Financial Services: Prudential Requirements

The Committee consisted of the following Members:

Chair: Mr Graham Brady 

†Binley, Mr Brian (Northampton South) (Con) 

Connarty, Michael (Linlithgow and East Falkirk) (Lab) 

Cooper, Rosie (West Lancashire) (Lab) 

Crockart, Mike (Edinburgh West) (LD) 

Hands, Greg (Chelsea and Fulham) (Con) 

Heaton-Harris, Chris (Daventry) (Con) 

Hoban, Mr Mark (Financial Secretary to the Treasury)  

Jones, Graham (Hyndburn) (Lab) 

Leadsom, Andrea (South Northamptonshire) (Con) 

Leslie, Chris (Nottingham East) (Lab/Co-op) 

McFadden, Mr Pat (Wolverhampton South East) (Lab) 

Sharma, Alok (Reading West) (Con) 

Wilson, Sammy (East Antrim) (DUP) 

Mark Etherton, Committee Clerk

† attended the Committee

The following also attended, pursuant to Standing Order No. 119(2):

Baker, Steve (Wycombe) (Con) 

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European Committee B 

Wednesday 14 March 2012  

[Mr Graham Brady in the Chair]  

Financial Services: Prudential Requirements

8.55 am 

The Chair:  Does a member of the European Scrutiny Committee wish to make a brief explanatory statement about the decision to refer the relevant documents to the Committee? 

Chris Heaton-Harris (Daventry) (Con):  Thank you, Mr Brady. It is a pleasure to serve under your chairmanship for what I believe is the first time. I hope you are gentle with me on this occasion. I understand that the shadow Minister is not feeling his best, so perhaps I will speak for about 45 minutes instead of the usual two, just to ensure that his pain lasts that tiny bit longer. It might be helpful to the Committee if I explain—in only a couple of minutes, I assure the hon. Gentleman—the background to the document and the reason why the European Scrutiny Committee recommended it for debate. 

The Basel Committee on Banking Supervision is a committee of banking supervisory authorities. It frames guidelines and standards in different areas. In June 2011, the committee published a slightly revised version of its December 2010 document, “Basel III: A global regulatory framework for more resilient banks and banking systems”, commonly referred to simply as Basel III—or Basle III, depending on one’s preference. 

In 2006, two directives, known together as the capital requirements directive, CRD, introduced a supervisory framework within the European Union designed to ensure the financial soundness of credit institutions, banks, building societies and certain investment firms, while reflecting the Basel II rules on capital measurement and capital standards. Subsequently, two packages of amendments known as CRD II and CRD III were adopted in the amending directives 2009/111/EC and 2010/76/EC. In July 2011, the Commission presented the draft regulation on prudential requirements for credit institutions and investment firms, document (a), and the draft directive on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, document (b), as a package known as CRD IV. The intention was to replace the capital requirements directive and to partly introduce Basel III into EU law. 

The Commission’s proposals in the draft regulation concern maximum harmonisation of prudential requirements, the definition of capital, treatment of specific exposures, counterparty credit risk, liquidity, leverage ratio, Basel I floor and commencement. Those in the draft directive concern powers of the competent authority of the host member state in relation to branches, parliamentary oversight, sanctions, responsibility of the management body in considering risk issues, corporate governance, a supervisory review and evaluation process, capital buffers on commencement, transposition and repeal. The European

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Central Bank opinion, which is document (c) in the pack, comments on the Commission’s legislative proposals for CRD IV in documents (a) and (b). On 8 November 2011, the House approved a reasoned opinion about the breach of the EU’s treaties’ subsidiarity principle in the draft regulation to be sent to the Presidents of the Commission and the European Parliament. 

In recommending the debate, the European Scrutiny Committee suggested that, in addition to exploring with the Minister progress on solving the various important issues the Government had highlighted to us—I believe the Minister is fresh back from a trip to Brussels to discuss the matter—as shown in paragraphs 1.21 to 1.25 of our last report on this subject, hon. Members might want to hear answers to the unanswered points we put to the Government in our previous report, namely our concern, set out in the reasoned opinion, about the proposed internal market legal base of the regulation and the legality of delegating powers to the Commission in article 443 of the regulation, and our concern about article 60 of the draft directive and the attempt to impose rules on national Parliaments in the way suggested in that article. 

The Chair:  I call the Minister to make an opening statement. 

8.59 am 

The Financial Secretary to the Treasury (Mr Mark Hoban):  It is a pleasure to serve under your chairmanship this morning, Mr Brady. I am pleased to have the opportunity to discuss the European Commission’s proposals on prudential requirements, the European Central Bank’s opinion on the proposals, and of course the European Scrutiny Committee’s thorough report. 

There are two elements to the Commission’s proposals on prudential requirements. The first is a regulation on prudential requirements for credit institutions and investment firms which, in particular, aims to increase the quality and quantity of capital that banks are required to hold and to introduce minimum liquidity and leverage standards throughout the EU. The second is a directive on the supervision of credit institutions and investment firms. Together, the proposals are designed to implement the Basel III agreement on banking regulation and supervision in the EU. 

Basel III is one of the most important reforms that the international financial system has seen. There are those who argue that full implementation would undermine growth at a time when we need to do everything we can to support global recovery. We disagree. A time of instability, when bank balance sheets are under pressure and scrutiny, is not the time to row back from strengthening those balance sheets. 

The Commission’s proposal for a regulation deviates from Basel III in crucial areas, thereby weakening the agreement reached by the Basel committee. In doing so, the proposals significantly dilute the minimum standards agreed internationally for global banks and increase the taxpayer’s potential exposure to future losses. As was discussed at the reasoned opinion debate in November, I share the scrutiny Committee’s concerns that the draft regulation is designed to embed maximum harmonisation of prudential requirements. By severely constraining member states’ flexibility to implement higher prudential

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standards than the minimum agreed internationally, the Commission’s proposals impede member states’ ability to ensure financial stability in their own jurisdictions. 

The Government share the Committee’s concern that empowering the Commission with a delegated power is an inappropriate vehicle to conduct macro-prudential policy at member state level. We are exploring whether the use of the Commission’s delegated powers complies with article 290 of the treaty on the functioning of the EU. 

The Government also agree with the Committee’s assessment that the proposal’s primary objective should be prudential supervision. We would have preferred the Commission’s proposals for revising the CRD to have continued the existing approach of a single directive, adopted under article 53 of the treaty, concerning freedom of establishment. However, we do not believe that any challenge to the Commission’s choice of legal basis would succeed. 

As hon. Members are aware, the draft directive includes provisions for the transmission of information to bodies such as parliamentary Committees. We have expressed our concern on the impact that that could have on parliamentary scrutiny Committees and have been reassured by the Commission that its intention is not to prevent Parliaments from doing their important work. 

As this Committee will be aware, the ECB published its opinion on the Commission’s proposals on 25 January 2012. On the whole, the ECB opinion is closely aligned with the Government’s view. In particular, the ECB opinion calls for the full implementation of Basel III and emphasises the importance of giving individual member states the flexibility to apply more stringent prudential requirements where systemic risks to financial stability arise. 

We have a once-in-a-lifetime opportunity to reform financial services to ensure that we embed a system that works in the interests of the wider economy by ensuring a stable banking sector. It is critical that EU policy makers stand firm against pressures to delay, obfuscate and pander to vested interests across the EU to soften standards. With respect to the prudential requirements legislation, that means implementing the Basel III agreement in full. At the same time, member states must retain the right to apply higher prudential standards to respond to the unique risks and characteristics of their own markets. 

The Chair:  We now have until 9.55 am for questions to the Minister. I remind hon. Members that those should be brief. Subject to my discretion, it is open to hon. Members to ask related supplementary questions. 

Chris Leslie (Nottingham East) (Lab/Co-op):  Good morning, Mr Brady. I am glad that everyone is feeling so chipper and upbeat this morning. I commend the hon. Member for Daventry for his presentation on behalf of the European Scrutiny Committee. That was very helpful. I have a number of questions for the Minister, but will be as brief as I can. 

