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Session 2007 - 08
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General Committee Debates

Banking Bill

The Committee consisted of the following Members:

Chairmen: Mr. Roger Gale, Mr. Jim Hood, Mr. Eric Illsley
Barlow, Ms Celia (Hove) (Lab)
Blizzard, Mr. Bob (Lord Commissioner of Her Majesty's Treasury)
Bone, Mr. Peter (Wellingborough) (Con)
Breed, Mr. Colin (South-East Cornwall) (LD)
Eagle, Angela (Exchequer Secretary to the Treasury)
Flello, Mr. Robert (Stoke-on-Trent, South) (Lab)
Gauke, Mr. David (South-West Hertfordshire) (Con)
Hoban, Mr. Mark (Fareham) (Con)
Hosie, Stewart (Dundee, East) (SNP)
Keeble, Ms Sally (Northampton, North) (Lab)
Newmark, Mr. Brooks (Braintree) (Con)
Pearson, Ian (Economic Secretary to the Treasury)
Pugh, Dr. John (Southport) (LD)
Robertson, John (Glasgow, North-West) (Lab)
Smith, Geraldine (Morecambe and Lunesdale) (Lab)
Todd, Mr. Mark (South Derbyshire) (Lab)
Viggers, Sir Peter (Gosport) (Con)
Wilson, Phil (Sedgefield) (Lab)
Alan Sandall, Mick Hillyard, Committee Clerks
† attended the Committee

Public Bill Committee


Tuesday 4 November 2008

[Mr. Roger Gale in the Chair]

Banking Bill

10.30 am
The Chairman: Good morning. This is the ninth sitting of the Committee and we now come to discuss clause 1.

