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A pre-funded scheme would be capital-intensive, and the second argument is that that money would be better used by a bank, building society or credit union, rather than being tied up in the Financial Services Compensation Scheme. Accumulating the fund could increase the pressure on bank capital and liquidity. There is also the possibility—at least we hope so—that once the scheme had been built up, it would never be used. We have gone through a period of extreme volatility and instability, and I am not sure of the value of having a significant sum sitting in the hands of the FSCS that might never be used. We do not expect another comparable period of financial instability, and there are better ways to use that money than having it tied up in that way.
The report envisaged in new clause 6 would be a good way to set out the arguments about a pre-funded scheme. Before the Government laid regulations in this area, the House would have to be persuaded that this is the right approach.
The third point is that the pre-funding debate encroaches on more than just the banking sector. The hon. Member for South Derbyshire (Mr. Todd) talked about building societies, and there are other categories of deposit-taking institutions, such as credit unions. There is also concern in other parts of the industry that they would have to pay the costs of mistakes in the banking sector. The Association of British Insurers has said:
“We are concerned...that the present approach requires all sectors of financial services to contribute to the costs. This involves cross subsidy which imposes an unfair burden on the insurance industry, particularly in cases where, as in Bradford & Bingley, insurers have already made substantial contribution through the provision of additional capital by their investment arms.”
Several insurers subscribed to the rights issue, and they would be doubly penalised if they lost that money and had to make an excess payment to the FSCS. The present arrangements mean insurers could end up paying twice.
A powerful case has been made that a pre-funded scheme is not the appropriate approach. There is another argument to be made, and we will come to that in the debate on the special resolution regime in the next group, but I shall flag it now briefly. For customers, the best deal is continuity of service. They want to be able to go into their bank and withdraw cash, or have their cheques cashed, use their debit cards and have their standing orders and direct debits honoured. They do not want to have to wait for five days, seven days, a month or however long it takes for the FSCS to send them their cheque. Continuity of service is a much better way to resolve the problem than dependence on a compensation scheme. If continuity of service were the priority for protecting depositors, we would not need a pre-funded scheme.
The argument for a pre-funded scheme has not yet been made strongly enough. The arguments against it are much stronger, which is why I have tabled new clause 5.
Amendment No. 17 is a probing amendment, and flags up a debate that we had in Committee, although it was truncated. It concerns the challenge posed under the passporting arrangements for financial institutions in the European economic area. That enables an institution regulated in one state to establish a branch in another. It is part of the liberalisation of financial markets in the EU. The home state acts as a prudential regulator,
looking at capital and deposit protection, while the host state—the country in which the branch is established—looks after the conduct of business rules.
It was those rules that enabled the Icelandic bank Landsbanki to establish a branch trading as Icesave in London. Icesave was able to upstream some of the money attracted from UK depositors to Landsbanki in Iceland to reduce its dependence on funding from wholesale markets. Customers of Landsbanki would have realised that they were covered up to £50,000 under the deposit protection schemes in place when Landsbanki went into administration.
The first layer of the protection was under the Icelandic guarantee scheme, while the second layer was a top-up from the FSCS. However, as events have demonstrated, the first layer of support depends on the capitalisation of the bank and, in this instance, on the sovereign guarantee of the home country. In the absence of support from the Icelandic Government, the UK Government could have been on the hook for that first layer of protection.
That problem has been resolved by the IMF and UK loans to Iceland, but it illustrates the challenges that we face. As EU financial services markets are liberalised, customers are being put at risk because they depend on the home state for an element of consumer protection. I raised this matter in a debate on a European directive, when the Minister’s predecessor, the present Secretary of State for Children, Schools and Families, was Economic Secretary. It was not adequately resolved then, and the Treasury and the FSA need to think very carefully about how we alert UK consumers to the risk that they face when they do business with a branch of an institution incorporated in another EEA member state. That is a lesson that we need to learn from the debates about Landsbanki and related matters.
