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Clause 7

Banking Bill – in a Public Bill Committee at 9:00 am on 6th November 2008.

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General conditions

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

I beg to move amendment No. 75, in clause 7, page 4, line 27, leave out ‘not reasonably likely’ and insert ‘highly unlikely’.

I, too, welcome you to the Chair, Mr. Illsley. The amendment is also in the name of the hon. Member for Fareham, who will no doubt want to say a few words. The clause, which covers general conditions, is another important part of the Bill. The amendment is in tune with some of the previous amendments discussed, which concern how and when the powers, and the stabilisation powers in particular, are used, and their effect on the enterprise that they are used upon. On the face of it, the amendment may seem semantic, in that we are seeking to delete the words “not reasonably likely” and replace them with “highly unlikely”. In the Bill, we are attempting to consider not just current conditions but conditions in the future when this legislation may be used in different circumstances. Hopefully, it will not be used in a general sense, but in the specific case of a particular banking operation. The amendment refers to the timing of the use of such powers, which is crucial.

Our proposed regime should be invoked only when it is clear that all other possibilities for retrieving the situation in which the bank finds itself have been properly explored. Moreover, the board and the advisers must have made every effort to prevent the failure and have been given the necessary period of time to pursue such opportunities. In fact, everything possible must have been done and must have failed before the regime can be invoked. In such a situation, it is not just “reasonably likely” but highly unlikely that they will meet those threshold conditions.

As I said earlier, such a measure is all about timing. If at all possible, we should try to maintain the integrity of the whole business. We should consider the value of  that business and the opportunity for it to continue. We should not take precipitate action that would jeopardise that possibility.

Leaving action too late could jeopardise the possibilities for protecting the depositors, which is the principal thrust of the Bill. None the less, exercising those powers too early could jeopardise the interests of other stakeholders in the business, so the timing is critical. Just as we discussed the opportunity of exercising the powers in a flexible way, so, too, the authorities will want as much flexibility as possible in determining exactly when they introduce the powers.

The amendment is designed to raise the bar to protect, to a certain extent, the bank and its directors in their efforts to maintain the enterprise. We do not want action to be taken too early in the interests of depositors without necessarily taking into account the interests of other stakeholders. We are talking about pre-solvency situations. The enterprise at that stage may be solvent, but it may not reach the threshold conditions. There is a period of time in which there are opportunities to save it.

The Government should seriously consider the amendment, particularly in light of the remarks made by the hon. Member for Fareham during our debate on the last clause. The amendment will provide some measure of confidence to those who are being asked to invest substantial sums in the banks. It is likely that part of any operation to try to meet the threshold conditions will inevitably involve recapitalisation or the raising of additional capital. Going out to seek fresh capital when there is a possibility that the trigger will be pulled because it is “not reasonably likely” that the bank will meet the threshold conditions is a whole lot different from going cap in hand with a clear indication that it is highly unlikely that the trigger will be pulled. To a certain extent, it will give a view on whether a capital-raising exercise is a possibility. It may even jeopardise the capital-raising exercise, thus defeating the whole purpose of trying to maintain the entity as a whole.

Although, it may seem merely semantic to change the words, they are highly significant. If we are moving the bar, or having the bar set at such a low level as “not reasonably likely”, it will affect the efforts of any bank under threat of not being able to meet its threshold conditions to retrieve the situation. An awful lot of things may not be reasonably likely at any one stage, but that does not mean that they will not happen. Efforts can be made and negotiations can be undertaken, but once they have been completed and it becomes clear that any rescue measure seems to be beyond redemption, in that sense, it then, of course, becomes highly unlikely. At that stage, it is inevitable that the threshold conditions will not be met, and the powers can be exercised.