First, will the Financial Secretary update us on what happened at ECOFIN yesterday? I understood that the European Scrutiny Committee wanted the debate that we are having today to take place before yesterday’s meeting, to inform itself about issues that were likely to be debated or were expected to be decided at yesterday’s meeting. 

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I agree with the Minister on the question of asserting the principle of subsidiarity point and the important role of Parliament in being able to decide for itself its own relationships with Ministers and the Crown in respect of the release of information. 

My specific questions relate to some of the detail in the documents. First, will the Minister bring us up to date on the definition of tier 1 capital in CRD IV? I understand that one draft suggested that anything accounted for as equity under national law standards would meet the legal form required, but many people say that that would dilute the requirements set out in Basel III. Will the Minister update us on that? 

Mr Hoban:  On the hon. Gentleman’s first point, CRD IV was not on the agenda for yesterday’s ECOFIN meeting. Discussions are ongoing in working groups, but the Council of Ministers has yet to agree an approach. I will keep the European Scrutiny Committee informed of progress. 

The hon. Gentleman asked about capital definitions. Basel III requires a single definition of common equity. There is indeed a suggestion that there could be 27 different definitions of common equity. We think that goes against not only the spirit but the letter of Basel III. If we followed that suggestion through, what should be a solid framework or basis for calculating capital would look more like a Swiss cheese. We are therefore continuing to press on that matter. 

Chris Leslie:  Will the Minister tell us the latest on the possibility of deducting from capital thresholds amounts held by banking groups in insurance subsidiaries? Again, there is a question about the potential dilution of the level of banks’ capitalisation. 

Mr Hoban:  Basel III took into account particular banking models, including the bank assurance model that is particularly prevalent in France, although it also applies in the UK, particularly in Lloyds Banking Group. The package agreed in Basel III was signed up to by a number of European member states. Having been designed with significant input from Jean-Claude Trichet and Mario Draghi, the model reflected some European concerns. In CRD IV, we see a further dilution of Basel III, unpicking some of the carefully sought compromises reflecting individual models of banking and the overall level of capital. Our concern is that the Commission’s proposals dilute some measures, particularly by allowing a more generous carve-out for bank assurers. The Commission says that will be addressed in the financial institutions consolidation directive, and we would like more progress to be made within that directive. 

Chris Leslie:  The proposals in the documents also deviate from Basel III by not containing a binding commitment to implement the net stable funding ratio under liquidity issues. Obviously, that is of significant concern. Will the Government press the Commission to ensure that there are binding arrangements on the net stable funding ratio? 

Mr Hoban:  These are complex areas, but if we think back to the start of the financial crisis, one of the problems identified was that liquidity was not properly

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regulated. The NSFR is one way of regulating it. At the moment, the draft directive does not include a commitment to have that as part of pillar 1 by 2018. We are acutely aware of the importance that liquidity can play in strengthening the banking system. In recent months, we have seen institutions that hold inadequate liquidity come under pressure. We need more progress on liquidity in CRD IV. 

Chris Leslie:  These debates are always a learning exercise for all of us, and although Members will be familiar with the term “going concern”, they might be less familiar with the term “gone concern”. At what point will we ensure that we have in place the capital arrangements necessary to ensure the proper and orderly winding-down of a financial institution? The document on CRD IV does not seem to mention gone concern loss-absorption capabilities. Why is that? 

Mr Hoban:  A series of reforms are currently going through the process. The one that deals with the hon. Gentleman’s question is the crisis management framework, which looks at how bank debt can be bailed in to provide loss absorbency. It parallels the Vickers commission’s proposal to enable bank debt to be bailed in in the UK. We are pressing the Commission to publish the crisis management framework as soon as possible, so that we can debate such issues properly. 

Chris Leslie:  The great fashion now is to use contingent convertibles—CoCos—as instruments that convert into equity at a pre-specified trigger point: for example, when a financial institution’s tier 1 capital falls below a certain limit. What is the Minister’s opinion about the use of CoCos in the definitions of tier 1 capital arrangements, particularly for systemically important financial institutions? The Basel committee has rightly said that such institutions should be subject to extra capital requirements and that that capital should not be made up of CoCos, but CRD IV does not stipulate that. 

Mr Hoban:  The debate around CoCos is still developing. It ties back also into the issue of loss of bailable debt. A number of institutions across Europe have already issued contingent capital, before the conclusion of CRD IV. CoCos potentially have a role to play, but in considering capital and bank debt overall, we need to ensure that if a bank fails, there is has the capacity within the bank to absorb losses without requiring a contribution from the taxpayer. 

Mr Brian Binley (Northampton South) (Con):  It is good to serve under your chairmanship, Mr Brady. 

When I collected the papers this morning, I wondered what my constituents would think of such a great quantity. They would certainly expect me to ask some questions, because the contents of all these papers must have a sizeable impact, particularly on the small businesses that I represent. I have two questions. I understand that the Government like most of the proposals, but do not really want to say so, although they are concerned about questions relating to the Vickers report. Will the Minister explain that, in layman’s language? Secondly— 

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The Chair:  Order. Questions should come one at a time. 

Mr Binley:  Then I shall stand up again, Mr Brady, because I am going to get my questions out. 

Mr Hoban:  The debate that we are having with the European Commission and with other member states in the capital working groups is about ensuring that CRD IV affords a position that will enable us to introduce the recommendations of the Vickers report— 

Mr Binley:  I am finding it very hard to hear the Minister. Will he speak up, please? 

Mr Hoban:  In the Commission working groups, we are discussing how we can amend CRD IV so that it will enable us to implement the Vickers findings, which include a ring fence around retail banking activities and the ability to apply a high capital surcharge to ring-fenced entities, as well as matters relating to loss absorbency and depositor preference. We are making good progress on the application of additional capital surcharges, and the most recent draft produced by the presidency includes a mechanism enabling us to do that. In parallel, the Commission, recognising the debate in the UK and across Europe that has been triggered by the Vickers report, has set up a high-level group to consider such matters in more detail. 

Mr Binley:  I still do not quite understand how all that will impact on my small businesses. I repeat: will the Minister tell me in layman’s terms how that might affect a small business in my constituency? 

Mr Hoban:  One of the services that should be within the ring fence is the provision of banking services, particularly to small and medium-sized enterprises; it may also include SME deposits. That will mean that in the event of a banking crisis, the services that SMEs in Northampton South will be looking for will continue to be provided by a bank, which will be to the advantage of businesses in my hon. Friend’s constituency. 

Michael Connarty (Linlithgow and East Falkirk) (Lab):  I hope the Minister agrees that we are still in a banking crisis—certainly, all the banks that I have been looking at are still in crisis. That impacts strongly on SMEs, because banks are withdrawing agreements and loans to small businesses because of the losses they are suffering over the Greek Government haircut on commercially held debt in Greece. The crisis has not gone away. 

I have a number of questions, some on process, some on principle and some on detail. I apologise to the Minister if I go over some points again. Let us start with what is going on in the financial services working group. It did not come to ECOFIN yesterday, but the Minister promised in the explanatory memorandum he provided to the European Scrutiny Committee that “a second compromise text” would be presented in mid-February, and would be dealt with in the financial services working group, 

“with a view to agreeing a Council position on 13 March”. 

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He said that the Council did not agree a position yesterday, but has a new proposal been put before the working group, as promised in his written response to the European Scrutiny Committee? 

Mr Hoban:  I believe a new draft text has been circulated, but there has been insufficient progress in the working groups to enable it to come before ECOFIN. 

Michael Connarty:  What amendments have been made? Are they in our direction or away from the British Government’s position? 

Mr Hoban:  There has been progress in a number of areas. I will highlight one that goes back to the question asked by my hon. Friend the Member for Northampton South. It relates to introducing a capital surcharge for ring-fenced entities. The text in that case has definitely moved in our favour and provided a clearer legal base for us to enter into such a system. 

