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To be published as HC 1534-i

House of commons



Treasury Committee

Independent Commission on Banking

Monday 10 October 2011

Sir John VickerS, Martin Taylor, Bill Winters and Martin Wolf

Evidence heard in Public Questions 1 - 127



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Oral Evidence

Taken before the Treasury Committee

on Monday 10 October 2011

Members present:

Mr Andrew Tyrie (Chair)

Tom Blenkinsop

Michael Fallon

Mark Garnier

Stewart Hosie

Andrea Leadsom

John Mann

Mr George Mudie

Jesse Norman

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Sir John Vickers, Chair, ICB, Martin Taylor, ICB Commissioner, Bill Winters, ICB Commissioner, and Martin Wolf, ICB Commissioner, gave evidence.

Q1 Chair: Thank you very much for coming before us and for the huge amount of work that all of you have done, and one of you missing, on a very complicated subject of enormous importance to the country at the moment, and indeed well beyond these shores. Before we get into some of the meat of the report itself-and you have had from us a list of questions that we had for the interim report, which I think to some degree will serve as a basis for these exchanges-could you say whether you are happy with the fact that Moody’s downgraded our banks, apparently in response to your report?

Sir John Vickers: Thank you very much, Chairman. May I just place on record, on behalf of the Commissioners, our thanks to the secretariat who worked with us, who were absolutely magnificent in all their work? We would never have been able to put this together without that.

On the Moody’s downgrade, insofar as that is a reflection of a step of progress in getting the taxpayer off the hook, I personally would see it as an entirely benign development.

Q2 Chair: So there is no downside to the downgrade?

Sir John Vickers: Insofar as it reflects that factor, and that is what was emphasised when they made the downgrade, I would see it as a natural reflection of the taxpayer getting one step further off the hook, so I would not see a downside in that.

Q3 Chair: You are not concerned by reports that it might trigger a further bailout in RBS?

Sir John Vickers: There are many other things going on in the world but the reason cited in the context of the downgrade was the implicit Government guarantee, and on that I have expressed the view. Maybe others have-

Martin Taylor: I think if Moody’s had published a report on the UK banks and had said, "We don’t take the ICB’s suggestion of removal of the implicit guarantee seriously and we therefore see no need to downgrade the UK banks", we would have considered that a retrograde.

Q4 Stewart Hosie: Sir John, you have said that the annual pre-tax cost to banks of the actual reforms would be in the £4 billion to £7 billion range. Was that an in-house analysis or was it an average of external analyses? How did you come to that figure?

Sir John Vickers: Yes, what we have said is that our best estimate would be within that range. There is a lot of uncertainty around that however. The evidence that went into formulating that estimate is a mix of things. A number of City analysts, particularly in the summer, produced their own estimates, which we were able to look at and study and assess their methodologies and so on. We also had data provided to us on a confidential basis by the banks so we could compare and add that other evidence to the evidence pot that we had available. It was a combination of our survey of external work, together with our own internal work and, as I have indicated, that internal work had the benefit of confidential data from the banks. It was on that basis that we thought that some of the City estimates, which ranged up to £10 billion annually, were going too high and that the likely true number-no one knows exactly what it is-was distinctly lower than that, and hence we arrived at the range you described. That is the private cost to the banks.

Q5 Stewart Hosie: Within that, £1 billion to £3 billion is what you have called the social cost, which leaves us between £3 billion to £4 billion on your estimate, possibly higher. Can you tell us how that £3 billion to £4 billion non-social cost is derived? How do the banks come to that figure? What would that cost figure include?

Sir John Vickers: The difference between the £4 billion to £7 billion range and the £1 billion to £3 billion range is that the latter are the private costs and former the social costs, but it was not the banks who were providing an estimate of that difference; that was our own work. The two main factors are, first, the point already discussed about the curtailment of the implicit Government guarantee and we believe that most of the private cost to the banks, which comes through funding costs principally, relates to the curtailment of that implicit guarantee, which is not a cost to the economy as a whole although it is a cost to the banks.

The second most significant factor in that difference is that on the recommendation of higher equity requirements, together with the recommendation that the ring-fenced entity has its own self-standing capital pot, there is a tax differential between equity and debt and that differential translates to a private cost, although it is not a social cost, because the Exchequer gains the revenue from that tax difference. So if you put those two ingredients into the pot they are more than half the £4 billion to £7 billion, hence the £1 billion to £3 billion.

Q6 Stewart Hosie: Equity costs, a self-standing capital pot, the tax difference between equity and debt and the curtailment of the implicit guarantee is effectively that difference. That £4 billion to £7 billion in total, is that all of the banks or is that just the big four?

Sir John Vickers: I stress that these are all uncertain figures, but the intention is that it be the cost to the banks as a whole. By far the largest element of that relates to the largest banks, not only because they are the largest banks but also because the value to them of the implicit guarantee is proportionately greater than to smaller banks.

Q7 Stewart Hosie: Of course. In terms of those costs, whatever they end up being, what do you think the balance is between what will fall within the ring-fence and what will fall outwith the ring-fence? What number falls on the narrow banking and what number falls on the investment side?

Sir John Vickers: Again, precision is impossible and would be spurious but there are strong reasons to think that most of the cost would be outside the fence because in terms of unstructured universal banking, the scope of Government support, should there be a calamity, applies not just, as it were, to High Street banking in the UK but much more generally. So we think it is likely that the majority of the cost would be outside the fence; probably a bit of both however.

Q8 Stewart Hosie: Has there been any comment in terms of the possible impact on investment or lending decisions if the bulk of that cost was lying outside the ring-fence?

Sir John Vickers: If it is outside the ring-fence and if international wholesale and investment banking is competitive to the extent that it is, then the competitive marketplace would discipline the pass through of that cost to the final consumer. But even on a ready reckoner basis if one assumed it was an even spread right across all the balance sheets of those costs, given an aggregate balance sheet of £6 trillion or so, then the £4 billion to £7 billion would translate, say the number is £6 billion, to one-tenth of 1%, so that is the scale of things in proportion to the balance sheets.

Q9 Stewart Hosie: So if banks come and say, "We are terrified this is going to damage us" we can point to you and say it is a few basis points and we shouldn’t really worry about it?

Sir John Vickers: You are welcome to point to our report on any matter.

Q10 Stewart Hosie: Just one final question. You said that, "Establishing the private costs of the recommendations, the proportion of these that are social costs and the benefits of reform all necessarily involve significant irreducible uncertainties". Can you tell us what the most significant irreducible uncertainties are on the cost side of the equation?

Sir John Vickers: There are quite a few of them. There is, first of all, uncertainty about how large the implicit Government guarantee is and that might be a matter that comes back in a later question, so that would be one factor. That one itself evolves through time so even if one had a perfect snapshot of it now, that would not speak to the future in, say, 10 years’ time necessarily.

Another area where it is very hard empirically to quantify the matters at hand is to what extent there are cost synergies between retail banking on the one hand and wholesale investment banking on the other. We have tried to propose a design for the ring-fence that maintains to a very considerable extent such synergy benefits as exist. Some may be forgone by the restrictions on the transfer of capital within a group, if there were to be a ring-fence, but to quantify that is a difficult thing to do. We did not get a great deal of evidence from the banks that aided us in that quantification, but that would be another example.

Q11 Stewart Hosie: In terms of what you were able to quantify, you did say that, "The recommendations would deliver net benefits, it would reduce the probability or impact of crises by a range between one-fortieth, 2.5% and one-thirteenth, 7.5%". How on earth did you get to that degree of certainty, to the 2.5% and 7.5%?

