House of COMMONS









Monday 22 February 2010



Evidence heard in Public Questions 271 - 403





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Transcribed by the Official Shorthand Writers to the Houses of Parliament:

W B Gurney & Sons LLP, Hope House, 45 Great Peter Street, London, SW1P 3LT

Telephone Number: 020 7233 1935


Oral Evidence

Taken before the Treasury Committee

on Monday 22 February 2010

Members present

John McFall, in the Chair

Nick Ainger

Mr Michael Fallon

Ms Sally Keeble

Mr Andrew Love

John Thurso


Memorandum submitted by Mr Corrigan

Examination of Witness

Witness: Mr Gerald Corrigan, Managing Director, Goldman Sachs Bank USA, gave evidence.

Q271 Chairman: Mr Corrigan, welcome to our inquiry into financial institutions, too important to fail? We are grateful to you for coming back again to give us evidence. Can you introduce yourself formally for the shorthand writer, please?

Mr Corrigan: I certainly can, and thank you for the welcome, Chairman. I am E. Gerald Corrigan, Managing Director at Goldman Sachs in New York. I guess I have appeared before your Committee two or three times in the past and it is nice to be back.

Q272 Chairman: We have your submission and that will form part of the written evidence. I suppose, appropriately, what I should ask you is what does Goldman Sachs do for society? Do you respond to society's needs or just God's calling?

Mr Corrigan: In point of fact, Chairman, I think that Goldman Sachs, despite the fact that it is essentially a wholesale bank, does commit substantial, time, energy and resources to community service. I will use that for starters. For example, in the recent past we have a community service network where something like 23,000 of our employees worldwide work in their respective communities around the world: small business development, poverty reduction and so on. As another example, we recently sponsored a programme called 10,000 Women where we developed from scratch a programme aimed at outreach to women entrepreneurs primarily in very underdeveloped countries throughout the world.

Q273 Chairman: I will tell you what I am getting at, Mr Corrigan. How do the services provided by Goldman Sachs service the real economy and benefit the real economy?

Mr Corrigan: I misunderstood your first question, so let me deal with it now. In terms of the real economy, the function that Goldman Sachs and other large banks and investment banks provide is they are at the centre of the process of mobilising savings and playing a very important and, I think, constructive role in the allocation of savings on a worldwide basis. It is the mobilisation of savings and their allocation to the most efficient possible uses that is at the end of the day the engine of economic growth, rising standards of living, and all the rest of it. I think that investment banks in particular, because they are active both as direct intermediaries and as the leaders in capital market development, play a particularly important role both on the allocation side and the mobilisation side.

Q274 Chairman: New York magazine reported that without the $13 billion taxpayer grant that Goldman Sachs received from the AIG bailout the firm could have been destroyed. What would have happened had the Government not saved AIG?

Mr Corrigan: Let me answer that question on two levels. First of all, as I think you know, for a number of years I was President of the Federal Reserve Bank of New York and, because of my prior association with the Federal Reserve Bank of New York, in the period immediately after the New York Fed in particular played such an important role in the decision to stabilise AIG I asked myself the question myself many, many times, "Suppose I had still been there at the New York Fed, what would I have done?" and my honest, rigorously objective answer, frankly, was I probably would have done exactly what the New York Fed in collaboration with the United States Treasury did at that time because there is virtually no doubt in my mind that a day or two after the failure of Lehman Brothers had AIG also gone into bankruptcy the consequences for financial markets in the real economy in the United States and around the world would have been calamitous. Having said that, let me quickly add two other points, the first being that it is absolutely accurate to say that at the point in time when the decision was made to stabilise AIG by the Fed and the Treasury, Goldman Sachs' exposure to AIG was essentially flat. We had exposure that was partly covered by collateral and we had exposure that was also covered by hedges, but - make no mistake about this - notwithstanding the fact that our exposure was net flat at that time, had AIG gone into bankruptcy, in other words had the Fed and the Treasury not stepped in, I think that the knock-on effects for Goldman Sachs and other market participants in that framework and in those circumstances would have been very, very adverse.

Q275 Chairman: Could it have been fatal for Goldman Sachs?

Mr Corrigan: I would not say, fatal, no, I do not believe that.

Q276 Chairman: The question was asked what have the taxpayers received for the $50 billion worth of cash in guarantees for giving Goldman access to the Federal Reserve as its lender of last resort? If you get $50 billion, that is the difference between life and death, surely to God?

Mr Corrigan: That is not accurate, Chairman.

Q277 Chairman: Is it cash in their pocket then, $50 billion?

Mr Corrigan: I am not sure what the $50 billion refers to. I have never heard that number.

Q278 Chairman: How much did you get from the Fed then? How much has Goldman Sachs had?

Mr Corrigan: In the context of the AIG settlement?

Q279 Chairman: Yes.

Mr Corrigan: The total settlement from the Government and the Fed to Goldman Sachs, I believe, was $12.2 billion. It is in that order of magnitude.

Q280 Chairman: I think my colleagues will come back to this because there are other areas you have had assistance from, particularly getting access to the Federal Reserve as lender of last resort.

Mr Corrigan: There was no material direct assistance involved there whatsoever.

Q281 Chairman: We will come back to that. Why did Goldman Sachs decide to become a bank holding company at the same time as Morgan Stanley did in 2008?

Mr Corrigan: What happened, Chairman, was in the context of the other events that were unfolding at that time there was a joint decision by the Treasury and the Federal Reserve that they concluded that it was in the interest of the cause of greater financial stability that Goldman Sachs and Morgan Stanley were given the opportunity to become bank holding companies, which did bring with it at the time the potential - I underscore the word "potential" - for being able to draw on Fed discount window facilities which at the time were extraordinary in nature. Both Goldman Sachs and Morgan Stanley decided to accept the invitation to become bank holding companies. To the best of my knowledge, neither Goldman Sachs nor Morgan Stanley ever relied in a material way on the use of the Federal Reserve discount window in that timeframe. I would also emphasise ---

Q282 Chairman: Can I say to you, Mr Corrigan, on 21 September 2008 you announced that you had become a bank holding company along with Morgan Stanley, but as part of becoming a bank holding company you got access to the Federal Reserve's emergency lending facilities. Was that not the reason why you became a bank holding company?

Mr Corrigan: I think that in the circumstances there were two or three things that were important. One was most of us did think that there were clear advantages to having that potential, but again I want to emphasise the word "potential". I also think that there was a recognition that as a part of becoming a bank holding company Morgan Stanley and Goldman Sachs both would become subject to consolidated prudential supervision by the Federal Reserve and I think there was, with justification, a widespread view that quality and rigour of Fed-style consolidated prudential supervision was stronger and more effective than the previous regime under the direction of the Securities and Exchange Commission.

Q283 Chairman: Have you changed the way risk is measured and reported to board members since the crisis?

Mr Corrigan: First of all, we are always changing that.

Q284 Chairman: Do you still measure risk using the Value at Risk measurement?

Mr Corrigan: Let me give you two or three very specific examples of ways in which we have changed those approaches. The first that I would single out is the framework within which and the approaches through which we do a whole family of stress tests and the ways in which that has changed in a very material way over the past two years. I think we were always among the most progressive firms in the industry in terms of the design and rigour of the stress test that we had used even before the crisis, but over the past two years that effort and the approaches we take to it have been taking many steps up the ladder. I will cite two examples. We have now developed in a very sophisticated manner the procedures through which we can take very rigorous scenario and stress test results and take them on a thoroughly integrated basis through the P&L on a global basis within a matter of time. We have also substantially upgraded the speed with which we can compile counterparty exposures to any counterparty just about any place in the world across all legal entities, all product groups. We have introduced, and I think we may be the only organisation that has done this, the use of what we call reverse stress tests as kind of an overlay on the more aggressive stress tests that we use in the first place.

Q285 Chairman: Do you still measure risk mainly using the Value at Risk measurement?

Mr Corrigan: We never used VaR as the primary or only measure of risk.

Q286 Chairman: But you have used it?

Mr Corrigan: We still use it, yes. VaR by itself is one of several dozen metrics that we use on an ongoing basis.

Q287 Chairman: Do you trust the risk measurements of other financial institutions? I will tell you the reason I am asking this question of you. We had Mr Varley from Barclays before us last week and he said that he is perfectly relaxed about how they assess risk in their company and he understands it. The previous week we had Professor Charles Goodhart, a former MPC member, and Professor John Kay, a Financial Times columnist, and I asked Professor Goodhart if the industry could measure risk and he crisply answered "no". John Kay followed that up by saying that he has lectured at Oxford for the past 25 years and his lecture notes on risk are now in the bin as a result of that. That is the background to my question.

Mr Corrigan: I appreciate the question and, frankly, it is a damn good question. Let me try it again. First of all, as I said at the outset, VaR in and of itself is one very limited and very imperfect indicator of risk. There is no question about that. It is based on models that by their definition are backward looking. It is one of many.

