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I have four points to make on banking reform, some of which have been touched on by others. First, we need to fix the bust tripartite regime. The Chancellor’s proposals for banking reform seem to reward the FSA and give it the primary role. But supervisors are not bankers; there is a fundamental flaw to that idea. The supervisors who monitor a bank have a vested interest, once it goes wrong, in validating the quality of its
assets. The situation would be the same for individuals who put loans on to the balance sheet in the first place. As soon as a bank goes wrong, they must be taken off the case because they have a vested interest in arguing that the loans are good.
As the hon. Member for Leeds, East mentioned, we learned only today, as a result of a freedom of information request, that five out of the seven individuals in the FSA with some responsibility for supervising Northern Rock have now left their posts. All of them should have left their posts within a few days of the situation going wrong. They should have been replaced by experts who are accustomed to dealing with bank work-outs.
Secondly, on the Bank of England, the Treasury Committee made a recommendation in its report with which I wholeheartedly agree. We should establish an individual in the Bank with the credibility that stems from the title of deputy governor who has responsibility, as the head of financial stability, for maintaining relationships and running a stricken bank in crisis. It was interesting to me that the right hon. Member for Norwich, South (Mr. Clarke) came into the Chamber specifically to support that recommendation, and I hope that the Financial Secretary will give us her initial view of it. There is clearly widespread support for it throughout the House.
On the subject of deposit protection, it is agreed that small depositors need to be protected. Had 100 per cent. protection existed up to the £35,000 level, which is now in place, the run on the bank would not have occurred. I have some questions—I raised them in Committee, but I went along with the report—about the feasibility of a pre-funding scheme for depositor protection. It is a good idea but it needs to happen over a prolonged period. Banks currently lack trust in each other and are therefore not lending money. To some extent, that gives them a bit of liquidity on their balance sheets, but as we experience weekly, a new sector of the financial community is calling in facilities. The banks therefore need their facilities to fund their obligations, and if we imposed a significant additional obligation to provide funding for a deposit protection scheme, we would be doing so at precisely the wrong time. It would aggravate the current liquidity crisis.
I suggest that the Financial Secretary examine the existing deposits that commercial banks have with the Bank of England. Some £2.7 billion is currently sitting on deposit. Interest on that money funds the operations of the Bank of England, but also generates a profit for the Treasury. That profit could be used as an insurance policy to provide significantly greater insurance protection, or the capital sum could be used as a first call on a deposit protection scheme. Money is sitting there and I urge Treasury Ministers to consider those suggestions. The alternative is to build up such a fund gradually, over a period of years. However, that would inevitably run the risk of the good banks bailing out the poor banks, and I do not support that.
Thirdly, other hon. Members have mentioned capital adequacy. The Basel II regulations, which were introduced last year, need to be reconsidered by international bodies. As has been said, Northern Rock used Basel II to justify increasing its dividends as recently as last July. Banks are actively incentivised by Basel II to encourage debt of more than 365 days to be placed in off-balance-sheet vehicles. One reason that banks welcomed Basel II is
that it allowed them to take more of their existing commitments off balance sheet and have less capital on balance sheet. That seems a perverse incentive to me. A solution can be achieved only through international co-operation, and I hope that the Treasury and the Bank of England are actively engaged internationally with financial authorities to consider what adjustments need to be made, especially to capital adequacy but also to banking reforms.
Fourthly, other speakers have mentioned credit rating agencies. We discovered in the Committee an inherent and multiple conflict of interest at work. I found it extraordinary that, according to Standard and Poor’s figures, the credit rating agencies currently give 570 corporates, financial institutions, insurance companies and sovereign issuers a triple A rating while, as at the end of last year, they gave 9,418 special investment vehicles a triple A rating. That large disparity has mushroomed in recent years and clearly drives the credit rating agencies’ business model. We need more competition and that needs to be achieved on an international basis. This country cannot start imposing a regime on only credit rating agencies that operate here, because that would drive the securitisation business offshore, and we clearly do not need to do that.