Sir John Vickers: I hope we hedged the statement that you have quoted with appropriate caveats, but the basic arithmetic was as follows. We have been talking about the cost of the measures. Turning to the benefit side of the equation, the cost of financial banking crises is absolutely huge. We took as what we consider an entirely reasonable but working example the central estimate of a study of the Bank for International Settlements, which is that a financial crisis, if you like an average one where there is no such thing as a typical one, might well entail a GDP loss that has a net present value of 60% of annual GDP, so the range is huge around that.

Then you have to say, "How often do crises come along? What insurance premium would you pay if you could get rid of them altogether?" and do that thought experiment. On what we think is a reasonable worked example, that insurance premium was 3% of GDP to eliminate crises altogether, and that equates to about £40 billion of GDP at the moment, a little bit more, and it is by comparing that £40 billion with the £1 billion to £3 billion that you get the 40th or the 13th.

We were not claiming that that insurance premium is an absolutely rock solid number. We were putting together what we considered to be a number of reasonable assumptions, coming out with an estimate, which others are perfectly free to disagree with on the upside or the downside, but that mechanically is how we got to the figure that gave rise to the 40th or 13th.

Q12 Chair: Setting aside the numbers, do all the banks agree that methodology?

Martin Taylor: Well, they haven’t proposed a different one as far as-

Chair: That is not quite the question. Do the banks now accept that they are a subsidised industry, like agriculture or any of the others that collect a cheque from time to time?

Sir John Vickers: They have not, in those terms or in similar terms, said as such to us. I would, however, say that I think there is a shared view that there ought not to be an implicit Government guarantee, that there ought not to be an implicit subsidy, but views differ as between the banks and ourselves and others about quite how large that implicit guarantee might-

Q13 Chair: I said setting aside the numbers. My question is just on the methodology, which you do set out in your report and which is interesting.

Sir John Vickers: I do not recall anyone arguing that there ought to be a subsidy.

Q14 Chair: There has been no challenge to this methodology from the banks? They will be coming before us; I just want to be clear.

Sir John Vickers: Yes, others have produced different answers but along similar methodologies. For example, internationally, the Institute for International Finance have a method, with which we do not agree, which produces much, much higher cost figures. I forget what they do on the benefit side of the equation. Theirs is a global study not a UK study.

Martin Wolf: I just wanted to add on this particular point that, as I am sure you know, the rating agencies quite normally analyse the creditworthiness of banks on the basis that they stand alone and support ratings, which is indeed what they have just adjusted in the case of Moody’s for UK banks, and bank analysts, so the employees of banks quite normally use those different ratings to assess the impact of changes in support. So it would appear to me that the financial sector broadly and the banks’ employees explicitly do recognise that there is a subsidy associated with Government support and that it has considerable value. That was the question you asked.

Chair: It is. I do not want to prolong this discussion.

Martin Taylor: I simply wanted to say some of the banks have argued that in normal times the subsidy was not a benefit to them because it was passed through to customers. I don’t think we agree with that. As to the question of whether the subsidy exists, given the Dexia story over the last two or three days you simply have to look around you. Subsidies are very, very clearly there and alive and well.

Martin Wolf: A great many institutions were saved by taxpayers around the world and in this country, and if they had not been saved by taxpayers they would have collapsed and their creditors would have lost money, that is a subsidy, period.

Chair: That is why I have been asking the question, not is there a subsidy but is there agreement of a methodology by which it should be calculated.

Q15 Mr Ruffley: Sir John, your report concludes that, "Any economic impact resulting from the proposals specifically on UK competitiveness, including that of the City, should be broadly neutral or positive, especially over the longer term". I just wondered, can we deduce from that that you think in the short or medium term there might be damage to the City’s competitiveness?

Sir John Vickers: That is not the intended inference at all. We saw our task as being for the medium and long run. In other words, our task was to propose a set of measures that would be a much better platform for stability and a more competitive platform in the marketplace for the future. There clearly are short-term issues and if we had recommended a very tight timetable, such as get it all done by 2014, then I think there could have been a detrimental impact on the shorter term from the recommendations, but we went for a longer timetable than that. Indeed, the end date we recommend is the same as the Basel date of the start of 2019. We believe that that, together with the nature of the proposals, should remove any concerns that people might have had about a shorter term adverse impact.

Q16 Mr Ruffley: Just to be clear, you do not think, because of the timetable you have set out and the Chancellor has endorsed, there will be any short run negative impacts on the City’s competitiveness in the world?

Sir John Vickers: Correct, that is my view and if there is policy credibility, and this is a matter for Government and Parliament, behind measures that would make for improved banking stability in the UK, I think there might be, as it were, a dividend from that credibility, even before the implementation date.

Q17 Mr Ruffley: Sure. Many commentators, particularly Charles Goodhart, have made the assessment that it will be harder for UK investment banks to compete with foreign competitor banks and a result could very well be the so-called Wimbledonisation of the City of London, that is to say the UK hosts the tournament but all the leading players are from overseas. In terms of the analogy, foreign banks might prosper to the relative disbenefit of UK banks in the square mile. Do you agree with that assessment?

Sir John Vickers: The curtailment of the implicit Government guarantee, which we were just talking about, inevitably raises the funding costs of banks that have been benefiting from that guarantee. In line with the response to the earlier question, insofar as that is mostly felt in the international activities, then the funding costs of the affected banks in that area increase as the entirely natural counterpart of the market perception that that guarantee has been curtailed. So there is that effect and we have never sought to say otherwise.

Beyond that, there seems every reason to think that London remains an incredibly attractive centre to base banking operations, both for UK banks and other banks. I welcome the openness and internationalism of the City as a host but I certainly would not expect Wimbledonisation in the terms that you describe. Maybe British tennis will improve, as it is at the moment.

Q18 Mr Ruffley: Have you had any comments from UK investment banks that their competitiveness will be hit? Have they quantified for you or have you tried to quantify what the impact will be on UK investment banks in the square mile?

Sir John Vickers: Part of it comes out of the response to the questions earlier about the £4 billion to £7 billion and where that is felt and so on. I am conscious that Bill and Martin are better placed to answer that than I am certainly.

Q19 Mr Ruffley: Perhaps Mr Winters might want to reply, specifically on the UK investment banks competitiveness vis-à-vis foreign investment banks.

Bill Winters: A large portion of this cost that John referred to earlier will relate to the international investment banking operations for UK banks, for sure. That is where we think the costs will be concentrated and obviously, as John said, the objective of our Commission, and I think this Government and other Governments around the world, exclusively and entirely has been to eliminate the subsidy. If you speak to the American Government, the French Government, the German Government, they all want the subsidy out. Each country has taken its own path to reducing or eliminating that subsidy. The UK has asked us to conduct this report, which we have done and which we are discussing.

The United States passed the Dodd-Frank Act, which does not recommend ring-fencing, does not have an increased primary loss-absorbing capacity, but does introduce notions such as the Volcker rule, which prevent banks from proprietary trading. Of course there is a ring-fence already in the United States between commercial banking and investment banking, which has been around in various forms for 70 years.

When we speak to American bankers they frequently say that the American banks are being tremendously discriminated against relative to British and other European banks. The British banks of course say that they are being discriminated against; the French and the German banks say the same about their own Governments.

The only thing I am certain about is that every Government has the objective of eliminating the subsidy in its entirety. The second thing I am pretty sure about is that we have been more thoughtful about the process, perhaps in part because we are an independent Commission that had a year and a very strong secretariat to work through this in a relatively neutral environment, but perhaps for other reasons. I think we have come up with a thoughtful approach to removing the subsidy that is particular to the nature of banking in Britain, and I think that puts us in a good place.

