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Financial Services Authority Annual Report 2008-09 - Treasury Contents

Examination of Witnesses (Question Numbers 80-99)


25 NOVEMBER 2009

  Q80  Jim Cousins: In the Daily Mail.

  Mr Sants: It may have been reported in the Daily Mail; they were referring to a speech I made on 9 November.

  Q81  Jim Cousins: Yes, there we are. We realise that the banks have got considerable refinancing problems ahead of them over the next few years. The Bank of England has made that clear. Can we anticipate that there is a similar range of issues for the insurance industry?

  Mr Sants: I think, as we commented before, three points. First of all, as you know, the overall prudential regime of the insurance company was modernised post the 2000 period, post the concerns that occurred with a number of the life companies at that time, this has proved to be an effective prudential regime, which is being further modernised by Solvency II. This prudential regime brought in in the last few years in the insurance sector has, clearly, been very beneficial to them in the current crisis. The second observation: as you well know, the inherent characteristics of insurance companies, particularly with regard to liquidity risk, are very different. The third observation: I think, in general, I would say that our insurance sector is not particularly homogeneous and each individual company tends to have its own characteristics. I do not think that people should think that the risk to the insurance sector is of the same nature as has affected the banking sector over the last couple of years, so, no, I think the risk issues for insurance are very different to the risk issues for banking. Of course, we are in a situation where financial markets are much more stable than they have been, and insurance companies are also a beneficiary of that as well as the banks. I think it would be wrong to take the view that because we have not had a crisis in insurance we are going to. I think that would not be a fair analysis of events. What is important that we do is that we make sure our supervisory lessons that we have learned primarily as a result of the events in the banking sector over the last couple of years are, where relevant, carried across to the insurers. We are working to ensure that is happening and, in particular, putting in place a new approach to stress-testing in the insurers which draws on our experiences in banking and is utilising the same pool of technical specialists that we have now hired. We have hired something over a 100 or so new technical specialists to equip ourselves to take our own views on risk, on balance sheet risk and stress-testing risk. We will be carrying across those lessons to the insurers, which I am sure will be a further strengthening of the regime.

  Q82  Jim Cousins: Did you want to say something?

  Lord Turner of Ecchinswell: I think Hector has said everything, unless you wanted to follow up. As Hector said, we continue to look very carefully at all sectors, but I think insurance is a very different category because it does not tend to face the same refinancing risk as banks because it does not have liabilities that roll off. The fundamental difference of insurance is it is not doing the maturity transformation of short-term liabilities and long-term assets, which is the very particular risk of a banking system, but it does not mean it does not have other risks, and we are watching them very carefully.

  Q83  Jim Cousins: Mortgages: would you like to have a similar power of regulation over second charge mortgages as you have over first charge mortgages?

  Lord Turner of Ecchinswell: I think it would be a logical tidying up of the system. Obviously, the position which people are in, in terms of affordability, relates to the combination of their mortgages and in our latest mortgage review, which we put out in mid-October, we have talked about a regulatory requirement for lenders to meet an affordability requirement, and it will be more difficult for us to police whether they are truly working out affordability if we have absolutely no control over a second mortgage which can change the affordability. In general, we think it might be a logical tidying up of the existing regime.

  Q84  Jim Cousins: That is helpful. When we turn to the affordability requirements that you have laid down, I think you would both recognise that at the moment there is a requirement for very high deposits and substantial arrangement fees and there is not a great availability of mortgages other than on a quite restrictive loan-to-income and loan-to-value basis. I am aware of the fact that none of your requirements have laid down specific figures for loan-to-value, loan-to-income, and so on, but you will be aware that, for example, the Council of Mortgage Lenders feels that your affordability requirements will inhibit the availability of mortgages, particularly to the less well off, who do not start out in life with the bank of mum and dad behind them.