What will we do when the next crisis arrives? The impact of global credit contraction is not yet over. The initial impact has been on the banks, from bailing out their off-balance-sheet vehicles. It recently struck the monoline insurers and is now affecting the hedge fund community. Where will it strike next? There is little clear understanding of where leveraged securities are held in the financial system. We should not be surprised if insurance companies emerge with lower bonuses and significant holdings, especially in countries such as Japan, where they have been desperate for yield, with such low interest rates. We should not surprised if pension funds are affected.
Northern Rock was fundamentally a domestic business, although my hon. Friend the Member for Hammersmith and Fulham said that it is now conducting activities in three other jurisdictions, which was news to the House. No nation’s central bank is large enough to cope with the failure of a major bank. What will the Chancellor do if a similar sized—or, heaven help us, larger—bank needs help? The latest legislation gives the Treasury the power to step in during the next year until the banking reform Bill is in place. A much wider framework of solutions is needed. Rather than hoping and praying that something else will not happen to this country, we need to work with international organisations and devise an international framework of supervision, which will be effective as and when the larger crisis occurs.
7.25 pm
Mr. Mark Hoban (Fareham) (Con):
The debate has been conducted in a measured and reasonable tone. I congratulate my hon. Friends the Members for Sevenoaks (Mr. Fallon) and for Cities of London and Westminster (Mr. Field), my right hon. Friend the Member for Hitchin and Harpenden (Mr. Lilley) and my hon. Friends the Members for Hammersmith and Fulham (Mr. Hands) and for Ludlow (Mr. Dunne) on
their contributions, as well as the hon. Members for Twickenham (Dr. Cable) and for Caithness, Sutherland and Easter Ross (John Thurso) and the right hon. Member for Holborn and St. Pancras (Frank Dobson), who presented a stout defence of old Labour’s values, but seemed sadly out of place in today’s Chamber and today’s Labour party. I also congratulate the right hon. Member for Norwich, South (Mr. Clarke), the hon. Members for West Bromwich, West (Mr. Bailey), for Leeds, East (Mr. Mudie) and for Northampton, North (Ms Keeble), and especially the right hon. Member for West Dunbartonshire (John McFall).
The right hon. Member for West Dunbartonshire opened the debate in characteristically understated fashion and thus made the Treasury Committee’s critique of the events of the past few months all the more devastating. The Committee’s report, which found consensus among its members, sets out some of the major issues that we need to face when considering banking reform, and analysed thoroughly the reasons for the position today, whereby the Government have nationalised Northern Rock.
We all accept that the credit crunch is a global problem and that it was and remains a significant challenge to financial markets and Governments. It was also a significant test of the tripartite arrangements, which the Prime Minister introduced and which were found wanting. The hon. Members for Leeds, East and for Caithness, Sutherland and Easter Ross said that perhaps the people involved contributed to the problem. However, I strongly believe that any institution that is set up to regulate the financial services sector should be effective, regardless of who fulfils the roles of, for example, chairman of the Financial Services Authority, Governor of the Bank of England or even Chancellor of the Exchequer. Those arrangements should work whether it is the first or last day of someone’s time in office. When we consider the Government’s reforms, which they will introduce later this year, we must ensure that they work regardless of the personnel involved.
As the report makes clear, there are concerns about the regulatory supervision of Northern Rock by the FSA—it goes into some detail about that. We should welcome the fact that the FSA is conducting its own review of its relationship with Northern Rock.
The report also highlights the role of the Bank of England and the provision of liquidity in the market. I believe that the report is right when it says that it is difficult to assess whether the Bank of England, by responding to calls from other financial institutions to increase liquidity, would have prevented Northern Rock’s problems from emerging. There is no clear cut case one way or the other.