Clause 1

Question proposed, That the Clause stand part of the Bill.
The Economic Secretary to the Treasury (Ian Pearson): It is a pleasure to serve under your chairmanship, Mr. Gale. As you are aware there are good reasons why we have only now reached clause 1, but it is the meat of the Bill in terms of the special resolution regime. I shall take a limited amount of time to set the scene because clause 1 gives us a good overview of the framework of the regime tools.
The clause sets out the broad purpose of the SRR, which is to address a situation in which all or part of the business of a bank has encountered or is likely to encounter financial difficulties. It outlines the tools at the authorities’ disposal under the SRR. The special resolution regime includes the three stabilisation options: transfer to a private sector purchaser, to a bridge bank and to temporary public sector ownership. As the Committee will hear when we consider clauses 13 to 24 and 30 to 38, the stabilisation options are exercised through the stabilisation powers, which effect the transfer of shares and other securities or property, rights and liabilities by operation of law. Those stabilisation powers include the onward and supplemental transfer powers set out in clauses 25 to 29 and 39 to 41.
Clauses 42, 43 and 55 provide for a package of safeguards relating to the exercise of partial property transfer powers, which, as Members are aware, proved of particular interest to stakeholders during the public consultation process. I draw attention to the safeguards here because the Government will be issuing a consultation document on them, as I indicated in my letter to Committee members last week, as well as the draft code of practice, which the Committee has seen, on Thursday of this week.
I have established an expert liaison group of banking sector practitioners, including legal and insolvency experts, to advise the Government on the development of the safeguards. The group held its first meeting last Friday, and the consultation document that we publish on Thursday will reflect its views on the Government’s proposals. It will also have a key role in continuing to advise the Government through the process of consultation and beyond. Yesterday I tabled a new clause on the position of the liaison group, and we will debate that in due course.
Mr. Mark Hoban (Fareham) (Con): It will be helpful to Committee members if the Minister sets out who the members of the expert liaison group are.
Ian Pearson: I will circulate the names of the members of the group to the Committee.
Returning to the overview of the SRR, part 1 of the Bill includes provisions on compensation, incidental functions, the role of the Treasury and how the regime applies to building societies. The special resolution regime also includes the bank insolvency procedure and the bank administration procedure, which the Committee will consider when we come to parts 2 and 3. The special resolution regime outlined in clause 1 is at the heart of the Bill; it establishes a permanent and credible framework for authorities to resolve a failing bank. The SRR provides the authorities with the tools to deal with banks in financial difficulty in a manner that supports the public interest in financial stability, confidence in the banking system and depositor protection.
In most situations, normal regulatory interventions or voluntary action by the management of the bank can resolve an individual bank’s difficulties. However, bank failures will sometimes occur and can damage confidence, disrupt financial markets, harm depositors and generate significant costs to businesses and to the economy as a whole. Bearing that in mind, it is worth taking a couple of moments to outline the background to the development of the special resolution regime and the genesis of this part of the Bill.
The recent period of sustained disruption in global financial markets, starting in the United States in the summer of 2007, has had a widespread impact on financial markets, firms and economies across the world. In the UK, the most visible consequence of that has been the financial difficulties faced by a number of financial institutions, including Northern Rock plc.
In summer 2007, Northern Rock found itself unable to finance its activities, due, among other things, to a business model that was heavily reliant on funding from the wholesale money market. In the light of those severe difficulties, the Government took action to maintain financial stability, while protecting consumers and the interests of the taxpayer.
In February 2008, when it became clear that, in the light of prevailing market conditions, no institution was prepared to make an offer to take over Northern Rock that was judged adequate to protect the taxpayer, the Government took the decision to take the bank into temporary public ownership. To that end, legislation to give the Government powers to transfer the shares or property of a failing bank was brought forward in the Banking (Special Provisions) Act 2008, which received Royal Assent on 21 February of this year. The main transfer powers expire, under the terms of that Act, on 20 February 2009. That Act provided the Government with temporary powers should further action be needed while permanent legislation—this Bill—was being prepared and passed.
The prudence of that approach has been demonstrated by events concerning Bradford & Bingley plc. On Monday 29 September the Government used both the share and property transfer powers provided by the 2008 Act to bring the bank into temporary public ownership and then to transfer the deposit book to a private sector purchaser. The special resolution regime outlined in clause 1 replaces the 2008 Act with a permanent framework for the authorities to resolve a failing bank, with objectives that include protecting and enhancing financial stability and confidence in the banking system, and protecting depositors and public funds. Those objectives will be considered under clause 4. By setting out a clear and credible statutory resolution regime to address a failing bank, which removes control from the bank’s management by overriding the powers of shareholders and directors, the regime also provides a strong incentive for banks and their directors to take action to prevent their business from getting into difficulties.