As I have said, we should seriously consider those points because, as we noted when we discussed the last set of amendments, confidence in the marketplace, the cost of capital and the ability to maintain a competitive operation within the general marketplace should not be jeopardised. I have referred to the measure being just for depositors and they are, of course, an important part of the legislation, but so too are other aspects of the whole banking business. That includes those who provide the capital for banks and the way in which banks generally operate in the competitive marketplace. With those factors in the mix, we should be careful  before exercising the powers and we should ensure that the conditions to be pursued are set at an appropriate level. The bar should not be set too low. In addition, the authorities should not be brought in too early as that could even be to the jeopardy of depositors—although not necessarily. However, it could certainly be to the jeopardy of other stakeholders.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 9:15 am, 6th November 2008

I do not have much to add to the comments of the hon. Member for South-East Cornwall, who highlighted the challenge posed by the wording of the Bill. It certainly seems that there is a low hurdle for the FSA to jump to trigger the powers. I shall touch on the issue of time scale, which the hon. Gentleman also mentioned. An institution might have a short-term funding problem for a week, but the position might be resolved in a month. What is the time scale for the exercise of the second condition? It is not clear how much leeway the authorities would give a business in that situation. We need to probe that matter. In part, it might be dealt with in a revised code. The hon. Gentleman and I have opted to strengthen the constraints in the Bill, but that might not be the best way, so we need some clarity about when the condition applies. The Bill states:

“Condition 2 is that having regard to timing and other relevant circumstances”.

Clearly timing is a key factor. I am not sure what “other relevant circumstances” those who drafted the Bill have in mind, but we need to understand the context in which the power would be exercised and how the regulator would define “not reasonably likely” in relation to that area.

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

Nobody wants precipitate action taken when a bank gets into difficulties, but I also hope that nobody wants the situation to be left so that it is too late to exercise stabilisation powers in a timely manner. The question is what balance needs to be struck and what judgments need to be made in that area? I fully understand the points made by the hon. Member for South-East Cornwall; he wants to probe us on the conditions and establish whether the bar is being set at the right level. We believe it is and I shall explain why.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

Can my hon. Friend explain why the FSA should be the one to pull the trigger and how he wants the FSA to operate because there has been failure in the regulatory regime? I want assurances about what the exact expectations and the justifications were.

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

I shall happily cover that point, although the hon. Member for Gosport has raised it and we have discussed it on a number of occasions, including on Second Reading and in debate on other parts of the Bill.

Let me explain why the tests we are putting in place with these two general conditions are the right ones. The purpose of the clause is to make it absolutely clear that the authorities will not—indeed, cannot—use the stabilisation powers until it is clear that a bank is failing and that voluntary or regulatory action is no longer appropriate to resolve the situation. Clause 7 has two conditions that need to be met. The first is that

“the bank is failing, or is likely to fail, to satisfy the threshold conditions”.

The second is that

“having regard to timing and other relevant circumstances it is not reasonably likely that (ignoring the stabilisation powers) action will be taken by or in respect of the bank that will enable the bank to satisfy the threshold conditions.”

That point of “reasonably likely” has been raised by the hon. Member for South-East Cornwall with his amendment and the word “timing” was discussed by the hon. Member for Fareham in his contribution. On timing, it is not appropriate to set in the Bill a future time limit by which the bank has to demonstrate that it is reasonably likely that it can turn the situation around. The two conditions are to ensure that the bank is put into the special resolution regime at the right time. The cumulative effect of both conditions achieves that, as they cover a decision based on, in the first instance, the current situation of the bank regarding quantitative and qualitative conditions, and a decision about whether the future turnaround of the bank is unlikely. Those decisions are designed to ensure that the SRR powers can be exercised before the banks enter insolvency. One reason for that—as we have discussed in relation to other clauses—is to preserve whatever residual value there may be in the failing bank, which is a point that the hon. Member for South-East Cornwall made strongly on Tuesday. Acting at that time increases the chance of a private sector solution or a swift resolution through a bridge bank. Given that fact, the reasonable likelihood for the second test provides the right level of assurance for stakeholders that voluntary or regulatory action will no longer work, while increasing the prospect of a successful resolution.

The use of any of the stabilisation options also includes a strong public interest test which we will debate in clause 8. As Lord Turner recently said to the Treasury Committee, things can move very quickly when a bank is in a failing situation. These are matters of judgment, but I do not think that the amendment proposed by the hon. Member for South-East Cornwall would help. We believe that the two conditions set the bar at the appropriate level.

