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There are clear signs in the Bill that our reports have helped to shape it, as it stands, although I suggest that there are still areas for improvement during its parliamentary stages. I want to look at four main areas today. The first is the immediate context, and how that affects our approach to the Bill. The second is the special resolution regime and the bank insolvency provisions. The third is depositor protection, and the fourth is the governance of the Bank of England.
On the immediate context and how it affects our approach to the Bill, it hardly needs to be said that a great deal has changed since we published our report in mid-September. However, recent events have reinforced the point that we made in both our reports that banks are special institutions with a special role in the economy.
The Treasury Committee returned last week from a visit to Japan, a country whose Government massively, if belatedly, recapitalised its banks in response to the crisis that it faced in the 1990s. During our visit, it became obvious to us that the role of the banks in the economy was equivalent to the circulation of blood in the body. If the blood stops flowing, there is a thrombosis, and that is what we have seen in the banking system in this country. The recent massive transfusion of capital into the British banking system demonstrates that the Government have learned many of the lessons that were emphasised to us during our visit to Japan, most notably the need for swift and decisive action and, secondly, the need to attach conditions to recapitalisation relating to lending and the running of banks, making it clear that the days of business as usual for bankers are over.
The capacity of the Government, together with the Bank of England and the Financial Services Authority, to act effectively in the current crisis does not mean that new legislation is any less necessary. In fact, one of the key lessons that we learned in Japan was the difficulty of returning to what were described as “normal conditions” in the banking sector. The new legislation will serve as a crucial pillar of the public sector approach to banking in what we eventually consider to be normal times.
The second item on which I want to focus is the special resolution regime and the bank insolvency provisions. The Bill provides a welcome return for the Bank of England to the heart of financial stability—something that the Treasury Committee has been calling for since we produced our report, “The run on the Rock”. In that January report, we argued that the authorities should design bridge-bank and third-party transfer arrangements for struggling banks in order to provide alternatives to the nationalisations that we saw with Northern Rock and others more recently. I welcome the fact that the Government have accepted our recommendation and devised a special resolution regime.
The Bill confirms that the Financial Services Authority should pull the trigger, placing a financial institution into that special resolution regime. Our September report on banking reform agreed with that position, recognising that there should be a clear line of responsibility, but we also recognised the need for the Bank of England to have a check on the process, with specific legislative provision to enable the Bank formally to recommend that the FSA place an institution into the special resolution regime. That came out of our experience with Northern
Rock, when we decided that there should be no hiding place for the Bank of England, the FSA or the tripartite authority. Records should be made public immediately or later on. We suggested that such a check would focus minds in the Bank and the FSA, ensuring that every i was dotted and every t crossed in the regulatory process.
I accept that now is not the time to let further banks fail in the sense of their becoming insolvent. Any such bank failure would currently represent a systemic risk to the financial system, further undermining the already fragile confidence in the banking system. However, in the longer term it is important to have a specific insolvency regime for banks, and the Bill provides for that.
Mr. Redwood: I am grateful to the Treasury Committee Chairman for giving way. Has his Committee considered whether there should be any limit on how much a Government should be able to borrow and commit to bank rescue?
John McFall: We have not specifically done so, but if the right hon. Gentleman is asking for my opinion, I should tell him that I do not think that there should be a limit at the moment. I go back to my point that the banking system is the blood circulating around the economy, which is what makes it so important in securing financial stability. Once that stability is established, we can look at other issues later.
The Treasury Committee also considered depositor protection and we concluded in our January report that such protection afforded by the Financial Services Compensation Scheme was a mess: it was complicated, confusing and did little to instil confidence among savers. We took a fairly relaxed view about the level of the compensation limit and we saw little reason to increase it from £35,000 to £50,000. We believed that more than 80 per cent. of deposits were saved, although not deposits by value. The goalposts have moved considerably since then with other countries unilaterally increasing their protection—in some cases, to 100 per cent. of deposits, as we saw with the Republic of Ireland. It is therefore sensible for the FSA to move into line with our peers in order to prevent the danger of drainage of deposits from UK banks.
Even more important to our Committee was the speed of payout. The Financial Services Compensation Scheme website refers to recipients of compensation having potentially to wait months for access to their funds. That is simply not good enough, so we urge the Government to stand firm on the tough, seven-day deadline for processing compensation. In fact, the real test of the FSCS will be whether it can deal with the fallout from the Icelandic banks in a speedy manner.
An important precursor to speedy payout is that the relevant data are to hand. On our visit to Japan, we saw that banks were required to have frequently updated depositor information available in a common format for the use of the deposit protection institution. I know that the banks here are reluctant to do the same; they say that it will be preposterously costly, but at least one bank is able to provide such information in the UK—the Abbey bank. In its submission to the Treasury Committee, it told us that it was already doing it. If Abbey can do it, why cannot other banks do the same? That is absolutely necessary if the public are to have the confidence in the
banking system that they need. The Government need to ensure that similar arrangements are in place across all banks in the UK.