Steve Baker (Wycombe) (Con):  May I draw my hon. Friend’s attention to article 170 on the use of models? I have looked through the provisions, and most seem so elementary as to be not worth stating. For example, under article 170(e), 

“the institution shall complement the statistical model by human judgement and human oversight”. 

Does my hon. Friend share my view that such elementary provisions should not be imposed on institutions? Institutions should be capable of coming up with them for themselves. 

Mr Hoban:  One would have thought so, but we saw that in the run-up to the financial crisis people placed undue reliance on models or credit ratings, and institutions did not use their own judgment to question and challenge models and ratings. It may seem elementary, but in the past the elementary has often been overlooked. 

Chris Heaton-Harris:  I have a couple of questions. I noticed a recent article in Money Marketing headlined: “Hoban warns Europe over restricting UK regulators”. I am keen to get the language right, not only for my hon. Friend the Member for Northampton South but for my own sake. I managed to avoid these matters when I was in the European Parliament and left them to people who got really excited about them. We are pressing for jurisdictions to retain the right to apply higher levels of regulation, are we not? How is the Commission pushing against that, or have we won the argument to go that one step further? 

Mr Hoban:  In the directive we see the expression of a debate between member states and the Commission. The Commission regards the proposal as a maximum harmonisation directive under which the same approach would be applied in all 27 member states, but there is a group, which includes the UK, which believes that member states should have the freedom to go beyond high common minimum standards and to impose high levels of capital, if doing so is in the interests of their banking system and wider economy. There is growing recognition of the importance of our view, which was expressed recently in a letter sent by 12 Heads of

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Government before the March Council. There is a recognition that, yes, we should have higher common minimum standards, but that member states should be able to go further if necessary. 

Chris Heaton-Harris:  I thank the Minister for his reply, but I wonder why financial services are such a special case. Before Lisbon, it was always the case that a directive or regulations came through as a framework, but a member state could, if it wanted, go beyond the details contained therein. Why have we got ourselves into this position? Is there something in the Lisbon treaty that I did not see that flicked a switch so that that cannot happen? 

Mr Hoban:  This has arisen post-financial crisis. I do not think it was triggered necessarily by what was debated in Lisbon. Now, in what I hope are the later stages of the crisis—we shall see—there is a discussion about whether there should be maximum harmonisation in a number of areas of financial services. The debate in the Commission has moved on from the minimum harmonisation that we saw before to thinking much more about maximum harmonisation, to help to underpin a single rulebook so that the same rules are in place in every jurisdiction. In some cases, that helps businesses based in the UK to trade elsewhere in Europe, but in others, particularly where it affects financial stability, that trend towards maximum harmonisation is unhelpful. We need to be given the freedom we need to protect the stability of our own economy. 

Chris Heaton-Harris:  As I understand it, that is the Achilles heel of our argument. In some aspects of regulation we are asking for maximum harmonisation to be the limit; in others, we would like to go a bit further ourselves. I can understand the European Commission’s point of view: it just wants us to settle on a view. 

I have one further question on the Commission’s general views of the Government’s position on financial regulation. Today’s newspapers are full of the problems that solvency II is bringing to the City of London. At least in the press if not in the Treasury, there is a general feeling that the City is under attack from financial regulation. Does the Minister believe that his representations to the Commission are being heard and that we are in positive negotiations? Or are we just trying to claw back bits that we might already have lost in debate? 

Mr Hoban:  The example of solvency II is slightly off the topic, Mr Brady, but is helpful. The challenge is that the Commission and the Council have agreed a treatment of capital for insurers, which is supported by the Prudential and others. It is my hon. Friend’s former colleagues in the European Parliament who are seeking to unpick that compromise. When I raised the matter with Commissioner Barnier last week in Brussels, it was clear to me that the Commission supported the compromise agreed with the Council, and that it is the Parliament that seeks to unpick that deal. 

The fact that the Commission supports our position demonstrates that the Commission does listen and responds to our arguments about the impact of financial services on the real economy. That does not mean that we win

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every battle we fight, but we are making good progress. The changes in the CRD IV reflect the strength of our arguments and support from other member states, and an appreciation in the Commission of some of the challenges that we have made to the directive. 

Michael Connarty:  I turn to one or two matters of principle. I agree with the Minister that the European Central Bank is right to want everyone to have minimum standards. I understand that the ECB supports our Government’s position that individual Governments should have the ability to extend and strengthen those standards, but the ECB also supports the idea that the Commission should have the right to bring in delegated Acts which, until the European Scrutiny Committee received the most recent written information, I understood our Government opposed—quite rightly, I think. Do we still oppose the ECB’s position, and oppose that the Commission be given the right to bring in delegated Acts? 

Mr Hoban:  The hon. Gentleman is right to highlight the ECB’s support for our position on higher common minimum standards and the flexibility to go further, and I hope the Commission listens carefully to the ECB’s recommendations. As I briefly touched on in my opening remarks, we are still challenging the legality of the delegated powers and will continue to push that debate in Council and with the Commission. 

Michael Connarty:  Can I ask why we have this wishy-washy resolution before us? I have noticed that when the Government are in a corner, they normally just leave the difficult parts out of these resolutions, but that undermines the point of having the debate at all. It is quite clear that we have substantial positions of difference, but the Government do not mention them and do not ask the Committee to take a position on them—in fact, they are basically messing us around. That is not why the European Scrutiny Committee sent here documents here; it was not to get the Government to table a resolution that has no relevance to the points of real contention. As my fellow European Scrutiny Committee member, the hon. Member for Daventry, said, there are points of contention that need to be highlighted, debated and eventually voted on in this Committee. 

Mr Hoban:  I do not agree that it is wishy-washy. The proposed resolution encapsulates the key points of difference between the Government and the Commission. For example, it says that 

“the Committee…supports the Government’s view that to protect financial stability, avoid unnecessary international arbitrage”— 

the hon. Member for Nottingham East made some of those points about watering down and diluting bank assurance and definitions of capital, which are included—the EU should “fully and faithfully implement” Basel III and provide 

“Member States with the flexibility to respond in a timely manner to systemic risks”. 

Again, that argues against the maximum harmonisation approach that the Commission outlined. 

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Far from being wishy-washy, the motion is very clear and will be read and listened to in Brussels, because it encapsulates the main points of disagreement between the Government and the Commission. The hon. Gentleman may feel that the main points of disagreement are about some of the legal base issues, but for the Government the principal point is not about the legal base, but about whether the provisions will give us the freedom we need to impose the right capital standards on our banks to protect businesses and taxpayers in this country. 

Andrea Leadsom (South Northamptonshire) (Con):  My hon. Friend the Minister will have noticed that he has three passionate defenders of Northamptonshire businesses here today, so I would like to pursue slightly what my hon. Friend the Member for Northampton South said. Does my hon. Friend the Minister share my concern that although we all agree that capital and liquidity requirements were far too low before the financial crisis, now may not be the time to raise capital and liquidity requirements given that only 1% to 2% of the big banks’ balance sheets are invested in the real economy—SMEs in Britain, from which we all derive our work and employment? Does he agree that we should instead acknowledge that, because corporate debt is risk-weighted at 100%, whereas Government and other trading activities are much lower in capital terms, we risk incentivising banks through capital and liquidity requirements not to lend to the real economy, but instead to again invest their balance sheets in lower capital using activities? 

Mr Hoban:  There are a couple of points to think about in my hon. Friend’s comments. We need to ensure that banks are properly capitalised against the risks that they face, so we must get the risk-weighting right. We need to ensure that the capital that banks hold matches the risks they face, which means that it is important in every lending portfolio. 

If my hon. Friend wants our banks to be purely domestic, she should be advocating their break-up. Why is lending to UK SMEs 1% of banks’ balance sheets? It is because they are international banks. They operate not only in the UK, but globally—in part to serve the interests of UK multinationals that operate across the world. In the eurozone, if banks do not have adequate capital or levels of liquidity, confidence in them is undermined and it becomes harder, not easier, for them to lend to the wider economy. The fact that UK banks have held higher levels of capital and liquidity than some banks in the eurozone has meant that they have withstood the crisis in reasonably good shape and they have been able to increase their lending to SMEs and businesses in 2011, compared with 2010, which is a sign of their strength, not of their weakness. 

