Banking Bill

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Mr. Todd: I want to amplify briefly the point that I made in my intervention on the hon. Member for Fareham. We are contributing to the process of producing in the code not a specific disaster plan, but a document that is effectively enshrined in law. As it is referred to in the Bill, it will be a permanent feature of the regulation of banking in this country, and will be used as a reference document of some considerable substance.
I felt when I read the code that it was written, perfectly understandably, in the crisis-room mentality of dealing with the circumstances that we face and how we are using powers now—the hon. Member for Fareham, very fairly, said that it is easier to criticise and a lot harder to write. It was not written in normal circumstances, in which we could perhaps respond with a wider range of policy options than we have been using until now. That is my first, guiding principle.
Additionally, to use a sort of Rumsfeld term, this is an opportunity for us to express certainty about uncertainty, particularly about risk and the principles of risk. One of my anxieties about the way in which the code is written and, of course, to some extent about the necessary actions that we have taken recently, is that they entrench in our citizens, and to some extent our institutions, an assumption that the state will intervene and provide, almost regardless of what circumstances we face. That is, baldly, an unhealthy position.
The document is an opportunity—I should say straight away that this needs to be carefully expressed—to restate some principles of moral hazard that the state’s action should in normal circumstances reinforce, although I recognise that these are not normal circumstances. Those principles, broadly, are that if a person runs or invests in a business, they must expect to take risks and, in some circumstances, may find failure and, in ultimate circumstances, utter failure and complete loss of their investment and employment. That is a part of a mixed economy. We should not try to suggest that if a person is in a deposit-taking institution, for example, such failure might not happen because the state can always intervene and resolve some of their problems. That is the first moral message that needs to be reinforced. There are circumstances in which a business might collapse. One can imagine circumstances in which that might be allowed to happen, for example, in the case of a small business or one that operates in such a niche function within the marketplace that its departure might not necessarily cause either a loss of confidence or an impact on financial stability. I think that we have recognised that the US, in the Lehman Brothers example, probably made the wrong judgment about when to reinforce moral hazard and that the consequent effect on confidence and stability was so profound that it should have accepted a greater responsibility to intervene.
Mr. Hoban: That is a very good example of when predictability in the market would help. Actually, the expectation of investors, based on actions that the Federal Reserve took on Bear Stearns, was that it would bail out Lehman Brothers. The fact that it did not, and allowed moral hazard to take its course, became an even greater shock, and triggered a further wave of problems.
Mr. Todd: That indicates some of the risks in an inconsistency of approach. The world is inconsistent, but the difficulty is that the jeopardy in that case was rather profound. It was probably the wrong decision. I can see why it was made, but I think it was an error. None the less, there might well be circumstances in which some other institution, not quite like Lehman Brothers, could be allowed to fail; and we should allow it to happen.
6.15 pm
Mr. Bone: I entirely agree with the case that the hon. Gentleman is making, but I have not been able in my own mind to come up with a situation in which any Government, whatever their political colour, would allow a financial institution to go under. Does the hon. Gentleman believe, in reality, that that would happen?
Mr. Todd: In reality, the answer is yes. It could happen, and we should reinforce the message that in some circumstances it would. If we do not give that impression in a document of this kind, we risk giving the impression that, in some way, it is a charmed circle activity in which there is some form of intervention—but not, of course, one that necessarily protects shareholders’ rights; that jeopardy is pretty explicit in the choice of objectives that have been set. However, some other stakeholders certainly have protections in place that provide for the state to be the fall-back position.
The second moral hazard is that depositors should take some responsibility for their decisions when choosing where their deposits should be placed. For perfectly understandable reasons—I do not criticise the Government; I can see where they are and how they got there—we have given the broad impression that whatever has been done by UK licensed deposit-taking bodies, people will be okay to whatever investment limit they have chosen. The difficulty is that if one allows that message to be given out repeatedly, people will chase the best rates without any thought. That, of course, will incentivise market behaviour, which chases exactly those depositors.