Q288 Chairman: My question to you is very specific, Mr Corrigan. Do you trust the risk measurement of other financial institutions with whom you deal?

Mr Corrigan: That is a very difficult question to answer, Chairman, because I am not intimately familiar with the risk measures that other financial institutions use.

Q289 Chairman: In a globalised interdependent market we have to be aware of that.

Mr Corrigan: The question is very good. Let me say this: I will suggest to you and to the Committee that when you look at the experience of the financial crisis over the past two years I think that one of the clear lessons that emerges is that we must all, first of all, do a better job of recognising the distinction between risk monitoring and risk management. They are two different things. Risk monitoring has to do with getting the right information to the right people at the right time. Risk management has to do with what you do with the information once you have it. I would suggest, Chairman, that casual observation across major financial institutions over the period of the crisis suggests to me that there were important failures in risk monitoring that by their nature suggest to me that risk management would suffer accordingly. In other words, if you do not do the risk monitoring reasonably well you are going to have a problem with the risk management.

Q290 Chairman: So if I come back again and try to get an answer out of you, in the quieter moments you do not really trust the risk measurement of quite a number of other companies, do you?

Mr Corrigan: I would not go that far, Chairman.

Q291 Chairman: You must have a doubt in your mind, Mr Corrigan?

Mr Corrigan: I really am not in a position where I can pass judgment on the risk measurement of other companies.

Q292 Chairman: So you would have no doubt in your mind dealing with other companies in terms of their risk measurement?

Mr Corrigan: Any institution has to have some sense of other counterparties' risk management.

Q293 Chairman: Why did Professor Charles Goodhart and Professor John Kay answer us in such a definitive way?

Mr Corrigan: Maybe they know more than I know.

Q294 Chairman: You are Goldman Sachs, you are supposed to know everything.

Mr Corrigan: I cannot answer that question.

Q295 Mr Fallon: Turning to Goldman Sachs' international role, have banks like Goldman's not accentuated sovereign risk in countries like Greece by arranging loans for securitisation against future revenue streams that do not appear on the books or currency swaps that have not been calculated at normal exchange rates? Have you not contributed to the risk?

Mr Corrigan: Let me respond to that on two levels, if I could. First of all, on the currency swap question, if I could deal with that, this Committee knows very well that governments on a fairly generalised basis do go to some lengths to try to "manage" their budgetary deficit positions and "manage" their public debt positions. There is nothing terribly new about this, unfortunately, and certainly those practices have been around for decades, if not centuries. I think we have to keep that perspective. In the specific context of the question about Greece and currency swaps, it is true that a family of currency swaps that were entered into jointly by Goldman Sachs and Greece in the late 1990s and early part of the 2000s were of a nature that they did produce a rather small but, nevertheless, not insignificant reduction in Greece's debt-to-GDP ratios at that time. However, it is very clear to me, based on the investigation that I have done over the past few years, that those transactions were very much consistent and comparable with the standards of behaviour and measurement used by the European Community. There was nothing inappropriate. They were in conformity with existing rules and procedures when they were entered into. That is not to deny that they did, in fact, produce a very small reduction in Greece's debt-to-GDP ratio in the timeframe of 2000-01. When those transactions were entered into personnel from Goldman Sachs consulted with the appropriate authorities at Eurostat, as did, as I understand it, the Government of Greece and, again, there was no indication whatsoever that those transactions were not in line with existing practices, policies and guidelines. I should also say that those guidelines and standards were modified in 2007 which suggests that perhaps they were more liberal than they should have been back in 2001.

Q296 Mr Fallon: The effect, as you have acknowledged, was to help Greece fiddle its books. The New York Times alleged that you have done similar securitisations for other countries including Portugal, is that correct?

Mr Corrigan: Personally, I am not familiar with that situation. I do not know the answer to that but I can certainly make it available to you. By the way I think - maybe I am wrong here - that the reference was FX swaps, I am not sure it was directed in securitisations, but it certainly seems to be very true that Goldman Sachs was by no means the only bank that was involved with these countries in these types of transactions.

Q297 Mr Fallon: If I can just quote from the article: "Instruments developed by Goldman Sachs, JP Morgan Chase and other banks, enabled politicians to mask additional borrowing in Greece, Italy and possibly elsewhere". Did that include the United Kingdom?

Mr Corrigan: I do not know.

Q298 Mr Fallon: So it is possible, is it?

Mr Corrigan: It is possible.

Q299 Mr Fallon: Thank you.

Mr Corrigan: I am reasonably, if not very, clear that these transactions, which were consistent with existing guidelines and regulations, were not limited to Goldman Sachs and Greece.

Q300 Mr Fallon: But you see the point?

Mr Corrigan: I see the point.

Q301 Mr Fallon: By enabling politicians to mask additional borrowing banks like yours have, in fact, accentuated the sovereign risk of these countries which the markets now are focusing on.

Mr Corrigan: I think it is reasonably clear to me with the benefit of hindsight that in the particular cases that we are talking about going back to the late 1990s and early 2000s the standards of transparency could have been and probably should have been higher. Yes, I agree with that.

Q302 John Thurso: In your submission to us, Mr Corrigan, you say that "financial excesses were unquestionably one of the causes of the crisis, but shortcomings in public policy were important contributing factors". What were those shortcomings in the UK?

Mr Corrigan: I am not sure I would want to necessarily single out the UK because, as I see it, it was really shortcomings across the community of nations. Let me cite two fairly obvious examples. In the period leading up to the crisis the scale of the global imbalances in trade and current accounts was virtually without precedent, as far as I can tell, in the history of mankind. No one country, whether it was the US, the UK or even China, by itself produced that result but all countries contributed to it. If I could single out another example, the trends that we were seeing in budgetary deficit terms, which are much worse today than they were before the crisis, is another example. In that particular area, while the numbers for the preceding period were nothing like what they are today, one can say that both in the US and the UK they were not as good as they should have been. Finally, as another example of public policy, certainly in the US - I would not attempt to speak for any other country - you could make a very good argument that interest rates were too low for too long. The fact that interest rates were too low for too long is one of the things that contributed to the so-called "reach for yield" and it was in turn the "reach for yield" phenomenon that made it all too easy for some of these highly levered, highly structured credit products to gain wide acceptance in the financial marketplace. There is no shortage of public policy issues that did play a role in the origins of the crisis.

Q303 John Thurso: Clearly the imbalance is at the root of a great deal, but what would you have had either the American or UK Government do, say, between 2005 and the crash?

Mr Corrigan: It is bad enough for me to say what I think the US Government should do; I am a little hesitant to say what the UK Government should do. With the benefit of hindsight I certainly think that the authorities, broadly defined, should have been much more rigorous in really looking at the credit origination process, especially as it pertained to mortgages. I do not think there is any question that some of the excesses in the mortgage origination space certainly in the United States (and I suspect here too although I am not as well informed) were something that should have got much more intense scrutiny much earlier in the game. I also think that it is fair to say that some of the issues surrounding what I like to call financial infrastructure, the plumbing if you will of the financial system, should have gotten more attention earlier. Finally, I think it is very clear, with the benefit of hindsight, that we were not as rigorous either in the industry itself or in the official community in terms of standards for capital and liquidity adequacy.

Q304 John Thurso: What I am trying to get at is, bearing in mind that before the crash some of us might have had a gut feeling that there was too much risk and been concerned, I never met a banker who wanted more regulation or anything other than to keep chasing the fox as hard as they could. I did not meet a banker who was not delighted by the chase for yield. Is it not a little disingenuous to link almost equal-handedly the financial excesses of the banking system with these public policy issues? They are undoubtedly a contributor to the climate but what we are about is how you deal with those institutions.

Mr Corrigan: That is a very good question for which I do not think there is a nice, neat answer. Let me cite two examples. I use the current account in the public sector and then I will talk a bit about mortgages in the private sector. I dare say that there were very, very few people anywhere in the world with knowledge of economic and financial affairs who did not recognise, certainly by 2005, that the growing current account and balances on a global scale were unsustainable. You would be hard pressed to find too many smart people, whether they were central bankers, practitioners or college professors, who were using those words in 2005. What was unspoken was most of those very same people were also saying or at least thinking that the adjustment to those unsustainable conditions was going to be orderly and gradual. Of course it was not. How do you square that circle? I do not know, except to say that if you look in my statement at the specific agenda for reforms that I have outlined that is where you start. With all of this talk about narrow banks, restrictions on activities of banks and all the rest of it - and I am not persuaded as to their merits - if we fail to get that agenda for reform essentially correct that I think raises in my mind the very powerful question of whether any form of restructuring the financial system would really produce the desired result of greater stability in the long run. I could argue very easily that if we fail in the reform agenda we are going to fail no matter what we do with the structure of the system.