Andrea Leadsom:  My hon. Friend knows well that, in this country, we are proposing counter-cyclical capital and liquidity requirements. As I said at the start of my question, I am certainly not advocating inadequate capital and liquidity requirements; I am only observing that now is not the time to be ratcheting up those requirements, because that would effectively be shutting the gate after the horse has bolted. 

My hon. Friend also said that if I want big international banks to be domestic and competitive, I need to advocate that. As I think he would agree, ever since I came to this

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House, I have been advocating the break-up of the taxpayer-owned banks into their brands, and a radical improvement in the competitive outlook in the UK, with new challenger banks being brought in—I would welcome his comments on that point. I am sure that my hon. Friend would also agree that in the United States, which has about 3,000 banks, nobody notices when one or two go bust every month, so part of our problem with the banks being too big to fail is simply that our banks are too big, and that there are not enough of them. 

Mr Hoban:  We all agree that there should be competition in banking, which is one reason why promoting competition is a clear objective of the Financial Conduct Authority. That is also why the Government, rather than selling Northern Rock to Barclays or HSBC, have sold it to Virgin, to create a strong challenger bank, and to achieve a good return for taxpayers’ money. As a consequence of the aid given to Lloyds bank, a number of its branches are for sale and exclusivity has been given to the Co-op, to enable them to build up their banking system. We are therefore seeing new challengers entering the market, but we have a different banking structure to the US. 

As a whole, we have seen consolidation in the UK, not only in banking, but in building societies. There used to be a huge network of local building societies and over time, they have consolidated too. We need the circumstances in place to enable more competition, and the Government have taken further action to do that, but we also need to recognise that those banks need a customer base. Customers must want to opt for those banks, and a test faced by challenger banks is to ensure that they have a competitive offering, of interest to business and retail customers alike. 

Several hon. Members  rose  

The Chair:  Order. I remind hon. Members to try and keep their questions to the context of the bundle. 

Andrea Leadsom:  Our discussion is still on a relevant theme, which is that the Treasury Committee has pressed the Government very hard—and continue to do so—on a specific primary objective for the FCA to promote competition, instead of it being a secondary objective, as it effectively would be at the moment. My hon. Friend may be aware that the Financial Services Authority has no incentive to promote competition. A number of us have taken a lot of evidence from would-be new bankers, who have been sent away to develop a trading room at the cost of £1 million or more, and have then been told by the FSA, “No, you are not having a banking licence.” That is a major issue, and although my hon. Friend and I have had this discussion many times, I would be interested to hear again why he thinks that that would change when there is only a secondary objective for new competition. 

Michael Connarty:  On a point of order, Mr Brady. I have taken the trouble to read these papers over the last year or so and I know that that question is not at all relevant to anything in the bundle. It is a very interesting topic but it has no relevance, and I hope we will not start to enter into another banking discussion. We have much to press on this issue in this bundle. 

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The Chair:  There is much to press on this issue and there will be further opportunities to do so. I have reminded hon. Members on both sides of the Committee to keep their questions to the context of the bundle, and I am sure that the Minister will reply similarly in context. 

Mr Hoban:  All I would say, Mr Brady, is that if my hon. Friend looks at the Financial Services Bill, she will see that promoting competition is one of the three operational objectives that will drive the performance of the FCA. The Bill has moved on since the Treasury Committee made its report, and I recommend it. It is a good read. 

Michael Connarty:  I am the representative of Falkirk East, where the Airdrie Savings Bank has opened another branch. Diversity has been talked about, but it has nothing to do with this. I want to go back to the point of principle. I remind the Minister of what he said in his written submission: 

“the Government believes the inclusion of Article 443 of the draft Regulation, which would allow the Commission to adopt delegated acts to impose stricter prudential requirements”— 

contrary to what the hon. Member for South Northamptonshire was talking about earlier— 

“for example in relation to a particular Member State, is inappropriate and goes beyond the objectives of the proposal; and furthermore, this is a significant deviation from the Basel III agreement, in which prudential requirements are only minimum requirements, allowing Member States the possibility to impose higher prudential requirements.” 

That is such a fundamental challenge to the principle of Basel III that surely it must be one that the Government have as a red line. It certainly illustrates the concern of the European Scrutiny Committee and the reason why we are having this debate. Once again, it is competence creep by the Commission, which would allow it to regulate by delegated legislation even this country’s banking system, and surely it must be resisted by the Government. Why is that not in the resolution? Do the Government have no red lines when it comes to Europe? Are they totally supine because they get a deal on some other matters behind closed doors? 

Mr Hoban:  I refer the hon. Gentleman to the proposed resolution, which 

“provides Member States with the flexibility to respond in a timely manner to systemic risks in their jurisdiction”. 

That may not be dressed up in the language of legalities and articles, but I am keen to ensure that the resolutions are— 

Michael Connarty:  Wishy-washy. 

Mr Hoban:  No, comprehensible by Members who will at some point need to vote on them on the Floor of the House. I think it is very clear where we disagree with the Commission, and the resolution before the Committee reflects that. 

Mr Binley:  I wish to pursue the point made by my hon. Friend and neighbour the Member for South Northamptonshire, specifically regarding credit availability to small and medium-sized businesses. I am from the Business, Innovation and Skills Committee, so I am not

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quite as involved in the detail of the proposals as most of my colleagues. I am, however, involved in small and medium-sized business, and I know that most of the Government’s promises have not come to fruition and that there has not been more credit available to many such businesses that are struggling to exist— 

Mr Hoban  rose—  

Mr Binley:  Let me finish, please. Will the Minister assure me that there is nothing in this whole pack of papers that will make it more difficult for the small and medium-sized businesses I represent to gain the credit that they need to continue? Will he go further and say that within this great pile of papers there is some good news for those small and medium-sized businesses, which will provide the growth agenda that he so desperately needs? 

Mr Hoban:  I have three points to make in relation to my hon. Friend’s remarks. First, when the Financial Policy Committee looked at the level of bank capital a couple of months ago, it made it clear that banks should build up their capital not by reducing lending to businesses or to households but by putting a restriction on the distributions they made out of their profits, which meant tackling cash bonuses and dividends. The Financial Policy Committee and the FSA are mindful of the fact that one easy way to build up bank capital is to restrict lending, and they want to put in place measures that require banks to take action other than restrictions on lending to build up their capital. 

Secondly, my hon. Friend should stop and think about the amount of gross lending to SMEs in 2011 compared with 2010. We cannot control whether SMEs pay back their debt, but we can do things to help maintain the flow of gross lending to SMEs, which was up in 2011 by about 10% compared with 2010. That does not mean that every business in my hon. Friend’s constituency will get the credit that it thinks it needs, because banks have to make commercial decisions about price and credit risks. None of us wants to see a situation in which, because of bad judgments on credits, the taxpayer has to bail out banks again. 

Thirdly, if my hon. Friend is looking for some good news, the risk weights applying to SME loans are being reassessed as part of this discussion to see whether they are, as some would argue, too high. The only aspect of the review that might irritate my hon. Friend is that it is being carried out by the European Banking Authority. 

Chris Heaton-Harris:  The Minister could use the European Scrutiny Committee as his friend in this matter. When we wade through these documents, which is just so much fun there can be a party atmosphere in the Committee, we are trying to protect not just parliamentary sovereignty but the interests of the country. We suggest things that would back up his argument when he goes abroad. I was worried when he said just a moment ago that he was not concerned about the principle of which legal base is used. Having argued about using correct legal bases for different directives for a very long time, he will know that the push for any sort of tax on a common basis across the EU means

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that different legal bases that really should not be used are being mooted as the vehicle to drive these things. If the Government choose to ignore the worries about a legal base in one area we are opening up all sorts of issues for ourselves elsewhere. 

