Banking Crisis - Treasury Contents

Memorandum from Prudential plc


  We note a tendency for commentators to refer to what was in all essentials a "banking crisis" as a "financial services crisis". However, this is an inquiry to "learn lessons from the banking crisis" and whilst it is important that conclusions specific to banking are learned and applied, it is also important that such remedies are not applied without due cause to other types of financial sector business.

  There is no doubt that we are facing a tough and complex economic environment and there continues to be a pressing need to ensure all businesses in financial services are adequately capitalised. However as a whole, the insurance sector has weathered the current global economic turmoil well so far, as a result of its more conservative business model (when compared to the banking sector) and the industry's more defensive capital position. Our liabilities are consistently of a longer duration than banks and day-to-day liquidity is not an issue for insurers in the way it is for banks.

  Restoring consumer confidence is key to resolving the financial turmoil. Governments' current primary focus should be on measures to alleviate the severity of the economic downturn and its effects on the community, and on stabilising the banking system both to revive lending and to restore confidence in banking institutions—not on regulatory change. Any future regulatory or legislative responses that are decided now or in the future must take into account the differences between the various sectors of the financial industry, particularly between banking and insurance, and be matched to specific needs and identified shortcomings.

  The insurance industry is an important and integral part of the UK economy and the life insurance sector is a critically important source of long-term finance for UK industry. The Government should be fully aware of the wider market impact of further market intervention, both in terms of creating an unlevel playing field for the insurance industry in the UK but also placing UK companies at a disadvantage globally. The strategy for the Financial Services Compensation Scheme should be reviewed urgently including both the compensation levels and the funding methods, in particular the concept of cross-subsidisation between sectors, and any other proposals that would have the effect of reducing the appetite of the life insurance sector for long term investment in industry.


  1.  Prudential plc is an international retail financial services group with significant operations in the UK, Asia and the United States. Our purpose is to promote the financial well-being of our customers and their families, with a particular focus on saving for retirement and income in retirement. Prudential's portfolio of well-known and respected brands has attracted more than 21 million customers (and policy holders and unit holders) worldwide.


  2.  Securing financial stability in the coming months must be the first priority for the Government. There are a variety of tools the Government and supervisory bodies can use to help achieve this.

Accounting standards

  3.  There has been much discussion of the role of auditors in relation to the banking crisis. In our view, the focus should be on accounting standards. In particular, the latitude apparently afforded to off-balance sheet funding structures (for example: Special Investment Vehicles and conduits). This has made interpretation of accounts, from the investors' perspective, more difficult in these challenging times.

  4.  In principle, we believe in transparency and market consistency. The temptation to weaken or change fair value accounting should be resisted as it is an effective tool in delivering necessary information to investors. Any weakening could further undermine investor confidence. However, the application of fair value across the balance sheet should be consistent. Ascertaining values for assets and liabilities, particularly when markets are not deep and liquid, is very difficult. There are times when market values are wildly irrational and allowing those values to determine capital adequacy in those circumstances could be dangerous. Regulators need the flexibility to suspend rules regarding capital adequacy to provide capital relief, as in the circumstances in which many institutions now find themselves.

Credit Rating Agencies

  5.  Credit rating agencies have an important role to play in investment. However, some regulators, investors and lenders have in the recent past relied too heavily on agency ratings, at the expense of their own in-depth analysis. In future, we believe that this reliance should be addressed and that the agencies should not receive any payment from banks, corporates or managers of security issues.

  6.  We support greater oversight of credit rating agencies but it is important that any legislative response is appropriate and considered fully. For example, we are concerned about the European Commission's draft Regulation on Credit Rating Agencies. In our view it includes overly prescriptive corporate governance obligations. Further consideration also needs to be given to the extraterritorial effects, the potential impact of the withdrawal of ratings and the risk of political interference putting the independence of ratings in doubt.

Tripartite Arrangement

  7.  Prudential has concerns about the structure of the tripartite arrangement. When introduced in 1997 the arrangement appeared to work well but we now see that it failed to anticipate or provide effective action to counter development of unsound practices in the banking sector. We believe there now needs to be a better defined structure and allocation of responsibilities: this is particularly so in the case of the relationship between the FSA and the Bank of England and the need to ensure that potential issues are picked up and acted upon at an early stage.

Regulatory Capital and Liquidity Requirements

  8.  A number of reforms to regulatory capital and liquidity requirements have already been introduced in the UK and elsewhere. Whilst there may be scope for changes to Basel II in light of the current economic turmoil it is important to note the fundamental differences between the banking and insurance sectors which are likely to make any read-across inappropriate. Furthermore, any regulatory capital requirements based on Basel II or the proposed Solvency II regime need to be sufficiently flexible to avoid the problems associated with pro-cyclicality.

International Financial Regulation

  9.  We particularly welcome the reforms proposed by the G20 to reflect today's economic realities in the make-up of international bodies such as the Financial Stability Forum but feel that it would be unwise to rush into wholesale reform of the architecture of international financial regulation—although some specific incremental measures will be necessary. For example, we support the proposal for supervisory colleges for all cross-border financial institutions, where supervisors can share information and best practice. Allied to this we believe that there is a need for forward-looking mechanisms and fora where regulatory information can be shared, reviewed and analysed for macro-economic trends and impacts.

Role of the Media

  10.  At a time of significant market volatility and low consumer confidence, the media can be a powerful communication avenue. However, information sensitive to listed companies should only be released in a timely manner and through the regulated channels. There is concern that this did not happen. This is not just relevant to journalists but also credit rating agencies and analysts.