  Lord Turner of Ecchinswell: This was a set of considerations of which we are well aware and I think are clearly expressed in the mortgage market review that we put out, that there is a very careful trade-off to be struck here, and that is why we deliberately made that a discussion paper and why we would like as many people as possible to be involved in this debate, because it is a social trade-off. If we place any sort of limit, any requirement for affordability, then it is almost certainly the case that somebody somewhere will be restricted from getting a mortgage who might have been able to pay it off and for whom it might have been a good mortgage. There is no ability of any regulator to get it absolutely right. On the other hand, if we do not in some way regulate this market, I think we will go back to the other form of customer detriment, which is not failing to get a mortgage but ending up with a mortgage which is unaffordable. What we tried in the mortgage review was to say, okay, given that balance, what is the intelligent way forward? We looked very carefully at whether loan losses, inability to pay and, therefore, problems for the provider as well were closely linked with loan-to-value ratios or loan-to-income ratios and we found that although there was a correlation, it was not an extremely tight correlation. There are some relatively high loan-to-value ratios—in fact many—which are effectively paid off by people, so you want to be wary of limiting that, and similarly with loan-to-income rations. We found, for instance, that whether or not a loan was self-certified income was a much better predictor of getting into trouble than whether it was high loan-to-value or loan-to-income ratio. We put out a discussion paper that says that our present proposal is to go forward with a ban on the self-certification of income, not to have across the board LTV or LTI limits, to explore whether there are, as it were, toxic combinations of LTV or LTI—combinations where you say, if it is more than this LTV and more than this LTI, you really are doing something very dangerous—and place a requirement on providers and intermediaries to go through a process which checks that this is affordable, and I think that that is a reasonable balance. What we have been trying to do there is to strike a balance and not go as far as saying you cannot have a loan-to-value of more than 80%, or 90%, or whatever, well aware that there are some high loan-to-value ratios which are affordable and which, as you say, are very important for access for precisely those people who are not fortunate enough to have parents who can give them the deposit to get them going.

  Mr Sants: We are trying to drive home a message of good common sense. Surely, good common sense is not to take on mortgages that you cannot afford. That is a good starting point to open up a debate. People do not want to take out mortgages that they regret and they cannot afford in future years.

  Q85  Chairman: I think one of the comments that Jon Pain mentioned to me when I was talking to him was that nearly 50% of mortgages in the market have no proof of income.

  Mr Sants: 45%.

  Q86  Chairman: 45%. That is quite a high figure, and I think we need to be careful.

  Lord Turner of Ecchinswell: That exploded in the ten years running up to the crisis, and the mortgage market review that we sent out in October illustrates that this is one of the best single predictors you can get of whether you are going to have problems with repayment. It is a much more powerful predictor than the LTV or the LTI level.

  Mr Sants: It is not just a consumer protection issue; it is a prudential issue. There is an integrated risk issue here. Something of the order of one-third of lenders are not assessing affordability. We would think, and you would think, I am sure, as well, that the lenders should be assessing affordability rather than just looking at simple loan-to-income ratios. We want a more sophisticated approach to affordability assessment for prudential purposes as well as for consumer protection issues.

  Jim Cousins: You obviously recognise that at a time like the present, if you are trying to operate a flexible labour market, which might be in the wider economic interests, to have onerous requirements to predict income many years in advance may be quite unreasonable.

  Q87  Chairman: Focus on affordability—we did that. So we are at one with you in the sense of affordability.

  Lord Turner of Ecchinswell: We are well aware of the balance that you are suggesting we need to strike, and we have tried within what we have proposed to strike that balance between alternative considerations.

  Mr Sants: A lot of people in the lower income groups get involved in interest-only mortgages, and actually interest-only mortgages can often lock them in, in times of falling house prices, so it makes it more difficult to move around. I think we also need to bear that consideration in mind.

  Jim Cousins: Mr Sants, in this company to talk of interest-only mortgages is to raise a very delicate topic!

  Q88  Sir Peter Viggers: Consumer protection is one of your key objectives, yet top management time must have been diverted into the banking crisis over the last year or so. Can you tell us a word about your consumer protection approach? Does it permeate everything you do, or is it segregated into separate departments, and what are your priorities for the coming year?