My hon. Friend the Member for Northampton, North asked the familiar question about why the FSA should pull the trigger rather than the Bank of England. We believe that the FSA, as the regulator of firms, should be the lead authority in deciding when a bank is failing. That position was supported by respondents to the January and July consultations. Giving the trigger to another institution would be likely to lead to dual regulation of financial firms, which would be wasteful and costly. Obviously—I have made this point on a number of occasions—at such a time the tripartite authorities would be in close contact, as they are now.

If the hon. Gentleman feels that he has to press the amendment, I will encourage the Committee to oppose it. We believe that the test of reasonable likelihood—the two conditions in clause 7 and the public interest safeguards in clause 8—sets the right level, but I appreciate the probing way in which he has pursued the amendment.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury 9:30 am, 6th November 2008

I thank the Minister for his response. During the debate on the last two or three clauses, I and the hon. Member for Fareham have pointed out some potential unintended consequences of the Bill. The principal thrust of the Bill is to protect depositors; it is  obviously designed to prevent runs on individual banks, and that is absolutely right in today’s situation. In many respects, it is hard to disagree with the Minister, because if the principal thrust is to protect depositors we want as much flexibility as possible to enter into an arrangement to achieve that objective at the most appropriate time. The hon. Member for Fareham and I were saying that that has consequences regarding perhaps how capital can be raised—the cost of that capital—the wider institutional market perception of the Government’s proposals and how deposit-taking institutions undertake their business. We do not know the consequences of course; we are trying to predict them. So often in this place we rush headlong into legislation, with the right intention—to achieve a speedy response to an unfortunate event—and then we live to repent, because of consequences that we had not thought of.

I shall not press the amendment because the matter has been well highlighted and ventilated in the Committee. However, I urge the Minister and the Treasury officials to think about the consequences that may unwittingly be brought about because of the fundamental desire to protect in all possible circumstances the interests of depositors. There are other interests that sometimes need to be balanced.

It is difficult to argue against what has been said on the main thrust of the Bill. We were probing the Minister, and also pointing out that there might be unintended consequences and that those might not be in the greatest interest of the UK economy and the banking network as a whole. That is the danger. On that basis, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I beg to move amendment No. 86, in clause 7, page 4, line 38, leave out subsection (6).

I want to probe how the special resolution objectives that were set out in clause 4 interact with the power to pull the trigger. We will look at the interaction between the objectives and other parts of the legislation under clauses 8 and 9.

It would be helpful to think about how the sequence of events is covered. Clause 7 gives the FSA the power to pull the trigger, which will determine whether the Bank or Treasury can exercise the stabilisation powers referred to in clause 1(4).

The Bill presents that as a linear process. The first step is either that the FSA will determine that the Bank, under clause 8, may exercise the stabilisation powers to enable it to sell a bank to a private sector purchaser or transfer it to a bridge bank, or that the Treasury will put the bank in temporary public ownership. The second step, if no financial assistance is given, is that the Bank of England will decide whether it should transfer the bank to a bridge bank or a private sector owner. The FSA, having said that the trigger can be pulled, may delegate the responsibility for what powers and options are used when no financial assistance is given. If financial assistance has been given, either the Treasury can take the bank into temporary public ownership, or the Bank can use the stabilisation powers to transfer the bank to a bridge bank or a private sector provider.

However, clause 7(6) appears to suggest that the FSA will act within a different framework of objectives from the Bank and the Treasury. The objective that will drive  the FSA in that context will be the need to meet conditions 1 and 2, but it also appears that it will be driven by the objectives set out in the Financial Services and Markets Act 2000. There is not a complete match between those two sets of objectives, and after the FSA has pulled the trigger the Bank of England or the Treasury might decide not to exercise the stabilisation powers because they do not believe that to do so would be appropriate in the context of the clause 4 objectives.

The FSA might pull the trigger, and the Bank and the Treasury could say, “No, we will not bother doing that because we do not think that we can achieve our objectives after you pulled the trigger.” So what happens then? That might be part of the problem about the sequence of events, but I am not sure that the process is as linear as the Bill suggests. The Minister has said that the tripartite authorities will discuss resetting all those things, but will they get to the point of saying together that they would pull the trigger and take action so that the decisions are made virtually at the same time? That way, the FSA would in effect only pull the trigger if it believed that the Bank or the Treasury would use their stabilisation powers.

