of the language in later clauses. Clause 7(3), for example, says that the power can be exercised if

“it is not reasonably likely that...action will be taken...to satisfy the threshold conditions.”

That sounds a relatively low test and I think people would expect a higher test where the threshold conditions are to be invoked. We will come to that. That is why it is important in this debate on part 1 to tease out some of the language and the meaning, certainly in relation to that clause. The explanatory notes state:

“Those conditions essentially demarcate the boundary that must be crossed before the stabilisation powers...may be applied to a bank.”

That does not further our understanding of how clause 7 will work.

The issue of partial transfers is one of the most contentious in the clause, and stakeholders have expressed concern about it. Before debating the relevant clauses, we will want to see as much as we can of the draft statutory instruments that relate to partial transfers, or a clear statement from the Government of the principles that might underpin them. Part of the architecture of the reforms is that the power should be set out in primary legislation, the safeguards in the secondary legislation and further elaboration in the code of practice. We need to see that entire package before we decide whether we are content with the Bill. The Minister has expressed his willingness to make it available, for which I am grateful, but the state that the code of practice was in when it was circulated on Thursday suggests that there is still some way to go before those documents approach a reasonably final stage.

My final point is that the Bill focuses on what will happen when things go wrong. It is important to have the right set of solutions in place when that happens, but I am sure that all members of the Committee feel that prevention is better than cure. We want to ensure that the FSA, the Bank and the Treasury, in tandem with the work that we are doing here to the legislative framework, look carefully at how they will ensure that the preventive framework is in place, so that those powers will hopefully remain sitting on a shelf gathering dust after the current crisis is over, rather than being used on a regular basis.

Photo of Peter Viggers Peter Viggers Conservative, Gosport 10:45 am, 4th November 2008

This is a crucial clause in an important Bill. We must realise that we are not going back to the year 2006. When the legislation is passed, we will not be returning to the happy, confident days before the credit crunch impacted a year or more ago. To that extent, the Minister is completely right when he says that the measures we are putting in hand are permanent and that many of the issues relate to a new permanent framework, and that is why it is so important to get it right.

When the US authorities were faced with difficulties and introduced Sarbanes-Oxley, the effect on the banking industry and the efficiency of financial markets was disastrous. The City of London will be allowed to expand to a greater extent than it might otherwise have done because the American financial markets are now rather constipated and hampered by the bureaucratic and legalistic effects of Sarbanes-Oxley and the imposition of measures that caused difficulty for their operation.

Some of the measures that we are introducing now will be permanent, but others will of course be temporary, and that imposition will need to be removed if we are to return to the days of an efficient and confident banking system. We need to distinguish carefully between the permanent measures, which we must get right, and the temporary measures needed to satisfy the present difficulties.

I have previously—I remember raising the issue with the Minster—put forward the nearest analogue to the present situation, which is the situation of Lloyd’s of London in the 1990s. I draw on my experience as a director of a bank in the secondary banking crisis of the 1970s, so I have, uniquely in the Committee, been here before. I was also one of the four members of Lloyd’s of London’s audit committee when it pushed through what was then the biggest single corporate rescue in the history of finance, so I am sure that the nearest analogue to our present situation is Lloyd’s of London. In that case, an insurance underwriter would underwrite a risk and then lay it off by reinsuring with another insurance entity. That second insurance entity would then lay off his risk. What would develop was what was known in Lloyd’s days as a spiral, which was a spiral of reinsurance so that the second, third, fourth, fifth—perhaps the 15th—insurer did not know the exact nature of the assets he was reinsuring. That is a very close parallel to the current collateralised debt obligations. Our present difficulties arose because of the creation of collateralised debt obligations in the United States initially, and the reinsurance and refinancing of the toxic assets in a spiral very similar to the Lloyd’s spiral of the 1990s.