  Mr Sants: The serious question is have we set up the organisation effectively: ie do we have an organisation that is properly able to discharge our obligation to both look at conduct as well as prudential issues? I think we have done that, and we have done that through the changes we have made to our supervisory practices in the last two years and the reorganisation that we put in place on 1 October. As you know, in terms of a process now, we have one integrated single supervisory division under Jon Pain so they can make integrated risk assessments, which I think is the best way of judging forward-looking risk, both prudential and conduct, but the specialists who support those supervisors are themselves specialists in conduct and prudential issues. Specifically we have set up a new conduct and prudential risk department. The specialists' job is to make sure that the supervisors are properly assessing both sets of risk, so we have created that oversight mechanism, if you will, over supervision to extract the maximum benefit from integrated risk assessment but combined with an oversight mechanism of specialists to ensure that the right level of balanced is achieved. In terms of the actual activity of the supervisors over the last 12 months, we are a risk-based organisation. We have a finite level of resources, albeit significantly expanded from some years ago for the larger firms, and we do have to make judgments, and it is the case, as you would expect with the very large banks, that in the last 12 months the majority of supervisors' time has been addressing prudential issues and I think that rightly reflects the fact that at the end of the day prudential and conduct are both issues of relevance to customers. If a bank fails, I think it is obviously relevant to the customers. So we do now also track with effective Management Information, what our supervisors are doing, and so, yes, I can say in the last 12 months the predominance of time on the large banks has been on the prudential issues, but as we move forward (and we will be setting that out in our outline of the business plan in January with the fee proposal) it is clear our forward book of work will see more of a balance returning between conduct and prudential issues.

  Lord Turner of Ecchinswell: Can I add one point which is when Hector and I earlier this year were discussing potential changes to the organisation structure, one of the things that I was very keen on (and Hector was as well) was that we ended up with some organisational groups which were dedicated to prudential risk and to prudential policy and to conduct risk and conduct policy, and the way I would put it is we want to make sure that there are people who care about conduct risk when the rest of the world is only focusing on prudential risk and the people whose job is to care about prudential risks when, as I think was broadly the case three or four years ago, the world, including probably this Committee, was primarily focused on conduct risk. One of the great dangers in running a large organisation is that you do switch your focus entirely to the issue of the day, and we have deliberately created an organisational structure where there will be people who are caring about the things which are not right at the top of the public agenda at that time.

  Q89  Mr Fallon: Mr Sants, can I ask you about the Retail Distribution Review in box 11 on the Annual Report, a matter on which I have written to you, about what appears to be a requirement on investment advisers to take time off to pass qualifications that they may not have passed or even taken 20 years or so before? How many advisers are affected?

  Mr Sants: In total, across the board of the industry, there is something of the order of 60,000. How many within that are employed in stockbroking, I am not sure I can immediately tell you.[2]

  Q90 Mr Fallon: How many are likely to have to retake exams that they might not have passed when they first qualified 15 or 20 years ago? You described that number to me as significant originally.

  Mr Sants: It is certainly the case that if people already have credible and acceptable qualifications which are equivalent to the level that we have asked for, then that would be an acceptable set of qualifications. If they have passed exams of an acceptable level, then they are not being asked to retake them.

  Q91  Mr Fallon: How many are being asked to pass exams that they have not passed before? How many people are being affected by this? Is it hundreds?

  Mr Sants: As I said, I will have to come back to you with an estimate. It will obviously be a subset of that 60,000. I would imagine it would be a few thousand, but I do not have the precise number to hand. It would only affect those who have not got any existing qualifications which are appropriate, and I think this Committee in the past has shown general support for the concept that it is right that people providing an advisory service should be appropriately qualified.

  Q92  Mr Fallon: Have you any estimate of the proportion of advisers in particular firms that might be affected?

  Mr Sants: Within the stockbroking community alone, as I said to you, I do not have that figure to hand. I am happy to supply it to you. I have some estimates, as I say, of the overall numbers, which would be a significant proportion of that 60,000, but that covers the rest of the advisory community. I do not have the figures to hand of the specific numbers, which is what I took to be your question, of the stockbroking community. I do not have that figure to hand.

