Examination of Witnesses (Question Numbers
25 NOVEMBER 2009
Q60 Sir Peter Viggers: Do you think
that mark to market has meant that we have dealt with the problems
Mr Sants: I think that there is
a valid argument that says mark to market has pluses and minuses.
It does have some procyclical elements but does equally lead to
problems crystallising earlier and therefore solutions having
to be found earlier.
Lord Turner of Ecchinswell: On
the other hand, I would stress that. I do not think it would have
helped us if, this time last year, we were mark to marketing the
whole of the banking books of banks. We would have convinced ourselves
that there were problems far greater than actually occurred because
there was an overshoot in markets and I think that our overall
approach is that there is an appropriate role for mark to market
in the things which legitimately exist within the trading books
of banks and are liquidly tradable, but the correct and appropriate
long-term accounting approach to the banking books of banks is
an accrued interest or an economic loss approach, not a mark to
market approach. In the past, there have been arguments about
extending mark to market to the banking books of banks as well.
Q61 Ms Keeble: I want to ask you,
Lord Turner, about your suggestion of a Tobin tax. This was arising
out of the Prospect interview, which has obviously given
rise to a huge amount of debate. What is your view now on that?
Lord Turner of Ecchinswell: My
overall view is that when you go through such an extraordinarily
big economic crisis which has challenged a whole set of intellectual
assumptions about the way the financial system works and the benefits
of liquid traded markets and how far they are beneficial and up
to what point, when you have been through a crisis of that scale,
it is useful to have a debate about issues which involves all
of the options, which is why, for instance, I very much welcome
that there is a debate about breaking up the banks and making
them smaller, even if I do not actually necessarily agree with
some of the conclusions, but I am very glad that, for instance,
John Kay has put his proposals down. I think it is very important
in these environments that we look at all the possible issues.
The arguments in favour of a transaction tax rely on the idea
that while a significant degree of market liquidity in traded
markets, which requires there to be traders making money out of
position taking, is beneficial, it is possible for markets to
have too much trading activity in them and there is a point beyond
which, rather than producing beneficial liquidity, it produces
harmful volatility. That is a serious proposition put forward
by many serious economists and I think it is one that we should
think about. It may well be that a transaction tax is undoable
in practice or that there is no possible international agreement,
but I think that there are a variety of ideas such as that, such
as taxes on the size of banks, such as a levy on banks to deal
with the potential costs of bailing them out in future, there
are several of these which have been proposed by different people
and I think it is appropriate for the world now to hand it to
a trusted body to look in detail at all of these options, which
is what the IMF has now decided to do.
Q62 Ms Keeble: So you see that one
as being more of starting a debate than putting forward a realistic
proposition for a tax to be introduced.
Lord Turner of Ecchinswell: Let
us be clear as to the background of the comments I made in that
Prospect interview and I would like to be absolutely clear
on that. It was against the background of being asked, what are
you going to do about bankers' bonuses? What are you going to
do about excessive trading activity? The answer is that what a
regulator can do is to have an influence over the structure of
incentives so that they do not create unnecessary and unreasonable
incentives for risk taking. We can also have a focus on the aggregate
level of bonuses, of remuneration, insofar as that is at the expense
of building up capital ratios, but where you have a bank which
has a reasonable level of capital and if the structure of incentives
is reasonable, then, beyond that, no regulator can be responsible
for the level of pay. To do that is to ask us to be in charge
of a prices and incomes policy even while fiscal and monetary
policy is set for inflation. If you are worried in the long-term
about the level of traders' pay, what you have to be saying is
you think there is some activity going on here which is making
a super-normal return, in which case you have to address that
either by things in the competitive arena, the competition arena,
or by things in the taxation arena and not by regulation. So,
the statement was against the background of essentially saying,
"Society cannot ask a regulator to regulate the level of
pay in a particular sector of the economy". If you think
that level of pay is too high, you must be making some statement
about super-normal returns and there are other instruments with
which you should attack it.
Q63 Ms Keeble: Given where the debate
is now, because it has moved on quite some time since August,
what do you think is the most likely way forward given that it
needs international consensus as well for dealing either with
the problem of excess remuneration, which could be done through
windfall tax, or through the underlying factors which are what
I think you called socially useless activity by the banks?
Lord Turner of Ecchinswell: Let
me be absolutely clear what the single, most important instrument
to address unnecessary volumes or unnecessarily risky trading
activity is. It is not any of these taxes, it is capital requirements.