I turn now to amendments Nos. 13 and 14 in this group. Clause 165, as drafted, sets out how the special resolution regime is to be paid for and provides for the FSCS to contribute to the cost of a resolution regime. Initially, that contribution will be made by the deposit-taking sector: when it exceeds the levy from that sector for a year, it will be picked up by other contributors to the scheme. The amendments would insert into the clause a recognition of what would happen ordinarily when a business is either acquired by a private sector company or goes into liquidation or administration.
Traditionally, the cost of a private sector acquisition is borne by both the vendor and the purchaser. For a company that goes into liquidation or administration, the costs of resolving the problem that I have described are borne by the shareholders and creditors. It is important that that is clear. Rather than it being discussed by way of a comment in Committee, or put in the code of practice, it should be in the Bill, so that people know fully who is expected to pay for the resolution regime.
Mr. Colin Breed (South-East Cornwall) (LD):
May I say a few words about the compensation scheme? The essence of any such scheme is the confidence that the public can place in it. Whether we are talking about a pre-funded scheme, which is fairly unlikely to cover the whole amount that might well be necessary, or some other mechanism, depositors will need absolute confidence, first, that the money is there for them to have, and secondly, that they can get their hands on it fairly
quickly. Even after Committee and our other debates, we have not yet quite got what the public would recognise as a clear compensation scheme in which they could have absolute confidence.
Some issues are still up in the air, such as pre-funding. There are issues about the way in which foreign banks with UK branches will form part of the scheme. There is also the question of an absolute assurance on whether different branded products are treated similarly. Even now, in the Bill’s Report stage, I do not believe that the average member of the public clearly understands that they can have real confidence in the compensation scheme, as they understand it.
I suspect that there is a growing feeling among many members of the public that what happened was, in many respects, a debacle. They had to put their hand in their pocket to bail out the banks in whatever way, and given the cheap loans situation and everything else, they may well consider that any future compensation scheme should in some way be the responsibility of the banking industry. If such a scheme, however drawn up, is somehow dependent on the Government underpinning or guaranteeing it—of course, it is not the Government’s money, but the taxpayers’ money—I am not quite certain that members of the public will be thrilled to bits. They think that they have probably paid enough. They are looking to Government and Parliament to come up with a proper scheme in a new banking Bill to address those issues, so that they can have confidence in a compensation scheme, and their ability to access and understand it. They want to know that wherever they put their hard-earned cash, they can have confidence in a compensation scheme.
The various amendments put forward, both in Committee and today, are attempts to improve the situation, and in general I support them, but with regard to this important aspect of the Bill, I do not believe—we may speak about this later—that we have arrived at a situation in which there is that cast-iron confidence, knowledge and security that depositors require if they are to put their money back into institutions. In some respects, the Minister may agree that the measures are still a work in progress, particularly as regards pre-funding. I accept that there are improvements, and that we are getting closer to arriving at such a situation, but I still do not think that we are close enough.
Ian Pearson:
Let me start by addressing new clause 6, tabled by the hon. Member for Fareham (Mr. Hoban), which would require the Treasury to lay a report before Parliament before bringing forward any regulations under section 214A of the Financial Services and Markets Act 2000 to introduce pre-funding. It is worth recalling that those regulations will be laid before Parliament in draft. They will need to be debated and approved under the affirmative procedure before they are made, so there will be ample opportunity for debate and parliamentary scrutiny—plenty of time for the Government to set out their thinking, and for Members of this House to challenge and question that reasoning. As I have said before, this is not a matter on which the Government would expect to have to act without prior consultation. Pre-funding is not an emergency action after the event—quite the reverse—so I expect that there would be plenty of material, including consultation documents, in the public domain before the regulations were laid, or before
the report that new clause 6 proposes had been prepared. In short, I do not think that such a report would be of much use or assistance to hon. Members when they consider the draft regulations. I hope that I have made it clear that there would be extensive consultation beforehand, and I hope that the hon. Gentleman will not press his new clause any further. As well as requiring consideration of the impact on the levy payers who contribute to the contingency fund—as I said, that will be considered in any case through consultation and parliamentary scrutiny—the proposed measure would require the report to consider whether pre-funding was the best way to achieve the objectives of the special resolution regime. I do not see the connection between pre-funding and the achievement of those objectives.
