12 Sep 2011 : Column 758

Let me set out the commission’s recommendations and how we propose to respond. The first proposal is the introduction of a ring fence around retail banking. The Government have welcomed, and welcome, this recommendation in principle. As the report states,

“the objective of such a ring-fence would be to isolate those banking activities where continuous provision of service is vital to the economy and to a bank’s customers.”

In other words, that is the provision of key domestic retail banking services, such as taking deposits from individuals and small businesses or providing them with overdrafts. The central benefit of a ring fence is not to end large universal banking groups, but to make them more easily resolvable in a crisis.

The costs should fall on shareholders and the wholesale debt holders, not on small depositors or on taxpayers. A successful ring fence will be able to ensure the continuation of vital payment services that are crucial to preventing an economic collapse, and this directly addresses the perceived implicit taxpayer guarantee, which is at the heart of the too-big-to-fail problem.

The commission has also proposed a more flexible ring fence. In terms of scope, it says that

“domestic retail banking services should be inside the ring fence, global wholesale/investment banking should be outside, and the provision of straightforward banking services to large domestic non-financial companies can be in or out.”

Many will see this as sensible, and it will reduce inefficiencies resulting from any mismatch between customer deposits and business lending within an individual bank.

On the strength—or height, if you like—of the ring fence, the commission recommends that the retail subsidiary should have what it calls “economic independence”. In other words, it should meet regulatory requirements on a stand-alone basis, and its relationships with other parts of the group should be at arm’s length and regulated in the same way as relationships with third parties. A great deal of detailed work will now be required to see how that principle can be put into practice.

Secondly, the commission has also made important recommendations to ensure that banks have bigger cushions to withstand losses, so the large retail ring-fenced banks should have equity capital of at least 10%. It also recommends that retail and other activities of large UK banking groups should both have primary loss-absorbing capacity of at least 17% to 20%, including long-term debt that can be written off, so that, unlike last time, both shareholders and bondholders bear losses, not the taxpayer. Within that, the commission recommends some regulatory discretion over the composition of this loss-absorbing capacity, and again many will see that as sensible.

Thirdly, the commission recommends the introduction of depositor preference. I repeat again in this House that the Financial Services Compensation Scheme covers 100% of eligible deposits up to the new European limit of €100,000, or £85,000. The depositor preference proposals would bolster the scheme by ensuring that other bank creditors were subject to losses first when a bank went bust, minimising the cost to the scheme and ultimately to the taxpayer.

The fourth set of recommendations relates to competition in the banking sector. These have not had as much attention as the other recommendations, but they are arguably as important to families and businesses. I agree with the commission that the best way to ensure a reliable and affordable supply of lending to our families and businesses is through competition.