Mr Hoban:  My hon. Friend makes two helpful points. We use the Scrutiny Committee and its deliberations to help us in debates in Brussels. The reports the Committee produces are hugely helpful in that respect. That is why we were very supportive of the reasoned opinion that the House debated in November. It is unfortunate that more national Parliaments did not express the same concern. The process is helpful. As was touched on in a debate in the Chamber a couple of weeks ago, more engagement between the Scrutiny Committee and Government at an earlier stage in a policy direction is helpful and can be very constructive. I am looking forward to my evidence session this afternoon in that vein. 

My hon. Friend makes an important point about the legal base. He is absolutely right that in some cases the legal base is fundamental and is used to argue for common taxes and things like that. We need to be vigilant on this. The point I was making and perhaps I did not make it elegantly, is that the motion is trying to focus on some of the impacts rather than on the legality and the detail. It should be clear to all those who read them what motions like this, which express the will of the House, stand for. There will be no doubt in Brussels about which bits we are getting at as a consequence of this motion today. 

Steve Baker:  I was grateful for my hon. Friend’s earlier answer about the need to spell out elementary truths in this document. Indeed, we could have dipped in virtually anywhere and found something that is really teaching granny to suck eggs in the financial system. I am struck that one of the issues here about the terrain of the debate on all of these questions, including capital adequacy in relation to commercial risks, is that we have left in place all the moral hazard in the financial system and now we are trying to regulate away the consequences. Is there anything in this document that deals with the underlying moral hazard in the financial system? 

Mr Hoban:  One of the reasons why we have moral hazard in the financial system is the existence of the implicit taxpayer guarantee. The work that we are doing through the Independent Commission on Banking aims to remove that in the context of the UK by ensuring that banks hold enough capital to absorb losses or that where those losses exceed their equity, bondholders are bailed in so they bear that cost. As I said earlier, CRD IV is one part of the European jigsaw on this. The next document that we expect to see—the crisis management framework—will deal more explicitly with the issue of moral hazard and the implicit taxpayer guarantee. We should not see this as the only venture by Europe in these matters. I am keen to see the crisis management framework being brought forward because while we tackle the implicit taxpayer guarantee here at home, we need to make sure that that is tackled across Europe as well. 

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Michael Connarty:  I wish to continue to press the Minister on the matter of principle. I refer to the European Scrutiny Committee’s 56th report of session 2010-12. This is the purpose of our meeting today, I hope; this is why we send them for debate. Paragraph 0.28 —the final paragraph—of our report, which is the first document in the bundle but the last document we considered, states: 

“In addition to exploring with the Minister progress on solving the various important issues the Government has highlighted to us,”— 

they have been explored in terms of the detail— 

“in the debate Members might ask to hear answers to the unanswered points we put to the Government in our previous Report”— 

this is the second report that has put this to the Minister— 

“namely: our concerns, set out in the Reasoned Opinion, about the proposed internal market legal base of the Regulation and the legality of delegating powers to the Commission in Article 443 of the Regulation; and our concerns about Article 60 of the draft Directive, that is the attempt to impose rules on national parliaments in the way suggested.” 

These are fundamental to why we are here. Was the Minister involved in any way in discussing the drafting of the resolution and, if so, why did he choose to leave out those two very important points, which are the reasons behind this? Behind all the questions asked by other Members about how it affects SMEs and so on is the question of whether we give the Commission the power, which should lie in a national Parliament, to decide how our banking system is structured in a way that helps our economy. 

Mr Hoban:  I hope the way the resolution is drafted makes it clear that the UK wants to be in a position where it can go beyond high common minimum standards to impose additional capital requirements where that is appropriate, to reflect the nature of the UK banking system. We are in a position to implement the reforms proposed by Sir John Vickers, so that we have reform of the banking sector itself, to move to a more stable and sustainable level of economic activity. In my opening remarks I addressed the points on both article 443 and on article 60. We are exploring the legality of the legal base for article 443 and whether it is appropriate to use article 290 of the treaty. We have pursued the issue about article 60, to which the hon. Member for Linlithgow and East Falkirk referred, with the Commission and through the working groups. Our understanding from our discussions with the Commission is that article 60 is not meant to impede the work of parliamentary scrutiny Committees. We are dealing with those issues in our debates with the Commission. 

Michael Connarty:  May I press the Minister on that point? Are these red lines for the British Government, or have they given up the point of principle and just want to debate these matters? These issues seem to be so fundamental that the Government must say that they are red lines, or what signals are they sending to the European Commission, which will wear any Government down to get an increase in its competences? We have to be firm enough to say, “These are red lines and we will not give this up.” If we do not, the reality is that all the things that the Minister has said, if there are delegated acts given to the Commission, can be overcome and overtaken by anything the Commission does. If we give

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up this power to the Commission, we give away our right to do anything in the banking system in regulation that it does not wish us to do. 

Mr Hoban:  But the whole thrust of what we are trying to do in Brussels with CRD IV is to ensure that we have the power to do things such as the Vickers report— 

Michael Connarty:  To go further. 

Mr Hoban:  To go further. We talked just now about article 290 and we are concerned about the legality of it. We will continue to debate it. We have been assured that article 60 will not impede the work of Committees such as the European Scrutiny Committee. I am not sure how much further I can go in pursuing— 

Michael Connarty:  Red line. 

Mr Hoban:  We do not need a red line in article 60, because it does not do what the Committee says it will— 

Michael Connarty:  Article 443. 

Mr Hoban:  We are working on article 443 at the moment. It is too early to look at individual articles, because there is a lot of debate going on in Brussels. Our position is crystal clear. We believe in the UK that we should have high common minimum standards, but the ability to go further where that is appropriate. That is a key lesson that we have learned from the financial crisis. We do not believe that a one-size-fits-all model works across Europe. There are circumstances when higher capital needs to be applied and we need to get those rules right. We are working on that currently and we are some way from reaching a final agreement on this. I have committed to keep the European Scrutiny Committee up to date with our discussions on it. We are clear on the Government’s priorities on this and the motion sets them out clearly. 

Mr Binley:  This is my final point, Mr Brady, you will be relieved to hear. May I welcome the Minister’s good news? Good news in these times is very hard to come by, and we should applaud every little gem we get. I want to question the Minister on the statement that lending to SMEs went up by 10%. This is important, although not directly related to this point, in terms of what the Minister said. Yes, lending was up by 10%, but it was way down on what it was some eight years before that. The real point, however, is that the 10%, as with most of the lending, is related to the very top end of SMEs. An SME has up to 500 employees, but it is those companies in the middle and down below that are not getting money. Will the Minister recognise that and take that on board? 

The Chair:  I hope the Minister, in doing so, will clearly relate the answer to the documents before us. 

Mr Hoban:  The document before us ensures that banks are properly capitalised to enable them to lend to businesses. The worst thing that could happen is for banks not to be in a position to absorb losses and to end

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up either being bailed out by the taxpayer or having to rein back their lending to SMEs. We will not get lending to SMEs going unless we have a strong banking system. CRD IV will help us towards that, but other reforms, such as the Vickers reforms, which CRD IV should help us to achieve, will lead to the conditions that my hon. Friend seeks. 

Andrea Leadsom:  Let me make one last attempt specifically relating again to capital weightings. The Minister says that some review of risk weightings is ongoing to enable banks to be more incentivised to lend capital to corporates more cheaply, but does he agree that there is a fundamental problem when some of our big banks have only 1% or 2% of their balance sheet assets invested in the real economy? 

Going to back to what my hon. Friend the Member for Northampton South said, if we continue to allow enormous banks to exist—and try to deal with moral hazard and “too big to fail” simply through the regulatory system, rather than through competition—how will we ensure that they have the right incentives to lend to the bit of the economy that creates jobs and wealth? 

Mr Hoban:  The banks’ capacity or willingness to lend depends not only upon capital requirements, but also upon the strength of the economy and on getting the overall economic environment right, so that not only banks are in a position to lend, but also businesses want to borrow to promote and fuel investment. We do not want to see—I am sure that my hon. Friend will agree—some of the practices that we saw in the run-up to the financial crisis, when risk was mispriced and when banks lent money to businesses when there was no hope of return, which led to the taxpayer having to bail out the Royal Bank of Scotland and Lloyds. We need to ensure that the business practices followed by banks are consistent with having a stable, sustainable banking system and economy. I hope that my hon. Friend is not thinking that we should go back to those boom days when there seemed to be no control over how much banks lent and to whom and at what price they lent, which led to some of the collapses in the banking system. 

