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Reforming Financial Markets
12.33 pm
The Chancellor of the Exchequer (Mr. Alistair Darling): With permission, I shall make a statement on the Government's proposals for reforming financial markets. Copies of our proposals are contained in a document that is available in the Vote Office.
The world economy has been hit by a severe financial crisis, which has resulted in the worst economic downturn for well over 60 years. Its origins lie in failures in the banking system around the world. Financial institutions in many countries simply took on too much risk. They became over-reliant on wholesale funding and too exposed to particular products, and irresponsible pay practices made banks take unnecessary risks.
It is also clear that some financial institutions appeared to have little appreciation of what was going on inside their own businesses. However, regulators and Governments too must learn from the events of the last two years, and understand better the risks that come from rapid globalisation in the financial system.
Our economy has a clear need for well-managed, well-functioning banks and financial institutions to perform a vital set of functions, channelling investment and helping people to save and plan for the future. The financial services industry is also a major employer in this country—of over 1 million people—and it will continue to generate wealth for our country in the future.
Our central objective must be to ensure that, as we come through the downturn, we reform and strengthen our financial system and rebuild it for the future, with consumers who are better informed, financial institutions that are better managed, and markets that are better regulated. The proposals that I will set out today build on our previous reforms to provide a new settlement that is open, competitive and effective and able to meet the needs of both business and families; that inspires trust and confidence on the part of businesses and consumers; that ensures robust regulation that reduces the likelihood of failures without preventing innovation; and that provides effective mechanisms for dealing with the failure of financial institutions should they occur.
I want to take steps to help consumers make better informed choices. To ensure that they are given access to free impartial financial advice, we will legislate to introduce a national money guidance service and impose a levy on the financial sector to help fund it. We will also legislate to consolidate Financial Services Authority resources to provide separate independent consumer education, setting up a lead provider of consumer information and personal finance education. Consumers will also get more protection, along with a greater right of redress and access to compensation if things go wrong. We will also improve arrangements for depositor protection, including legislation to pre-fund and expand the role of the Financial Services Compensation Scheme.
Because of the events of the past two years, there are fewer firms in the market providing financial services. It is essential that we retain competitive markets, as they play a key role in providing consumers with value and choice. We want to see greater competition and greater choice for consumers, as well as a bigger role for mutuals and building societies, so the Office of Fair Trading and
the FSA will ensure that we maintain competition in the market for financial services. As we come out of this downturn, we need to promote a competitive market that enables new entrants—which may include non-banking institutions—and innovation to benefit consumers and businesses. In that way, we will see better informed consumers who have greater choices in a more competitive market.
We also need banks and financial institutions that are better managed. We need a change of culture in the banks and their boardrooms, with pay practices that are focused on long-term stability, not short-term profit. The FSA now has powers to penalise banks if their pay policies create unnecessary risk and are not focused on the long-term strength of their institutions. From now on, I will require the FSA to report every year on how financial institutions are complying with their new code of practice for remuneration, and how it will deal with firms that do not comply.
Bank boards and institutional investors must also become better equipped to do the job and understand their businesses, with more effective risk management and greater independence of non-executives, who must not be afraid to ask searching questions. Next week, Sir David Walker will report on measures that will deliver improved corporate governance at financial institutions, ahead of his final report in the autumn.
Building on reforms already made, my proposals today will strengthen regulation of the financial system. They will cover three areas: first, new regulatory powers to allow tougher regulation of individual firms; secondly, measures to deal with the potential failure of institutions that could have a significant impact on the economy; and thirdly, a strengthened framework for financial stability to deal with system-wide risks in today’s more complex and global markets. We will continue to work with other countries to deal with what is, at heart, a global problem.
I asked Lord Turner to make recommendations, which the FSA is now implementing, to strengthen the regulatory regime and increase the intensity of supervision. They will strengthen the rules to ensure that banks hold enough capital as a buffer against losses, to introduce a back-stop power ensuring that banks do not over-extend themselves by lending too much when they do not have the strength to do so, and to increase the focus on bank liquidity so that they are able to carry out their business at all times. Those measures will help ensure that financial firms are stronger, more resilient, and better able to serve the needs of our economy.
I will also introduce legislation in the autumn to give the FSA a new statutory objective for financial stability, and extend its powers to ensure that it has the appropriate rules to deal with different risks in individual banks, and tougher powers and penalties against misconduct, and that it can take account of new developments in the financial sector—including expanding regulation where necessary, for example for systemically important hedge funds.
We need to ensure our resolution regime can deal with financial institutions of all sizes, including banks that are very large or complex. As these banks are often global, we also need an international mechanism for resolving large multinational banks, and we will bring forward proposals to G20 Finance Ministers when they meet in London in the autumn.