  Q93  Mr Fallon: Do you have any estimate of what proportion it could be inside individual firms?

  Mr Sants: I would not myself want to hazard a guess at the moment. I would rather give it to you in writing. As I say, if they are already appropriately qualified, we are not requiring them to re-qualify. We would only be asking those people who have not got demonstrable qualifications to achieve them, and I think that is a position which we all thought was a very reasonable one to take; that it is an important task and that people should be properly qualified, and demonstrably so.

  Q94  Mr Fallon: Lord Turner, could I ask you about the current European proposals on the European Banking Authority. Have you seen this Committee's report?

  Lord Turner of Ecchinswell: I have read the summary of it, yes.

  Q95  Mr Fallon: Do you share our concern about the application of the so-called fiscal safeguard?

  Lord Turner of Ecchinswell: I think one of the difficulties is that the term "fiscal safeguard", which was put in at an early stage of this, is still very vague as to what it is referring, and I do not think there has been a high degree of specificity from anybody as to what precisely is the fiscal safeguard that we are trying to achieve. I think it is very difficult to debate this without getting down to: this is the very specific instance of something that could have a fiscal knock-on. I think you are generally right, though, in the Committee, to say that there are dangers at the speed at which we are progressing in Europe on this and that we need really to go through the details of it, but whenever I have read concerns about the fiscal safeguard I have always wanted to know precisely what are we talking about; but I think that is the level of detail that we need to get to in order to know how to write these rules in a way which really does address the legitimate concerns. I think the phrase is sometimes used in a very general fashion.

  Q96  Mr Fallon: If it is a specific fiscal consequence, are you content that it can only be appealed by the Member State affected to a majority vote?

  Lord Turner of Ecchinswell: It is not clear to me that there is anything that they are doing in the intention of the European Banking Authority which would impinge the fiscal autonomy of particular countries.

  Q97  Mr Fallon: But if it did, are you content that the Member State affected could only appeal to a majority vote?

  Lord Turner of Ecchinswell: I would like to come back to you on that specific issue. It is not an issue which I have thoughts on precisely at the moment. This is a very complicated thing which is continuing to evolve.[3]

  Q98 Mr Fallon: Do you share the Committee's view that the Article 21 powers could also have fiscal consequences?

  Lord Turner of Ecchinswell: Again, I will have to come back to you on that. That is not something that I am closely familiar with.[4]

  Q99 Mr Todd: Can I cover two areas, the first of which is consumer protection. The Council of Mortgage Lenders' Chairman said, "I have a sneaking suspicion that regulators see consumers as wanton children who have a tendency to want what is not necessarily good for them." I have to say, when he refers to "wanton children" I was not quite sure which side of the consumer bargain he might have been talking about, bearing in mind the experience that we have had. How do you place yourselves in relation to consumers? Do you believe that they are unable to make their own decisions in an informed way?

  Lord Turner of Ecchinswell: I think this is a very important debate and I think we have moved into a sort of nuanced halfway position, but we are aware that there is a whole spectrum of possibilities here and we need to think about exactly how we locate along it. I think it was our past, fairly clear philosophy that we believed that provided one provided adequate information one should not be, for instance, in any way limiting the terms of a mortgage and saying you cannot buy a mortgage of that category, that there was a caveat emptor provided that there was information clearly provided. I think the awareness of the difficulties that consumers have in making sensible decisions—which I have to say was something I became very aware of when I did the work on the Pension Commission, which is why I ended up and our Commission ended up proposing an inertia mechanism that switched round the inertial decision from opting in to opting out—those whole insights of behavioural economics are important and, once you realise that, one is willing to be a bit more interventionist to defend consumers against making actions that they will regret. On the other hand, I think we have to be very, very careful of then leaping through to a highly paternalistic point of view, and the trouble is there is a point along the spectrum here and the Mortgage Market Review was trying to suggest a particular point on that spectrum.

2   Ev 30 Back

3   Ev 28 Back

4   Ev 29 Back

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