Banking Bill

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The Chairman: We will come to amendment No. 5 at the appropriate point.
Mr. Hoban: I beg to move amendment No. 36, in clause 156, page 81, line 20, at end insert
‘and ensuring that no such investment shall cause there to be a prevention, restriction or distortion of competition in the relevant lending market;’.
The amendment deals with the way in which money that has accumulated in a pre-funded scheme should be invested. Concern has been expressed to me about the potential distortionary impact that a fund might have depending on how much has built up within it, and about its impact on the wider savings investment market. Will the Minister clarify how he thinks that the fund will be invested in the future? What comfort can he give that it will not be invested in a way that leads to distortion?
Ian Pearson: The Government believe that the amendment is unnecessary. If pre-funding is introduced, our intention is that the contingency funds built up would be invested in the national loans fund, as is provided for in clause 158. Funds invested in the NLF will have been lent to the Government and will be used to minimise Government borrowing. At the end of each day, the Exchequer must borrow from, or place funds on deposit with, the money market depending on the net position after balancing outflows in order to finance expenditure again. Any funds from the Financial Services Compensation Scheme will represent an inflow and arrangements will be put in place to minimise the impact of the flows and ensure that there is no distortion of money markets.
The purpose of proposed new section 214A(2)(f) is to enable the regulations to specify some of the detailed requirements on NLF investors. Proposed new section 223A(2) in clause 158 allows the Treasury to agree terms and conditions with the FSCS from the borrower’s point of view. The FSCS is an independent body so will have to contract with the Treasury, like any other lenders to the Government. We need to be able to regulate both sides of the transaction and equally, of course, to keep both sides separate in our minds. There is no intention that new section 214A(2)(f) would be used to require the FSCS to take a different approach from that set out above to the investment of contingency funds, but of course were that to be proposed in the future, parliamentary approval would be required under the affirmative resolution procedure. We could then build in safeguards to meet concerns about distortion at that stage. I hope that that clarifies the point for the hon. Gentleman.
Mr. Hoban: I am grateful to the Minister for his response, which clarifies the matter put to me. On the basis of that reassurance, I beg to ask leave to withdraw the amendment.
Amendment, by leave, withdrawn.
Amendment proposed: No. 5, in clause 156, page 81, line 27, at end insert—
‘(2A) In making any provision by virtue of subsection (2)(c) the Treasury must take account of the desirability of ensuring that the amount of the levies imposed on a particular class of authorised person reflects, so far as practicable, the amounts of claims made, in respect of that class of person.’.—[Mr. Hoban.]
Question put, That the amendment be made:—
The Committee divided: Ayes 5, Noes 7.
Division No. 1]
Bone, Mr. Peter
Breed, Mr. Colin
Hoban, Mr. Mark
Hosie, Stewart
Viggers, Sir Peter
Blizzard, Mr. Bob
Flello, Mr. Robert
Keeble, Ms Sally
Pearson, Ian
Robertson, John
Todd, Mr. Mark
Wilson, Phil
Question accordingly negatived.
Question proposed, That the clause stand part of the Bill.
2 pm
Mr. Hoban: Even if I did not object on principle to pre-funding, I would still object to the clause because, in response to the previous group of amendments, the Minister did not give us sufficient reassurance about how it will be used in practice or about its scope. It is broadly drafted and gives the Government the flexibility to do pretty much what they want in a pre-funded scheme on the back of an affirmative resolution. That does not give security or confidence to the wider financial services sector.
Notwithstanding that fact, I have an objection of principle to a pre-funded scheme. There has been quite vigorous debate since last October about the merits of a pre-funded compensation scheme. There are arguments why one might be appropriate. One example is that it would not be pro-cyclical. If there was a large default by a bank now, banks would have to contribute through the levy, at a time when their capital was under pressure. Clearly that would exacerbate the current position. The argument is that under a pre-funded scheme a contingency fund would be available to absorb those losses rather than increasing the levy at a time when banks are in difficulty.
The Governor of the Bank of England, who is supportive of a pre-funded scheme, said that
“if you wait until there is a problem, that’s a pretty bad time to ask banks to put up a large amount of money”.
That is not an unreasonable comment. I accept that, which is why we support clause 159 in principle. It would enable the scheme to borrow from the national loans fund. However, on balance there are some stronger arguments against a pre-funded scheme. We believe that any assets held by the fund would be better deployed by the financial services sector as a whole—not just by the banking sector but by insurers, IFAs, investment managers and all the people who could be subject to a contingency fund. It would be better if they retained their own capital and determined how to deploy it rather than having possibly significant sums locked up in a pre-funded scheme.