It is worth pointing out that subsection (4) relates to our old friend financial assistance. Given the debate we had on Tuesday about financial assistance, it would be helpful to understand what sort of financial assistance the Government envisaged in the context of the FSA being able to pull the trigger. It would be helpful if the Minister expanded on how the FSA’s objectives under the Financial Services and Markets Act interact with the objectives under clause 4 and how the decision-making process will work in practice, as opposed to how it appears to work legally.

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

The amendment looks at the FSA’s decision on whether the general conditions are met and proposes that that should be subject to the SRR objectives, and I would like to explain why I do not agree with that. A fundamental distinction needs to be made between whether the SRR should apply and what actions should be taken. Deciding whether the general conditions are met is an exercise in determining whether the SRR should apply, not what actions should be taken in pursuance of it.

The SRR objectives are relevant to what actions should be taken, and they stipulate them clearly, but they should not condition whether it is appropriate for the SRR to apply to a bank in the first place. The general conditions relate specifically to regulatory and voluntary action outside the SRR rather than action under it. That is important in providing confidence to stakeholders and the market that stabilisation powers cannot be exercised before other, non-SRR options are deemed not appropriate. That was the point made by the hon. Member for South-East Cornwall. It is right to consider what steps can be taken before the trigger is pulled and stabilisation options are considered.

The general conditions in clause 7 are linked to the threshold conditions set out in the Financial Services and Markets Act 2000. Therefore, in exercising such decisions, the FSA will be acting according to its objectives and principles under the Act. That is the point referred to by the hon. Member for Fareham, and it is absolutely  right that that should be the case. In deciding whether the general conditions in clause 7 are met, the FSA would have regard to the rules and guidance in the threshold conditions section of the FSA handbook, which has regard to the statutory objectives set out in the FSMA.

The conditions have been designed to give the market confidence that regulatory and voluntary options have been explored before a bank is put into the SRR. Given that, to impose a different set of objectives over and above the principles and objectives that guide the FSA’s decisions under the FSMA would provide confusing and possibly conflicting guidance to the FSA in exercising its discretion. There is clearly a distinction to be made between the actions taken under the SRR and whether the SRR should apply, which will depend on the conditions being met and the FSA’s exercising its decision-making power in accordance with the rules and guidance in the threshold conditions in its handbook.

For those reasons, I hope that the hon. Member for Fareham will feel able to withdraw his amendment. He raised an interesting point about whether the FSA would pull the trigger if the Bank did not want to act. As I have explained on a number of occasions, the decision to pull the trigger is taken by the FSA, but it will be taken after close consultation with the Bank of England and the Treasury. As various consultations have made clear, it is not a linear process. Very few things in real life are; I think that Einstein said that even a straight line was not necessarily linear. Authorities would consult each other on all decisions, as is set out in the Bill. In practice, the intention would be that the decisions would all be taken and announced together.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

The clause goes to the heart of some of the problems that we saw in the Northern Rock debacle. My hon. Friend has described how he thinks the procedure will work in practice. How much scenario planning—war games or whatever—has there been or will there be to test how the procedures would work in practice?

Photo of Ian Pearson Ian Pearson Parliamentary Under-Secretary, Department for Business, Enterprise & Regulatory Reform, Economic Secretary, HM Treasury 9:45 am, 6th November 2008

We can probably say that the relationship between the Bank of England, the FSA and the Treasury has been forged in battle over recent months. Extensive and close consultations have been held. I do not think that circumstances could arise in which the FSA would pull the trigger without knowing what the Bank or the Treasury was going to do. There is close co-operation, and I do not doubt that it will continue.

Photo of Sally Keeble Sally Keeble Labour, Northampton North

The issue about the working of the tripartite authorities is critical, and Opposition Members and some Labour Members have been critical of it. The mechanism was supposed to resolve some of the difficulties that arose last time. Will the Minister be clearer and say exactly what steps have been taken to check or work through how the mechanisms would resolve some of the current difficulties, and how they would operate in practice?