Other concerns that we raised about the FSCS were the complexities of protection by bank, rather than brand, and the coverage of deposits held in foreign-owned banks. The recent confusion over Icesave deposit protection underlines the point. For deposit protection to be of use, it must be simple and well understood.
Our Committee continues to see merit in a pre-funded compensation scheme whereby banks contribute more in boom times than in bust times. When the hon. Member for Sevenoaks (Mr. Fallon) and I visited Washington last December, we were told by the American Institute of Banking that that was a necessity. It is important, therefore, to make preparations now for the introduction of a pre-funding scheme in readiness for the next financial crisis, although we hope that it will not happen. However, I accept that now would not be the most opportune time for the banks to start contributing to such a scheme: pre-funding would be a medium to long-term innovation, to commence only once banks were better capitalised.
Much of the Committee’s report last month focused on the governance of the Bank of England. It is disappointing to note that there is little sign, as the Bill stands, that account is being taken of our recommendations—although, in fairness to the Government, I must add that they have been faced with a tight timetable. I hope that the Minister who replies today will be able to indicate that they will give careful consideration to our proposals.
Let me highlight two important concerns about the Bill. First, its proposals relating to the financial stability committee are unsatisfactory. The committee is to have a non-executive majority and a largely advisory and monitoring role, but is to be chaired by the Governor. In our report, we argued that the FSC should be established as an executive body, completely distinct from the court and with a status comparable to that of the Monetary Policy Committee.
Secondly, we are not convinced that the general financial stability objective currently proposed for the Bank of England is properly calibrated to its actual functions. As we said in our recent report,
“There is no consensus about what financial stability means, how it should be measured and how the balance should be struck between the pursuit of a financial stability objective and other public policy objectives. There is no indication that a new statutory objective for the Bank of England would be accompanied by matching objectives for the Financial Services Authority and the Treasury. Above all, the Bank of England, while being endowed with certain financial stability functions and powers, is not being granted a coherent set of instruments in order to influence financial stability.”
We proposed two functional objectives rather than one general objective. That is one respect among many in which I hope that a good and well-timed Bill will become even better as it passes through the House.
At the beginning of his speech, the Chancellor said that he would work constructively with others. As he knows, ours is a cross-party Committee. We worked for 12 months on proposals on which we have agreed, and I think that they are worthy of further consideration. We need a strengthening of the Bank of England, and an enhancement of the status of the financial stability
committee to make it commensurate with that of the Monetary Policy Committee. We need to ensure that the tripartite authority does not become a sleepy backwater in normal circumstances; it must be constantly alert, and financial stability must be one of its key aims. We must also develop robust protection for depositors, because if that is not achieved, public confidence in the banking system will be undermined.
I bring those constructive comments—developed over 12 months on a cross-party basis—to the Chancellor’s attention for further consideration in Committee, and I wish the Bill well.
5.54 pm
Dr. Vincent Cable (Twickenham) (LD): Today’s debate is a little surreal. Although we are still in the middle of an enormous crisis, the Bill deals only with certain parts of it, albeit in a sensible and helpful way. I think we have exhausted “burning house” analogies, so let me produce another analogy: we are still experiencing the shock of a major tsunami wave. Bodies are still being fished from the waters and people are still being rescued, yet here we are debating how to set up a tsunami detection scheme and rebuild developments.
That sense of reality was captured, to an extent, in the closing paragraph of the House of Commons note, in which someone beavering away in the House’s research department wrote, rather sadly, “It is a measure of the pace of events that reaction to the Bill’s publication has been virtually drowned by other events.” It merited not a single mention in any of the serious newspapers. We are dealing with something which, although important, is in a sense not directly connected with the massive events that have been unfolding.
Many of the important issues that are tied up with the banking rescue scheme and all that swills around it are not touched on, directly or indirectly. The Bill clearly not does affect the principle of the lender-of-last-resort facility, although, as the Chancellor pointed out, it extends that principle to building societies. The key provisions of the rescue in terms of inter-bank lending guarantees are enormously important, but I understand that they are not directly affected by the Bill either. It does not deal with the way in which nationalised banks will operate, with the issue of the shadow banking system—which is the source of many of our difficulties—and how it should be regulated in future, or with the issues of competition policy and the role of the clearing system, raised several years ago in the Cruickshank report.
Although I do not dispute the importance of the Bill’s provisions, they deal only partially with the problems that we are experiencing. Arguably the most important, or second most important, part of the Bill relates to deposit protection, but over the last few weeks the deposit protection system has been overwhelmed and, in practice, it has become largely irrelevant to the restoring of confidence and stability.