Andrea Leadsom:  That is not what I said. 

Mr Hoban:  The problem with this debate is that it is easy to make big statements, but it is actually quite difficult to get to the detail. The detail is in CRD IV. We need a competitive banking system and more entrants to the market, but we need well-capitalised banks that are in a position to lend. If one looks at what is happening in Europe with inadequately capitalised banks, they are not in a position to lend, which is causing part of the slow-down in the eurozone that is having a devastating effect on our own economy. 

The Chair:  As no more hon. Members want to ask questions, we will proceed to the debate on the motion. We have had quite wide-ranging questions, and I hope that the debate will be focused entirely on the papers that have been referred to us by the European Scrutiny Committee. 

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Motion made, and Question proposed,  

That the Committee takes note of European Union Documents No. 13284/11 and Addenda 1 to 4, relating to a draft Regulation on prudential requirements for credit institutions and investment firms, No. 13285/11 and Addenda 1 and 2, relating to a draft Directive on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms and amending Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate, and No. 5876/12, relating to an opinion of the European Central Bank on a proposal for a Directive on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms and a proposal for a Regulation on prudential requirements for credit institutions and investment firms; supports the Government’s view that to protect financial stability, avoid unnecessary international arbitrage and reinforce market confidence in EU banks it is crucial that the EU builds upon the G20 commitment to fully and faithfully implement the Basel 3 agreement and provides Member States with the flexibility to respond in a timely manner to systemic risks in their jurisdiction or to mitigate fiscal risk; and supports the Government’s ongoing efforts to reform the UK financial sector and system of financial regulation in order to protect UK taxpayers’ exposure to future losses.— (Mr Hoban.)  

9.54 am 

Chris Leslie:  I was wondering how long the discussion would go on, and I am actually quite cheered up— 

Mr Hoban:  You look chirpier. 

Chris Leslie:  Well, I am relatively cheered up by the calibre of our debate, because it is important properly to scrutinise this massive bundle of documents. In a sense, that goes back to my concern about parliamentary scrutiny of these many financial services reforms, and banking reforms generally. My view is that, as well as the European Scrutiny Committee, we probably need some sort of financial services regulation scrutiny Committee. The Treasury Committee does a fine job, but it has a limited number of members, a limited amount of time and a vast array of issues to cover. We seriously have to find an opportunity to revisit how we may properly debate the matter. Indeed, I thought the original intention was to debate this issue on the Floor of the House, but something has happened in the meantime. 

I am still not clear on the mystery of why the ECOFIN meeting did not get to grips with the matter. Obviously, the Minister is engaged in many negotiations below the surface, and he has a difficult balancing act to strike. The Opposition broadly support the Basel III process. Learning lessons from the global crisis is important, and the CRD IV arrangements should allow us to take that opportunity. 

From the questions I have raised, it is apparent that there are various twists and turns, not all of which are in line with the British view of how to strengthen regulation. The Minister has put his head firmly on the block today on a number of issues, such as maximum harmonisation, and whether we are going to win on that, the article 443 changes, and so on. We are mid-process, so it is difficult to tell exactly where this will end up, but I hope we get an opportunity properly to scrutinise the final arrangement. The presidency’s target date for wrapping this up is sometime in June. 

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The hon. Member for South Northamptonshire makes some important points. We need stronger risk weighting, but we should also be sensitive to the impact that risk-weighting definitions will have on the real economy. That is a difficult balancing act to strike, but pretending that such risk weighting will have no impact and no read-across would be to turn a blind eye. I do not claim to have an immediate solution for squaring that circle. 

My hon. Friend the Member for Linlithgow and East Falkirk also raises some important points. Many things are conspicuous by their absence from the motion, so I am not particularly inclined to support it. The motion is not especially firm, but I do not want to oppose the Minister’s attempt to get the best deal he possibly can in his negotiations in Brussels, so if the Committee divides on the motion, I will abstain. It will be interesting to see what happens during the rest of our considerations. 

We need to be a bit firmer with the Commission on many points. We have to talk about such things in plain English. If we fail to follow the golden thread that hits companies and consumers on the front line in our constituencies, we are not doing them a very good service. The difficulty with such debates is that our eyes can glaze over and we think, “Oh well, this stuff is all very technical and I am not particularly interested.” But, retrospectively, we all look back and say, “Oh, my goodness. What happened?” Getting this right is crucial, and I wish the Minister well in his endeavours, but we will be watching closely. 

9.58 am 

Michael Connarty:  It has been a joy to debate this subject with the Minister. For me, these are times of particular interest, as my degree is in economics, and my honours degree dissertation was on monetary theory and the problems of equity—really, it was all about the macro-economics of the UK economy and the disturbances caused by the behaviour of local government at the time, which used various borrowing mechanisms that seriously undermined the liquidity of the banking system. 

I note the Minister is taking the right approach on the definition of what is called equity tier 1. I hope he convinces the Commission to move away from its definition, which is so lax that, if it had its way, 27 different instruments would be eligible to be called equity tier 1, which are opposed by our Government because they are very dubious. My hon. Friend the Member for Nottingham East raised the question about the double counting of using insurance instruments as secondary to shares, when in fact we should be talking about something much more concrete. We hope that the minimum standards will be very firm. That may not the answer that the legions of the Northamptonshire SME support group want to hear, but the fact is that in the European context there is great laxity in what Governments are allowing to be called substantive reserves, against which banks lend and people borrow. That is the fundamental issue. 

My own professor worked for the Bank of England. He was a gold medallist from Cambridge and the youngest professor with his own department at the university of Stirling. He always argued very strongly that the rule should be 8%: if we want a secure banking system, institutions should have to hold 8% in Government bonds or gold to be able to lend. We moved so far away

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from that that we were lending on junk—it had no value—and leveraging that 30 times. That is why the whole thing imploded. 

I have great sympathy for those who are looking for loans for small businesses, because it is the failure of security in the banking system that caused the collapse and continues to cause the collapse—it is not going away in my area. More small businesses are being foreclosed on by the banks as they try to rake back some of the loans that they put out. I referred to this earlier. Many of those banks gave substantial loans to the Greek and Irish Governments. A bank in the UK that has given money to the Greek Government is having to take a haircut, as it is called, of 70%—it is getting 30p in the £1 back. As I said on the Floor of the House, that is more Sweeney Todd than Vidal Sassoon—more like a throat-cut than a haircut. Banks are having to make that up and get their debt level down by foreclosing on small businesses. It is shocking. 

We have to get this right, and I think the Minister is going in the right direction. I hope that he, with the support of the European Central Bank, will convince the Commission to be much firmer about what is considered to be correct and not correct. Speaking as a member of the European Scrutiny Committee, I can say that we wish the Government well in getting the details correct; however, we are deeply concerned that the European Commission is once again seeking to use the general debate, which is going in the right direction, to advance its competence in an area in which it should not have competence. 

When I was Chair of the European Scrutiny Committee, I attended many seminars with Commission officials and Treasury officials where the pressure from the officials of the Commission was massive. The Commission wants to strengthen its position in finance; it wants to have a European tax and to have control of the banking system. The Commission wants one central controlling mechanism: itself. We must resist that at every turn, and that is clearly why we put down a reasoned opinion. Under the Lisbon treaty, a reasoned opinion is put down when a Government believe or a Parliament believes that there is a breach of subsidiarity. That is the only time we do it. That is why a reasoned opinion is put down. We do not do many—perhaps three or four in a year if we are pressed—so we are obviously deeply concerned that this process contains within it a position of the Commission that will breach our subsidiarity and lead, step by step, to its taking over the regulation of our banking system. Once the Commission has been given a delegated power, it can use it for any purpose it wishes—and it will. It has done that again and again in different spheres. It will start to take control if it can. 