Q20 Mr Ruffley: Final question, Sir John. What are the chances, do you think, of a major UK bank moving its company HQ outside of the UK as a result of the ICB proposals?

Sir John Vickers: We have put a lot of work-

Mr Ruffley: It is a straightforward question. What is the probability of one of the major banks relocating its HQ?

Sir John Vickers: Obviously those are questions for the banks but my response to your question would be a low probability. We put a great deal of work into this and we have calibrated our proposals on equity, on other primary loss-absorbing capacity, the design of the ring-fence and so on. The intent, absolutely, is to achieve the stability benefits at the lowest cost to the economy and indeed to the affected banks. If we had disregarded those considerations, the ones behind your question, we would have come up with different proposals, but we think where we have calibrated it, and I draw attention to two things in particular, firstly, the ring-fence-one of the advantages of the ring-fence architecture is you can have higher domestic standards than apply internationally. So one of the merits, as we see it, of the design is to enable international standards to apply to international business. As for retail banking itself, that is not the kind of activity where the difference of a few basis points on capital requirements or funding costs will cause a whoosh of business one way or the other, because the High Street is the High Street.

We have looked very carefully at things like the European rules around passporting and branching and all the rest, and there is quite a lot both in the interim report and the final report to back up our belief that the probability of relocation is low.

Q21 Mr Ruffley: So neither Standard Chartered nor HSBC nor Barclays intimated to you or any of your colleagues on the ICB that they would consider moving out of the UK as a result of the proposals?

Sir John Vickers: It may have been at a very early stage before we had got to the design.

Mr Ruffley: I am talking about your final proposals.

Sir John Vickers: Our final report? I was at a conference in Washington a couple of weeks ago where Bob Diamond said almost the opposite. Well, not the opposite of that but he said that some uncertainty has been taken away, London is a terrific place to do business and so on. Your question was as a result of our proposals if they were adopted-

Mr Ruffley: Your final proposals, yes.

Sir John Vickers: -and I think the short answer to your question is no.

Martin Taylor: I think if a bank were to take that decision it would not be just as a result of our proposals. It would take into account other things that the banks frequently complain about, as the Committee well knows, such as the bank levy, levels of personal taxation and so on. But we have had nobody make that threat to us.

Q22 John Mann: Mr Winters, you said it is the policy objective of every Government to remove subsidies. Does that include the Government of China?

Bill Winters: No, it does not and I realised as soon as I said that that there are exceptions. Thankfully the Chinese banks are not competing with British banks for international investment banking business, so in terms of the context in which British banks are operating, and therefore the competitiveness of the British banks, I think the countries that represent the competition for British banks are uniformly in favour of removing the subsidy.

Q23 John Mann: Today’s competition?

Bill Winters: Today’s competition, that is right. I think that begs the question if in the future countries choose to subsidise their banks, what should the proper policy response be for Britain? That is not within the remit of our Commission but it is a very vexing question because it is hard for us to see that subsidising British banks, because other countries have chosen to subsidise their banks, creates value in the short, medium or long term for the British taxpayer.

Q24 John Mann: Sir John, why are no other Governments adopting your proposals? Why is it that we have got it so right and have they got it so wrong?

Sir John Vickers: I would say two things in response to that. First, we were asked to produce proposals for UK banking against the background of the factual situation here. The factual position for the UK is different from that of a lot of other countries, in terms of the ratio of banking assets to GDP, which is partly a reflection of the success of the City of London, so that by itself is not sinister although it is a potential risk to the UK economy. Then with unstructured universal banking you have High Street banking and international investment banking, as it were, on the same book.

It is also the case that some other countries are taking steps, if not precisely the same steps. Bill has already referred to Dodd-Frank in the US. The Volcker rule is part of that structurally, and it is in a context where even after the repeal of Glass-Steagall there are forms of separation between banking and other kinds of financial activity in the same groups with Rule 23 and Regulation W. The Swiss are a country with another very high ratio, unlike the US but like us, of bank balance sheets to GDP. They had a commission whose main focus was on capital and loss absorbency more than on structural issues, and there are other countries looking at the matter. Who knows where policies in different countries might lead, but we are not prescribing beyond the UK. That was the task we were set and that is what we have sought to do.

Q25 John Mann: Which begs the question whether that was the right brief.

Sir John Vickers: In a sense, that is not a question for us but since you have asked it-

Q26 John Mann: I think it is a question for you in the sense that because the Governor is making dire predictions since your report, not because of your report but since your report, are we looking-we, Britain plc, Government, the rest of it-far too inwardly for solutions and missing the moving world?

Sir John Vickers: No, I believe we are not. I did say that we are not seeking to prescribe beyond the UK. I think our remit was perfectly appropriate in its geographical scope. As to the nature of our recommendations, we are clear in the report, and we were in the interim report, that on capital and loss absorbency we think there is a case that goes well beyond the UK for higher capital requirements and much greater loss absorbency, and we comment on the international Basel initiative in that regard. But our work was very outward looking, it was very conscious of the international competitiveness issues that the UK banks face and the role of banks, UK and other, in the success of the UK economy, so I do not think this was a parochial inquiry in any way.

Martin Wolf: Let me just add something on that, because it is a context I have thought a lot about. I think it is important to be perhaps a little bit more precise about why this was, in my view, a very sensible terms of reference for us and where other countries may stand. We are all aware obviously that the US position is, in fundamental ways, different in that both investment and retail banking is dominated by a very large domestic market, so it is a very different context in the banking sector, and is much smaller-a fourth as large relative to GDP as ours. The relevant comparison would be other countries of roughly our size, France, Germany, Italy. At the time when this crisis occurred, we had clearly much the most severe banking crisis of these countries with the most expensive rescues. It naturally led the Government, in the light of our position and looking at some other countries smaller than ours with very high bank balance sheets relative to GDP, to ask us to look very closely at the possibility of managing the risk for the British taxpayer in the light of the exposure of this industry to the world economy.

As I am sure you are aware, since you have raised the issue of the ongoing crisis, it seems not implausible, no one is using a crystal ball, that a number of countries similar to ours are going to register very significant losses in their banking systems in the near future and they are already being called to mount very expensive capitalisation exercises, recapitalisation exercises associated with that. It would not seem to me very surprising if, in the light of that experience, and their view of what was appropriate for their countries, the management of their banking system might move more in our direction because their experience will be closer to ours, which it was not up to now. So I consider that what we have done was utterly appropriate in the light of our experience and our situation. What we were asked to do was appropriate and this story and this crisis is very far from over.

Q27 John Mann: On that point, and with what the Governor is saying and what we can observe emerging in front of us, the world is going to move rapidly beyond the implementation of your recommendations, it would appear, and therefore have not we been asking the wrong questions? If there is a crisis greater than 2008, which is what the Governor is seeming to suggest is possible, then we do not have the ability to throw taxpayers’ money at it in the way that we did before, therefore we are in an entirely different economic paradigm. So have we not been asking the wrong questions at the right time and coming up with things that are about to be bypassed by the inevitable turn of events from the ongoing crisis?

Martin Taylor: This is a very important point, I think made very clear in our report. We were very aware that we were not trying to design a system that would have prevented us from suffering the last crisis. We are very well aware that banking crises are inherent in the structure of the industry as subsidised, as promoted and as structured now, and our desire was to create a structure that would be resilient in the face of future crises, in particular to have a structure that would allow losses to fall without generating huge crises for those who fund the banks. That is essentially what we have been trying to do. Obviously if something enormous happens in the next three months our recommendations will not have been implemented, therefore they could not prevent it, but it is obvious to me at least, and I think to the other Commissioners, that provided these are put in place they will provide a banking structure that would deal exactly with the sort of eventuality you are describing because that is exactly what we were trying to do.