The single biggest thing that was wrong with the capital requirements
under the existing regime is that they were not just a little
bit too low, but they were dramatically too low for trading activities.
80%/90% of what we will do on this is to get those capital requirements
right. Anything else is interesting issues that we have to look
at but is peripheral to the single most important thing we will
Q64 Ms Keeble: Thank you. That is
helpful. I wanted to ask you about women in the City because you
will have seen our inquiry on that and also perhaps the comments
that the Equality and Human Rights Commission made which was that
they thought that you were the people who were supposed to be
delivering on this. You, in your letter, have said that whilst
you welcome the gender equality duty, you do not consider that
you have a particular duty on the gender equality objective, but
you have made comments about what you are doing to take it through.
Can you say, first of all, in your remuneration policy statements,
if you find evidence of gender pay gaps, what action you will
take and whether you will make the information public.
Lord Turner of Ecchinswell: First
of all, on the general point, obviously the 2006 Order, I think
it was, required public authorities such as ourselves to have
due regard for gender equality issues. I think that is different
from making it a statutory objective for us. It is not one of
our primary statutory objectives. There are other things like
equal rights bodies which do have responsibility to pursue it
as objectives. I think when Parliament did that, it was because
they wanted to make sure that other authorities have due regard
for it, they are thinking about it, they are responding to clear
problems, but it is not, as it were, a primary focus of our activity.
Our activity is focused on conduct of business and prudential
soundness. Nevertheless, due regard does mean that whenever we
are involved in policies where there is a possibility that there
might be a significant gender equality issue, we should have regard
for itwe should keep our eye out for itand that
is what we are doing in relation to the remuneration code which
we are now involved in and I will ask Hector to comment on that.
Mr Sants: We have set out the
facts that, when we are doing our reviews with the remuneration
codes, which we committed ourselves to do, we will be taking a
look at firms' compliance with the gender equality issue and we
are also currently in discussion with the EHRC to see how we can
best take forward over the long-term a partnership to make sure
that we are appropriately focused on that issue with regard to
our remit. Obviously, if we were to find when we were reviewing
compensation practices, which we are doing at the moment as you
know, which do not comply with the law, then we would work with
the EHRC to make sure that appropriate action was taken.
Q65 Ms Keeble: Would you report it
publicly or would you report it to this Committee?
Mr Sants: I think we need to discuss
that with the EHRC; we are in the process of talking to them about
how we can usefully help them. They are obviously the prime mover
here. We are delighted to be able to help them. We have to have
regard to objective, as the Chairman said, and we are in discussions
now as to how we can usefully help them.
Ms Keeble: One of the key issues with
our inquiry is, how do things get progressed? You can either rely
on goodwill in the banks either for enlightened self-interest
or for whatever reason, which might take quite a long time, or
you can say, as you have, Lord Turner, that the Equality and Human
Rights Commission that was set up has to deal with it, which would
mean a David of an organisation taking on the Goliath of the City
of London which I think is a bit unequal, or it means an organisation
like yourselves taking a more proactive position than just saying
that you have a general duty in this area which you could say
about the whole of humanity in a way. Why do you think you should
not take a more proactive position?
Q66 Chairman: Perhaps you could give
us a quick answer and we can move on to the next question.
Mr Sants: We are. That is why
we put that element in our remuneration code, it is an important
issue, which we take very seriously.
Lord Turner of Ecchinswell: I
think we are taking the degree of proactivity on this which is
reasonable given our legal mandate. If Parliament wanted us to
be the primary mover rather than the EHRC, then they could change
that. I would not necessarily recommend thatI think it
makes sense for the EHRC to be the primary agency in this respectbut
I do not think it is for us to suddenly start saying the EHRC
will never manage to deal with the City so we are going to turn
ourselves into an EHRC for the City. It is, basically, for Parliament
to make those decisions about which are the responsible authorities
for particular aspects of policy.
Q67 John Thurso: I want to ask about
narrow banks, but, first, can I ask one quick question about capital
adequacy? I read a report last week that suggested that the appropriate
level of capital adequacy in order to achieve the objective for
stability would be in the order of 20% at Tier 1, which is two
and a half times where we are now. Is that the kind of level you
are looking at?
Lord Turner of Ecchinswell: First
of all, I think it is very important that we realise that when
we change the level of capital requirement, we change it through
three mechanisms. We sometimes change the definition of the numerator
of what is capital; we often change the definition of the denominator
of what is weighted risk assets; and we also change the ratio.