The Government have not given a clear indication about the period over which a scheme would be built up. Would it be over two, three, 10, 15 or 20 years? How much would institutions have to contribute over what period of time? Clearly, the quicker the build-up of a fund, the greater pressure financial institutions would come under as a consequence of contributing to it. That is a concern.
In the United States there is a pre-funded scheme. We had a discussion earlier about the FDIC. There is a different banking model in the US, compared with the UK. Like the hon. Member for Sedgefield, I was in the States in the summer. I drove past the First National Bank of Collinsville, which had just one branch—in Collinsville. It was to be covered by the FDIC. I asked the Congressmen I was with whether they did not think it a risk having an account with such a bank. They replied that as long as they did not put in more than $1,000, they would be okay because they would be covered. That shows the fragmentation in the US banking market. There is a much greater expectation of banks failing, because they are smaller, less well capitalised and more prone to default.
There is another reason why we do not believe that pre-funding is necessary. The important thing in the event of a default is ready access to cash. We need ready access to cash for depositors, but the FSCS needs ready access to cash too. It has to have access to that liquidity, which is why the facility available under clause 159 is so important. It gives the FSCS access to liquidity. If we had a pre-funded scheme we would not know, when the balances were being built up, at what point there might be a bank insolvency and whether there would be enough money in the scheme. If there was not enough money in the scheme, we know that the FSCS could draw on liquidity from the national loans fund. There is no fundamental requirement that suggests to me that we must have a pre-funded scheme, as long as there is access to loans from the national loans fund.
One of the messages that came across in our discussions on Tuesday was the absolute necessity for ready access to cash, but that is different from the desirability or otherwise of a pre-funded scheme. Indeed, Nigel Jenkinson, the director of financial stability at the Bank of England, said that pre-funding was “not necessary, but desirable”. There is a very important distinction to be drawn.
Although there may be consensus among some people that a pre-funded scheme is desirable, there is certainly no such consensus in the banking sector. I have the impression that the Building Societies Association is not sold on the idea either—Adrian Coles, speaking in the evidence session on Tuesday, was very explicit about that. Let us not forget that the BSA scheme has not been a failure; it has always looked after its own and it has always swallowed its own smoke, to use the Minister’s phrase from earlier.
Adrian Coles said:
“There is a choice of whether to put it in the compensation scheme to protect depositors, or whether to keep it in the building society balance sheet. At the margin, if the money is taken out of the building society and put in the compensation scheme, depositors...are slightly less safe by the amount that the building society has given to the compensation scheme.”——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 44, Q122.]
That demonstrates that we must think through the economic analysis of the issue. Adrian Coles went on to say that
“if there were a requirement for pre-funding, and if there were a requirement to keep capital at the current level in building societies, the only place the money could come from is higher mortgage rates or lower saving rates for building society customers.”——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 47, Q131.]
An economic cost is attached to a pre-funded scheme. Adrian Coles talked about it in the context of building societies.
Ms Sally Keeble (Northampton, North) (Lab): I am grateful to the hon. Gentleman, because he is quoting from answers to the questions I asked in the evidence session. Does he agree that one of the issues that the building societies pressed closely was risk-related premiums, because of their perceived lower risk of failure?
Mr. Hoban: Indeed. I thought the hon. Lady’s line of questioning on Tuesday was very fruitful, and showed the experience that she and her hon. Friend, the hon. Member for South Derbyshire, have gained from the Treasury Committee. She put the finger on the very point: yes, there is a cost to the building society from putting money into a deposit protection scheme. However, it goes back to our previous debate about risk weighting. If a sector has a lower risk, should it contribute less to a pre-funded scheme? We talked about that in the context of different institutions when we were discussing amendment No. 6. Equally, different business models have their own consequences. The more cautious approach that building societies traditionally adopt leads to a lower risk of default in the building society sector.
The Minister whispered, “Bradford & Bingley”. As I am sure he knows, Bradford & Bingley was a demutualised building society that was swallowed up by a former building society, Abbey, which is now owned by Banco Santander. Bradford & Bingley and some of the other demutualised building societies took a very different model from that of the building societies currently in the building society sector.
Ms Keeble: May I put to the hon. Gentleman a point that it was not possible for me to put to the institutions on Tuesday? There is public concern, and the public interest would probably be in favour of a pre-funded scheme, because of people’s concerns about the general behaviour of financial institutions, precipitating some of the crises.