The most telling criticism of the events of the past few months focuses on the steps that were taken when it was decided that the Bank of England should act as lender of last resort. The mishandling of the announcement triggered the panic on our high streets and led to the Government being forced to announce the guarantees on Monday 17 September. It was clear that the tripartite authorities expected that the announcement could have a negative impact on depositors. Sir John Gieve, whom the report quotes, said:
“In the event we knew that there was a risk that that balance would go the wrong way and it did.”
The Governor of the Bank of England said:
“The nature of a bank run is that it is a knife edge: it might happen, it might not. That is exactly why a bank run is so difficult to handle.”
I believe that that view was supported by Callum McCarthy. Given that uncertainty about how the announcement about lender of last resort status would be taken by the depositors, it is regrettable that more thought was not given to the contingency plans that should be in place or the handling of the announcement.
I was interested in the comments that the right hon. Member for Norwich, South made, when he contrasted what happened in September with his experience of the events in London of 7 July 2005. They were two very different experiences, but the fact that there was a well organised and well oiled machine in place on 7 July is in stark contrast with what happened in the days around the Bank of England’s declaration that it would extend facilities to Northern Rock. Insufficient thought had gone into the presentation of that decision, which did not go down well with the electorate or Northern Rock’s depositors.
Once people saw the queues running round the block, that triggered the questions: what do we do now? What is our contingency plan? Again, it was clear that insufficient thought had gone into the guarantees and related issues, and that the discussion on the guarantees was not brought to the attention of the principals until 16 September, which was the day before they were made. It therefore appears that the response to the run was cobbled together, rather than being part of a long-planned-for procedure.
Comments have been made about war-gaming and whether people should have gone through the scenarios. It is clear from the report that there had been some wa-gaming and discussion about what should happen. The Governor of the Bank of England pointed out—again, this is supported by the chairman of the FSA—that more work needed to be done on the arrangements for handling a banking crisis. The Governor described that work as urgent, but unfortunately it did not proceed with an appropriate degree of urgency. As a consequence, when the banking crisis happened in September, the arrangements were not in place to handle the situation in a way that would give confidence to depositors at an important moment.
Having identified the risks two or three years ago, the Government did not prepare for a banking crisis and did not take the action that the Governor had said should be taken, which created a problem in the long term. Consequently, when the arrangements that were put together by the Prime Minister faced their first test, they failed because of a lack of leadership and a lack of preparation. The Treasury should take ultimate responsibility for those problems.
Let us consider the actions that we need to take. There is common ground on the need to intervene earlier to prevent the deterioration of a bank’s position. The shadow Chancellor, my hon. Friend the Member for Tatton (Mr. Osborne), made that argument in December and the Chancellor has adopted that approach. Rather like the Treasury Committee and the right hon. Member for Norwich, South, we believe that the powers for early intervention should rest with the Bank, not the FSA, which flows from the Bank’s role in money markets and
its responsibility for monetary policy. Also, the fact that it acts as the lender of last resort means that it should have the powers to intervene. That will lead to some overlap between the Bank and the FSA, but the Treasury Committee was right to talk about the need for
“‘creative tension’ within the regulatory system”.
It is right to have that tension there and to create institutional arrangements that are perhaps not as tidy, but which would be more effective. We also believe that the deputy governor’s role in respect of financial stability should be enhanced and that an experienced banker should fill that role, as an understanding of financial markets and institutions will be critical to the Bank’s wider powers of intervention.
We have advocated a special resolution regime for the banks concerned. There should also be powers to ensure that deposits protected by the deposit insurance scheme are ring-fenced.
I shall talk briefly about the deposit protection scheme. It is important that the scheme should provide reassurance to customers when there is a banking crisis. It is right to revisit the scheme in the light of the problems that we have seen. We believe that it is right to increase the cover to £50,000 and, crucially, to streamline the administration of the scheme so that protected deposits are paid out quickly, which again should reassure consumers. We differ from the Treasury Committee in that we believe that the scheme should be not a pre-funded scheme, but a post-funded scheme. A pre-funded scheme would impose an additional unnecessary cost on banks and other deposit takers, which would be borne by customers and shareholders. Deposit protection schemes should be a safety net. We should have a regulatory system that is predicated on effective regulation and the prevention of crises, rather than one focused on picking up the cost of failure.