Photo of Brooks Newmark Brooks Newmark Opposition Whip (Commons)

I have to agree with everything that my hon. Friend is saying about some of the causes. Does he agree that another major cause was that many of the directors of these banks did not understand where some of the hot shots on the derivative desks were making the money? The derivatives they were trading were very complex and highly leveraged. The question here is how we legislate to ensure that directors understand where their institutions are making their money and what the risks associated with those assets are.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

Indeed. My hon. Friend makes a very good point. I recall being called in by the then Prime Minister Margaret Thatcher, who told the assembled junior Ministers that we would be faced with a number of complex situations. Quite often it was difficult to understand the nature of the complexity of the issues that were being put to us. I remember her saying with a very firm and direct gaze, “Never do something you do not fully understand.” That is exactly what happened in the secondary banking crisis. There were people in senior positions in banks who did not fully understand the nature of the complicated instruments that they were acquiring. They saw those very clever hot-shot people dealing in these assets. They saw that fees were involved. They saw that it was very profitable and they allowed the deals to go through.

There is an exact parallel here with Lloyd’s of London. I remember it very well. One Lloyd’s underwriter would nod through risks that he did not fully understand. In the trade he was known as the nodding donkey. Anyone wanting to offload a risk could go to him and he would agree because he was making a great deal of money out  of trading in assets that he did not fully understand. There is a close parallel. I could go into considerable detail on this. It took up a great deal of my time in the 1990s, but the parallels between the Lloyd’s spiral then and the banking spiral in the last year or two is very close.

Photo of Brooks Newmark Brooks Newmark Opposition Whip (Commons)

There is one other point to make. People at Lloyd’s felt that they could effectively pass the sardines continually around and that everybody would keep making money. It is analogous to what has gone on in the last 10 years and the theory that it was the end of economic history; we had ended this era of boom and bust and we could manage growth for ever. Perhaps this is the hubris that we have found—I do not mean to be too political here—with the current Government’s thinking that they could control events and control cycles. But at the end of the day it is difficult to control cycles. Therefore the Bill needs to address a little bit more how we manage our way through difficult times, particularly economic cycles. We have seen today that we have not ended the era of boom and bust.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

I very much respect all the points that my hon. Friend makes. He is one of the Members of Parliament who, in a previous incarnation, dealt with very large amounts of money. He understands large sums with lots of noughts on the end, which are difficult to grasp if one has not been involved in banking and international financing matters.

There are close parallels between the Lloyd’s situation of the 1990s and the banking situation that has developed in the last year or so. What lessons can we learn? I have made the points before and it is a matter of regret to me that despite the fact that I have talked to journalists from the Financial Times, made speeches on the Floor of the House and raised the issue with the Minister, the points that I am about to make have not been fully understood and comprehended.

What did Lloyd’s do? How did it face up to that very difficult situation? Faced with a spiral of risks, which were not fully understood, that had been undertaken by a range of bodies, Lloyd’s separated the toxic assets—the uncertain assets—from the viable, continuing business. That is what the banks should be attempting. They should be carrying out a much more scrupulous, careful and determined analysis of their assets and should be separating out the viable, continuing business. All the banks and building societies that we have been talking about have very sound businesses and assets. The accountants and others need to identify the parts that are definitely, provably sound and then separate them from the assets that are not definitely, provably sound. Of course, not all of those assets will be defective and useless; many will be valuable. When I talk about toxic assets or doubtful assets, I am not talking about worthless assets, but those with a value that cannot be completely proven.

Lloyd’s separated the uncertain assets and moved them into a new vehicle, which was called Equitas. If we were to follow that plan in the current banking situation, Smith bank Ltd would identify the proven valid assets, which would stay in the parent company, but all the uncertain assets would be relegated to a subsidiary—for  the sake of simplicity, let us call it Smith Toxic bank Ltd. Smith bank Ltd owns Smith Toxic bank Ltd, which owns the uncertain assets. There are two key points: first, it is crucial that new money—taxpayers’ money, investors’ money and shareholders’ money subscribed by way of rights issue or preference shares—does not go into the old, mixed up Smith bank Ltd, which includes toxic assets, but into the new Smith bank Ltd, the parent company, which only has assets that are known to be sound.