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Pre-funding is about building up funds to meet the costs of contingencies that may, or may not, occur—we hope that they will not—and one of those contingencies requires the Financial Services Compensation Scheme to contribute to the costs of the use of tools in the special resolution regime. The choice of tools, and any decision about whether the scheme should contribute to the cost incurred, would need to be made in the light of circumstances. Decisions would then need to be made about the way in which any FSCS contribution was to be financed, so I do not know what a report prepared before pre-funding was introduced could usefully say about the hypothetical future use of the special resolution regime tools. The new clause is unnecessary, because there will be extensive consultation, and by referring to the special resolution regime objectives it does not help in any event.
Mr. Hoban: One of the objectives of that regime is the protection of depositors. In justifying any need for a pre-funding scheme, the report would have to address whether such a scheme would help to protect depositors. That is the link between what the report should set out and the regime’s objectives.
Ian Pearson: I do not think that the hon. Gentleman’s new clause makes that particularly clear. He is referring to the principle of pre-funding, which he addresses more directly in amendment No. 5, which would remove from the Bill the clause that amends the Financial Services and Markets Act to allow the introduction of pre-funding. Before dealing with the points that he has just made, may I stress again that the Government have absolutely no plans to introduce pre-funding for the FSCS at this time.
We can see, as can everyone, that it would not be right to impose additional financial burdens on banks and building societies at a time of great financial stress. However, there are important arguments in favour of pre-funding. Recent events have highlighted the way in which pre-funding could allow for spreading the costs of bank failure over a longer period of time, and reduce the extent to which firms have to contribute after such failure, when financial stress may be greater. Pre-funding can also mean that the failed firm will contribute to the costs of failure on the “polluter pays” principle, or, as I said before, according to the principle of companies consuming their own smoke. None of those are arguments for introducing pre-funding now, but when times get
better, we believe that it will be right to consider the case for it again. All that clause 164 does is to allow that to happen. There will be time for consultation and debate, and parliamentary approval will be required through the affirmative resolution procedure. The introduction of pre-funding will not be hidden away in any respect—quite the reverse, in fact, as we would want an open debate on the issue.
I am a bit disappointed that the hon. Gentleman has suggested that he wants to press his proposal to a Division before hearing the Government’s response, but I suspect that this is quite a well-worn path that we have trodden in Committee. He needs to reflect on the comments made by the hon. Member for South-East Cornwall (Mr. Breed) and on how the general public will see the issue. To say, as a matter of principle, that the official Opposition are against pre-funding is tantamount in the public’s eyes to saying, “Conservatives do not think that banks should pay up front in the event of a future bail-out.” The hon. Member for Fareham argued in Committee that banks should pay after an event over a very long period on an interest-free basis.
Mr. Hoban: I did not say that.
Ian Pearson: I will check the record. The general public will not consider it unreasonable to take a power to allow banks to pay up front for the costs of dealing with potential future difficulties. They will think that that is the right thing to do.
The hon. Member for Fareham has sought to explain amendment No. 17, but I am not sure about its purpose. If I explain how the FSCS applies to foreign banks, it will answer some of his questions. First and simplest, if a foreign bank owns a subsidiary that operates as a bank in the UK, the subsidiary is a UK-authorised person with a FSMA part 4 permission to accept deposits. In other words, it is a UK bank, which means that the FSA regulates it, that it is a full member of the FSCS and that it pays FSCS levies exactly like other UK firms.
Secondly, if a bank incorporated outside the European economic area operates in the UK through a branch established here, it needs a FSMA part 4 permission to accept deposits like a UK bank. It must be a full member of the FSCS, and it must pay levies like UK firms, although that is, of course, calculated solely on the deposits held at the UK branch.
Thirdly, as is well known now, an EEA bank can operate through a branch here using a passport under the relevant EC directive issued by its home member state. Depositors are protected by the home state deposit guarantee scheme, and the bank may also join the FSCS top-up arrangements, provided that the FSCS offers better protection to depositors than the home state scheme. If it joins the FSCS top-up arrangements, it must pay an appropriate contribution to any levies. Foreign banks are already required to make appropriate contributions to any FSCS levies that apply to the relevant class of firm.