At home, we can better deal with risks by ensuring that safeguards are in place—for example, by making banks hold capital at a higher level that reflects not only the possibility of failure, but its cost. By introducing higher standards and transparency, the FSA can also improve the functioning of key markets, such as the derivatives markets, so that problems in one institution are less likely to spread through the entire system. The FSA and the Bank of England will make institutions put in place practical resolution plans that can be deployed in the event that they get into difficulties.
There is, of course, a debate to be had about whether Governments should restrict the size of banks or separate different types of banking, as happened in the United States in the 1930s. I believe that that is a simplistic solution, which fails to take into account the complexity of today’s financial system. Small banks as well as large banks can threaten financial stability, as in the case of Northern Rock. Equally, both retail and investment banks, in different parts of the world, have failed in the past year, and it is not only banks that can affect stability, as we saw in the example of the American insurance company AIG. In addition, the approach of one regulator for one category of institution deemed to be systemically important and another regulator for the rest seems to me to miss the point, because what is systemically important can change rapidly, as we have seen in the past two years. Instead, the regulatory system has to recognise and respond to the complexities of individual institutions, and that is what we are doing.
We also need to strengthen the framework for financial stability. That is a question not only of institutional powers and responsibility, but of better understanding what is happening in the markets. No simple fixes—no institutional reform—could have prevented these problems from occurring. There are different institutional frameworks in countries across the world, but no one model has been successful in insulating a country from the current crisis. Although regulatory arrangements were not the cause of the current problems, we need the right institutions to maintain financial stability and we must ensure that they have the right tools to do the job.
The move in this country to a single regulator 12 years ago addressed problems with the previous regime of multiple self-regulators, which did not reflect the changing nature of financial markets, and our approach has been adopted by many other countries. However, 10 years on, the world had moved on again; some of the global problems of the past two years went beyond the scope of existing regulation, while others were simply not given sufficient attention by regulators and central banks. In this country, the authorities have been able, over the past year, to deal quickly and effectively with a number of financial stability issues, such as those relating to the Dunfermline building society and Bradford & Bingley, but further reform is now needed.
We will therefore legislate to set up a new council for financial stability, which will bring together the Bank of England, the FSA and the Treasury. It will not only deal with immediate issues, but will monitor system-wide financial stability and respond to long-term risks as they emerge. That needs to be done on a formal statutory basis. The council will draw on the expertise of the FSA and the Bank, which are and will remain independent of
Government, by looking at their regular reports—the financial stability report and the financial risk outlook—and formally responding to their recommendations. In that way, when risks or threats to stability are identified they will be addressed. This body will do that in a way that is transparent and accountable—so that people can see how and why decisions are made—with the regular publication of minutes. The council’s responsibilities will be set out in law, with published terms of reference. In discussion with the Treasury Committee and the House, we will consider how to increase accountability through greater parliamentary scrutiny.
We have already taken significant steps to improve the way in which we monitor and manage risks to the financial system as a whole, through more systematic use of stress testing of financial institutions, for example. The proposals that I am making today will further strengthen our ability to identify and deal with systemic risks, and will ensure that the authorities can be held to account for their actions. We also need to consider what further counter-cyclical measures are needed, in order to allow us to lean against the credit cycle and prevent the build-up of risks that could threaten the stability of the financial system. The principle of leaning against the cycle is easy to agree, but deciding what action to take and when to take it is far more complex. At the moment, there is no clear consensus here or abroad, but I believe that central banks will have an important role to play in that area.
Today’s global market for finance means that new measures can be effective only if they are implemented on a broad international basis, so under our presidency of the G20 we will continue to press for measures to strengthen the international regulatory architecture, building on the proposals agreed in April. In Europe, too, we will argue for enhanced monitoring of system-wide risks, while retaining the crucial link between national regulators and Governments. By working internationally, our efforts can help us deliver more effective supervision of global banks, stronger international standards, and a more responsible global financial services sector.
We intervened to stabilise the banking system, while retaining a clear view that banks are best managed and owned commercially and not by the Government. We intend to return our stakes in the banks to the private sector, in a way that brings best value to the taxpayer, promotes competition and maintains stability, and we will use the proceeds to cut Government debt. We are empowering consumers, supporting better corporate governance and strengthening regulation, so that our financial sector can continue to be an engine of prosperity. I commend this statement to the House.
Mr. George Osborne (Tatton) (Con): I thank the Chancellor for his statement, although frankly almost all of it was splashed over the front pages of today’s newspapers. Once again, Parliament comes last, instead of coming first.
Of course, there are some elements of the White Paper that we welcome: the improved consumer advice; David Walker’s report on corporate governance, to which we look forward; a much better resolution regime for failed banks, which is clearly necessary; and the Chancellor’s remarks on pay and bonuses, although he could have set a better example with the pay and bonus package for the chief executive of RBS.
However, in most part, this White Paper is a totally inadequate response to what has happened over the last two years.