Unlike the 2008 Act, the SRR has been designed as permanent legislation and therefore provides a framework with strict conditions that must be met before the powers are exercised, clear objectives that the authorities must have regard to in exercising those powers, and refined stabilisation powers that are targeted in their effect alongside new tools such as the bank insolvency procedure. Clause 1 also establishes that each of the tripartite authorities—the Bank of England, the Treasury and the Financial Services Authority—has a role in the operation of the special resolution regime. The powers and responsibilities of those bodies are extended by the Bill, in line with each institution’s current mandate and responsibilities, to enhance the UK framework for financial stability and depositor protection. The SRR also provides the authorities with a wide range of tools to meet the above objectives, by resolving a failing bank or facilitating fast payout to depositors. The establishment of the special resolution regime was widely supported by stakeholders throughout the consultation process; I am also grateful for the support from Opposition Members.
As I have said, clause 1 clearly sets out the framework for the whole package of SRR tools—we will debate the tools later—giving the authorities the full range of options for dealing with a bank that is experiencing difficulties. I appreciate that the Committee will wish to discuss many of the provisions that the clause summarises, and which I have just briefly run through. I am looking forward to debating the provisions in detail over the remaining sittings. However, I propose that detailed consideration of those provisions be reserved until we reach the corresponding clauses. I will be guided on that by you, Mr. Gale. Given that clause 1 is a broad summary clause, intended to provide users of the Bill with a clear understanding of its contents, I urge that the clause stand part of the Bill.
The Chairman: The clause is fairly wide-ranging—as the Minister has indicated—and it is up to the Committee to decide how broad it wishes the clause stand part debate to be, bearing in mind that we need to try to avoid covering too much ground that will be touched on under other clauses. If it becomes necessary to embrace other arguments and discussions prior to further clauses being reached, I shall bear that in mind. As the issue is complex, I am acutely conscious of the need to have a fairly wide-ranging debate now. The decision is in the hands of the Committee.
Mr. Hoban: It is a pleasure to serve under your chairmanship, Mr. Gale, for this ninth sitting, which by my reckoning takes us to about halfway through the Committee’s proceedings. I am not sure that we have broken the back of it yet, but the end is in sight. I take note of your comments, Mr. Gale, about guiding our debate. I recognise the challenge in trying to restrict remarks. One could make a speech that lasted for both sittings today and well into Thursday, but it would not be in my interests or those of the Committee to go down that route—
Mr. David Gauke (South-West Hertfordshire) (Con): Shame.
Mr. Hoban:—although my hon. Friend might tempt me to do so if he is not careful. I want to give a sense of where we are coming from over part 1 and to set the backdrop for our debate on it.
As the Minister said, clause 1 sets the scene for part 1. I share his recognition that one of the learning points from the crisis over the last year is the lack of a decent toolkit for dealing with the problems of a failing bank. That came out particularly clearly from the debate on the future of Northern Rock and the time it took to resolve that situation suggests that we did not have the right tools available. I suspect that if the tools that were initially developed in the Banking (Special Provisions) Act 2008 and have been fleshed out in this Bill, had been deployed in respect of Northern Rock they would have produced a different outcome. We do not know what that outcome might have been, but we have seen how Bradford & Bingley was tackled and in some respects it was not dissimilar to Northern Rock in its problems. A very different solution was found for Bradford & Bingley compared with Northern Rock.
It is in a way disappointing that the Government have not listened to the warnings that they were given prior to this crisis about the adequacy of the framework for dealing with a failing bank. At the end of one of the scenario-planning exercises that the tripartite authorities undertook and which looked at this issue in about 2005, both the Governor and the then chairman of the FSA, Sir Callum McCarthy, highlighted the need for a review of the tools that were available. They recognised that the framework that was in place was not sufficient to deal with the consequences of a failing bank.
The Bill provides a set of tools, the stabilisation options in part 1, the insolvency procedure in part 2 and the administration procedure in part 3. When considering those stabilisation options and the transfer to a private sector purchaser and to a bridge bank and temporary public ownership, we need to bear it in mind that this part of the Bill invests significant powers in the tripartite authorities. Those powers enable them to make important decisions affecting the function of the banking system and the wider financial sector, as well as affecting the outcomes for individual institutions and their creditors. The framework for the exercise of these powers is set in clauses 4 and 5, and we will talk about them in more detail later on.
For my part, I would want to see before Report in this place a more detailed code that is much closer to completion—I accept it might not be finalised—than the one that was circulated to us on Thursday, so that we can be sure that a robust framework is in place that will govern the use of these powers. I am sure that when we reach clause 5 we will have a long discussion about the nature of the code.
10.45 am
The concern I have—also expressed in the response to the stakeholders’ consultation—is to ensure that there is a proper framework in place so that these powers are exercised in a predictable way: that people know the circumstances in which they will be exercised. That is what we are lacking at the moment. We will try to tease out how we shall know the circumstances in which the powers will be exercised. That requires further elaboration in the code and I hope that today’s debate helps us establish more detail.
In talking through this part of the Bill, it might help the Committee if the Minister were able to use recent examples of how the powers in the special provisions Act have been used, to illustrate how they will be exercised in the framework in this Bill and to explain the points of difference between the special provisions Act and the Bill before us. The Minister referred to how Bradford & Bingley was dealt with in the context of temporary public ownership and the transfer of shares and property. We also had the situation with Heritable where the FSA determined that the threshold conditions had been breached and that led to deposits being transferred to ING Direct and the rest of Heritable being placed into administration; there was a similar pattern with Kaupthing. These are powers that we would expect to see in this Bill.