I make that point because, actually, in the area of the trading
book, where have already made very major changes increasing capital
requirements against some categories of the trading book by three
or four times and where there is now a fundamental review of trading
book capital adequacy going on within the Basel Committee which
could produce similar increases across a wider range of the trading
book, that will not change the declared ratio at all, it will
change what you multiply the ratio by, and we do have to be careful
of that, because otherwise there is a danger that we change various
definitions of the numerator, of the denominator and the ratio
and we do not quite spot what we have done in total. So any discussion
of ratio has to have regard for that. There are changes coming
forward in the numerator and the denominator which of themselves
would be equivalent to at least 2-3% changes in what the ratio
is. In relation to the 20% figure I am not sure I can immediately
recognise which report you are working on.
Q68 John Thurso: It was actually
18.8, I think.
Lord Turner of Ecchinswell: From?
Q69 John Thurso: It was from either
the OECD or the European Central Bank.
Lord Turner of Ecchinswell: I
think what we have all realised, and what we spelt out in a document
we produced at the tail end of October, is that there is no absolute
science to this.
Q70 John Thurso: I want to deal with
narrow banking, so what I am after is this. Is the scale of increase
from around about 7-8%, which is where we are now, to around about
18-20% what you have in mind?
Lord Turner of Ecchinswell: I
would not like to say that at the moment, because it is a process
that we are going through internationally. We certainly are already
well advanced in very significant increases in capital requirement.
Let me give you one particular factor. If you take Core Tier 1,
common equity, if you take the absolute minimum limit of the previous
rule, it was actually 2%, because it was a half of 4% and half
of 8%. We now have a regime which requires that to be above 6%
and above 4% on a forward-looking stress basis. So we have already,
in some aspects of capital, very significantly increased it already.
Q71 John Thurso: Can I turn to narrow
banking. Judging from the comments that you made to Sally Keeble,
your thinking is evolving. When we last discussed this you were
pretty well against the concept of narrow banking. You have just
said that you appreciate the work that John Kay has done. Are
you edging towards a rapprochement of some of kind with the Governor?
Lord Turner of Ecchinswell: No
rapprochement is required with the Governor, since we agree on
so many things. Let me be clear on this debate. It is one that
we addressed, again, in the document which we set out at the end
of October, and on which we had a conference devoted in early
November, because it relates to the "too big to fail"
debate. I would say I think it would be something which I would
hugely welcome if this Committee had a detailed focus on (if it
has enough time before we get into election, et cetera), because
I fear that we will have a brief discussion on this, as we have
had a brief discussion before, and do no more than skim the surface
of an immensely important debate, and I would urge you to have
a proper inquiry on this where you bring people in and have a
session entirely devoted to it. I think the crucial thing to understand
in narrow banking is that there are a range of different ideas
being put out there and, in particular, there are two completely
different ideas. John Kay's idea is not about separating commercial
banking from investment banking. It is about separating retail
deposit-taking from commercial banking. I disagree with John.
I think it is very useful that he has put his debate forward,
but he knows I disagree with him. He gave me a copy of his pamphlet
two months before he produced it. I wrote him a lengthy response
over the summer saying, "John, here is why I disagree with
you", and I actually think that John's proposal would make
the banking system significantly more risky than it is at the
moment. I think there is a different debate to be had as to the
distinction between commercial banking and investment bankinga
new Glass-Steagall divide. There I think the issues are not those
of principle. I think, in principle, there is an attractive concept
there. I think it is simply very difficult, in practice, to distinguish
between that element of involvement in treasury and trading activities,
which is a natural and legitimate element of providing a commercial
banking service, and when that becomes unnecessary proprietary
trading on its own sake, just to give you an example. You cannot
create two. Therefore, that is why in that area we have focused
on the capital requirements and things like the living wills and
resolution approach to have an internal division within banks.
Q72 John Thurso: Thank you for your
suggestion about looking into this in detailone I hope
that the Chairman might well think about because I think it is
a very important issuebut one of the core points in all
of this is that you have what has been described as utility banking,
which is the utility that is required to make the world of commerce
and industry go round and for individuals to be able to deposit
money and receive interest, and so on. At the other end of the
scale you have what some people have called "casino banking".