For a start, the White Paper contains no serious analysis of what went wrong. I received a copy of it only 20 minutes ago, during Prime Minister’s questions, but the only admission that I can see of any responsibility for what happened is the sentence that states that
“the crisis has shown that aspects of prudential and macro-prudential supervision...were insufficient.”
That is the understatement of the century, given that half the British banking system has had to be nationalised. It also ducks every difficult question that needs to be addressed if we are to protect our society and our economy from a repeat of the mistakes that have caused such trouble. How do we replace the failed tripartite regime? What tools do we need to stop the excessive debt levels that did so much damage to our economy? How do we ensure that we have a banking system that competes across the world, and offers families and small businesses in this country the services that they are currently denied in this credit crunch, without the British taxpayer picking up the bill for the mistakes that are made? None of those difficult questions is properly addressed today; every single one is left to the next Government to deal with. It is more of a white flag than a White Paper—a complete surrender of this Government’s responsibility to fix the system for regulating the City that they created and which so spectacularly failed.
Let me press the Chancellor on some specifics on the conduct and content of regulation. First, on the tripartite regime, he must see how dysfunctional it has become. Institutional jealousies and blurred lines of responsibility mean that everyone gets involved but no one is in charge. Let us remember where this all began—with the arrogant decision from the new Chancellor in 1997, without warning or consultation, and in the teeth of the opposition of the late Eddie George, to remove banking supervision from the Bank of England. My right hon. Friend the Member for Hitchin and Harpenden (Mr. Lilley), the then Shadow Chancellor, warned from this Dispatch Box that it would leave no one responsible for the liquidity of the banking system or to guard against systemic collapse. Sadly, that prophecy turned out to be all too true. No one was responsible for liquidity. No one was looking at systemic risk. Even the FSA itself admits that it took its eye off prudential supervision. When the crunch came over Northern Rock, no one knew who was in charge. Almost two years later, we still do not know who is in charge. The Chancellor should have come here today to bury the tripartite system, not to praise it. The only thing that stops him is the vanity of the Prime Minister who refuses to admit that he made such a fundamental mistake.
The same applies to the content of regulation. The first half of Lord Turner’s report contains the most damning critique of what went wrong with this Government’s economic policy. He points to the “major and continued macro-imbalances” in the British economy. He says that the failure to spot this was
“one of the crucial failures of the years running up to the financial crisis”,
“vital activity of macro-prudential analysis...fell between two stools”.
What does this White Paper propose to do with that vital activity in future? It puts it between two stools again. After two years of thinking in the Treasury—wait for it—we are going to have a council on financial stability that will bring together the Treasury, the Bank of England and the FSA. I thought that that was what the tripartite regime was supposed to be about all along. We do not need another divided committee. We do not want more divided responsibilities. We need clear lines of accountability that run all the way to Threadneedle street. They do not exist at present.
Instead of clarity, what we get from the Government is confusion. The Governor of the Bank of England appeared before the Select Committee on the Treasury two weeks ago, and he said:
“We were given a statutory responsibility for financial stability in the Banking Act, and the question...to which I have not really received any adequate answer from anywhere, was: what exactly is it that people expect the Bank of England to do?”
We are none the wiser after this White Paper. Perhaps it would have helped if the Chancellor had shown the White Paper in draft to the Governor of the Bank of England two or three weeks ago instead of in recent days.
Is it not absolutely clear that the Bank of England now has to be given not just the responsibility but the tools for macro-prudential regulation? Can the Chancellor confirm that there is not a single new power for the Bank of England in the White Paper? The Bank of England should have the power to call time on debt, as we suggested almost a year ago; it should be able to set counter-cyclical capital rules in conjunction with other countries—and, by the way, that would be a much better use of international co-operation than the current proposals from the European Commission, which are ill conceived and damaging to the UK—and it should have the statutory powers to intervene when the structure of a financial institution threatens the whole economy, so that, in the Governor’s words, it can force its “sermons” to be listened to.
The Bank of England cannot do any of those things unless it has the experience and knowledge of their day-to-day regulation. Let me make it clear to the Chancellor today that the next Conservative Government will abolish the tripartite system, and let me tell Parliament first—unlike his policy—that we will put the Bank of England in charge of the prudential supervision of our banks, our building societies and our other significant financial institutions. We have learned from this crisis the old truth that one cannot separate central banking from the supervision of the financial system and that sound regulation is not just about a checklist of rules but about the authority to exercise judgment and to see the bigger picture.
Sitting alongside a stronger Bank of England we will have a powerful regulator to protect consumers—a regulator with the clout and focus not just to add more health warnings alongside the acres of small print that already come with financial products but to stamp out unfair practices such as mis-sold payment protection insurance and excessive bank charges. We will set out the details of that in our own alternative White Paper later this month. Will not the choice be clear then?
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