Q28 John Mann: Did you consider at all looking at what some would suggest is the unique British situation of the opaqueness of finances in so many UK Crown Dependencies and the impact that has on the financial crisis that we have had? Was that part of your consideration of whether to look at that?

Sir John Vickers: We did not look at that.

Q29 Chair: Mr Wolf, you have shown a big difference between us and America, not least on the GDP share in relation to the banking sector. Switzerland has a ratio banking sector to GDP share roughly the same as ours, and they are taking a very different route, aren’t they? Did you look at that?

Martin Wolf: We looked at Switzerland very closely in our policy. The recommendations we made, as far as I can see-Bill can comment on this perhaps-follow very closely in respect of loss-absorbing capacity; we have come out with a very similar sort of framework for that. In Switzerland’s case-they might have followed this, maybe they still will-the domestic retail banking industry is so small a part of the overall balance sheets of their giant banks, because obviously the economy is roughly an eighth of ours, that I think they felt that merely ring-fencing the retail bank would not be enough to give reasonable stability to what would remain as enormous global banks, in the case of UBS and Credit Suisse, and therefore I presume their view was, or has been so far, that this sort of ring-fence would not be appropriate. Again, they may re-examine this but Switzerland is on the opposite end from us. That is why I tried to compare us with a country like France, Germany or Italy, because Switzerland has a tiny domestic market relative to the size of these two extraordinarily large banks.

Bill Winters: One thing to add to Martin’s comments is that I think the big difference between the Swiss approach and the approach that we have recommended is that, while the aggregate loss-absorbing capital number is similar-it is 19% in Switzerland, it is 17% to 25% for a large bank here-the composition is different. The Swiss have recommended that all 19% be capital, as in equity or contingent capital, which is structurally subordinated and has equity-like characteristics, whereas we have recommended that a portion of that 17% to 20% could be senior debt as long as it is subject to bail-in at the point that the bank is deemed unviable by regulators. While it is a relatively technical difference, it is quite substantial in terms of expected cost.

Chair: That is an important point.

Martin Taylor: I do not regard the Swiss approach as being diametrically opposite to ours. As you know, I spend a lot of time in Switzerland. I think there there has been a lively interest in our deliberations and our report has received a lot of publicity. The biggest challenge for the authorities there is to keep their wealth management businesses safe from the investment banks and the rogue trader loss at UBS three weeks ago has brought this whole subject up again. I do not believe that the Swiss have reached the end of the road in regulating of the banking industry yet.

Q30 Chair: As a Commission, you couldn’t have timed that one better yourself, could you, to have that popping up?

Martin Wolf: You are fingering us for doing it.

Q31 Michael Fallon: I want to come back to costs, Sir John, because in annex 3 you discuss how the costs might be attributed round various external groups and so on. What range of this, whether it is £4 billion to £7 billion cost, would be passed on to consumers?

Sir John Vickers: I find it easiest to think in terms of what that might imply in terms of interest rate percentages, and earlier I said that if that were spread evenly across the £6 trillion of assets then it would be of the order of a tenth of 1%. That is just the starting point of any calculation. If it is right, as we believe, that most of the cost proportionately would fall outside the fence rather than inside the fence and if international competition disciplines that, then the extent of the pass through to bank customers on both sides of the fence would tend to be lower than that initial figure.

Q32 Michael Fallon: Sorry, lower than a tenth of 1%?

Sir John Vickers: In terms of the pass through to the final customer.

Q33 Michael Fallon: Lower than a tenth of 1%?

Sir John Vickers: Yes, because of absorption to some degree within banks by a combination of measures to mitigate, lower remuneration, possibly including lower bonuses and lower returns to investors, one would not expect one-to-one pass through to the end consumer.

Q34 Michael Fallon: You suggest this amount of 10 basis points as an average, I think. Will some SMEs pay more than that?

Sir John Vickers: As a result of the implementation of proposals of this kind?

Michael Fallon: Yes.

Sir John Vickers: I do not see a reason why, as a result of these proposals, one would expect a higher figure. Of course out in the marketplace different SMEs pay for different things, but I struggle on the spot to think of why certain SMEs would have a higher impact as a result of the implementation of proposals of this kind but others, former bankers, may be able to do better.

Martin Taylor: The credit spread paid by SMEs at the moment, I am afraid, as the Committee is probably aware, is many hundreds of basis points. I do not wish to say that 10 basis points here or there does not matter but I do not think it will be noticed. I think it will get lost in the roundings. If you compare it with the average bank rate movement of 25 basis points when they happen, the 10 basis points plus was, as John says, supposing that all the costs were passed through to borrowers. We do not believe they will be. We believe that a lot of the costs will be absorbed by other actors, by investors, by staff.

Q35 Michael Fallon: I just want to be clear about this. You are saying that the total cost of all this, £4 billion to £7 billion, will not make any real different at all to borrowers, whether they are small businesses or personal account holders. Is that right?

Martin Wolf: It is important to understand how big bank balance sheets are. £4 billion to £7 billion sounds like a great deal of money even in the context of our current deficit, although it is pretty small compared to that. But the bank balance sheets are so enormous that related to that it is quite a modest sum and, on our assumptions that much of the costs will fall on the balance sheets outside the ring-fence, the conclusion that the possible proportional rise on the cost of borrowing is very low is completely plausible simply because the balance sheets, the total loans outstanding at the banks are so gigantic.

Q36 Michael Fallon: I am just looking for the answer. You are saying personal account customers, small businesses, won’t notice this?

Martin Taylor: Should not notice the difference.

Q37 Michael Fallon: Should not notice the difference.

Martin Taylor: The balance sheets of the bank are £6 trillion. If the cost is, say, £6 billion, to take a number between £4 billion and £7 billion, it is a thousandth.

Sir John Vickers: In direct response to your earlier question, I would not say no difference at all. I would say a relatively small difference in line with what others have said. I would like to add that we are talking about the higher funding costs and so on. The architecture of ring-fence design we believe should be friendly to SME lending because it is a framework where, for one thing, the retail deposits in the UK can be channelled into UK SME lending to non-financial corporates rather than some of that going off into international wholesale and investment banking, so it is a framework for channelling savings into lending. So we think that that should be a good and stable one.

Q38 Michael Fallon: So not only will it not be any more expensive but it will increase the supply of affordable credit to SMEs; is that the proposition?

Sir John Vickers: I am not asserting that it would increase. I am pointing out that it is a framework that should have a positive in that regard. How to quantify that is very difficult, and I would not seek to do that, but I am just pointing to the structural architecture we would see as being friendly to SME lending in that regard. Had we gone for a narrower fence, which had kept retail deposits inside the fence and all corporate lending outside the fence, I think that would have given rise to problems and a much greater impact on conditions for lending to SMEs. We deliberately avoided those problems by the wider and indeed flexible ring-fence design.

Q39 Michael Fallon: It ought to ensure more affordable credit to small businesses, but you cannot put a number on it?

Sir John Vickers: I cannot put a number on it and of course there are many other factors in the macroeconomy that affect the nature of that lending, as we all know.

Martin Wolf: If I remember correctly, total corporate lending is 10% of the balance sheet; is that right? To non-financials, of which small and medium enterprises are themselves a sub-category, to try and predict what the cost would be on a very small component of a small component of these giant balance sheets is effectively impossible, but you can certainly ask the banks how they would intend to attribute any increased costs they see.