Q305 John Thurso: That leads me neatly on to asking you about narrow banking in particular. The basic proposition behind this, which is why I asked you the questions I did, is that a lot of people, and indeed this Committee, recognise the problems of the imbalances. None of us could foresee what was coming. The financial system has acted as a sort of force multiplier rather than having the impact of helping to put the fire out and therefore the basic proposition is, if you take down the force multiplier, you have a better chance of surviving an event were it to happen in the future. Your memorandum makes very clear - and indeed your previous comments have made clear - that you are a pretty strong opponent of narrow banking and have very considerable doubts. Given that Goldman Sachs as it is now configured, as a bank holding corporation and its particular lines of business, would be the big loser if the Volcker proposals were to go forward in America, is this not a case as one British lady once said of, "He would say that, wouldn't he?"?

Mr Corrigan: I can understand you asking that question. I am very mindful that there are certainly people who might say, and perhaps do say, that I am sort of conflicted here. I understand that but I will say the following two things: one, I searched my mind and my soul very aggressively in terms of coming to that conclusion. I would also emphasise as some of you know that Chairman Volcker and I have been very close personal and professional colleagues for 40 years. There is no one alive for whom I have greater admiration and respect than Chairman Volcker. For me to take a position which does not conform in all of its details to the position he is advocating is a wrenching human experience. I do not like to be in that position at all, but it is my best call and I have to call it as I see it. That is how I see it.

Q306 John Thurso: Clearly you have given this a lot of thought. Why are you so opposed to the concept of narrow banking?

Mr Corrigan: Because I do not think it will work. That is the short answer. First of all, as narrow banking is typically defined, there are shadings of opinion. I am familiar with the Governor's position which he defines essentially as activities of a utility nature. Just to take that one example, that would imply that most of what banks do on the asset side of the balance sheet would be lending. The fact of the matter is that when you look at the crisis of the past two years, and every single crisis in my professional lifetime, going back more than 30 years, the thing that has driven every crisis has been failures in credit origination and lending, whether it was the LDC debt crisis in the early 1980s, the real estate leverage finance crisis in the late 1980s or the experience of the past two years. Moreover, even if you think you can make it work, when you set out in effect to carve up or recreate, whatever words you want to use, the core of the financial system that transition - even the Governor admitted this in his appearance before your Committee - would take years. Part of my thought process is we do not have years to spare. What we have to do is to really attack in the short term this reform agenda that I spell out in my statement. I want to also emphasise, even though it is a little beyond your question, one of the things that I discuss in this statement is the so-called resolution authority question. That is truly critical because resolution authority, whether it is US style, UK style, European Community style, is a promise through which we are saying that we will solve too big to fail. As a technical matter, that is correct because it is very hard for this Committee to see how we can really satisfy ourselves and our critics that we can fix too big to fail without a very well designed and well executed framework of resolution authority. As I suggest in the last section of my statement, achieving that is going to be damned hard to do. We have never done it in the history of mankind. We have never orchestrated and arranged the orderly wind down of a large, much less complex, institution.

Q307 John Thurso: Let me, if I may, just bring you back to the narrow banking you dislike for one moment to ask one last question. In recent evidence to us, Paul Tucker was appearing, and I put to him the point that one of the things that has happened fairly recently - and indeed Goldman is a perfect example of it - is that firms that began and operated for most of their lives as unlimited partnerships where each partner's total, individual wealth was at risk had a culture of assessing risk and of behaving towards risk in a way that is different from those who are benefiting from capital that has been lobbed in by shareholders. The converse of that of course is that one can understand why they reap the rewards of that; whereas it is more difficult to understand why the rewards should be reaped where it is other people's money. The core point was not about the reward. It is about the fact that, when you were a partnership and indeed before you were a bank corporation or incorporated at all, you were a highly successful firm indulging in certainly the majority, if not all, of the things you do now. Why could not somebody like Goldman Sachs go back to that stage which is essentially what one definition of narrow banking would look at? Would you not begin to get that differentiation between capital that is supplied for a solid and conservative return, which is what one always expected from a bank share in this country anyway, and the more speculative and better understood quantification of risk that the old partnerships delivered?

Mr Corrigan: First of all I am not sure that, even as a matter of history and going back to the long history of Goldman Sachs, many people at least would define even Goldman Sachs as a private partnership as a narrow bank because the range of its activities was always fairly broad. I am not sure I would go quite that far but, having said that, there is more than a grain of truth in your hypothesis that, other things being equal, the private partnership model had an awful lot to commend it. That I think is the reason why the decision by Goldman Sachs and others, including some private banks here in the UK, to give up their private status and become publicly held companies went on for years and years and years at times before the decision was made to take that step. I think that it is probably true that the core reason why most of what had been private, financial groups in the UK and in the US tradition made the shift from private to public was access to capital. They concluded, as the world was changing, as the scale of transactions was changing, as the risk factors were changing, that they needed more capital than they could accumulate as a private company.

Q308 John Thurso: Do you think then possibly that that is at the heart of the problem, the ability of very, very large institutions to accumulate very, very large amounts of money? In this country 50 years ago the total financial services industry was 50% of GDP. Now it is 500 times and there are similar figures for America, I am sure. Is that maybe not the problem rather than the solution?

Mr Corrigan: I think there is some truth to the proposition that in many countries - and therefore in the world - the system probably is over banked, if I can use those words. It would be hard to argue against that. Having said that though, there is another side to that equation. The other side to that equation is that I cannot subscribe to the view that simply because an institution is big or simply because it is big and it is complex it is a necessary condition why it should not be allowed to function on that basis. Again, I say that for two sets of reasons. One is that in virtually all jurisdictions the authorities already have the capability to step in, order an institution to shrink its balance sheet, cut its dividends, et cetera I think that one of the failings of the past has been that this so-called doctrine of prompt corrective action, stepping in early, was much more a slogan than it was a practice. We have to change that. On the other side - and again there is some of this in the statement that I have made available to the Committee - it is a little hard for me to envision a world in which we did not have financial institutions of size and financial institutions that have large amounts of capital to commit to the market place. If you look at one of the examples I use in the statement, it is in the aftermath of the crisis we had a situation in which private partners, thank goodness, had been able to raise something in excess of half a trillion dollars in fresh capital for banking institutions. The amount of risk that a small number of institutions had to be willing to 'fess up to to accomplish that is very large. It is a little hard for me to see how that would happen if we had a world of just narrow banks. You can turn around and say maybe we would not have had the problem in the first place.

John Thurso: I was just about to make that observation. At the end of the day, it is not those institutions that have ended up with it; it is countries.

Q309 Chairman: Goldman's decision to become a bank holding company suggests that its investors and bond holders derived benefit from potential government support. Is that correct?

Mr Corrigan: I am not sure. These are rumours. As I made clear, there is no question ----

Q310 Chairman: We have the AIG bail out. We have the TARP money. We have the NTIC bonds. You have Lehman Brothers who were a competitor. Surely there is a potential advantage for Goldman? Do not tell me there is nothing at all.

Mr Corrigan: Of course.

Q311 Chairman: Therefore, is it possible to value the potential support that Goldman has?

Mr Corrigan: The potential support that Goldman has is not in any wild sense different from the potential support the lots of institutions have.

Q312 Chairman: You are representing Goldman. That is why I am asking you the question.

Mr Corrigan: There is no question whatsoever that Goldman Sachs benefited substantially by the collection of special central bank and governmental initiatives that were put in place at the time of the crisis, just as other institutions benefited substantially.

Q313 Chairman: This is the type of question Joe Public asks: should you pay the government for the support that they have given you or should we demand change to eliminate the bank's need for it?

Mr Corrigan: "Pay for" is again a difficult question. Society as a whole, including big financial institutions, clearly benefited from that. That is one of the reasons why these various ideas of taxes, financial institutions and financial markets are getting so much attention these days. It seems to me that the jury is still out as to how that is going to play out.

Q314 Chairman: Why is there such bad feeling in the public's mind about Goldman Sachs?

Mr Corrigan: First of all, I do not think it is uniquely directed at Goldman Sachs. I think the public is pretty damned angry at financial institutions generally, pretty much around the world. I do not think it is unique to Goldman Sachs. Goldman Sachs probably have been disproportionately singled out. Part of that is because it has been quite successful in both managing the crisis and in its performance after the crisis. I think it is also singled out because it is an institution that fundamentally deals with wholesale markets and wholesale counter parties. It is not an institution that, even in its 150-year history, has been involved on the retail sides of banking and financial markets.

Q315 Chairman: People are picking on Goldman unfairly then?

Mr Corrigan: I did not say it was unfair. The fact of the matter is that, whether it is Goldman Sachs or the industry as a whole, I think it is perfectly understandable that people are angry.

Q316 Chairman: John asked you about the resolutionary regime and you said not in human history have we created an adequate resolutionary regime. Two points flow from that. One, if we cannot do it globally, do we just go ahead and do it nationally?