I am not sure I like the term. I prefer to call it the area where
risk is quite properly taken. At the first end, the utility end,
you need a culture that is based on prudence, on prudential management,
as all utilities should be. At the other end you have people whose
job it is to measure and take risk because they are in investment
merchant banking. In the old days they were largely partnerships
and, as the Governor told us yesterday, because they were partnerships,
there was a culture of awareness of risk because it was all their
own money. What you now have is a conflation of the two cultures,
so you have lots of people in limited companies who have the protection
of the utility but still take the risk and, therefore, they are
not actually paying sufficient attention to it. The argument really
is about how you get people who are in the risk-taking business
to take proper account of it and not use the utility as a way
of funding those activities without taking proper account.
Lord Turner of Ecchinswell: I
agree that that is an argument. I would, however, point out that
Northern Rock was clearly, by that definition, a utility bank
involved in basic functions and not significantly involved in
fancy trading activities, and Lehman Brothers was a trading bank
not significantly involved in basic utility activities and, basically,
both of them had problems.
Q73 John Thurso: You and the Prime
Minister have a flaw in that argument, and the flaw is this. Northern
Rock was allowed to go bust, and we were perfectly happy about
that. It went bust; end of story. It was nationalised, taken over,
broken up. Lehman Brothers was deemed to be allowed to go bust.
So the argument is actually not quite that straightforward.
Lord Turner of Ecchinswell: No,
Northern Rock was not allowed to go bust in the normal fashion.
The crucial definition of "too big to fail" is too big
to fail in a fashion which involves losses to people other than
equity holders. The distinction between what happened to RBS and
what happened to Northern Rock actually is quite minor. One was
a 90% dilution of existing equity holders; the other was a 100%
dilution through nationalisation. Certainly we should have the
possibility of doing nationalisation options in future, but that
is a quite straightforward thing to do. The crucial issue in "too
big to fail" is what is the treatment of debt providers?
When we say "too big to fail", we mean too big to fail
in a fashion which meets the normal characteristics of an insolvency
or a wind-down, where losses are imposed on debt providers, and
in that respect Northern Rock did not fail, it was rescued.
Q74 John Thurso: Can I put one last
area to you. We have heard evidence and we have observed that
a number of countries in Asia are requiring operations of other
countries' banks to become subsidiaries so that they are regulated.
Is there merit in looking at the concept of ensuring that different
parts of an operation are wholly separate subsidiaries so that
you can look at separate levels of capital, et cetera, so that
actually you end up with a kind of bank core at the top but all
its actual operations are in differently licensed and differently
capitalised subsidiaries that are discrete and can, therefore,
die without bringing the whole thing down?
Lord Turner of Ecchinswell: Yes,
I think there is great merit in looking at that. That is an idea
that I have actually referred to at length in various speeches,
and I am personally, I guess, associated in the world with being
somewhat of a spokesman for that approach. It is a controversial
approach, which is sometimes opposed by people across the world
who say that it will get in the way of the useful flow of capital
across the world. I am not convinced by thatand the Standing
Committee of the Financial Stability Board, which I chair, is
focusing specifically on the pros and cons of that argument with
a requirement to come back to the G20 by August next yearbut
my overall sentiment is to be very sympathetic to what you have
Q75 John Thurso: So in looking at
the concept of narrow banking, that is a further element that
we should take into account?
Lord Turner of Ecchinswell: I
think, crucially, in looking at narrow banking one should not
simply look at the idea of how you separate groups between each
other, but also the internal organisation of groups and the extent
to which, either by national location or by categories of activity,
you can create legal structures where it is possible to rescue
one part of the group while allowing another to go bankrupt. That
is certainly something that we should look at and are looking
Chairman: Your views on narrow banking
for us looking at that are very welcome, and we will certainly
take that seriously.
Q76 Nick Ainger: Lord Turner, the
Financial Services Bill, which will be before the House very shortly,
gives the FSA new powers to regulate remuneration, including bonuses.
Sir George Mathewson has commented on this. He says, "Interfering
with contracts that have been reached between willing participants
is a somewhat dangerous route to go down. I also think the FSA
has enough tools already in order to ensure bonus systems which
could be said to threaten the overall financial system should
not exist." Do you agree with Sir George?