  11.  Securing financial stability is fundamental to protecting the taxpayer, now a significant stakeholder in some of the UK's financial institutions.

UK Government's action

  12.  The UK Government's response to the banking crisis was significant; however it arguably would have been more effective had the Government acted sooner to take an international lead in addressing the crisis. The absence of a strong Government response to early symptoms of the crisis exacerbated uncertainty in the markets which in turn has fuelled the downturn in consumer confidence.

Northern Rock and Bradford & Bingley

  13.  The decisions to "nationalise" Northern Rock and Bradford & Bingley were made by Government to protect the economy, but the decision to treat the Bradford & Bingley bailout costs as a charge on the Financial Services Compensation Scheme was inappropriate to the circumstances and has placed unjustified pressure on soundly managed commercial banks and insurers. We submit that this is not a proper use for the Scheme, and that the effectiveness of the overall arrangements is called into question by action of this type. Furthermore, we are concerned about the impact on the insurance industry of the general pool arrangements of the FSCS. Banks are in a fundamentally different position from insurers and have funding needs of a size and nature that makes it unreasonable to expect insurers (or other financial firms) to contribute on the present basis—if at all. There is a potential risk that insurance companies will be contributors but not beneficiaries. Given the events over the last few months we expect there to be significant increases in the fees as a result of the bailout costs. We understand that the FSA intends to conduct an internal review of the fees regime. However, we advocate strongly that a wider review of the scheme is urgently needed, going back to first principles on the legitimate role of such schemes and the practical limitations of industry levies to finance them.

  14.  In the context of events surrounding Bradford & Bingley, we would strongly urge against any retrospective changes to existing bond documentation. Insurance companies and pension funds in the UK are very significant investors in bank debt, including subordinated debt, and any such changes relating to this debt issued by banks would have very serious consequences for the creditworthiness of UK financial markets and the ability of both banks and insurance companies to organise the financing of economic activity on bases that have until now been found generally effective. Any further recapitalisation must maintain market confidence which would not be achieved by cutting loose subordinated debt or indeed by any comparable unilateral action to override existing contractual obligations. Our credibility as a financial centre would be jeopardised by such action.

Recapitalisation programme

  15.  The principle of a government financed recapitalisation scheme was structurally sound but some of the main terms appear to be counterproductive. If the purpose of government support to the banking sector is to help banks to return rapidly to normal levels of lending and profitability, the penal interest rate charged in relation to the preference shares and the consequential dividend suspension work against the objectives underlying the programme. The penal rate has not only led to low take-up but even greater Government share ownership, and inhibits resumption of lending on normal commercial terms and criteria. We believe that this, coupled with the five year ban on dividends, will do little to help attract new investment capital and so permit companies to redeem Government share holdings rapidly—which we see as essential components in the programme.

Investments in UK financial institutions

  16.  The Government's long-term strategy following the taking of majority and minority shares in UK banks has not been made clear. Whilst the Government's immediate objective is to ensure the stability of the financial system, it is a fundamental expectation that these businesses, whilst under partial ownership, will be run as commercial operations and be restored to fully private sector ownership at the earliest opportunity.

  17.  This investment approach has consequences for other financial institutions which need to be fully appreciated. Firstly in the UK, insurance companies competing against subsidised banking groups are subject to further market distortions. (For example bank deposits are protected fully yet investors holding insurance products have more limited protection). This makes it difficult for insurance companies to compete against those banks in receipt of Government help. In light of this, the Government should consider fully the impact across the market of any changes proposed to compensation arrangements. Secondly, on an international level, global insurance companies are subject to greater market distortions if other governments take alternative investment approaches to the UK. It is therefore essential that there is a coordinated global approach by governments to ensure UK firms are not further disadvantaged.

  18.  The Government should not be a long-term shareholder. When the time arises, the Government's exit must be a smooth, managed process avoiding any risk of destabilising the market whilst taking into account the need for a level playing field with other financial institutions at all times. The counterproductive role of the ban on dividends in this respect has already been mentioned.


  19.  The structure of UKFI with an independent Chair and Board is welcomed.


  20.  The banking crisis is now a global crisis of confidence and resolving this is paramount to restoring and stimulating the market. It can be argued that the maintenance of sound retail banking and availability of both loan and deposit products on sound terms is ultimately the most important form of consumer protection.

  21.  There is a role for the prudential supervisor of banks to ensure that banks do not pursue "unsound" banking practices. In protecting the consumer, this must preclude underpricing to stimulate volume to an extent material to the survival of the bank. Direct regulatory intervention to control product prices and the terms of lending are undesirable per se and a source of distortion and inefficiency in the market.

Retail Banking

  22.  The longer term approach of a traditional commercial bank with a strong deposit base and loans, largely held to maturity, contrasts with the short term "originate and sell down" model of the investment bank, thereby encouraging risk taking. It may be an appropriate opportunity to differentiate more clearly between these types of institutions and the regulatory regimes to which they are subject.

Protection in non-UK jurisdictions

  23.  Further clarity is required from the Financial Services Compensation Scheme on the criteria under which UK citizens investing funds in non-UK jurisdictions are covered by the Scheme.


Rights of shareholders

  24.  We welcomed the approach adopted by the Government when offering existing shareholders the right to take up new equity.

Responsibilities of shareholders

  25.  The underlying principle is that shareholders look to company boards and particularly to non-executive directors to ensure that the company is run with their interest in view, and to provide an effective challenge to executive management where this is in question. Large institutional shareholders cannot be expected to micro-manage large financial institutions in sectors where they do not have direct operational expertise, nor is that their role. Within limits, they are also entitled to rely on the vigilance and competence of regulators.

January 2009

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