One does not invest new money in a body that has assets of uncertain value, which is why I think that the Hank Paulson plan is fundamentally flawed, although I am not claiming to know more about banking than Mr. Paulson. It is flawed because it involved putting the $700 billion of new money into mixed bodies that included the toxic or uncertain value assets, rather than putting it into proven, sound top companies.

Photo of Peter Bone Peter Bone Conservative, Wellingborough 11:00 am, 4th November 2008

My hon. Friend is making a clear argument. The standard way that accountants would deal with the matter would be to provide fully against what we have called the doubtful, or toxic, assets. Those should have been written down and established before any investment decisions were made. Would that not have the same effect as my hon. Friend’s suggestion?

Photo of Peter Viggers Peter Viggers Conservative, Gosport

I think that one needs to go further to identify and isolate the toxic assets. Drawing on the parallel of Lloyd’s of London, taking a top company and making allowances and provisions against its assets does not have the same decisive and incisive effect as separating off the assets. Identifying and isolating toxic assets is a central feature of the way ahead.

Photo of John Pugh John Pugh Shadow Minister (Treasury)

The hon. Gentleman puts forward a therapy for many banking ills. Does he consider that the procedure that he is mapping out would probably have been a better way of dealing with Northern Rock in the early days, when some of the sub-prime mortgages were held by Lehman Brothers and an agency of Northern Rock?

Photo of Peter Viggers Peter Viggers Conservative, Gosport

Indeed. My point has general application. My central point is that new money should go into the purged body, so that shareholders and taxpayers know that they are investing in a sound body rather than a tainted or uncertain one.

There is some good news here. My second point is that if the tainted assets are identified and isolated—carefully identified and cross-checked against other tainted assets—it will be found that because the spiral has involved reinsurance or, in the case of CDOs in banking, reinvestment, in a ring, all the banks that undertook that insurance or investment made reservations against their investment, because they too were uncertain about the value of the asset. When all the tainted assets are pulled together and carefully cross-checked, the bank that undertook the collateralised debt obligation and then sold it on will be found to have made reservations against the CDO, as did the second, third and fourth banks and so on, perhaps in a multiple ring. There will have been a duplication of reserves in the spiral, and therefore the risk and the potential loss will not be quite as great as had been thought. That is the good news.

I urge that there be much closer analysis and breakdown of risk, that investment go into the purged top body and not into the mixed body, and that an analysis of the toxic assets be undertaken, perhaps by a different body. If Smith bank toxic assets and Jones bank toxic assets are pulled together and carefully identified, the lesson of Equitas is that there will be duplication and the risk will not be as great as originally thought. That is exactly what the sage of Omaha has discovered; his American company has invested in Equitas, demonstrating that the value of the loss was not as great as it should have been.

I have seen some references to the point that I am making. For instance, last week a former Japanese Finance Minister made an important speech, urging that there be closer analysis of the risks that banks have undertaken and more careful identification of the toxicity of the assets. I return to my central point, which is that I am not satisfied that the authorities—the Bank of England, the Treasury or the Financial Services Authority—have done enough to ensure that banks undertake as scrupulous and detailed an analysis of their prospective losses as they should.

Photo of Brooks Newmark Brooks Newmark Opposition Whip (Commons)

I agree that the Paulson plan was flawed, in that it effectively asked taxpayers to stump up for all the bad assets. My hon. Friend’s solution is to try to separate off the bad assets—effectively creating a good bank and a bad bank—but he will find that many assets defined as toxic are not really. They are assets that are effectively under water compared with when particular individuals took out loans. These houses still have a value and over time these particular assets will, with inflation, rise and no longer be toxic assets.

A weakness of some of the solutions that have come up is that there is no solution to deal with the front-end crisis, which is a super-decline in asset values, almost to an extent that the values of houses are lower than any rational market would say that they are. One needs to come up with a solution that gives confidence to people who are borrowing and to the housing market, so that over time many of these so-called toxic assets effectively reflate their way out of their toxicity.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

Indeed. Using the word toxic is shorthand, which is why I did expand and say uncertainty, because uncertainty derives from not knowing how other people will value the assets. A book of mortgages will have a high value if people are confident in property prices but if they are not confident the value is doubtful and becomes “toxic”. We need to restore confidence. If one is drowning and wants to restore confidence, one has to get a foot on the bottom of the swimming pool. It is no use just splashing around. We have to find a firm, clear point of certainty, which in my opinion is to have assets that are certified as valid and sound. That is where new money should go, not into the mixed body.