Lord Turner of Ecchinswell: I
think we have most of the powers that we need, and the rule that
we have made already will achieve our ends. I think it is useful,
if Parliament wishes to give us that slight extra power and clarify
that we have that capability, but we have already, in the rule
which we passed in July, put in place a regime which, broadly
speaking, we believe we have the power to make stick, because
we have the ability to demand that firms explain to us their overall
structures of remuneration, we have the ability to look at individual
contracts and we have the ability, if we are unhappy with those
contracts, either to prevent firms doing particular businessif
we were unhappy about the category of contracts in a particular
trading area, we have the power to say, "We think that is
creating risk; so you cannot do that activity"we can
do a variation of permission or we can impose capital requirements.
So we have significant mechanisms other than those legal powers,
but I think they are useful additional fall-back positions. Hector,
do you want to comment on that?
Mr Sants: One additional comment
might be helpful. We would not envisage that we would be using
these powers with regard to contracts retrospectively. So the
idea that, somehow or other, we would be unwinding contracts that
had been entered into in the past, I think, would not be how we
would envisage operating. What we would be doing, of course, which
we have already said we would do is that, if a contract could
not be reasonably unwound, we would expect the bank to put in
mitigating measures to deal with that extra risk. That is the
way we would be tackling retrospective issues.
Q77 Nick Ainger: But the provisions
of the Bill actually state that you, the Authority, may prohibit
persons from being remunerated in a specified way. Does that not
imply that, if there is a contract already in place but which
you believe is in breach of the general rules which you set in
relation to remuneration for that institution, you actually would
have to somehow break that contract? Is there not a retrospective
element? It is not that I am opposed to that if that is the effect
that the contract has.
Mr Sants: Obviously there is a
Bill process being carried through at the moment. It is not our
understanding that it is retrospective in nature. It would apply,
as we would understand it, to contracts entered into after the
Bill becomes law. As you say however, it is our job to carry out
the will of Parliament. If Parliament tells us that it is meant
to be interpreted in a different way, obviously we would act accordingly.
Lord Turner of Ecchinswell: Perhaps
we ought to just distinguish the two uses of the word "retrospective".
There is retrospective as it relates to a contract which has already
been written (and I think that is a very tricky issue in general
in relation to Parliament) but there is a separate issue as to
whether it be retrospective in October next year to a contract
written in July next year after Parliament has made an opinion.
That, you might imagine, might be more acceptable. I suspect part
of the confusion in this debate is between those two different
uses of the word "retrospection", and some of the comments,
in particular the comments that Lord Woolf was making, I think,
really relate to the first category of retrospection.
Q78 Nick Ainger: Thank you. You say
you have got powers anyway. How often have you used them? There
is real concern out there that it is business as usual with the
Lord Turner of Ecchinswell: We
have never been involved, until the last few months, in the regulation
of remuneration. That has not been something that we have done
before, that is something which we have done through a rule which
was passed by the Board in July this year and which will apply
to bonuses being paid from early next year onwards. So we are
now involved, but this is for the first time ever, in the review
of remuneration practices and in relation to looking in some cases
at individual contracts, and I think that is a major shift. I
would also say that in the past I do not think that remuneration
committees in banks have seen it as a major part of their function
to focus on the risk implications, rather than the labour market
competition implications, of the contracts that they have been
agreeing, and the first point of the principles of our rule is
that they have to do that in future. Let us be clear, this is
completely new stuff to it. It is not something our supervisors
have been at all involved in until the last month or so and we
had no rule on it until July.
Mr Sants: Also, just to pick up
your point about current practices, of course, as I am sure you
understand, banks distribute bonuses generally on an annual basis,
on a calendar year basis, so we have yet to have a bonus distribution
take place for the major banks since we put in place our new rules.
We have made clear, and indeed the banks have made clear, their
intention to comply with our Code. Of course, we would make them
comply with that practice. That will be applying to the 2009 bonuses
that are distributed in the early part of 2010, but the banks
themselves will not be making decisions on the size of those bonus
pools until after their books are closed. So we have yet to have
a bonus round when we have had our rules in place, but in terms
of individual contracts, where we have seen individual contracts
where the terms are not complying with our new framework, yes,
we have intervened and there have been a number of cases already
where we have required banks to alter individual contracts. We
are intervening on an individual level as we talk, but aggregate
bonuses distributions, have yet to occur.
Q79 Jim Cousins: Could I switch topics,
but before I do, Mr Sants, you recently made clear that you had
encouraged the restructuring of an insurance company earlier in
Mr Sants: You are referring to
Pearl, I assume. It was in the public speech of 9 November.