Mr Corrigan: Yes. I rather like the change in the UK banking law that was put in place in 2009. The reason why I rather like it relates directly to this question of resolution authority. One of the things that the UK in its wisdom did in the banking law reform was that it gave the Tripartite Authorities a menu. It said in effect, depending upon the circumstances, you can take alternative A, B or C. What I thought was particularly thoughtful about the ABCs, if I can put it that way, is that alternative C which I think is viewed as something of a worst case contingency to prepare for, as I understand it, allows for a government takeover that would permit the government to keep the failing institution open for at least a limited period of time. In that sense, it is a little bit like - perhaps a lot like - the term "conservatorship" as that is used in the United States. What is so important to me about that flexibility is that I strongly believe, based on all of my experience, that if we can buy a little time, two to four weeks, in order to try and execute orderly wind down of a large institution, including its international branches and subsidiaries, the cause for us to be in financial stability will be enhanced and we will have demonstrated that too big to fail is not the only answer. I like your approach a great deal.

Chairman: We have not answered all the questions yet in the UK, so do not run away with the fact that we have the perfect answers. We have a long way to go yet.

Q317 Ms Keeble: The Bank of International Settlements warned in January that it saw financial firms returning to the same risk taking behaviour that existed prior to the crisis. Do you think that that is fair criticism?

Mr Corrigan: I certainly hope not. Again, let me just cite a couple of factors. If you take Goldman Sachs for example, these days our tier one capital ratio is something around 15%. Far more importantly, our tier one common equity ratio, which of course takes account of the quality of capital, not just the amount, itself is something like 12.5%. I think both of those numbers are at or near high industry standards, but I think as a general matter they are representative of industry standards today and both are substantially higher than would have been the case prior to the crisis. I would also note that institutions both in the United States and elsewhere and through the BIS discipline are now publishing and paying more attention, as they should, to so-called leverage ratios. Again, if you look at leverage ratios at the end of, say, 2009 at Goldman Sachs, which is broadly representative of other firms as well, they are now in the range of 12% or 13%, which is about half of what they were prior to the crisis. Finally and most importantly - I can only cite Goldman Sachs numbers because the others I do not think are particularly well known - what we call our core excess liquidity, which essentially is unencumbered government securities, cash, things like that, at the end of the past year were about $160 billion odd or 18% of the total balance sheet. If you take those three metrics as examples, recognising that roughly speaking they are representative of broad industry standards, I am not sure I would say that is business as usual; but I will say that I do have some concerns that, if we are not very careful, at some point we can see minimal spirits beginning to pop up here and there again. We have to be much more aggressive and vigilant in the future than we have in the past to deal with those problems earlier rather than later.

Q318 Ms Keeble: I wanted to ask a bit more about the way in which you benefited from the crisis. Looking through the figures that we have been provided, after the US Government stepped in to support AIG, you got about 13 billion which was in fact the largest pay out that was provided. You also benefited after you became a bank from five billion under the FDI scheme. You also got a 10 billion loan under the TARP scheme, did you not? The Chairman was asking you about this. If you look at just the broad figures, it looks like you got a total of about 28 billion that you benefited from through a variety of means, through government backed schemes. Would that be an accurate figure to put to it?

Mr Corrigan: I am not sure I can trace the figure as you give it. First of all, the TARP number was ten. There is no question about that. That has been repaid and the warrants that were part of the TARP money have also been repaid. The warrants were repaid to the tune of I think a billion one and the profit that the Treasury made from the TARP money and the warrants was approximately at the rate of 22% or 23%. The Treasury made out pretty well on that one.

Q319 Ms Keeble: The FDIC was five billion?

Mr Corrigan: I cannot reconcile that number.

Q320 Ms Keeble: That is the figure we have been given. The pay out on AIG was 13 billion. You got seven billion to start with and then after the government stepped in it was 13 or 12.7, I think it was.

Mr Corrigan: The 13 is about right but again that 13 was a payment that called for five specific terms of the credit default swaps outstanding at that point in time. That was not a gift from heaven. This was satisfying a contractual obligation of AIG. As I said before in response to the Chairman's question, many people have asked the question why was there not some kind of a haircut or a discount on those payments that were made not just to Goldman Sachs but to a couple of dozen other institutions and in at least one or two cases the payments to those other institutions were larger than they were to Goldman Sachs. I think the answer to that question goes back to the environment at the time. By the way, a number of the institutions that got those payments were also foreign institutions. They were not just US institutions.

Q321 Ms Keeble: That is the same here. Foreign investments have benefited. What I am trying to get at is that in total, whether you call it a loan or whatever, Goldman Sachs benefited from round about $28 billion of US Government funding one way or another, either in a loan or whatever. Admittedly the loan was repaid but it was round about 28 billion. Is that about right?

Mr Corrigan: The arithmetic is right but I think you have to look at the components.

Chairman: We could do with a written submission on that.

Q322 Ms Keeble: Is it not the case that, looking at the submission you put in to us on page six, you argue for the financial institutions being left broadly as they are but with the prompt corrective action and enhanced resolution authority provisions? Do you think that that really satisfies the public demand for business not to be as usual through institutions that have had very, very large amounts in support from the government?

Mr Corrigan: In terms of the arithmetic of direct or indirect government support for Goldman Sachs, the numbers for other institutions are much, much larger than they are for Goldman Sachs.

Q323 Ms Keeble: $28 billion is a lot of money.

Mr Corrigan: When you take account of government guarantees, certainly in the United States, they were extended for existing assets of some financial institutions and some banks but that is neither here nor there. Your core question is right on the money. You cannot look at the post-crisis environment in the context of a single, individual institution. What we have been through here has involved governmental and central bank support for a majority of major financial institutions around the world. That is what made this so different from the problems we have had in the past with the possible exception of the 1930s.

Q324 Ms Keeble: Do you understand that the public might not feel that the prompt corrective action and enhanced resolution authority is sufficient indication that business is not going to be as usual from institutions that have had very large amounts of government support guaranteed?

Mr Corrigan: I think the public at large understand very well the problem of too big to fail. By any standard, that is what really has the public so angry. I agree with the public on that. It makes me pretty damned angry too. The question is where do we turn for confidence that we can actually solve the public's problem, leave the public with a much higher sense of confidence that we can deal with too big to fail? What I am saying and what I feel very strongly about is that your chances of achieving that result are going to be much greater in the context in which we take that reform agenda that is spelled out in that paper, put it in place but, as we put it in place, the premium is going to be those two doctrines that you mention. Are we going to be able to take prompt corrective action from a slogan to a policy? Are we going to be able to make enhanced resolution authority work? My answer is neither of those things is going to be easy. They are going to be very, very difficult.

Chairman: That is what fills us with dismay.

Q325 Mr Love: I want to press you, since we are on that subject, on this issue because you have laid out in your submission to us how that would happen. We have been told in previous sessions in this inquiry that if you look at for example capital and liquidity the Basel II reforms do not exactly give you a great deal of confidence that Basel III will solve the problem.

Mr Corrigan: I have some sympathy with that.

Q326 Mr Love: If you look at regulation, one of our academic submissions suggested that if you trusted in regulation you would be going down the same difficult track as we have just come through. You have admitted in the submission and in your statement today that achieving the resolution authority and the prompt action will be incredibly difficult. Therefore, I put to you in a sense what I think Mr Volcker is saying. If all of those three do not give us the security and satisfaction that we think is necessary after the credit crunch, should we not look towards some form of structural reform? I suspect he is probably fairly flexible about what form of structural reform but thinks that is a necessary part of the equation to solve this problem of too big to fail.

Mr Corrigan: I am not completely allergic, by the way, to structural reform but what we have to be careful of is the following: if we embark on a course of structural reform however defined and we do not have a genuine measure of success with that agenda for reform, the big question is is the system going to be safer or not. My answer is I am not sure, because if the structural reform effectively chases all of the risk out of the core of the financial system are we any better off or not; or have we simply hidden the risk, pushed it further out to the near bank or non-bank sector such that systemic risk actually is going up rather than down? That is a very, very hard question to answer. What I am looking for, if I can put it this way - I probably will regret the use of this term but I am going to say it anyway - is an insurance policy. My insurance policy is let us make sure that we really concentrate on that agenda. Let us make sure that both domestically and internationally we do all we can humanly do to get resolution authority to the point where we can make it work effectively, both within countries and across countries. I do not minimise those challenges at all but, by the same token, I do not minimise the challenges associated with fundamentally restructuring the very core of the international financial system. That is not easy to do either. Again, maybe with the passage of time - I never say never - we will decide we have to do both.

Q327 Mr Love: You would accept it is a daunting prospect to try and introduce resolution reform internationally that will ----?

Mr Corrigan: It will be very difficult. Again, if you take the Lehman example, if we followed the suggestion that is contained in the UK 2009 banking law where you could have in the US jurisdiction kept Lehman open for a couple of weeks or something like that, one of the benefits of that would have been that it would not technically have been in bankruptcy. Under those circumstances, while I am not a lawyer, I think it would follow that the authorities here in the UK would have not felt compelled on that Monday morning to in effect freeze all those Lehman assets that they felt they had no choice to freeze. It is not a perfect solution but it helps.