I am grateful to the Minister for his attention. I am concerned about this point. I hope that more can be done to satisfy me that the point has been grasped and that the Government are working in this way.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I am pleased to follow my hon. Friend the Member for Gosport, who made an important case and highlighted the problems in clauses that we shall be discussing.

My hon. Friend described the problem of what we have seen in the banking sector as a spiral. The accountants’ reaction to this is that all these debts are toxic. It is an unfortunate word because it really means doubtful value of assets. They might not be toxic. What has happened is a collapse in the market for those assets. As a chartered accountant, my reaction is to ask why we do not write those things down to their lowest possible value. That is the problem. If they are written down to where they are at the moment, there is a collapse in the asset base of the individual banks, which then has to be responded to by stuffing in capital through investments in shares and preference shares, which is the way that this crisis has been handled. I am interested in the idea of moving these debts out of the banks and putting them into separate subsidiaries. That is an interesting proposal because it then produces a good bank and a bad bank but the bad bank might not actually be a bad bank. That is one solution.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

If the hon. Gentleman has studied the Scandinavian banking crisis, he will know that the establishment of the bad bank there did eventually deliver a rather better outcome than had been anticipated because, as he says, they were not assets without value; they were simply assets for which it was not possible to determine an appropriate market value at that time, which had led to substantial writedowns. So there is merit in a bad bank option.

Photo of Peter Bone Peter Bone Conservative, Wellingborough 11:15 am, 4th November 2008

I am grateful for the hon. Gentleman’s intervention. I do think that we should be looking at that.

The other solution is to take a more realistic value of the provision made against the assets. Instead of writing them down significantly, they should be written down to a realistic value, as we heard Angela Knight argue in oral evidence. If that is done, the requirement for the capital to be injected into the bank is by no means so great.

I am also concerned that the Bill does not address the speed at which the Government have put in, or propose to put in, extraordinary amounts of money without really knowing the value of the banks. It is extraordinary that banks that could make billions year after year can overnight seem to become virtually worthless so that, without billions of pounds of investment by the Government, they would sink. We have already seen in today’s media that the proposed injection into Lloyds bank of huge amounts of preference money by the Government is now being said by Lloyds to be unnecessary because it will have repaid it all within a year. I question whether we are looking at the real problems or reacting to the crisis as we perceive it at the moment.

Photo of John Pugh John Pugh Shadow Minister (Treasury)

I do not know whether the hon. Gentleman shares my conceptual confusion. I listened carefully to what the hon. Member for Gosport said about differentiating toxic and non-toxic assets and what the hon. Member for Wellingborough said about how the toxicity of assets could change. The hon. Member for Gosport then redefined toxic and non-toxic in terms of certainty and uncertainty, but what is toxic or non-toxic then itself appears to be uncertain. I wonder whether  we ought to continue to use the term “toxic”, given that it is largely a metaphor and has no real resonance in economic science.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

The hon. Gentleman makes my point. The word “toxic” is trundled out in every news broadcast as though it means something, but it does not mean anything. It is the actual value of an asset that we cannot be sure of, and I think that we have got the approach wrong on that. My hon. Friend the Member for Gosport suggested a solution that really highlights the issue. The bad bank is nowhere near as bad as it looks, because those assets have been provided against time and again by different banks, so it is only really the first set of debts, where the first loans are in doubt and part of them will be valuable anyway, that needs to be provided against. I am not sure that the spiral of debt, which has led to a spiral of provision against the value, is necessarily the right way forward.