Q40 Michael Fallon: I hope you understand it is important to us, even if it does not appear very important to you.

Martin Wolf: We have devoted a lot of thought to this question and we have come to the view you say. I would also add the point, although I do not wish to stress this in any way because it is sort of more speculative, that should it be the case in normal times that the interest cost will be a little bit higher and that would have some effect on the economy then of course that would inevitably naturally be part of the decision-making framework for the Bank of England. It has to be, within their terms of reference, since they have to hit an inflation target and monetary conditions would be, if that were to be the case, a fraction tighter.

Martin Taylor: If I can put it in a more positive way that I think you seek, I think there is absolutely no reason why the banks should claim that anything in this report should reduce the supply or significantly increase the price of credit to small companies, nothing at all. If they claim that there is, you should question them very closely.

Q41 Mark Garnier: Could I just pick up an answer to one of Mr Ruffley’s questions? It was about whether the ICB report is going to make the City of London less competitive. Sir John, you answered this by saying that in itself it would not and, Bill Winters, you said that there are other things that are going to be contributing to people’s viewpoints on whether or not to stay in the UK, particularly obviously Barclays, HSBC and Standard Chartered. Given the fact that we have this financial regulation coming through, the ring-fencing of banks means you are going to have obviously no cross-subsidisation of the investment banks from the retail banks. You have Basel III coming through; you have your proposal for Basel III Plus; you have higher tax rates; you have all the rest of it. While I completely agree that in itself this report will not have a direct effect on the competitiveness of the UK banks, what consideration have you given to the whole package that is coming through? This is now getting a very complex place to do business and it is a very important part of our economy.

Sir John Vickers: We certainly strove to analyse the cumulative impact of all these things and the difference that our recommendations would make to them. That was very much part of the assessment. It may be that Bill is well placed, given his career and so on, to comment on some of the wider implications of your question.

Bill Winters: Sir John is absolutely right that we focused on the cumulative impact, and of course the cumulation was changing along the way and will continue to change for some time, as we see in terms of rules that are being put in place. The first thing clearly important to distinguish is between the competitiveness of British banks and the competitiveness of the UK as a financial centre. I think our statement about the competitiveness of the UK as a financial centre is unambiguous. This should be somewhere between neutral and very helpful to the position of the UK as a financial centre.

Q42 Mark Garnier: Discuss why helpful.

Bill Winters: We look at the things that would cause a bank like my former employer to decide whether to invest in the UK or not. We look at availability of resources, infrastructure, language skills, things where the UK is already a clear winner, geography, and so on. We also look at the desirability of getting international employees to work here and the UK historically has been a destination for the international employee, both because of the quality of life and also because of a relatively favourable tax regime. Regulation in the UK was somewhere between light and neutral in terms of intrusiveness in international banks’ business models and corporate taxation was neutral on a bigger scale.

The response to the crisis, quite understandably, has been to impose a cost on all members of the financial sector operating in the UK and it manifests itself in a number of ways, higher personal tax rates, balance sheet levies and much more intrusive regulation. Some of these things were entirely appropriate and probably inevitable in the context. Some of that might have been avoided had the British taxpayer not needed to shoulder the burden of the British banks. Of course the foreign banks were not bailed out during the crisis; they were bailed out by other countries. It was the British banks that were bailed out here, and that cost on the British taxpayer had a very normal reaction, which was to impose a cost on the financial sector and introduce uncertainty to the financial sector as a whole. That has clearly undermined the competitiveness of the UK as a financial centre.

We think we have taken one clear step in the direction of getting that right by providing certainty around the regulatory environment and hopefully dampening the impact of future externally generated credit crises on the UK economy so that the reaction from that Government in the future when there is a domestic problem need not be so impactful on the international participants. That is why we think, first of all, the overwhelming majority of the British financial sector is not British owned; something like 15% of the British financial services employment come from British-owned wholesale firms. The retail firms are not going anywhere. The wholesale firms are mobile, the capital and labour is very mobile.

So we think the proportion that is affected by our recommendations is a relatively small proportion of the total, and the improved predictability and certainty for the rest is quite helpful.

As for the second part of your question about the competitiveness of UK banks, as we have said, we would expect the investment banking arms, the non ring-fenced arms, to incur a higher funding cost. We think there are many ways for those banks to mitigate those costs, starting with changes to business models, which most likely do not involve lending to British corporations or individuals, although they may in some individual bank cases. You would have to look bank by bank. But carrying on from that, the cost can be absorbed by changes in business model, changes in structure, changes in cost base, of course lower remuneration for employees and lower ultimate payouts to shareholders to the extent that that is achievable and desirable.

Certainly my view is that British banks will come out of this at the end of the day, having gone through some difficult times, as in fact all banks are right now, in much better and stronger shape by virtue of having a policy platform implemented by their Government that is relatively clear. That unfortunately is not the case in the eurozone. It is not the case in the United States right now where the rules are very unclear and as a result banks are having a tremendously difficult time figuring out what to do.

Q43 Mark Garnier: Following on from one of Mr Fallon’s questions, which was about the availability of lending to SMEs, as the ring-fenced banks are building up their balance sheet, do you not feel that that will create a period of tightening credit to SMEs and, indeed, to retail borrowers?

Martin Taylor: As they are building up their capital base?

Mark Garnier: Yes, in order to meet your expectations.

Martin Taylor: In a sense that has been happening over the last three or four years and it is always difficult to disentangle at this phase of the cycle the extent to which demand for lending has fallen because people are not confident to invest and the extent to which the banks are tightening up their terms; they are certainly tightening up their terms from the pre-crisis levels. The answer we came up with for this, because there is clearly a danger that if you move capital levels too fast, too abruptly it will have an impact, was to spread it over the longest possible period of time. It is quite comforting to note, depending on what happens in the eurozone crisis, that the British banks have to quite some extent rebuilt their balance sheets since 2008, that as far as total loss-absorbing capital goes our 17% to 20% target is by no means out of reach for most of them.

The ring-fenced bank is for all the big banks, except Lloyds, a relatively small part of the total, so the extra 3% there is nothing like 3% on the whole lot. All of these factors, I think, should give some encouragement that it will not be as bad as you might feel.

Q44 Mark Garnier: Can I turn to the implicit guarantee, which we have sort of talked about in the context of some of the costs as well. We still keep coming back to the fact that Oxera came up with an implicit guarantee value of £6 billion, while Haldane came up with £57 billion dropping to £40 billion. You, I think, are saying £10 billion in your interim report. Have you nailed it down any tighter?

Sir John Vickers: We have made some progress between the interim report and the final report but less than the Committee may have hoped for. At the time of the interim report, we expressed our own view as being considerably in excess of £10 billion, and that is a position we held also at the time of the final report. You have mentioned the two studies that were at different ends of the spectrum and they differed by a factor of 10. The 57 is nearly 10 times six. We did further work and in the final report, using a Haldanetype methodology on the facts as they had moved on-and there is a complicated point about the length of the debt, where you do use the analysis-that figure had come down to 40, as you mentioned in your question. The Oxera number work was commissioned by RBS, and if one varied the assumption about the risk-free interest rate in a way that we thought was more realistic, then their number of six got up into the teens. It is still a difference of a factor of three, which is not great but it is better than a difference of a factor of 10 and all is consistent with our statement, our carefully crafted statement, considerably in excess of £10 billion.