However, one element of the Icelandic banking system fell outside the powers of the special provisions Act and it would be helpful for the Committee to understand how the Bill would deal with Landsbanki’s branch in the UK. A different set of powers was used to tackle the problems faced by Landsbanki. We need to understand how the Bill would tackle a situation where a bank’s branch based in the UK faced significant financial problems. A relatively large number of banks based in the UK operate through a branch system rather than through a UK subsidiary. We will come to that in clause 2, when I will probe it in more detail. That important issue needs to be resolved.
We want to ensure there is some predictability in the way that these powers are used. That will require us to probe some of the language in later clauses. Clause 7(3), for example, says that the power can be exercised if
“it is not reasonably likely that...action will be satisfy the threshold conditions.”
That sounds a relatively low test and I think people would expect a higher test where the threshold conditions are to be invoked. We will come to that. That is why it is important in this debate on part 1 to tease out some of the language and the meaning, certainly in relation to that clause. The explanatory notes state:
“Those conditions essentially demarcate the boundary that must be crossed before the stabilisation powers...may be applied to a bank.”
That does not further our understanding of how clause 7 will work.
The issue of partial transfers is one of the most contentious in the clause, and stakeholders have expressed concern about it. Before debating the relevant clauses, we will want to see as much as we can of the draft statutory instruments that relate to partial transfers, or a clear statement from the Government of the principles that might underpin them. Part of the architecture of the reforms is that the power should be set out in primary legislation, the safeguards in the secondary legislation and further elaboration in the code of practice. We need to see that entire package before we decide whether we are content with the Bill. The Minister has expressed his willingness to make it available, for which I am grateful, but the state that the code of practice was in when it was circulated on Thursday suggests that there is still some way to go before those documents approach a reasonably final stage.
My final point is that the Bill focuses on what will happen when things go wrong. It is important to have the right set of solutions in place when that happens, but I am sure that all members of the Committee feel that prevention is better than cure. We want to ensure that the FSA, the Bank and the Treasury, in tandem with the work that we are doing here to the legislative framework, look carefully at how they will ensure that the preventive framework is in place, so that those powers will hopefully remain sitting on a shelf gathering dust after the current crisis is over, rather than being used on a regular basis.
Sir Peter Viggers (Gosport) (Con): This is a crucial clause in an important Bill. We must realise that we are not going back to the year 2006. When the legislation is passed, we will not be returning to the happy, confident days before the credit crunch impacted a year or more ago. To that extent, the Minister is completely right when he says that the measures we are putting in hand are permanent and that many of the issues relate to a new permanent framework, and that is why it is so important to get it right.
When the US authorities were faced with difficulties and introduced Sarbanes-Oxley, the effect on the banking industry and the efficiency of financial markets was disastrous. The City of London will be allowed to expand to a greater extent than it might otherwise have done because the American financial markets are now rather constipated and hampered by the bureaucratic and legalistic effects of Sarbanes-Oxley and the imposition of measures that caused difficulty for their operation.
Some of the measures that we are introducing now will be permanent, but others will of course be temporary, and that imposition will need to be removed if we are to return to the days of an efficient and confident banking system. We need to distinguish carefully between the permanent measures, which we must get right, and the temporary measures needed to satisfy the present difficulties.
I have previously—I remember raising the issue with the Minster—put forward the nearest analogue to the present situation, which is the situation of Lloyd’s of London in the 1990s. I draw on my experience as a director of a bank in the secondary banking crisis of the 1970s, so I have, uniquely in the Committee, been here before. I was also one of the four members of Lloyd’s of London’s audit committee when it pushed through what was then the biggest single corporate rescue in the history of finance, so I am sure that the nearest analogue to our present situation is Lloyd’s of London. In that case, an insurance underwriter would underwrite a risk and then lay it off by reinsuring with another insurance entity. That second insurance entity would then lay off his risk. What would develop was what was known in Lloyd’s days as a spiral, which was a spiral of reinsurance so that the second, third, fourth, fifth—perhaps the 15th—insurer did not know the exact nature of the assets he was reinsuring. That is a very close parallel to the current collateralised debt obligations. Our present difficulties arose because of the creation of collateralised debt obligations in the United States initially, and the reinsurance and refinancing of the toxic assets in a spiral very similar to the Lloyd’s spiral of the 1990s.
Mr. Brooks Newmark (Braintree) (Con): I have to agree with everything that my hon. Friend is saying about some of the causes. Does he agree that another major cause was that many of the directors of these banks did not understand where some of the hot shots on the derivative desks were making the money? The derivatives they were trading were very complex and highly leveraged. The question here is how we legislate to ensure that directors understand where their institutions are making their money and what the risks associated with those assets are.
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