Photo of Brooks Newmark Brooks Newmark Opposition Whip (Commons)

My hon. Friend has made several excellent points, and it might be instructive, not only for him, but for my hon. Friend the Member for Gosport, and perhaps even for the Minister, to have a look at a new document that has come out today from the Centre for Policy Studies called “From Boom to Bust: a plain guide to the causes and implications of the banking crisis” by Mr. Howard Flight. Reading his analysis might be a helpful guide to the Minister in coming up with some robust solutions to the current crisis.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I thank my hon. Friend for his intervention. I have not had a chance to read that document, but I am sure it would be worth reading, because Mr. Flight is a superb author.

In conclusion, I feel that we should avoid using the word “toxic” because it is misleading. We just need to look at the basics of what a company is and what its value is. The banks cannot have gone from being the soundest investment one could possibly have, making billions of pounds each year, to having such colossal writedowns overnight. That just does not make common sense.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

Perhaps I could begin by responding to the comments by the hon. Member for Gosport and then move on to the issues regarding Landsbanki, safeguards, the code and consultation.

I accept the broad thrust of the analysis by the hon. Member for Gosport: that the origins of the global financial crisis were in the sub-prime market in the United States and that there was insufficient understanding of the impact of collateralised debt obligations on the whole market system. I do not particularly like to use the term “toxic assets” either. However, in this case we are talking about impaired assets in some shape or form.

The hon. Member for Gosport sees close parallels with Lloyd’s. There are some parallels, but there are also different circumstances. In the case of Lloyd’s and the reinsurance market some years ago, the company got into significant difficulties but it dealt with them. Banks or building societies may get into difficulties and they will manage them themselves. They will adopt a number  of strategies, whether that is writing down the assets or isolating and separating out bad and doubtful debts. I do not think that there was a systemic risk to the global financial system in the case of Lloyd’s, as there has been as a result of the problems in the sub-prime market. But that is not to say that the hon. Gentleman does not make a number of valid points about these areas.

The hon. Member for Wellingborough mentioned the accounting treatment in this area. He will be aware of changes that were announced a couple of weeks ago in how the mark-to-market rules are to be interpreted in distressed economic conditions. That has been a beneficial clarification. The Government were still right to take the action that they did on liquidity, recapitalisation and providing debt guarantees to stimulate inter-bank lending. It is important to recognise that action needed to be taken on all three fronts because of the financial situation that we found ourselves in.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

I would submit that the situation at Lloyd’s and the present situation are very comparable. When the Minister said that the Lloyd’s case would not have led to the collapse of the financial markets, he described Lloyd’s as a company. Lloyd’s is not a company. It is an unincorporated structure. The people backing Lloyd’s at that time were 30,000 of some of the richest people in the United Kingdom, whose names were put forward to become names at Lloyd’s. If Lloyd’s had failed it might well have led to the bankruptcy of some 30,000 leading citizens and would have had a devastating effect on the City of London and on financial markets generally. The parallel is closer than his remarks indicate.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I agree of course with the hon. Gentleman’s statement about the legal status of Lloyd’s. I was trying to draw a distinction between that and the problems that banks and building societies might face in the future.

Photo of Peter Bone Peter Bone Conservative, Wellingborough

I should be grateful for the Minister’s opinion. He talks about liquidity, which obviously needed to be put into the banking system, and bank guarantees, which I also understand, but I query the third element—the capital. If one has written these doubtful assets down to a level that is far less then they are worth, one is putting in billions of extra capital that would not be necessary if one had the right valuation in the first place.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

The hon. Gentleman is clearly right that in distressed market conditions assets get written down. In the case of banks that would affect their tier 1 capital ratios—hence the need for recapitalisation. Obviously we have gone through completely exceptional circumstances over the last couple of months, which is why there have been substantial international discussions, and why we took the action that we did across three fronts—liquidity, recapitalisation and debt guarantees—to get the inter-bank lending market moving. It is why there has been general consensus, as a result of those international discussions, that this is the right approach, and other countries have followed our lead. However, that does not neglect the need for banks and building societies to take action to deal with their own situations. The hon. Member for Gosport is completely right: hiving down the impaired  assets part of an institution to a subsidiary company can be an effective strategy, and some institutions have done that in the past 12 months.