Q328 Mr Love: I understand that. You have already emphasised that point. We were in Washington recently and we did not in our discussions there have a great deal of questions asked about our 2009 Banking Reform Act. Making reform on both sides of the Atlantic mesh together I think will be a major challenge for us. I want to come back to this issue you were suggesting about pushing all of our activity out into the unregulated sector. Of course one of the criticisms of narrow banking is that is exactly what happened. Investors will follow because they are looking for a higher return. What you will in effect get is government still in a position of offering an implicit guarantee but this time in the unregulated sector. Do you think that is a likely prospect if the Volcker proposals as outlined go ahead?

Mr Corrigan: I am not sure whether I would use the word "likely" or "possible" but it is unambiguously a risk that we cannot afford to overlook because if it happens we will pay a big price. That is my analogy with an insurance policy.

Q329 Mr Love: Although it would be nice to think that one of the options open to Goldman Sachs would be to go back to the private status that John talked about earlier on, the reality is if Volcker goes ahead Goldman Sachs will be faced with the option of whether it stays as a bank holding company or returns to something else. To what extent does that argument about implicit state guarantees influence what Goldman Sachs will eventually decide to do?

Mr Corrigan: First of all, I know you will understand I cannot answer that today because no one knows what the details of a Volcker like plan would be.

Q330 Nick Ainger: You were referring to the Volcker plan but is it not fair to say in fact it is not just the Volcker plan? This is the group of 30 report which was produced by the Financial Reform Working Group of which you were a member. Did you actually sign up to the recommendations?

Mr Corrigan: I was a member but if you read the fine print in the published document there are several places in which the document explicitly says that individual members of the group of 30 may or may not agree with all the recommendations contained in the report.

Q331 Nick Ainger: Presumably, there was a majority consensus - let us put it like that - that the recommendations should be put into the report?

Mr Corrigan: That is correct, but I was not part of the working group that prepared the report.

Q332 Nick Ainger: You are down as being a member of the working group.

Mr Corrigan: I was down as a participant which I agreed to do so long as they agreed to put those disclaimers in the report.

Q333 Nick Ainger: Were you a lone voice in expressing concern? I recognise what you said earlier about the huge respect that you have for Paul Volcker but this was recommendation number one. It was not hidden further down.

Mr Corrigan: I disagreed with it at the time.

Q334 Nick Ainger: What I am getting at is the great and the good of the world's financial organisations were members or participants in this working group. Presumably a majority of them felt that recommendation number one, which refers specifically to banks not getting involved in private equity funds, hedge funds and proprietary trading on their own account, was a good idea.

Mr Corrigan: I cannot speak for the majority of people.

Q335 Nick Ainger: Here we have a working group of very eminent and incredibly experienced people. Their first recommendation in a report, which is designed to look at the structure and what needs to be done to prevent another crash, is a clear recommendation. You do not agree with it but did the majority support that?

Mr Corrigan: I was not the only one who did not agree.

Q336 Nick Ainger: Did the majority support it?

Mr Corrigan: Yes, that is a fair statement.

Q337 Nick Ainger: There seems to be general consensus in your paper, from the evidence that we took in New York and Washington and the evidence that we have heard in London, around things that need to be done. That is certainly the resolution and winding down process, higher levels of capital and liquidity, better risk monitoring and so on. The difficulty is how would we achieve that, but nobody is arguing about the principle. The only argument that we seem to have found is whether institutions which pose a systemic risk should be engaging in proprietary trading on their own account or whether they should be involved in hedge funds and private equity funds. Can you briefly say why you are so adamantly opposed to something which is the consensus of the majority of the experts who were put together on that group of 30 working group and why you so vehemently disagree with them?

Mr Corrigan: I am not sure I would use the word "vehemently" to begin with because, first of all in principle, even today philosophically there are a lot of things that Chairman Volcker and I agree with, starting with the very basic principle - it is a term that we both use - that banks are special. With all due respect, I think you are exaggerating a bit how much emphasis to put on that group of 30 report. As to the substance of it, there are as I say in my own statement that you have a very substantial number of very open definitional questions and very open questions about what the intent of something along the lines of the Volcker thing is. If you look at the statement that Chairman Volcker himself submitted to the Senate Banking Committee a couple of weeks ago, the fact of the matter is even under his regime he is talking about banking organisations that were conducting a much, much wider range of activities than for example the so-called normal banking models. This is not a black and white issue. To me the key thing is that first of all I do believe that, on a case by case basis - I want to be very clear about this; it has been my view for years and years - there are unambiguously circumstances in which the kinds of restraints that Volcker is talking about may be needed and perhaps have been needed, but I think they can be dealt with case by case.

Q338 Nick Ainger: That is dependent upon the regulators of these financial institutions spotting that there is a particular problem.

Mr Corrigan: That is correct.

Q339 Nick Ainger: We have had evidence from people who know about these things. John Kay has been quoted already. You know from your vast experience that, as time goes by, the memory of what has happened fades and we end up with poor supervision again. It certainly seems to me that if we are dependent upon the regulator spotting a particular problem then we are going to have a problem eventually because, at some stage, the institution or the regulator will fail and we end up where we were in September 2008. Should not we as, if you like, policy makers be saying, "Look, we can try and perfect the regulatory system but we must accept it will never be perfect"? Therefore, you have to have a structure in which, when banks do fail, we have reduced the risk as far as we can which would certainly be the issue around proprietary trading. Therefore we do not get into the position where the taxpayer is having to bail out these major institutions. Do you not agree that just hoping that the regulators are going to do a very good job is not good enough?

Mr Corrigan: Certainly I do agree, as I think you know, philosophically with 85% of what you have just said. We are not light years away here. In either case you are hoping. In one case you are hoping that the regulators are going to do a better job in the future than they did in the past. In the other case you are hoping that this radical or at least fundamental restructuring of the financial system is going to work. Either way you are hoping.

Q340 Nick Ainger: It is belt and braces. You seem to be saying we are going to have a good set of braces but we do not need the belt.

Mr Corrigan: That is not what I am saying.

Q341 Nick Ainger: Other people are saying you need belt and braces. It is structural reform within institutions as well as putting in the agreed consensus about winding down processes, higher capital and liquidity and risk monitoring.

Mr Corrigan: We are having a bit of a semantic problem here. I thought I invented belts and suspenders as they pertain to financial institutions. Again, I do not disagree with what you are saying. I think it is a question of priority and what offers the best chance of the best result. We may have somewhat of a difference of opinion on that question but do not confuse a difference of opinion on that question with any suggestion that I am anything less than a belt and suspenders guy. I have been a belt and suspenders for 40 odd years. I am not about to change.

Q342 Chairman: We prefer a less provocative term. "Braces" please. I have to ask you a few questions for the public record for our inquiry. You have said that large corporations require large banks to meet their financing needs but if many small banks raised the same total amount of capital would not the system be better off, thanks to improved competition?

Mr Corrigan: If I thought that you could produce that result, the answer would probably be yes. Even as it stands now, credit syndicates for large corporations are often in multi billions of dollars, sometimes multi tens of billions of dollars. As a practical matter, there has to be a relatively small number of institutions that put together those syndicates and those facilities. Even now, when you have a small number of large banks that are willing to commit to a substantial fraction of their overall credit commitment, the syndication process involves dozens or in some cases many dozens of participating institutions. Again, there is a threshold here that I think is what accounts for my suggestion in those terms.

Q343 Chairman: If Goldman failed tomorrow, which national regulators would be affected? Could the company wind down in an orderly way?

Mr Corrigan: As far as the United States, the Federal Reserve certainly would be involved. The SEC would certainly be involved. The FDIC would certainly be involved. Here in the UK the FSA would certainly be involved. I guess the Bank of England now indirectly would be as well. The same would be true in Japan and in other smaller jurisdictions there would probably be. The so-called college of supervisors for Goldman Sachs I think has seven or eight countries.

Q344 Chairman: Is it feasible to expect international agreement on resolution regimes for global institutions, given the differences in bankruptcy laws and other complicating factors?

Mr Corrigan: I believe we can get to that point, yes.

Q345 Chairman: The Governor of the Bank of England does not.

Mr Corrigan: The really important thing is that the primary authority in the first instance would of course be in the United States because that is where Goldman Sachs operates from. The thing that would have to happen to make it possible to deal with resolution authority in other jurisdictions is the authorities in the United States would have to agree to a framework of something like conservatorship, where you can keep Goldman Sachs operational for a relatively short period of time to have the wind down. In those circumstances, I think we could have a much higher measure of success in dealing with the international ramifications of a situation such as the one you have described, yes.

Q346 Chairman: Increased leverage appears to be one of the causal factors in making the banking system more profitable, yet more fragile. Do you support leverage limits for banks?