Of course, the facts move on and the session began with questions about the recent Moody’s downgrade. Both the number of notches that we are talking about and risk appetites in the marketplace and, as it were, the price per notch, are fluid things, they move around.

Martin Wolf: Could I add one tiny thing? Assume that there is some Government support that is expected in the market, which seems to me pretty plausible, then the value of the guarantee depends on how bad lending decisions turn out to be ex post. We do not know how bad they are. We might hope that they will be so wonderful that there are no losses at all, in which case ex post the guarantee will turn out to have no value. If it turns out that they succeed in losing sufficiently large fortunes, the guarantee will be ex post of enormous value. That is part of what Andy Haldane’s work is about. It is clear that it turns out that the market assumed, before the crisis, that the value of the implicit guarantee was nothing and the reason the market assumed it is that it assumed the banks were safe. It turned out they were not, and then the guarantee exploded. That is what Andy has pointed out. All I am trying to point out is it is unavoidably uncertain, inescapably uncertain. We don’t know what the guarantee is worth because we don’t know what is going to happen to bank balance sheets, but it is important.

Martin Taylor: Banking can be very volatile.

Martin Wolf: That is why it is so volatile.

Q45 Mark Garnier: My next question is who is benefiting from this? Is it the shareholders of the big banks, which is us I suppose, or is it the customers of the banks? To what extent do people like Metro Bank benefit from it? It would have been said if they had failed, but nobody would really notice in the grand scheme of things. Who is benefiting from it?

Sir John Vickers: The benefits are proportionately larger for the larger banks. There is clear evidence of that. I believe that a bank such as Metro Bank is getting very little benefit indeed.

Q46 Mark Garnier: If any at all?

Sir John Vickers: If any at all, yes. To the first approximation I would say zero. In terms of who benefits, it is a bit like the earlier discussion about costs and where they are borne. I think it is a mixture; it is a combination of customers, shareholders and employees, depending on the extent to which they would be passed through.

Martin Wolf: It depends on how competitive you think the industry is.

Sir John Vickers: It does.

Martin Wolf: It turns out to be a very complicated question, but it depends essentially on how competitive the industry is, whether it is held by shareholders or distributed to customers.

Q47 Mark Garnier: Well, the important point I think on this is that if you have an implicit guarantee-

Martin Wolf: Or by employees who are part shareholders in this regard. Sorry.

Mark Garnier: Sure, but if you have an implicit guarantee, which is effectively to the benefit ultimately, I suppose, of customers, then does it matter if you have one? Since the vast majority of people in this country are banking with the big four or five, then if you have the implicit guarantee by the taxpayer, the taxpayer is putting it up but if you take it away then it is the same people who are paying for it in a different way because they are going to have to pay extra costs on their bank. Is the only reason why the implicit guarantee is such a bad thing because it is holding back people like Metro Bank and other small people coming into the market?

Sir John Vickers: No, I think there are many other reasons why.

Q48 Mark Garnier: Explain?

Sir John Vickers: I hope it is not an injustice to your question to put it in these terms. It is almost as though there is a merry-go-round that is robbing Peter to pay Peter. I think part of the problem is that quite a bit gets lost in the process. Even on that basis, the ordinary individual who may be getting a tiny sliver of benefit from the guarantee in terms of the rate at which they can borrow, as discussed earlier possibly too small to be noticeable, is at risk, is on the hook as a taxpayer to a considerably greater extent. To iron that out also has the very important benefit of getting incentives straighter for the future, because if the banks make decisions in a world where there is a big guarantee and where the markets are giving them funding costs as well on the basis that there is a large guarantee, then the brake on their risk taking is nothing like what it should be in a properly marketoriented system where those who supply the funds are themselves on the hook for the risks.

A lot of what we are trying to do, not just in terms of equity capital, loss absorbency, but depositor preference and all the other measures to try and get the taxpayer off the hook, is to get the risk borne by those who provide the risk capital. We saw very dramatically three years ago how you had a dysfunctional system where those who supplied the supposedly risk capital, the equity holders, certainly took a big hit, but a lot of those who had lent unsecured to banks ended up not being hit because the taxpayer was marched almost to the front of the queue after equity holders in terms of loss absorbency. That incentive gain I think is terrifically important too.

Q49 Mark Garnier: You refer to the costs as a very, very small percentage of the £6 trillion balance sheet. Surely the whole point about banks is that it is not the entire size of the balance sheet, but it is the interest rate spread that is the profit that it is making. Therefore, if the costs go up you should be looking at it as a proportion of the interest rate spread and not the entire balance sheet, because an extra cost is a P&L thing not a balance sheet.

Sir John Vickers: I think in a sense we are doing both. Doing it in terms of the balance sheet sort of scales it and if it were that uniform thing it would be around a tenth of 1% on these estimates. But as Martin indicated, the spreads have been much fatter than that, certainly relative to official rates, and indeed relative to official rates on other kinds of lending too in this current very strange macroeconomic environment.

Martin Taylor: If you look at the implicit guarantee as a form of free insurance provided by the taxpayer, effectively what the taxpayer has done is to say to the banks, although not explicitly because it was an implicit guarantee, "You can do what you like and you will be bailed out". The whole market believed that would happen, so obviously, as John said, that has a very negative incentive effect because you increase the likelihood that the banks do crazy things. That is exactly what happened in the run-up to the last crisis and it has been happening on the continent since. I think the problem about the guarantee in this highly globalised, very liquid banking market-very liquid when it is going well-has been that the free insurance has constantly increased the risk that the taxpayer was insuring and then when it all went bad the bill has been huge. If through reports like this we can get the incentives in the right place, we can make that sort of crisis less likely, because the banks will not be able to run such high leverage again because nobody will fund them to do it if there is a credible loss of the insurance, and if they do get into trouble the costs to the taxpayer should be either zero or very much lower. They seem to me to be two enormous benefits.

Q50 Mark Garnier: Can I just ask one last question? On many occasions you are referring to bad lending and the risk of bad lending and the fact that that risk can go up with an implicit guarantee. This is maybe coming from slightly out of left field a bit, but obviously to have bad lending you need to have bad borrowing, effectively. What assessment have you made of the financial literacy of the customers of the banks? I think it is quite an important point because you can’t sell something to somebody unless they are prepared to have it. If people were more financially literate they wouldn’t necessarily borrow. Have you made any assessment on the financial literacy of the UK consumer?

Sir John Vickers: On your prefatory remark, I think one needs to look at the lender, the borrower and the regulator as well in terms of some of the practices that were going on mid-decade in the marketplace. We have not looked specifically at financial literacy. I believe there are studies that the regulatory bodies and others have done on that subject in the past. However, part of our report when we turn to competition issues and consumer choice has very much concerned the information that is available to consumers. That is not quite the same as literacy, but one needs to have conditions for informed choice for the market to work well and, in particular, for improved switching to have the effect it should have in the marketplace. We have touched on the issue there, but we certainly have not addressed the literacy issue head on.

Q51 Chair: You wanted to come in a moment ago, Mr Winters?

Bill Winters: Yes, I was going to answer the question on percentage of profits. The estimate seemed to range from something well less than 10% impact on profits to as much as 30% all in the case where the bank does nothing in response to the changes. As we have discussed a few times, there is every possibility for banks to mitigate the cost at many levels so that the impact on bottom line profitability should be very small.

Q52 Chair: You were quoted, Mr Winters, in the FT as saying, I am paraphrasing, if we have succeeded in putting in place a structure to remove the subsidy then the case for the bank levy does not look very strong any more. Could you just elaborate on that?