Photo of Brooks Newmark Brooks Newmark Opposition Whip (Commons)

Did the Government consider converting debts such as bondholders into equity, as a way of right-sizing the impaired capital structures of those banks? That would give the balance sheet a sensible capital structure, as opposed to simply infusing taxpayers’ money to right-size the balance sheet, which would leave impaired debt in place. I mean junior debt not senior debt—bondholders, for example. There are many bondholders in all those banks, and they could easily have been forced to convert their debt into equity.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

We had detailed discussions with the banks on a wide range of issues concerning their financial position. We believe that we took the right course of action, in conjunction with the banks, to help to ensure stability in the financial markets.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

One of the difficulties with using the bad-bank option as a relatively rapid response to a crisis is that it requires the unpicking of the asset basis of the various businesses that have been handled differentially, because of the different approaches to writedown that banks have taken in short time frames. The Scandinavian model was facilitated by almost the entire Scandinavian banking system ending up in public sector hands, which meant that the separation of assets into a bad bank could be compelled through one coherent ownership model. That is not the case in the UK.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

That is a helpful clarification for the Committee, but I repeat that there is nothing to stop individual banks putting assets into subsidiaries at the moment. It is a perfectly permissible approach. We will discuss good banks, bad banks and partial transfers later, but the point emphasises the importance of the safeguard provisions. I shall speak broadly about them in a moment, and we will come back to them under clauses 42 and 43.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

May I take the Minister back to his comments on capitalisation and the writedown of asset values? Is it his view that the Government’s contribution to the recapitalisation of banks—either subscribed for by private shareholders or underwritten by the Government—is sufficient to cover historical writedowns only, or has some idea of future levels of writedown on both mortgage-backed securities and corporate debt been factored in?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury 11:30 am, 4th November 2008

I do not want to respond directly, but I will say that the agreement that the Government have reached with the banks has been designed to ensure that the banks are able to meet their tier 1 capital ratios. The overriding objective of the Government’s actions has been to ensure confidence and stability in the banking system.

Photo of Mark Todd Mark Todd Labour, South Derbyshire

The Treasury Committee queried an aspect of this yesterday. It was made reasonably clear that the FSA and the banks had modelled requirements according  to a variety of circumstances, which would have included a substantial further loss in their asset base before determining the capital injection requirement that the Government have subsequently offered.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I thank my hon. Friend for that comment. I understand that the Chancellor wrote to the Chairman of the Treasury Committee providing a significant amount of detail regarding the announcements that were made in the House on 8 and 13 October and that that is publicly available.

I move on to the point about Landsbanki raised by the hon. Member for Fareham. We can deal with it in more detail in clause 2, if it is felt necessary. We believe it right to put in place arrangements to ensure that retail depositors receive their money in full and we continue to work with the Icelandic authorities to ensure fair treatment for UK depositors and creditors. There clearly is a difference, which we discussed earlier, between subsidiaries of an Icelandic bank, which are regulated by the FSA, and branches, which are regulated by the home country authority. The Bill does not in general allow the authorities to take control of branches of European economic area banks in line with our obligations under Community law. There are clear EU law obligations that we need to apply.

The Bill differs from the Banking (Special Provisions) Act 2008 specifically with regard to new tools to deal with failing banks, such as the proposals on bridge banks, and the two new insolvency procedures—the bank insolvency procedure for fast payouts to depositors and the bank administration procedure to make partial transfers effective. There are other differences with regard to preconditions, framework powers and compensation. It might be helpful if I circulated to the Committee a brief summary of the differences between the Bill and the 2008 Act. We are able in the Bill to provide a permanent framework to refine and develop the powers in the Banking (Special Provisions) Act. In some cases those powers are very broad, and there was significant stakeholder concern about their broad nature and the fact that there is not the legal certainty that hon. Members rightly want. That is why the safeguard provisions, and others that we will come on to discuss, refine the powers in the Act.