If pre-funding were introduced, foreign banks operating here through branches would have to make an appropriate contribution to levies to build up a contingency fund, which could be used to meet the compensation costs of
the FSCS arising from the default of such a bank. In the Government’s view, there is no need to include any additional provision in the Bill along the lines proposed by the hon. Member for Fareham to make that happen. I hope that he agrees with that point on reflection and will not press his amendment.
Mr. Hoban: Does the Minister take on board my wider point that depositors with those branches depend in part on the guarantee given by the home state of the branch? They may not be aware of that issue, although they should be aware of it now. How can we ensure that depositors are aware of that risk in judging whether to place deposits with such banks?
Ian Pearson: I fully understand the hon. Gentleman’s wider point. He is suggesting that some depositors might have put their money in a branch of an Icelandic bank, for example, without actually knowing how that savings account was regulated. I agree with the hon. Gentleman that there is a clear need to make sure that branches of banks owned outside the United Kingdom make the basis on which they are regulated clear.
Mr. Todd: On that point, it was established in Committee that in all cases of deposits, we need absolute clarity about the precise protections. That example is a good one, but there are many others in which customers may not be entirely clear about how the deposits are protected and what risks they may bear in depositing with a particular institution. I am aware that the FSA is consulting on many of those aspects, but Members would welcome an update on its progress.
Ian Pearson: My hon. Friend is exactly right that the FSA is consulting on many of the relevant issues, but it is not currently possible to say what the outcome will be. There is a clear policy issue and a clear public interest in ensuring that the basis on which people put their money into banks, and the guarantees that underpin them, are clearly understood and communicated, and we want to ensure that that is sorted out.
The hon. Member for Fareham raised in Committee the matter relating to amendments Nos. 13 and 14, and I have set out before the reasons why it is important that the FSCS contributes to the costs of the special resolution regime, so I shall not repeat them in detail here. From what the hon. Gentleman said, I understand that his concern is to ensure that other persons, particularly a private sector purchaser or the insolvent estate, contribute to the costs of a resolution before the FSCS is called upon, and his amendments seek to achieve that.
Let me set out why I have sympathy with the general principle but do not agree with his amendment. As I said in Committee, I agree that in some circumstances, a private sector purchaser should be called upon to contribute towards resolution costs. However, there are also certain circumstances in which it would not be appropriate for them to be required to do so. For example, there may be administrative costs or additional compensation costs that a private sector purchaser would not be willing to pay, and any requirement that they do so might reduce the likelihood of a successful private sector solution, therefore I do not believe that, in all cases, the private sector purchaser should pay resolution costs before the FSCS or the authorities.
I have significant concerns about imposing the proposal that the insolvent estate fund resolution costs before any call upon the FSCS is made. Taking money out of the estate to fund resolution actions would lead to a smaller pot of money from which creditors and others would benefit. We wish to avoid that situation, as demonstrated by the “no creditor worse off” safeguard, and by objective 5 of the special resolution regime which emphasises the importance of minimising interference with property rights. In the case of one of the more likely resolution actions, a deposit book transfer, funding the resolution out of the insolvent estate might result in a de facto depositor preference regime, which the Government have sought to avoid, with the support of banks and investors in banks.
Of course, the cap will ensure that any recoveries that the FSCS could have secured from the insolvent estate had it paid out in the normal way will be taken into account. The FSCS will not be required to pay more than it would have paid under a normal payout. Although the private sector purchaser may be called upon to contribute in some circumstances, I hope that I have explained why I do not think that they should be the first port of call in all circumstances, and why there are also risks with requiring the insolvent estate always to be called upon before the FSCS.
Mr. Hoban: Amendment No. 14 reflects that point by stating “may require” rather than “must”. Nevertheless, it is important that, on Report, the Economic Secretary has put on the record the principle that, where appropriate, either the private sector purchaser or, in some cases, the insolvent estate, may be required to make some contribution.
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