Bill Winters: Yes. I think the comment was certainly broader in the sense that-and I think I commented on this briefly earlier-there were a number of steps that were taken in the aftermath of the crisis intended to deal in short order with the effects of the crisis, both regulatory and fiscal. With the passage of time and hopefully the received thoughtfulness of our report, the conclusion could be we have addressed some of those issues in a different way through the implementation of the recommendations that we have made. To the extent that we have been successful, then let’s go back and look at everything else that we have done from the onset of the crisis to today and ask whether it is really accomplishing what it was intended to accomplish. If the balance sheet levy was intended to raise money, then it raises money from a particular constituency and so be it. If it was intended to remove the subsidy from the banking industry to incent proper behaviour going forward by taxing wholesale funding or something like that, then we are dealing with that elsewhere and the levy should be removed.

Q53 Chair: Well, we do not need to do any mind reading because the Government themselves at the time of the introduction of the levy made clear the levy means, "The banks will now make a full and fair contribution in respect of the potential risks they pose to the wider economy", which must be an unmistakeable reference to the subsidy.

Bill Winters: That is certainly how I took it.

Q54 Chair: Therefore, you are arguing as a committee, I take it, for the removal of the bank levy if-

Sir John Vickers: No, I-

Chair: I am just following the logic inexorably to its conclusion if the proposals are implemented in full, and since we are agreed you have made as good an effort as it is possible to make to eliminate the subsidy, there can’t be a case for the bank levy.

Sir John Vickers: If I may say so, I think there might have been a little leap in logic there. I am no longer chairman of the Commission because there is no longer a Commission to be chair of, but if I could just say on behalf of the-

Chair: I am sorry about that leap.

Sir John Vickers: As a Commission, we did not address that point, and I think it would have been wrong for us to start issuing fiscal advice of that kind. In our-

Q55 Chair: That is a quite separate question, which is do you need the money, but the case for this is no longer there on the basis of the subsidy. It may be there because the Government needs some cash; correct?

Sir John Vickers: If our measures were completely successful in eliminating the subsidy, 100% successful, then that may well be a legitimate inference. We did not get that far in our deliberations. However, we did in discussion of competitive-

Q56 Chair: Have a go at getting a bit further now, because I think this is a very important question.

Sir John Vickers: In consideration of competitiveness more generally, I believe both in the interim report and the final report we noted that there are various instruments at the disposal of Government and that our measures should be seen in that context. Certainly, we did not collectively take a view, and I for my part have not personally taken a view, on what other measures could be offset in response to measures of this kind. I think we have tried to craft this package of measures in a way that has the least regulatory burden and the least cost for getting the desired effect. I think that has been a guiding principle of what we have done.

Q57 Chair: By which one must presumably, listening to that, want to conclude that the bank levy is not the least cost method?

Sir John Vickers: Might want to conclude that? I am agnostic on the question-

Q58 Chair: I am just trying to work out what the implications are of saying, "We have done our best to get rid of the subsidy". I am not going to prolong this but, "We think we have put in place the measures that are required going forward to get rid of the subsidy", so the other measures that were in places rough and ready tools-and that is a pretty clear description of a rough and ready tool that I just read out-is less strong.

Sir John Vickers: I think Martin wants to come in; if I could just say one brief thing on the way to that. My recollection is that the levy was not just about that and there are some issues about the nature of funding, liquidity issues and all the rest. I think there might be a bit more to it.

Q59 Chair: I have the explanation for this measure in front of me and I am not going to prolong it, but I think it is difficult to argue that it was put in with other purposes in mind.

Martin Wolf: This is purely personal, because we have no collective position, but to the extent that we do eliminate the subsidy then that reason for the levy is certainly weakened. However, there are, in fact, arguments that financial activity and financial services to customers more generally are under-taxed within the context of our overall tax system, particularly in relationship to value added tax, and there may be arguments, therefore, for having the levy for other reasons. Economists can always find good reasons for a tax, as I am sure you know.

Chair: They are such a bunch of politicians, don’t you think, colleagues?

Q60 Jesse Norman: No more than you, Chairman. I thought it was a highly mischievous line of questioning. If it could be shown that the subsidy was going to be eliminated, and if it could be shown that the subsidy was eliminated now as opposed to when you are predicting it in 2018-2019, and if it could be shown that the case for taxation was not as indicated by Martin Wolf, then the Chairman’s line of thought might have some validity.

I have a question for you, Sir John. You have put in place a relatively high backstop leverage ratio. Is there a danger that is discriminating against mutuals who have a quite different business model to most banks?

Sir John Vickers: Yes, I understand the question. The Basel III leverage backstop is a factor of 33, 3%. What we recommend with the higher equity ratios for the ringfenced entities, which applies to the larger ones-this would not touch many mutuals at all, but it could well affect some and one in particular-is a pro rata adjustment to that leverage gap, which would take you from a large ringfenced entity to a ratio of 25, roughly. On our judgment, that is a backstop in the sense that normally the binding constraint would not be the leverage ratio but rather the ratios as conventionally expressed in relation to risk-weighted assets. Indeed, if the backstop ratio became the binding constraint that might pose some sharp questions about whether the risk weights were really doing their job, which manifestly they did not do in the runup to the crisis. The recent eurozone debt also poses questions about the risk weights. Our feeling, certainly my feeling, is that even in areas such as mortgage lending, which of course a number of the mutuals do a very important amount of, a leverage ratio of 25 does not strike me as unduly prudent and unduly cautious. I feel very comfortable with that recommendation as we made it.

Q61 Jesse Norman: It is certainly a part of your remit, though, to do something that might have the effect of discriminating against mutuals and in favour of banks, I take it?

Sir John Vickers: No, we certainly do not wish to discriminate in that way, but we ended up with that factor of 25 to 33, and let’s face it, mortgage lending is not risk free, certainly not.

Q62 Jesse Norman: No, that is true. Martin Wolf, the report, which I think is an excellent piece of work, does not, it seems to me, address one of the crucial issues behind the problems that we have encountered, which is the origination of transactions that were not understood at the time when they were created and were subsequently sold on the basis of a similar lack of understanding. It may be that no one understands them even now. Is it your view that this is a defect or were you leaving that to other legislation or regulation to address?

Martin Wolf: I am not really the expert on this; I think Bill is more expert. Our sense was that within the terms of reference, which focused very much on banking, in particular British banking, we have addressed the principal issues that arise in that regard. As you of course know, the question of what to do about derivatives, which many of these were, how to introduce greater transparency, how to introduce greater stability into the dealing in them, the use of clearing houses and exchanges and everything associated with that is an important part of the global regulatory framework as it is evolving. I think there is a lot of debate about whether this is going to be adequate, but it is important to remember that inasmuch as it affected British banks as purchasers of this stuff, this was the investment banking arms purchasing in particular assets being created in the United States. This is part of the international business, so the ringfenced banks would be protected from this and that would be subject to the sort of international regulation that I have mentioned.

Meanwhile, for our ringfenced banks, obviously there is an issue because that was a very big question in the precrisis situation. Retail banks would continue to have such access to wholesale funding, but it is clear to us that the evolving rules of the FSA, presumably in future the Bank of England, will have and should have a considerable role in managing the extent of the exposure to wholesale markets, which, for example, most famously brought down Northern Rock. It does seem to us, and it is certainly my position, that within the context of the global regulatory environment and the British banking system those issues are quite adequately handled in other ways. I do not know whether Bill wants to add to that.