Photo of David Gauke David Gauke Shadow Minister (Treasury)

I am grateful to the Minister for his offer to circulate a document distinguishing what we have in the Bill and what is in the 2008 Act. Some elements of the Financial Services and Markets Act 2000 are to do with transfers of property too. As the Minister is being so helpful, would it also be possible to circulate a summary of any developments and changes regarding the Financial Services and Markets Act as well?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Before the Minister moves on, I should like to return to the comparison between the 2008 Act and the Banking Bill. Clearly the 2008 Act’s powers have been used to bring about change in a number of institutions—we have talked about Bradford & Bingley—but how would those circumstances have been handled if the wide-ranging powers in the Banking Bill had been  available to the Government? Knowing that will help us to understand how the Government will apply the powers in practice in a context with which we are familiar.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

It may help if I clarify those points directly. A Bradford & Bingley-type resolution is possible under the Bill, because clause 2 permits the transfer of banking to temporary public ownership via a share transfer. Clause 14 permits the partial transfer of the deposit book and branches, such as in the case of Santander. A similar result is also possible using direct partial transfer by the Bank of England to Abbey or any other private purchaser, or, alternatively, via a bridge bank. The exact resolution option used would depend on a wide range of detailed factors, but the options pursued in the Bradford & Bingley case are possible under the permanent regime if a similar situation arises in the future.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

That is very helpful, but can the Minister go further and elaborate—not necessarily now, but perhaps when we discuss the relevant clauses—on the factors that suggest one course of action rather than another? It will help to build a sense of how the powers will be used in practice if the Minister uses the same examples later on and says, “If this happens, we will use these powers for these reasons and if something different happens, we will use a different set of powers”.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

I shall see what is possible. The range of tools is an important feature of the regime and how the tools are used depends on the particular circumstances faced. With Kaupthing Edge, deposits were first transferred to a company owned by the Bank of England and then to ING Direct; under the Bill the same effect can be achieved in a variety of ways, as I have outlined with regard to Bradford & Bingley. I am happy to write to the Committee setting out the general differences between the Bill and the 2008 Act. If I can, I will give examples of how the same situations are still possible.

Finally, I want to respond to the comments made by the hon. Member for Fareham about the consultation process on the code. As I outlined in my initial remarks, on Thursday we intend to publish a consultation document on the safeguards and on the draft code received by the Committee last Thursday. I want to highlight the fact that the safeguards will be put in secondary legislation, which is what stakeholders have been asking of us. That obviously ensures that there will be proper parliamentary scrutiny in future.

As I indicated, I have already shared the draft code with the expert liaison group and I will ensure its continued involvement. However, given that we are publishing the draft code only on Thursday and there needs to be a consultation period, I cannot guarantee that we can have a further draft of the code by Report, because we will not have been able to get all the consultation responses. The assurance that I can give is that the real detail of the safeguards will be in secondary legislation. That will go through the parliamentary process, which will certainly ensure a level of scrutiny. Our intention is that consultation on the code will be finished and we will have the final version before the Bill completes its parliamentary passage. If there are any concerns about it there will be an opportunity for them to be expressed at a later date.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am grateful to the Minister for that clarification of the process, but two questions arise. First, will the code to be published on Thursday be significantly different from the code that members of the Committee saw last Thursday? Secondly, the Minister will be aware of the concern about the possible gap between primary legislation being passed and secondary legislation being debated. What is his view about that gap? Will secondary legislation be in place around the time of Royal Assent, or will there be a longer delay? The longer the delay, the greater the uncertainty in the market about how effective those safeguards will be.

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury

First, my understanding is that the code is not substantially different from the draft that the Committee saw last Thursday. It has been seen by the expert liaison group at first-cut level. Undoubtedly there is potential for it to be modified through the consultation process by the expert liaison group and by others who will naturally have an interest in it. I completely appreciate what the hon. Gentleman says about the gap. I would like as small a gap as possible between the legislation coming into force and the secondary legislation being improved and that is certainly what we will endeavour to achieve. The consultation document that we are issuing this Thursday provides some draft legislation showing what the secondary legislation would look like. There will be an opportunity for its external scrutiny, and I hope that it will be in good shape so that we can implement it as soon as possible after the Bill receives Royal Assent.

Question put and agreed to.

Clause 1 ordered to stand part of the Bill.