Mr. Hoban: I am not sure that I agree with the hon. Lady. This is probably where we part company on this matter. I think people will want to know that in the event of an institution becoming insolvent the compensation scheme has ready access to cash. That is the necessity that underpins the measure. We would not want to get into a situation where consumers believed that because the fund has only built up £1 billion, for example, that is all there is in the kitty. We have not really addressed what size the kitty might be to provide protection.
Mr. Todd: How long is a piece of string? [Interruption.]
Mr. Hoban: I am happy to give way if an hon. Member wishes to intervene.
The issue we are teasing out through this process is how big is the fund and how much do we need to put away? The conversation during the evidence-taking session on Tuesday suggested that it could be between £10 billion and £15 billion. The level of bank deposits earlier this year, when I was looking closely at the matter, took us as far as the 10th-largest institution. That was before the wave of consolidation over the past few months. We are talking about building up a significant fund just for banks, let alone the other sectors of the financial services industry that might have to contribute to a pre-funded scheme.
Mr. Bone: I take a slightly different view from my hon. Friend. As he said, we are talking about not wanting to reduce the capital in respect of building societies. In the case of the banks, that would mean paying out less dividend each year. That would actually be a charge on a person’s account and would build up over the years. An institution that failed would, for a number of years, have been contributing to that fund. Under the present scheme, a bank that fails does not contribute, because it has gone bust by that stage.
Mr. Hoban: My hon. Friend makes a valid point. It is one of the arguments that people could deploy in favour of a contingency fund. Of course, that depends on people’s expectations and whether banks fail in future. Until recently, we had not had a run on a bank since Overend and Gurney in 18-something or other. We hope that this is an unusual time and that it will be some time before we have a crisis on a comparable scale. The Governor of the Bank of England said in his speech in Leeds earlier this week that this was the closest that we have been since the first world war to a banking collapse. We could end up with a fund of between £10 billion and £15 billion sitting on deposit somewhere for another 80 years before it was required.
My hon. Friend mentioned a pre-funded scheme enabling an insolvent bank to contribute up front to the costs of its recovery, but that would be at a cost to shareholders or potential borrowers as the costs of capital rose, because of the way in which the scheme was to be funded.
There are important arguments against a pre-funded scheme: it is expensive, it is, we hope, unnecessary and it does not address the main point, which is that we must have cash available to meet the relevant needs if a bank becomes insolvent. Dr. Huertas, in his evidence on Tuesday, made the point that
“the deposit guarantee promise needs to be backed by the full faith and credit of the Government”
and that having a contingency fund would not be the full answer to the problem. He continued:
“If it ever got to the point that the deposit guarantee promise was limited to the size of the fund, the exhaustion of the fund and the removal of any type of deposit guarantee for the remaining depositors would be a severe threat to financial stability.” ——[Official Report, Banking Public Bill Committee, 21 October 2008; c. 33, Q96.]
Even if the Government take the route of introducing the fund, it is not an answer in itself and is not sufficient to create financial stability. It is, in effect, a means of paying up front for the potential costs of insolvency.
Loretta Minghella of the FSCS said that it is crucial that there is always a backstop and that people are confident that the Government will always be there for the scheme.
2.15 pm
I have talked a lot about the banking sector and how it might be affected by a pre-funded scheme. My contention is that as long as there is access to the national loans fund, that will create the liquidity that the scheme needs to repay depositors. Then, we can look at recovering the amounts from the levy payers over a reasonable period, so that we do not exacerbate the pro-cyclical tendencies that we might see if we asked the levy payers to pay immediately after the collapse of a bank. If we spread the repayments from levy payers, the burden would not be unfair, and they would pay only when a collapse has taken place.
I would like to deal now with what happens to others if there is a pre-funded scheme. In the insurance sector, given the nature of the impact of a collapse or an insolvency, the FSCS often pays out over a long period. Therefore, one argument from the insurance sector is that it pays out on long-term liabilities currently under the FSCS, so why should it pre-fund that scheme? If an insurance company that pays annuities becomes insolvent, the FSCS will pay out, over a long period, the compensation that annuity holders are entitled to, without having to go down the pre-funded route. The insurance sector is used to the idea of paying liabilities out over a long period. If insurers can do that, why can banks not do it?
The case has not been made for a pre-funded scheme. We could continue on a pay-as-you-go scheme, as long as there is a commitment to provide liquidity to the FSCS when necessary. Under the Bill, the powers are not sufficiently circumscribed to give people confidence in the shape and nature of a pre-funded scheme in the future.
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