As both the British Bankers Association and the CBI have made clear in recent days, it is important that we should get those reforms in the banking sector right. My hon. Friend the Member for Sevenoaks was right to be sceptical of the benefits that further regulation could introduce. We have seen the impact of the Sarbanes-Oxley rules on financial markets in the US and we cannot afford to make the same mistakes in this country.
We are still left with unfinished business in connection with Northern Rock. The nationalisation of Northern Rock is not an end in itself and is meant to be only temporary. However, no one can quite tell us how long “temporary” is meant to be, so perhaps the Financial Secretary could clarify that this evening. We are still waiting for the Treasury to bring forward the framework agreement between itself and Northern Rock’s management setting out the strategic direction of the nationalised business. We are still awaiting the business plan from Ron Sandler, which will determine the future size and shape of Northern Rock. I should be grateful if the Financial Secretary could clarify further when we might expect to see both the framework agreement and the business plan.
The cynic might think that the publication of those documents has been delayed to avoid the political fallout if the strategic objectives and the business plan require a shrinking of Northern Rock’s staff, which would be particularly damaging to the Labour party in
the north-east. I hope that the publication of those documents will not be delayed until after the local elections at the start of May, because that would do a great disservice to the taxpayers and would go to the heart of the point that my hon. Friend the Member for Hammersmith and Fulham made about insufficient accountability and transparency to the House about the operations of what has been referred to as the people’s bank.
We also know that widespread concerns have been expressed about the anti-competitive impact that the Government’s guarantees for Northern Rock could have on the markets for mortgages and savings products. We welcome the assurances given during the passage of the Banking (Special Provisions) Act 2008 that the Office of Fair Trading would play a significant role in monitoring that. Could the Minister update us on how discussions with the BBA and the Building Societies Association on that issue are being pursued?
One issue that has perpetually dogged the debate about Northern Rock is the treatment of Granite, which my hon. Friend the Member for Ludlow has raised persistently over weeks, as has the hon. Member for Twickenham. There is a debate about what liabilities the taxpayer has taken on—again, that is reflected in the supplementary estimate, which comments that our liabilities are “unquantifiable”. The Office for National Statistics is clear that they include Granite. That was the thrust of the ONS’s evidence to the Treasury Committee last week, when Martin Kellaway said:
“The Granite securitisation is complex. To whom do the risks and rewards accrue? They accrue to Northern Rock”.
On that basis, taxpayers will bear the risk of Granite’s funding, but the Chancellor in his letter to the hon. Member for Twickenham said:
“Granite and only Granite is liable to its bondholders under any scenario. The Government has not provided any guarantee arrangements to...bondholders.”
Will the Minister tell us who is right? Is it the ONS, which is the custodian of the true figures for Government debt, or is it the Chancellor who wants to keep those debts off the Government’s balance sheet and avoid the Government’s fiscal rules being breached if they exceed 40 per cent. of GDP?
The Government cannot continue trying to deny the fact that the taxpayer has taken on significant obligations through the nationalisation of Northern Rock. It is time that the fiscal rules and the measurement of the Government’s debt properly took into account Northern Rock’s full liabilities, so that taxpayers will know the risk that they are exposed to, as a consequence of nationalisation. That is the big gap that we seem to have in this debate. Whether in respect of the quality of the assets that have been acquired by nationalisation or the taxpayer’s exposure, we need to do much more work to ensure the transparency of Northern Rock to the taxpayer and the House.
No one should dismiss what happened to Northern Rock as simply the consequence of a global credit crunch. As the report indicates, Northern Rock’s problems, although created by its management and their strategy,
have become a headache for each and every one of us, as a consequence of the mismanagement of the crisis. I am afraid that that mismanagement is down to the Government, who must shoulder the blame for every taxpayer in the country having a second mortgage on their homes as a consequence of the nationalisation of Northern Rock.
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