We want to have the ability to be stronger and more disciplined in our approach to the banking system. I am all for that. The European Scrutiny Committee is certainly not in the position of conceding to the Commission the right to decide what will happen in each country. That is why we are deeply concerned that no red lines have been put down. There are no hard positions put down by the Government that give the necessary signal to the Commission. That is what we are hoping for when the hon. Member for Daventry said that we could be helpful to the Government. Our strong position in the European Scrutiny Committee and in these debates strengthens

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the arm of the Minister to go and say, “We can’t have this deal, because back in our Parliament, we will not give up our sovereign right on these matters.” 

I am not a Eurosceptic—I am very much pro-Europe—but I have concerns that the Commission does not necessarily share our vision of the European deal among the member states. That is my concern in the sphere of finance. I am therefore pleased that the Opposition Front-Bench is not minded to support the motion, which is too weak. I certainly think the European Scrutiny Committee will commend my party’s approach, and I hope that others will follow suit. 

10.5 am 

Andrea Leadsom:  I do not share the view that the financial crisis was driven by collapsing businesses. I think it was the other way round: the financial crisis and the banks pulling the plug drove businesses to the wall. The financial crisis was of the banks’ own making—it was all about leverage, under-capitalisation and so on—so I do not think it is right to say that requiring banks to have counter-cyclical capital and liquidity buffers is to let them take greater risks. The two things do not follow at all. In fact, I was a big supporter of the decision under Basel III to permit counter-cyclical capital buffers. The Governor of the Bank of England has certainly made clear his intention to ensure that when he sees a bubble forming in the future—let us hope he has the foresight to see it—he will be able to impose higher capital ratios. 

Now is a time when SMEs desperately need to recover, but it is also a time when the FSA has been enforcing higher liquidity and capital ratios, even though that horse has already bolted. We should be looking at giving banks incentives to lend to the real economy, as opposed to making it harder for them to do so. The hon. Member for Linlithgow and East Falkirk thinks that is not relevant, but I do not agree—it is entirely relevant. In the past, regulation trumped competition. I was a director of Barclays bank, running the financial institutions group, at a time when we saw the massive consolidation of the banking sector and the broker-dealer sector. Banks bought fund managers, broker-dealers and building societies, and they were all thrown into a melting pot, with their legacy systems, their inability to have a single customer view and their inability properly to measure what was on their balance sheets. That is the legacy we carry forward with us. We now have four or five banks with 80% of the SME market, and four or five banks with the 80% of the personal current account market. That is the bit that matters most to us in the UK. 

There is a trade-off between competition and regulation. As a nation, we need to bear in mind financial services’ importance to our economy in terms of risk—bank balance sheets equate to five times our GDP, which is way greater than for any of our European colleagues. However, we also have to acknowledge financial services’ unique importance to our economy because they account for 11% of our tax revenues, making them as important to our economy as the automotive sector is to Germany’s. 

That is why we need to pay careful heed to the European Union’s desire to take over the financial services industry. The Germans would never allow the

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EU to encroach on the automotive industry in the same way. A German ambassador to the EU told me the other day that the British were being extraordinarily selfish for not having a financial transactions tax—surely we wanted to help out the Europeans and surely we accepted that it was our responsibility that they are all in a dreadful state. Once I had got off the floor and caught my breath, I said, “How would you feel if the EU decided to impose an EU-wide tax on every car produced in Germany, because of its impact on climate change?” He then saw the point. Britain therefore has a unique interest in financial services, in the same way the French have a unique interest in agriculture and the Germans have a unique interest in automotive industries. We have to be uniquely diligent in ensuring that we do not allow the EU to start encroaching on our ability to manage what is a massive risk and a massive asset. 

Financial services are also a massive opportunity. The Treasury Committee has just visited China—I will get to the point, Mr Brady—and the Chinese domestic economy clearly has massive potential for mortgages, life and health insurance and all the vanilla financial services products that might be an enormous asset to the UK economy. However, we do not have the diversity and the number of banks focusing on different aspects of financial services to enable us to take advantage of that very real opportunity, which ignores and is outside the EU, for Britain to grow its economy. 

I know the Financial Secretary feels as strongly as I do about regulation. The difference may only be one of nuance, but I think that we have allowed regulation to trump competition to a perilous extent, and now we need to allow competition to be up there equal with regulation. The Minister has said that the Financial Services Bill is a good read, and I am enjoying it as my bedtime reading—when I struggle to sleep, it sends me off within five minutes—but the key point is that its overall strategic objective still does not include the words “promoting competition”. As I have said, much evidence suggests that the FSA has no incentive to, and indeed does not, support competition in the banking sector in the UK, and that simply has to change. 

10.11 am 

Chris Heaton-Harris:  I welcome the Minister’s acknowledgment that the European Scrutiny Committee can be a helpful foil in his battle against—or negotiations with—the European Commission. We provide a pretty good scrutiny service. We could do a lot better and we could work more with other Select Committees but, generally the members of the Committee—the other members, not me, unfortunately—have a great deal of expertise and can deliver decent scrutiny that the Minister can use in making his arguments abroad. 

I was pleased to hear that the Minister is concerned about the legal basis, which has been a long-running theme of mine, both when I was a Member of the European Parliament and now as a Member of this Parliament. The European Scrutiny Committee wanted this debate to address that question, and I hope that the Minister understands how seriously we take it, because of our concern about how it might develop in future. 

Article 148, on page 170 of the bundle, is entitled, “Risk weighted exposure amounts for exposures to corporates, institutions and central governments and

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central banks”, and includes the calculation for credit risk. In my 10 years in the European Parliament, I constantly banged on about the need for ordinary elected individuals—not that we are particularly ordinary—to be able to understand what is presented to them. Last night, when I waded through the documents, I was doing okay: I could remember the debate we had, and I had my little financial dictionary beside me; Google and Wikipedia were also a great help. Everything was fine until I reached page 170. Can the Minister explain the calculation at the bottom of that page? I can hardly even read it out, although for the benefit of Hansard I will give it go, although I will halfway through because of its ridiculous complexity. It goes: risk weight equals open huge bracket LGD·N open slightly littler bracket 1 over the divisor of 1 minus R— 

Michael Connarty:  Square root of—as in econometrics. 

Chris Heaton-Harris:  That is very helpful. Look, this is my point: I spent most of Sunday reading the documents and then assisting my daughter in her maths GCSE revision, in which she had to do quite complicated equations; when she started to moan, I just pointed to that calculation and said, “I gave up maths a long time ago—just after my A-level—and I have no bloomin’ idea what that means.” 

The Minister does not have to explain in great detail. I just wanted to make the point that if the people who have to scrutinise and who will vote on these things read to the documents and think, “Oh, my God, what’s this?” how can anyone understand the regulations and the very important issue of risk weighted exposure in credit? Such a calculation does not help scrutiny, and I doubt that it helps legislation at all. 

10.15 am 

Mr Hoban:  If my hon. Friend will allow me, I shall start by stepping back from the detail on page 170. We are seeing a series of responses to the financial crisis, which continues to unfold—I respect the view of the hon. Member for Linlithgow and East Falkirk. CRD IV and Basel III are part of that and deal with capital requirements for banks; they also deal with liquidity and leverage, which were not regulated under Basel II and received insufficient attention. 

We are also addressing, in such things as the crisis management framework, how to tackle the implicit guarantee and how to resolve failing institutions. That is important for us because one of the biggest distortions of the single market is the existence of the implicit taxpayer guarantee in some jurisdictions, so we need to attend to that. That is not the only answer, though. To go back to the point made by my hon. Friend the Member for South Northamptonshire, there is also an issue of competition. Clearly, the more competition there is in the market, the more helpful that is. Competition requires lower barriers to entry, but also lower barriers to exit, so the right resolution framework is very helpful in creating a more competitive market. Some would say that one of the problems at the moment is that it is very hard to leave the banking sector. It is much easier to leave it in the States, as my hon. Friend understands. 