It is important, in a document of this kind, to reinforce those principles. It does not need to be done at length, but I would prefer a firm emphasis on ensuring that when the state acts it should, in normal circumstances, seek to reinforce those moral goods in the market place rather than protecting the participants to the point where they lose the inclination for any kind of risk awareness. As the Sage of Twickenham remarked in a debate in which I was able to participate, if we protect everyone from foolish behaviour, we will have a nation of fools. That is a pretty sensible picture of the ultimate outcome of ignoring the moral hazard argument.
I encourage the Government to think further on the approach that they are taking in the code. Much work remains to be done. It has one rather embarrassing typo, which I am sure will be picked up, but there is more work of substance to be done on the document, and I am sure that we can all participate in it.
Sir Peter Viggers: The hon. Member for South Derbyshire made a thoughtful, well-informed and well-judged speech. The lesson of politics is that the battle is not so important; it is the war that matters. I do not necessarily expect the Minister to say that he accepts everything said by the hon. Gentleman and that he will order an immediate redraft, but the points that he made may at some point be taken into account. I completely share his view.
I want to address my remarks to clause 5(2)(d), which is on the crucial issue of the trigger for a special regime. We have to go back to 1997 and the creation of the tripartite arrangements between the Treasury, the Financial Services Authority and the Bank of England. The Bank, to great acclaim, was given the responsibility for setting interest rates, and to effect that the Monetary Policy Committee was created. Rather less noticed was the taking away from the Bank of its responsibility for banking supervision. The FSA was given the duty to control and monitor individual banks, while the Bank of England was given a more general power to control financial stability. The FSA fulfilled its duty, but there is little point in glossing over the facts: there were failures, and they happened on the watch of the FSA, which failed to perceive the systemic risks within some banks. We must learn from our lessons. There is no point in being too polite; we must say that there was a failure there.
The Government propose laying further specific duties on the FSA. Paragraph 26 of the draft code of conduct of the special resolution regime clearly states:
“The decision whether the bank or building society fails or is likely to fail to meet the threshold conditions is a regulatory matter for the FSA.”
That concerns me, because I have felt for some time that there should be a division of responsibility in the future, based on our learning from our mistakes in the past. The FSA should be given what I regard as the box-ticking, the responsibility for regulation, for ensuring that individual institutions meet certain criteria. The Bank of England, however, should be given responsibility for what I call banking supervision.
“The Bank of England may exercise a stabilisation power in respect of a bank in accordance with section 10(2) or 11(2) only if satisfied that Condition A is met.”
Clause 8(2) then states:
“Condition A is that the exercise of the power is necessary, having regard to the public interest in—
(a) the stability of the financial systems of the United Kingdom,
(b) the maintenance of public confidence in the stability of the banking systems of the United Kingdom, or
(c) the protection of depositors.”
In other words, the Government have put in the Bill the same kind of responsibilities for the Bank as it already has under current legislation. The responsibility for individual bank supervision is to remain with the FSA, whereas the general responsibility for financial stability, under clause 8, will be that of the Bank. That is not good enough.
The draft code of practice envisages, in paragraph 31, that the
“three public interest conditions may overlap (to a greater or lesser degree) depending upon the particular circumstances of the bank or building society and the wider circumstances of the financial system as a whole.”
So the legislation and the draft regulations envisage that there could be some overlap in the responsibilities and powers of the Treasury, the FSA and the Bank. Good, roll it on. Some level of duplication is necessary. It is not good enough to restrict the regulation and the power to pull the trigger to the FSA; the power to pull the trigger must also be available to the Bank of England, because only the Bank of England has long-term experience of bank control, the levers to affect financial stability and the traditions and ability to discern systemic risk, which the FSA, based on its record, has failed significantly to do.
As happens in the United States, I would give slightly different responsibilities to the FSA and the Bank of England, but I think that it is important that the Bank of England should not be restricted to the exercise of general powers and the stabilisation power referred to in clause 8. It should also have the ability to pull the trigger and implement the provisions to introduce the special regimes.