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

As my hon. Friend knows, we have consulted widely on the Bill. We have talked extensively to the Bank of England and the FSA, so it is not as if there has not been an enormous amount of discussion  on how the tripartite authorities will work together. There is consensus on the legislation that it is an appropriate way forward. In the evidence-taking sessions that we had at the beginning of the Committee, there was widespread acceptance, when the FSA and the Bank of England were asked questions by members of the Committee, that this was a workable and sensible way forward. We are following that in the Bill.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I think that the hon. Member for Northampton, North is alluding to the lack of clarity. The Bill is actually quite straightforward in that it offers the possibility of pulling the trigger and deciding on the stabilisation options. In that respect, there is a clear legal process. However, the implementation of the measure is more sophisticated, because there will be a debate or dialogue between the tripartite authorities about the problem bank. There could be a situation in which the Bank and the Treasury decide that they cannot use the stabilisation powers because they do not think it appropriate. Their conclusions will inform a decision by the FSA to pull the trigger. Effectively, they will have a veto over the trigger, but the Bill suggests that they would not have such a veto. There is a tension between the practical ways in which the powers will be exercised and the legal form. Actually, the practical implementation gives rise to some of the uncertainty and concerns that people have about how the tripartite authorities operate, particularly in the context of a situation such as Northern Rock.

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

I agree with the hon. Gentleman that a clear and sophisticated approach is being adopted to the legislation. Of course, the authorities will work extremely closely together on these matters. As we all appreciate, we are talking about exceptional circumstances. We have experienced such circumstances, and we have the examples of Northern Rock and Bradford & Bingley. We have learned lessons from those and the legislation that we have designed would have been appropriate in those circumstances. It will put a permanent regime in place that gives confidence to the financial markets that there is clarity in our approach. At the same time, our approach recognises that we cannot put the minutiae of future discussions between the three organisations in the Bill.

Photo of Peter Viggers Peter Viggers Conservative, Gosport

The Minister is seeking to reassure us about the procedures for consultation in relation to the pulling of the trigger—I should certainly like to be reassured on that. The procedure will work only if the Bank is sufficiently tasked and staffed so that it is capable of staying close enough to the situation for the consultation to be worth while. It is no good for the FSA to have the staff or monitoring capacity if the Bank is slightly divorced because it is unable to participate through a lack of resources. Will the Minister reassure us that the Bank will be resourced sufficiently to remain close enough to the situation to be worth consulting over such matters?

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

I agree that the Bank of England needs to be resourced to perform the tasks required of it, particularly the responsibility for financial stability under the powers given to it in the Bill. That is right and proper.

As a final word on the matter, because we are treading on the ground of a stand part debate, I want to make it clear that we are not designing a zero-failure regime.  There might well be circumstances—who is to say?—in which the Bank or Treasury decide not to use a stabilisation power where the threshold conditions have been triggered. In those circumstances, the bank might go into a normal insolvency, but it might also go into the bank insolvency procedure detailed in the Bill to ensure fast payout through the Financial Services Compensation Scheme. It is not a zero-failure regime, but we believe that the lead responsibilities among the different parts of the tripartite arrangement that makes up the authorities are the right lead responsibilities. Of course they will work together closely. That is the normal and expected way of things.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

One suggestion made in the context of the code was the need for a decision tree to set out the various steps of the process in order to enable users to understand what happens when and in what circumstances.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Indeed, that is part of the problem. I tabled my amendment to delete subsection (6) because I interpreted the clause to mean that the general conditions would be exercised very differently from the powers exercised by the FSA under the Financial Services and Markets Act. However, the Minister says that there is a boundary or demarcation line, and that the FSA will consider the threshold conditions in the context of the FSMA and its rulebook. That will be one part of the boundary, and then it will flip over into the powers granted by the Bill to the Bank and the Treasury.

However, that demarcation line does not actually exist. There is no clear line. It is more of an iterative process among the tripartite authorities—I do not think that one can have a circular decision tree—that will affect how the FSA exercises its powers under the FSMA and how the powers in the Bill will work. We are trying through a legal process to impose clarity where clarity does not necessarily exist, and part of the challenge is reassuring people about how the powers will be exercised when that degree of clarity is lacking.

That is part of the Government’s challenge in communicating how the Bill will work in practice. The explanatory notes do not make the process clear, so it is again up to our old friend the code to elaborate on that slightly circular process. We need to work a bit harder on explaining how the initial process will work in practice. However, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 7 ordered to stand part of the Bill.