Often, we lack the opportunity to step back. On the competition point, there are three operational objectives for the FCA: market integrity, consumer protection and competition. Prior to the Treasury Committee report,

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competition was a duty, not an objective. We are righting the balance between the FCA and the OFT. I completely agree with my hon. Friend: the FSA did very little on competition. The fact that it is now one of the operational objectives of the FCA will mean that competition is taken more seriously. That is because we think regulation and competition together can lead to better outcomes for consumers. We should not lose sight of that point. 

My hon. Friend also captured and summarised the British dilemma. We have a successful financial services sector. It is a huge employer: financial services and professional services together employ nearly 2 million people. In all our constituencies are people who work in the financial services sector. We therefore have a commitment to its continued success, but we cannot afford to put our economy at risk, as we have done in the past decade. When the sector was in crisis, the impact economically and on taxpayers was huge, as we bailed out RBS and Lloyds. We need to think about how to get the regime right to minimise the risk of a recurrence. 

In the run-up to the financial crisis, there was a credit bubble. Banks were lending money at ridiculously low interest rates with quite light conditions. I suspect that if we looked through the FSA’s report on HBOS, which was published last week, we would read about such behaviour, which led to the downfall of that bank, with a significant impact on the wider economy. We need to have in place a response to such crises. 

Where does CRD IV fit into that? There are three strands. Thinking about capital for a moment, that strand can be divided into two parts. One is about macro-prudential measures—the counter-cyclical capital requirements that my hon. Friend the Member for South Northamptonshire raised—and the other is about increasing the level of capital. We would all agree that banks were undercapitalised at the start of the crisis—that is why the taxpayer has picked up so many losses—and macro-prudential tools can help us to dampen the cycle. The interim Financial Policy Committee will shortly produce some more work on that issue. We need to get capital and counter-cyclical capital right. 

My hon. Friend the Member for Northampton South echoed a point about timing and impact made by my hon. Friend the Member for South Northamptonshire. I have discussed the matter with the FSA, as I share those concerns. Is the lack of available capital squeezing out lending to SMEs? It has sought to approach the change in capital standards in a way that minimises the impact. We need to bear in mind that, although there is a lot of emphasis on gross lending, which is why we set up Project Merlin last year, businesses are de-leveraging—they are paying back the loans. That is why almost record amounts of cash are being held on company balance sheets at the moment. That leads to bank de-leveraging. 

In my conversations with bank CEOs, none has said that capital is a restriction on their ability to lend. The fact that in their most recent round of results they all made commitments to maintain lending to businesses at 2011 levels, and expressed willingness to go further if there is demand, is a sign of that. 

Andrea Leadsom:  I have a question about risk weightings. Obviously, corporates are 100% risk weighted and Governments significantly less—many Governments are zero risk weighted—it is much cheaper in capital terms

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to trade Government bonds than to lend to corporates. Does the Minister accept that position that dates back to the days when it was always assumed that a corporate was much riskier than a sovereign? Have not the events in Europe highlighted the fact that risk weightings are a completely wrong incentive—an incentive for banks to do the wrong thing? Does he agree that it is important to focus on changing those risk weightings to make lending to corporates less capital intensive? 

Mr Hoban:  My hon. Friend is right to highlight changing perceptions of sovereign debt post-financial crisis. Basel needs to look at that. I would make the point that risk weighting should reflect risk and be based on an objective assessment of risk. That is why the European Banking Authority’s work on reassessing the risk weightings applied to SME lending is important. I am not sure that will lead to the outcome my hon. Friend seeks, but it should be objective and evidence based, as all policy making should aim to be. 

The second point I want to make to my hon. Friend is about moving to higher levels of capital. When Basel III was agreed there was a transition period up to 2018. What we have seen in the response to the banking crisis in the eurozone is market pressure for banks to increase their capital faster. It is not just about regulatory intervention: a set of stress sets was done early last year where more disclosures about banks’ holdings of sovereign debt were published, which led to bank analysts doing their own stress testing and identifying where the risk was. The move to higher levels of capital is not just about a regulatory intervention; in part it reflects market pressure. We just need to unpick those strands. 

It is also the case that, because eurozone banks have been less liquid or hold smaller reserves of liquid assets, they have faced more pressure. The ECB has had to pump in nearly €1 trillion in the long-term refinancing operation facility, which has been hugely beneficial in calming down the banking markets, but makes them more dependent on ECB funding. That was a reflection of the fact that banks did not hold sufficient liquid assets, which seized up the eurozone banking market and restricted lending there. There is a fine balance between the pace of transition to high levels of capital liquidity and market confidence. 

The UK banks are in a stronger position because the FSA acted sooner in requiring banks to hold more liquidity and more capital. They withstood the crisis in a far better state. From my conversations with the FSA and the Bank, I do not think that the requirement to hold more capital liquidity has acted as a brake on their ability to lend to businesses. They have made it clear that, if there is demand, there is supply of lending. 

As the hon. Member for Linlithgow and East Falkirk said, liquidity and leverage are important parts of Basel III and CRD IV. The hon. Member for Nottingham East also mentioned that in his remarks on the net stable funding ratio. We need to get the legislation and regulation right. If we want high common standards across Europe, we need to address the definition of equity tier 1, as raised by the hon. Member for Linlithgow and East Falkirk. To my mind, a high common minimum standard is not 27 definitions, but the measure, which we continue to work on, is not about having a consistent approach across Europe. 

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As I said earlier, bank assurance was dealt with in Basel III and is a trade-off between the provisions or allowance made for double counting and the overall level of capital held. CRD IV dilutes the standards on bank assurance without a commensurate increase in capital. I do not argue that we should require an increase the level of capital, but let us stick to Basel III and implement it in full. 

I will conclude by going back to page 170 of the bundle, not to explain the detail of the equation, but to highlight a valuable outcome of debates such as this, which was required by the European Scrutiny Committee. As hon. Members have made clear, these issues have an impact on business, on the functioning of our economy and on households. The role of politicians is not necessarily to second-guess the judgment of the regulator—were we to do that, we would set ourselves up as quasi-regulators, which would be dangerous territory. Our role is to set the perimeter or the framework for regulation, and political engagement is needed in that process. There need to be people who understand the formulae on pages 170, 171, 173 and so on; equally, there need to be people—us—who can translate the impact into what it means for business and can use that understanding to help inform the discussion. 

Of course, the way businesses and banks calculate capital is more complicated. They rely on internal models underpinned by a wealth of formulae to get the right outcome, but we need to be involved in shaping that outcome. Such debates are important because they help to inform not only our negotiating position, but the Commission on the importance of the issues. 

Supporting today’s motion would send a clear signal to the Commission that the UK wants to take control of the regulation of banking and needs the freedom to go further. Opposing the motion would risk sending a signal to the European Union that Parliament favours a single rulebook and maximum harmonisation, which I do not believe it does. Let us send the right signal to the Commission by supporting the motion. 

Question put and agreed to.  


That the Committee takes note of European Union Documents No. 13284/11 and Addenda 1 to 4, relating to a draft Regulation on prudential requirements for credit institutions and investment firms, No. 13285/11 and Addenda 1 and 2, relating to a draft Directive on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms and amending Directive 2002/87/EC on the supplementary supervision of credit institutions, insurance undertakings and investment firms in a financial conglomerate, and No. 5876/12, relating to an opinion of the European Central Bank on a proposal for a Directive on the access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms and a proposal for a Regulation on prudential requirements for credit institutions and investment firms; supports the Government’s view that to protect financial stability, avoid unnecessary international arbitrage and reinforce market confidence in EU banks it is crucial that the EU builds upon the G20 commitment to fully and faithfully implement the Basel 3 agreement and provides Member States with the flexibility to respond in a timely manner to systemic risks in their jurisdiction or to mitigate fiscal risk; and supports the Government’s ongoing efforts to reform the UK financial sector and system of financial regulation in order to protect UK taxpayers’ exposure to future losses. 

10.28 am 

Committee rose.  

Prepared 15th March 2012