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. I
distinguish between banking regulation and banking supervision. It
should be possible for not only the FSA but the Bank of England to pull
the trigger, because since the FSA is responsible for the routine
financial regulation of banks it will naturally be reluctant to
come forward and say that normal regulation has failed. It will
instinctively—naturally—not wish to say that the
regulation for which it is responsible has not been successful. There
should therefore be a separate mechanism giving the Bank of England the
power to supervise, and that power of supervision must provide it with
enough personnel and abilities for it to be close enough to the
management of banks to know when special action is required. Clause
8(1)
states: “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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