I had intended to discuss what are tricky and important issues in a non-partisan way, but I was provoked by the hon. Member for Tatton (Mr. Osborne). I do not propose to respond to his comments on the Bank of England, although I am perfectly happy to defend my position, and will continue to do so for as long as the crisis continues. I also acknowledge that he made some sensible
comments, with many of which I agreed, particularly his comments about Equitable Life. However, it is a bit childish for those who aspire to be Chancellor merely to rewrite history in such a blatant way.
I was especially fascinated by the hon. Gentleman’s account of how the Conservatives warned the Labour Government for years about the problems of personal debt. We are living through what I suppose is the economic equivalent of the Iraq war. I am sure that dossiers will be produced recording who said what when—and Conservative warnings about the emerging household debt problem are very thin on the ground.
I remember having exchanges on the subject with the then Chancellor, now the Prime Minister, back in 2003-04. It became quite a hot issue, although I do not recall the Conservatives contributing to the debate in any way. What they did do, although the shadow Chancellor may have forgotten, was set up a commission to examine debt problems, led by someone called—I think—Lord Griffiths. Its report, which I read, made it clear that there was no such thing as a general household debt problem. There was a debt problem relating to a relatively small number of high and low-income individuals with credit cards, and its recommendations were confined to that very narrow issue. There were no policy prescriptions relating to what was an emerging problem.
At the risk of being immodest, I recall that, at the same time, my colleagues and I produced a 10-point debt plan, which dealt with the problem exhaustively and in some detail. It has clearly been raided for ideas, particularly in what the shadow Chancellor has called Conservative ideas about how to improve regulation of the banking system. He mentioned two quite distinct ideas, which merged into one somehow, that it was important for future Governments to take on board. One related to asset prices. The Chancellor may recall exchanges between Members on our Benches and his, back in 2003-04, about the genuinely tricky problems of dealing with those prices, and the possibility of incorporating house prices in the Bank of England’s remit in measuring inflation. Again, I do not recall the Conservatives making any contribution whatever to the debate until today; the issue simply disappeared.
More importantly, there is the very good idea—which I am delighted the Conservatives have taken up, despite the fact that they have called it a Conservative idea—of counter-cyclical management of the capital adequacy of banks. That idea has been in circulation for some time; it has been well written up by Persaud and Charles Goodhart and others. If the hon. Member for Tatton re-reads my 2004 debt plan, he will see it all described in there, four years before it became a Conservative idea. I think we might now have had enough of putting all this on the record.
Stephen Hesford: On this plan, is there not a balance to be struck, which has not so far been explained? The hon. Gentleman can make populist points while we are in the middle of this situation, but is not this counter-cyclical idea potentially deflationary, in which case it would have the opposite effect from producing a strong and stable economy, which is what we have had over the last 10 years?
Dr. Cable: The hon. Gentleman is missing the point; the whole point is that it is designed to restrain rapid lending in a boom period and that that relaxes when the cycle turns in the opposite direction. [Interruption.] No, it is not. Technically, this is well understood; the Governor and people in the Financial Services Authority fully understand how it could work. It has been applied in other countries, and I think there is a fair degree of consensus about implementing it.
Let me move on to the substance of the issue and some of the ideas behind it. Before plunging into the technical arguments about banks, a useful starting point would be to acknowledge the fact that banks are inherently rather unstable, and that they always have been. This proposed legislation is the latest in 300 years of attempted legislation to tackle a big problem: how one preserves stability in a system of banking institutions where there will always be significantly less cash and liquidity than needed to meet the claims banks ultimately face. For that reason, banks have always faced runs or the danger of runs, and principles have been established over the years as to how to deal with that. Indeed, it was a British commentator, Bagehot, who came up with the idea—which I think the British authorities forgot last summer—that the first thing to do in a bank run is to pump in as much liquidity as is required at a commercial rate of interest against good collateral, in order to stop it happening.
The other subject the old-stagers always used to argue about in terms of banking was the problem to do with moral hazard. We have heard a great deal about that over the last year, and a constituent recently asked me what moral hazard was. I rooted around for a good definition, and I found what I think is a particularly good one from somebody called Herbert Spencer, who was, I think, a rather famous Darwinian. He said:
“The ultimate result of shielding people from the effects of folly is to populate the world with fools.”
In a non-technical way, that summarises what moral hazard is all about. Over the last year, the phrase has been used in a technical sense by the Governor of the Bank of England and others, but I think Spencer’s comment serves to remind us that if one goes too far in the direction of protecting banks or depositors, they will inevitably invest in risky activities, knowing perfectly well that ultimately somebody else—ultimately the taxpayer—will bail them out.
Despite the problems of moral hazard, there has been an acceptance in recent decades that protection must go beyond the simple Bagehot rule of pumping liquidity into the banks, and hence we have had in the post-war period—and in the pre-war period in the United States—systems of deposit protection, which have, among other things, assisted people, particularly when small banking institutions have gone down. There is quite a long history of that. When I was looking up the history of our own scheme, I found that there have been occasions when credit unions, for example, have fallen and the deposit protection scheme has been very useful in those cases.
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