Ian Pearson: As is evident, clause 5 provides for the Treasury to make a code of practice on the use of the stabilisation powers, the bank insolvency procedure and the bank administration procedure. The authorities—that is, the FSA, the Bank of England and the Treasury—must have regard to the code. The clause also provides a non-exhaustive list of the areas on which the code may provide guidance. As hon. Members are aware, a copy of the code was circulated to the Committee last Thursday and, as I said earlier, a consultation document on safeguards, including the code, will be issued on Thursday.
At present, the code covers further explanation of the SRR objectives, how they should be balanced, what regard the authorities should have to the code, further explanation of the roles of the authorities in the SRR, further explanation of how the authorities will judge that the general and specific conditions are met, factors to be considered when choosing the SRR tools, procedure for the announcement of the SRR tools and the Government’s arrangements for bridge banks and banks in temporary public ownership. That is not a comprehensive list, and it will undoubtedly be expanded and clarified as a result of the consultation exercise.
We have already had significant debate about the further explanation of the SRR objectives and how they should be balanced, but the hon. Member for Fareham, in a sort of online stream of consciousness, went through the code in fine detail. I will respond to some of his questions. He asked again whether the Kaupthing Edge announcement was a template. Not necessarily; we will consider such matters on a case-by-case basis.
A related question was how long to wait for a statement. We wish to make a statement as soon as is reasonably practicable, but as the hon. Gentleman said, the type of information given may depend, rightly, on the circumstances. For instance, if there is still a risk of loss of confidence in the banking system, that might affect the timing of an announcement as well as what can be disclosed in it. There are tensions between full and immediate disclosure and effective action. I think that he understands that. It explains why, although we want to publish information as quickly as is reasonably practicable, other considerations must be borne in mind.
Mr. Hoban: I am grateful to the Minister for that explanation—he picked up that I understand the subtleties—but the announcement about Kaupthing erred on the scanty side in terms of information. For example, it did not say what trigger conditions Kaupthing had breached to lead to the FSA’s withdrawal of permission. That is the level of detail that we want. We do not need to know down to the nearest 5p why there was an issue, but there was nothing to indicate why it had lost that permission. It was missing information that could have been given in any context. Maybe they had lost their claims representative. I do not know.
6.30 pm
Ian Pearson: I note the hon. Gentleman’s comments and will take them into account as part of our consultation on the code. Regarding the point he makes about the claims inspector, the FSA handbook does refer to all the threshold conditions. The FSA will update its handbook in the light of the Bill and will address such points. On the specific example of the appointment of a claims representative, I can confirm that this condition applies only to regulated activity when it comes to carrying out insurance business.
The hon. Gentleman also referred to paragraph 29 of the code and implied that the bank insolvency procedure is the default option. That is not the intention of this part of the code. This paragraph highlights the need that a strong public interest test, as outlined in clause 8, be met before the Bank of England exercises stabilisation powers which, as hon. Members have noted, are invasive. That is why we always need to think carefully before exercising these powers.
I want to respond directly to comments raised by my hon. Friend the Member for South Derbyshire. I can confirm that it is the Government’s intention not to create a zero-failure regime. Indeed, the bank insolvency procedure has been created expressly so that there is a credible failure option. It is possible that the authorities could decide in the event of a bank or building society failure that there is not a systemic risk, that the requirement for action under the special resolution regime is not necessary. I would, however, point out that if a significant number of retail depositors were affected we might still want to use the bank insolvency procedure to ensure effective, fast payout under objective 3, or because perhaps public funds had already been committed previously to the institution which relates to objective 4.
I also want to respond to the point my hon. Friend made that the code was written in times of crisis and that it should it reflect the actions in periods of financial stability as well as instability. The point I made that there is a credible failure option in terms of the bank insolvency procedure is an important one. I would want to reflect on my hon. Friend’s point while at the same time wanting to be clear that the code is specifically about the actions within the special resolution regime, that is actions that are being taken not under normal conditions but when a bank is failing. Even then, other tests have to be satisfied. In terms of when the code is written, I think it right that we should respond to circumstances as we see them at the moment, but the Bill allows us to revise the code so it can be updated in calmer times as well as in times of financial instability.
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