Mr Corrigan: Yes, but not in statutory terms. In the United States there is a statutory provision in the House Bill that as a matter of law they establish a 50% leverage ratio. I do not like the idea of that being a matter of law at all because who knows what the future will bring. I certainly do believe that Basel capital rules could be broadened out to include a leverage ratio. A leverage ratio only deals with so-called balance sheet leverage. In other words, the ratio of capital however defined to assets. A leverage ratio does not deal with what I like to call "embedded leverage". That is the leverage that is embedded in various classes of financial instruments, including certain classes of derivates. We have to be very careful that, while we institutionalise some form of leverage ratio, we all are sensitive to the fact that embedded leverage may well be more of an issue than a so-called balance sheet leverage. This is where this idea of higher capital liquidity standards becomes so very, very important.

Q347 Chairman: Which you have in your paper. Lastly, to what extent do you agree with the notion of contingent capital, where debt can be turned into equity at a time of crisis? Is it only for extreme circumstances or will it be a red flag to the market that will accelerate problems?

Mr Corrigan: I think that the concept of contingency capital has a lot to be said for it. We have had a little experience again here in the UK with contingent capital in the very recent past. The thing that I worry a little bit about - you talk about belts and suspenders; this is going to be real belts and suspenders - is that if we institutionalise contingency capital I would hate to see it work in the direction of reducing the amount of core capital to keep in the first place. Again, it is one of those slippery slope things that we have to be careful with but if we can guard against the concern that it results in lower core capital to begin with I think it is a worthwhile concept.

Q348 Chairman: If firms could fail and bond holders suffer when that happens, do you think they will be more interested in the level and pattern of compensation, say, in your or other firms?

Mr Corrigan: Yes.

Q349 Chairman: Would they press you more strongly to eliminate the possibility of excessive or executive risk taking?

Mr Corrigan: Yes.

Q350 Chairman: I hope your increasing number of away days to New York to here are becoming increasingly pleasurable. We can only thank you for your attendance. It has been very helpful to us in our inquiry into too big to fail.

Mr Corrigan: Thank you for the opportunity to be here. I am not trying to flatter you and your Committee but I must confess that, as I think I have said to you before, you ask very good questions. More power to you for that.

Q351 Chairman: Sometimes we do not get the most precise answers.

Mr Corrigan: You cannot have everything.

Witness: Mr Douglas Flint, Group Finance Director, HSBC, gave evidence.

Q352 Chairman: Mr Flint, welcome to the Committee and this inquiry into too big to fail. Can you formally introduce yourself, please?

Mr Flint: Of course. My name is Douglas Flint. I am the Chief Financial Officer and Executive director at HSBC with responsibility for risk and regulation.

Q353 Chairman: A few weeks ago two academics were before our Committee, Professor Charles Goodhart and John Kay, who said that it was almost impossible to measure risk today; yet we had Mr John Varley of Barclays coming before us who was very confident about being able to measure that risk. Are you as certain as Mr Varley that HSBC can measure risk accurately?

Mr Flint: I think one has to put it into context. There is no single measure of risk that can accurately measure risk. We try and everyone tries to triangulate it with a very, very great, wide range of measures and at the end of the day the thing that you get most concerned about is the tail events that do not get captured in models that look at historic experience. I think there are a lot of techniques that can be used to get a very good handle on risk. Where management comes in is looking at where those analytics might fail.

Q354 Chairman: What does that mean then for how we run banks?

Mr Flint: It means that you constantly have to challenge yourself and say what could go wrong. What are we not thinking about? What are we not capturing?

Q355 Chairman: Could you give an example of a black swan in the last year or two for HSBC?

Mr Flint: I think the black swan that we were most damaged by was the unprecedented speed with which liquidity left the markets, coupled with the fact that the US housing market, after a period of steady growth and then maybe expanding growth, collapsed. Those were unprecedented in terms of the speed with which they changed.

Q356 Chairman: Was your acquisition of Household in the US a black swan?

Mr Flint: I do not think it was a black swan. It was a mistake with hindsight but it was not a black swan.

Q357 Chairman: It was quite a big mistake.

Mr Flint: The buying of business dependent on the US consumer and the US housing market at the time did not look a great risk. With hindsight, it was, yes.

Q358 Mr Fallon: Andrew Haldane from the Bank of England told this Committee that there was no reason for finance to move east. Why have you moved east?

Mr Flint: We have not moved east. Our new Chief Executive is sitting in Hong Kong now because the incremental capital that we expect to deploy over the next several years is going to be concentrated in emerging markets, because that is where the growth is. He wants to be close to the pulse of that activity.

Q359 Mr Fallon: Do you think there is a danger that if we get the regulatory reforms wrong here more banks from the United Kingdom and the United States will tend to domicile outside?

Mr Flint: I think that is a risk, yes.

Q360 Mr Fallon: You are anticipating it?

Mr Flint: I am not anticipating it. I think there are very, very many structural advantages that this country, Europe and the United States have but in terms of where the incremental, economic activity is and where the incremental revenues in the financial sector will arise it will be predominantly in emerging markets and specifically in the Far East.

Q361 Mr Fallon: The purpose of your move publicly was to tap into liquidity rather than to avoid over-regulation.

Mr Flint: No, neither actually; not to tap into liquidity nor to avoid any regulation. We certainly did not do the latter and, as to the former, we have the largest pool of liquidity we have in Asia, so it was not to tap into that. We already have it. It was to tap into the growth in emerging markets in terms of economic activity that we can see. We want the chief executive of the business to be focused on that growth and that growth is in Asia.

Q362 Mr Fallon: Could we turn to the issue of subsidiarisation which the Committee pursued with Barclays last week? They told us that one of the advantages of a branch structure rather than a subsidiary structure was the way for example that funds were able to flow freely into central and eastern Europe. Is there any merit in that argument?

Mr Flint: There is no question that there is much more flexibility in a branch structure in terms of moving liquidity and obviously capital is fungible because it is a branch. I am not sure whether that is a good argument for a branch structure. I think there are equally good arguments in terms of risk and control that come with a subsidiarised structure - i.e., there are more reference points in the flow of liquidity and in the flow of capital that comes from a legal framework surrounding that. Both systems have their merits but there are arguments for both.

Q363 Mr Fallon: But you have chosen one?

Mr Flint: Very much we have chosen one, yes.

Q364 Mr Fallon: Why is that?

Mr Flint: In some ways, it is an accident of history in the way that we have grown by acquisition. Part of HSBC's DNA is that from the earliest days HSBC was hugely significant relative to the Hong Kong economy, and in every other country it was a guest, and therefore the whole group was built upon the basis that it would never rely on anybody looking after it apart from itself. More importantly, a governance and management structure, a subsidiary structure, gives you the integrity of a balance sheet and gives you the integrity of control over the flow of liquidity and capital, and it means you have people who are having to build responsibility from an early stage of their career for that whole balance sheet and for building relationships with regulators and the like, and they are working off a balance sheet that is audited, so in terms of the whole governance and control aspect, it suited our management style. Essentially that was an early premise within HSBC and has been continued thereafter. I am not saying it is the only way of doing it and I am saying it is a more expensive way of doing, but it has served us extraordinarily well.

Q365 Mr Fallon: But if that is true would the world not be a slightly safer place if other banks followed your model?

Mr Flint: It is a complicated question. Possibly and it would depend. Obviously you could have a subsidiary structure - and indeed there were elements of this in the Lehman situation where you had subsidiaries and then they cross-guaranteed each other - and you could destroy the integrity of the structure. Then you could have a branch structure that also puts checks and balances and brakes in place. There is no question in my mind that a subsidiarised structure, in the event of having to deal with severe stress situations, makes it easier to see how you would deal with them. More importantly from our perspective, it gives us a better management and governance structure internally.

Q366 Mr Fallon: So the answer to my question is "Yes"?

Mr Flint: Yes.

Mr Fallon: Thank you.

Q367 Chairman: Okay, if we could put it in simple terms: if you got into bother in the UK - and we do not want to envisage that at all - you would go to the Chancellor and say, "Look, Alistair, this is a problem and your problem is in the UK," whereas if you are a universal bank you would say, "Look Alistair, this is your problem but, actually, you have a problem in New York as well and you have a problem in Tokyo", or wherever. Is that correct? In other words, you can segment that problem?

Mr Flint: To a large extent, yes, because each of the major subsidiaries has separate flows of liquidity and separate flows of capital and we control the extent to which they have relationships with each other, so they are fairly self-contained.

Q368 John Thurso: I just want to pursue some questions on the concept of narrow banking but could I just ask a question regarding the answers that you have just given. You have said that using subsidiaries gives you clarity of management. Is it not the case that by having a properly funded separate balance sheet you are aligning the individual manager in the subsidiary with that balance sheet and therefore they are looking at risk in balance sheet as well as P&L terms?

Mr Flint: That is what I meant, yes.

Q369 John Thurso: That is the point you are making?

Mr Flint: That is the point I am making.

Q370 John Thurso: Thank you. Do you see therefore subsidiaries as an alternative to narrow banking as achieving much of what is desired but by a different route?

Mr Flint: I think they are very separate questions. I do not think there is a single model because financial stability comes both from organisational structure, the structure of the system itself, capital liquidity rules, supervision and so on, and you can choose from a menu, and depending on where you are in one part you can augment other pieces of that menu to come to the same answer. I think narrow banking and subsidiarisation are very different questions.

Q371 John Thurso: Because presumably if a subsidiary fails you could, if you wish to, let it go?

Mr Flint: I think that is a theoretical concept.

Q372 John Thurso: Reputationally?

Mr Flint: Reputationally I think it would destroy much or all of the business.

Q373 John Thurso: How will HSBC be impacted by what President Obama is proposing?

Mr Flint: We have only seen the sketchiest of details. Clearly if there is a levy on wholesale funding, there would be a cost to us of paying that levy, although we have, relative to virtually all of our peers, significantly less wholesale funding in our business model than anyone else, so there would be, on the first level, a cost to pay. I think one would need to analyse what the levy was designed to achieve. I am not saying it is not an idea worth considering, I think it is, but it would have a modest cost to us.

Q374 John Thurso: So you would not be too affected by it?

Mr Flint: In terms of the financial impact, no.

Q375 John Thurso: A lot of people have put to us that one of the critical things is to take proprietary trading out of utility banks, as it were. When he was before us, Mr Varley said that actually it was almost impossible to differentiate between what was full-on proprietary trading and what was actually trading on your own account but for a client. Do you not agree that it is wise to ensure that proprietary trading does not put a firm as a whole at risk?

Mr Flint: I certainly agree with the last part of your statement. No trading should be to an extent that it would put the firm at risk. I think there is a considerable difficulty in defining what we mean by proprietary trading.

Q376 John Thurso: How much do you do in HSBC?

Mr Flint: In terms of what a common definition would be of taking outright risk for the purpose of making a return, purely from the taking of outright risk, a very, very, very insignificant amount. Everything we do is as principal. There is no concept of agency any more. I think one of the important roles that banks play within the financial system within the economy is providing a platform through which real underlying businesses can alter interest rates, adjust foreign exchange exposures, hedge exposures on the investment side, create products to hedge the risks that their investors may be taking or they may wish to offer in the insurance and funds industry. All of that risk is effectively intermediated through the banking systems that have the platforms to give the execution, to have the counterparty strength and to give liquidity and best pricing. If you were to have a system where banks were not allowed at the end of the day to end up with a net position, ie no proprietary or principal position, the inevitable consequence is that the bid offer spread, ie the price, of intermediation would go up because people would only deal on the basis of a price that they knew they could get out on the other side, which would mean that ultimately clients would find that too expensive and would either not hedge their risk or would do it outside the banking system. You could end up with a multiplicity of unregulated entries providing the platform through which risk is managed. At the moment what the banking system does is provide a platform for risk management for non-banking institutions and it does so as principal.

Q377 John Thurso: HSBC has generally been thought to have had a good crisis. You have come out of it looking moderately strong and healthy. However, I recall not that long before the crisis there was criticism that you were pedestrian and too conservative and not sweating your balance sheet enough. Is the lesson therefore that when there is a bubble brewing to go and invest in pedestrian people who are not sweating their balance sheets enough?

Mr Flint: History would say yes. I remember, with some surprise now, that I spent probably two or three years of my life defending our capital and liquidity position in almost every meeting, where I was told that we were pedestrian and old-fashioned compared to other banks that were sweating their balance sheets a great deal more.

Q378 John Thurso: Do we need to regulate to make what you were doing, as it were, compulsory, or can we do that; is it possible?

Mr Flint: You get back to some of the drivers of the crisis, and one of them was a search for yield within the investment industry, and those that could not take yield were encouraging the investments that they made to take leverage within their own business model, so there was a pressure during the middle part of the first part of this century for businesses to be leveraged more. Some resisted it; we did; others did not, but at the end of the day the problems arose from asset bubbles and excess leverage and the combination of the two was toxic. I absolutely believe that one of the incentivisations that needs to be addressed is the incentivisation on managements to do what is conventionally popular at the time, which may involve taking their business models to a place they would not otherwise go to, ie leveraging.

Q379 Chairman: On that issue of needing to regulate to control the industry, it is an important point for us in the Committee. We have looked at it with a number of witnesses. We were never going to get to the stage that regulators know more than the industry. That has to be down to good corporate governance and practice, does it not, with the banks?

Mr Flint: It absolutely does. At the end of the day the first and foremost failing was on management, no question. The second aspect you need to have is proper supervision of management and governance over management, which is the board structure and the regulatory framework. Then I think it is also worth reflecting whether, in fact, there needs to be something complementary to the arrangements we have in place that alter the price of credit and the supervision over individual institutions that pulls together evidence that would be symptomatic of bubbles forming, and then inform the supervisory system that there needs to be adjustment to either capital ratios or liquidity or caps on lending to particular sectors or loan-to-value ratios within property markets, or whatever. You can see evidence of that in some of the systems that have had a good crisis or have come through similar crises. Hong Kong would be a very good example where we had a 50% decline in property prices in 1998 which was the first time ever property prices had fallen, yet the Hong Kong banking system came through that well. Why? Because loan-to-value ratios were capped at 70%. I am not saying that would be possible in every marketplace but there is some evidence that arrangements like that have a role to play.

Q380 John Thurso: You need more equity in those investments from the outside.

Mr Flint: From the outside; not equity in the banks, equity by the borrowers.

John Thurso: People are expecting just too much loan.

Q381 Nick Ainger: You were talking to Mr Fallon about the brand structure. Can I just be a little parochial? We have had a parliamentary petition about the Thurnscoe branch of HSBC closing and I was informed late last year that one of HSBC's branches in my constituency, Saundersfoot, was closing, and two weeks ago I was informed that my own branch in Pembroke Dock was also closing. It seems that you are either picking on me or there is a branch closure programme throughout the UK. Is that right? Why are you doing it at the moment? Some years ago there was a big shake-out of bank branches. Why are you doing it at the moment?

Mr Flint: We are certainly not picking on you.

Q382 Nick Ainger: It seems like it!

Mr Flint: One of the clearest statements at the moment is that customer behaviour in retail banking is changing. More and more and more of the transactions are being done online or over the phone. The footfall, frankly, through the physical premises is less and less. Therefore, simple business economics means that we are consolidating physical premises as customers use them less and less. That is the answer.

Q383 Nick Ainger: I have to say that every time I go to my branch in Pembroke Dock there is always a queue, but that is beside the point. Can we move on? One of the issues that has emerged from our inquiry so far is that there is a general consensus around things that need to be done to prevent a recurrence of the crisis. That is that we need proper resolution and winding down procedures for banks when they get into difficulties; we need higher capital and liquidity requirements; we need better risk monitoring, and so on. Could I ask you about living wills and whether HSBC have arranged or agreed a living will for your regulators?

Mr Flint: Recovery and resolution plans: we are in the process of discussing with the FSA what we would be required to do and, indeed, have a very open and good dialogue with the FSA in that regard. We absolutely agree. I think you need to put it in two pieces - recovery plans and responsibility of management. That is, in the event of an unforeseen tail-end stress event that happens in part of your business can you organise yourself to cope with that stress event without burdening anyone outside your own group, and I think our history has demonstrated that we have had a significant number of these events to deal with and have never taken any public money anywhere in the world, whether it has been Argentina default and pesofication, the subprime crisis in the US, the Asian crisis, LTCM, Russian defaults, swine flu, avian flu, SARS in Hong Kong. We have had individually significant events and have coped with all of them because we have had recovery plans of how we would deal with it, the formalisation of those and taking them to another level, and one of the things we try to do in every situation of stress that happens anywhere in the marketplace is learn lessons. It is clear from the resolution of Lehman and other situations that there are aspects of the interconnectedness of firms that we would do well to examine and see whether there are things that we would augment in our recovery plans to take account of, and I think that is of great benefit. In terms of resolution, that is really for the regulators. Where we are talking to the FSA is enabling them to get a better understanding of effectively the organisational structure and interconnectiveness of all the pieces of the group and the group to the rest of the financial market so there could be an understanding as to what steps would be taken, in the event of what I think are completely unforeseeable circumstances, to enter a resolution situation.

Q384 Nick Ainger: Coming back to the living will, say you are in negotiation with the FSA here: what about all your other subsidiaries? Are they doing exactly the same thing with their regulators in the other jurisdictions?

Mr Flint: I think there is no question that the UK is taking a lead, but I would say that stress test recovery plans - they have been given a new popular name - in terms of "is your capital and liquidity in and of itself sufficient to deal with any situation and what would you do in the event that you ran out locally?" has been part of a dialogue for as long as I have been around and I have been doing this job for close to 15 years. We have had those dialogues in terms of normal business-as-usual capital management with all of our subsidiaries and they have had those in conjunction with us with their regulators for a long time. It is getting more formalised, but this is part of normal management in terms of disaster recovery.

Q385 Nick Ainger: Disaster recovery, but what about actually failing in an orderly way? In the discussions that you have, and I am not suggesting certainly as a customer I want to see HSBC fail, presumably you are stress testing these issues and could you honestly say at the moment that HSBC UK could actually fail in an orderly way?

Mr Flint: Our own examination of our situation says that there is no foreseeable likely event that we could not accommodate within our own resources. As I said, we have gone through some severe stresses, the most significant being the most recent with the US subprime market, and we have accommodated that without any public help.

Q386 Nick Ainger: Let us learn from your lessons then. What would you recommend in terms of policy measures from your experience? What works?

Mr Flint: What I think works is scale and diversification. The reason we have been able to deal with situations that have arisen is that we have a very diversified business model by geography, a very diversified model by type of business that we do and, therefore, when one piece is doing badly other pieces have been doing well and there has been demonstrably enough value to be able to accommodate stress in one part of our system. The popular "too big to fail", we think there is a very strong argument for being large enough to cope.

Q387 Nick Ainger: But the fact that you do compartmentalise, quite clearly, from the response that you gave to Mr Fallon, you see that as a distinct advantage rather than just a huge universal bank?

Mr Flint: Yes because it does mean that in terms of the confidence that exists in individual parts of the group, a problem over here is a problem for that part of the group and for the holding company but it does not affect the sisters and the brothers, and therefore they can continue to enjoy support from their depositors, from their wholesale lenders, to the extent that they have them, and their customers, isolated from a problem that may be happening somewhere else in the world, so I believe it is a great strength.

Q388 Nick Ainger: In response to Mr Thurso's questions, you were talking about the capital and liquidity requirements and so on and whether you were seen as a pedestrian organisation. Historically, have HSBC carried a higher capital ratio than their competitors?

Mr Flint: Yes.

Q389 Nick Ainger: You think that again is a good policy?

Mr Flint: No question. At a time when people talked about tier one ratios of north of 9% or 10%, I was reminded that when HSBC acquired Midland Bank in 1992 the tier one ratio was 9.6% and throughout the whole of the 1990s, for the last 20 years, it has been the thick end of 9% plus. It has been a bit below sometimes but it has been in those kinds of levels. Many of our international peers have been half that level or less, so, yes, it has always been part of the mantra but, more important than that, I believe, has been an obsession with liquidity as much as, if not more than, capital. You run out of liquidity long before you run out of capital. If you do not have liquidity you are forced to sell liquid assets into bad markets, which you never want to do.

Q390 Mr Love: Mr Flint, you have come here today in the very fortunate position of being able to say how well HSBC came through this, but of course this Committee is looking at not what the best examples are but how we can ensure that the worst examples do not recur. You have talked about a number of issues which I suspect you would not expect us to accept can easily be replicated, such as corporate governance structures. It is quite difficult to replicate them across organisations. You have talked about good practice in HSBC's case, but, tell me, if I were to ask you in your position as a prominent banker what you would recommend to this Committee about how it deals with the whole of the banking system, what would you suggest are the important features?

Mr Flint: Genuinely I would start with defining the purpose of the banking system. Everything else is at the micro level until you have said what we are actually trying to achieve, and then make sure, as best one can, that one understands what the appropriate capitalisation of that system would be, and that the system can make the appropriate return on the capital that is being required of it to have, because I think it is very important that the system is capable of attracting the capital that supports the level of risk within it. I absolutely think there is a need to look at arrangements over the supply of credit as well as the price of credit. I think there are times when, to use the phrase, the punch bowl needs to be taken away and there needs to be an informed series of metrics that informs people who can then, through the supervisory process, either through the adjustments of capital or through caps or loan to value ratios or simple constraints, administratively or through supervision and capital, reduce the amount of credit supply, because I think that one of the clear lessons of this last crisis ---

Q391 Mr Love: Should we have a leverage ratio?

Mr Flint: No, I do not believe so. I say that because a leverage ratio is simply one accounting ratio over another, and while I think it is a useful metric, the complexity of getting definition, the scope of consolidation and the risk would mean that the leverage would be in the products rather than on the balance sheet. It is a useful tool to look at but it is not a panacea. One could get seduced into thinking that one had made a great leap forward in terms of control when in fact it had not done very much. It is worth looking at. I think the three things to look at are capital ratios on an unlevered basis, which is your leverage ratio, capital ratios on a risk-rated basis, and then liquidity, which is probably best expressed through advances to deposits, ie to what extent are you dependent on wholesale funding?

Q392 Mr Love: Apart from the subsidiarisation, which I think you have talked about, are there any other structural changes within the system or do you believe that the inherent benefits of large comprehensive banks outweigh any of the concerns that have been expressed about being too big to fail?

Mr Flint: I think there are other things that could be done to the framework itself. I believe that the move in many, many parts of the world - with Europe and America leading - to more central counterparties for the clearing of standardised contracts gives much greater transparency and much greater control over counterparty risk. I think that there is probably a need for some policy review as to whether there are some financial instruments that need to be controlled in terms of the scale of them and in terms of the purpose for which they are used. There has been a tremendous amount of innovation in our industry. All of it has a good purpose but all of it can be abused. It would be worthwhile looking at how instruments are used and whether in fact they can accentuate risk rather than hedge risk. I also think that we should always inform ourselves well with metrics but we should not get seduced that the past can tell us where the future is. I think we became over-reliant in the industry and in the supervisory framework on how good models were. In general terms, management in some institutions was seduced by that and supervisors were seduced by the output of models. I think a more interventionist supervision regime is probably necessary against what we have seen over the last five years really all the way round the world. More judgment.

Q393 Chairman: Do you think your wholesale creditors and bond holders unfairly benefit from implicit state support?

Mr Flint: I do not believe that any of them believe that it is relevant but it is absolutely a fact that it would be implicit against historical experience that the bond holders have had in most situations in most countries.

Q394 Chairman: In what other industry would they be bailed out if a firm failed?

Mr Flint: I suspect in utilities.

Q395 Chairman: So there is a case for making some utility element, as John Kay proposes?

Mr Flint: I do not think there is a case for that because I think if you took ---

Q396 Chairman: But that question gives you food for thought, does it not? You raised utilities with me.

Mr Flint: I did, in the sense that you would not let a power plant stop pumping electricity or gas or whatever because the creditors were not paid, and indeed the regulations do not permit that.

Q397 Chairman: But utilities are under a stringent degree of regulation.

Mr Flint: So are banks. I think that the very narrow banking model that John Kay put forward is, in my view, flawed, in the sense that the platform that the banking system provides for the bringing together of all risk in an economy, in the real economy if you like, to provide liquidity, price transparency and support to companies that need to hedge risk, is a very valuable asset, and if it was not in the banking system it would be somewhere else. Ultimately, the economy would bear the risk of that system failing. We have something that is, I think, very well-structured at the moment. You might decide to design it somewhat differently or put constraints around it, but the infrastructure that exists is enormously powerful and can be used enormously successfully.

Q398 Chairman: Do you think we will ever get to the stage where we will allow banks to fail?

Mr Flint: If you mean can banks wipe out their shareholders and be wound down without disturbing the rest of the financial situation, that should be an objective.

Q399 Chairman: Is it a realisable objective? In other words, can we get there?

Mr Flint: Yes, I believe we can.

Q400 Chairman: Until that day, as Stephen Hester says, you cannot take the politics out of banking?

Mr Flint: I am not sure I understand the politics of banking.

Q401 Chairman: I will tell you the politics, it is dead easy. You have got organisations which are too big to fail and the taxpayer helps them out, so until we get to the stage where there are not going to be any bank bailouts and the taxpayer is going to be off the hook then politics and banking have to go hand-in-hand.

Mr Flint: I think politics, banking and economics go hand-in-hand in the sense that the financial system is a transmission mechanism through which economic policy is affected, and no amount of regulation can mandate that a system can get into an excessive situation, which is why I think that one of the missing pieces in the architecture is something that controls the supply of credit rather than just the price.

Q402 Chairman: So regulators have got to take the punchbowl away when the party is in full swing sometimes?

Mr Flint: Yes.

Q403 Chairman: To what extent do you agree with the notion of contingent capital where debt can be turned into equity at a time of crisis?

Mr Flint: I think it is an interesting concept in theory. I have yet to convince myself that there is a sufficient pool of capital out there that would be interested in buying such capital to make it a credible solution, other than for institutions that are already in difficulty and are converting existing subordinated debt or other debt to something that is contingent, ie, their bondholders are in a stress situation. I do not believe there is sufficient capital looking for that type of hybrid equity and debt return to be a meaningful part of the capital structure of banks. In theory it is an interesting idea, I just do not think it is big enough to be real.

Chairman: Mr Flint, can I thank you very much for your evidence, it has been very helpful to us in our inquiry. We hope to have a report by the end of Parliament which can be passed on to the next committee after the General Election so that it can take this issue further. Thank you.