Bill Winters: I completely agree. There are a number of things that we did not go into great detail in in our report, including, for example, reviews of liquidity rules, for a very simple reason. We think they are absolutely central to the regulatory architecture and well handled by the Basel Committee already. Likewise, we think the infrastructure supporting the derivative business is well handled by the Basel Committee and the FSA. We refer to those things in our report but without going into detail because we did not have any value to add materially. In other areas where we thought that the global regulatory initiatives needed to go further or were not adequate for Britain, such as the level of capital adequacy and loss absorbency, we said we like what they have done so far and we need to go further in Britain. Obviously, we spent much more time on those things than where we were effectively giving a tick to the efforts that others had taken already.

Q63 Jesse Norman: Thank you both for that. In our commentary on your interim report, we asked if you could look at whether or not corporate governance might be improved in a way that assisted the stability of the banking system. Do you feel that your final report moved the debate on in that area particularly?

Martin Taylor: We have concentrated on the governance of the ringfenced entity in the sense of insisting, should Parliament approve, that it has separate independent governance from the rest of the organisation. I don’t think we felt-my colleagues may, of course, disagree-that we had anything much to add to the reviews that had already taken place on this subject.

Q64 Jesse Norman: David Walker has done some work on this, but the RBS report has not been published and there is no doubt that there was a colossal failure of corporate governance in several key institutions.

Martin Wolf: We could not comment on a report that did not appear, obviously.

Q65 Jesse Norman: No. We could not also rely on the work having been made public if it was not made public.

Martin Wolf: Precisely.

Q66 Jesse Norman: Thank you. On the ring-fence, do you think there is a danger that that will have the effect of increasing reliance on wholesale markets for either the ringfenced or the non-ringfenced entity? Perhaps the ring-fenced entity first for a shortage of deposits.

Martin Taylor: I do not see why the introduction of the ring-fence should change the quantum of deposits in the system. They may be distributed differently and clearly some kind of deposits will be mandated to be within the ring-fence.

Sir John Vickers: Without quantification, we talk about the desirability of regulatory constraints on wholesale funding of the ringfenced entity. I just think in the nature of things, because of the fact that retailer deposits and SME deposits have to be within those ringfenced entities, that has some implications for wholesale funding but that should be a solid platform, a combination of measures.

Martin Taylor: When talking to the banks about this, one of the difficulties we sometimes had was that we were trying to design a structure of a system, if you like an architecture, that would come in over a period of years and that we would hope would be reasonably durable. The banks are understandably most concerned about the shape of their balance sheets over the very shortterm foreseeable future. The fact that most of the British banks, with one single exception, are quite short of deposits at the moment and so on, these are the things that are shaping their fears. It was very much our desire in designing the ring-fence not to disadvantage deliberately any particular business model over any other, and that was why the flexibility on assets was built into it.

Q67 Jesse Norman: Why did you carve out securitisations, own loan securitisations, as being permissible within the ringfenced entity?

Bill Winters: We want the ringfenced bank to have access to the securitisation market should they choose to finance themselves partially through, for example, the securitisation of home mortgages. As is often the case with the securitisation of a home mortgage, some portion of that securitisation remains on the balance sheet of the originator. In fact, under EU directives and global Basel directives, known as the skin-in-the-game rules, it may be required for a bank to hold 5% or 10% of the risk in the securitisation on their own balance sheet. The advisability of that set of rules is a whole other question that we did not opine on, but to the extent that that is law and to the extent that the UK bank wants to or needs to finance itself using the securitisation market, which we think is a good thing properly structured, the skin-in-the-game rules, we would be obliged or-

Q68 Jesse Norman: You do not want to, as it were, own an entirely dead animal. At the moment you have not ruled out the possibility of someone securitising an awful lot of very bad quality debt and keeping it within a ringfenced institution.

Bill Winters: If a bank is in the business of originating bad debt and finding a way to hold on to 5% or 10% but sell off the other 90% to 95% they will not be in business for very long.

Q69 Jesse Norman: Or they don’t know. We have had that experience in the last few years.

Martin Taylor: They would be better selling off 90% of it than keeping 100.

Jesse Norman: Well, we hope.

Martin Wolf: The ringfenced banks would continue to do banking business and in the banking business-and this is a very important point-there are plenty of opportunities for making mistakes. I think there is a widely shared view that somehow we think that retail ringfenced banks are inherently safer than investment banks or inherently more guaranteed. We think neither. It is quite clear to anybody that the retail ringfenced banks can clearly make very bad loans and, indeed, I think that is one of the reasons for having higher capital in them. The reason for making the split was not that one is safer and the other is less safe or one more guaranteed and the other is less guaranteed. We genuinely think the banks will be better structured, better run, more resolvable if the split occurs. Clearly, it is possible in this model for retail ringfenced banks to acquire one way or another, as we know from the past, very, very bad assets. We hope they will not but history suggests that can happen.

Q70 Jesse Norman: The final question if I may, Mr Chairman. I take it it is not the view of the committee, or the Commission as it was, that, for example, a serious problem in BarCap would not have a knockon effect on the ringfenced entity in the event that they were separate, the nonringfenced part?

Martin Taylor: That is what Harold Wilson, after whom this room is named, used to call a hypothetical question and he always refused to answer.

Q71 Jesse Norman: I can put the question a different way, which is what have you done to look at what happens when one of these joint institutions gets in distress and, therefore, people want to start pillaging the ringfenced-

Martin Wolf: That is why they have independent corporate governance. You have defined precisely the condition that we looked at very closely. Do we refer to the Enron example? I don’t remember.

Sir John Vickers: Yes, we do.

Martin Wolf: In a situation in which, God forbid, BarCap as an independent entity were in serious difficulty and some CEO-obviously, I don’t wish to imply in any way this has anything to do with present management-were in this situation to want to take advantage of the resources available in the ringfenced bank, the corporate governance arrangements are designed to prevent it. Furthermore, should it be necessary to resolve BarCap in that situation, or a hypothetical investment bank in that situation, we do believe the structure we have designed would allow that to happen without bringing down the retail ringfenced bank. Yes, we do think it would make a very big difference to the continuity of retail banking in the UK and it would, therefore, give the UK Government-I have been looking very closely at what Alistair Darling has said about the pressure they were under-in such a crisis options that simply were not available at the time of the previous crisis. To my mind, and I think others on the Commission, this is perhaps the strongest single set of arguments for our proposals.

Q72 Chair: Just on BarCap, and this is a completely hypothetical question, do you think there will be brand contagion or contamination and how is that dealt with?

Martin Taylor: It is possible to conceive of circumstances under which that might be, but the supervisors ought to have the comfort of knowing that if the problem is in BarCap, the ringfenced bank is sound and so to the extent that there is a public concern about the ringfenced bank, they can safely support it with unlimited liquidity. Clearly, that would not be a problem for the central bank.

Q73 Chair: The ringfenced retail bank has retail customers who are hearing the news that the bank of the same name is going south.

Martin Wolf: I think this Governor can get up completely confidently in the situation-he would also be the regulator-and say, "Your accounts are safe. We stand behind it as lender of last resort". It did not happen in Northern Rock, as you remember. It would seem to me plausible, though one can never be sure so this is desperately hypothetical, that under those circumstances sensible members of the British public will take the view that the retail bank is safe. Of course, one cannot deny the possibility that they would disbelieve the officials, but I think that it is a compelling situation for him. He can be absolutely confident of saying this.

Sir John Vickers: That retail depositor is in a very different situation in this hypothetical world from last time around because you have self-standing capital in the retail entity. You have primary lossabsorbing debt on top of that. You have primary lossabsorbing debt and the higher international standards in the BarCap part of the entity. You have much greater ease of resolution. The official toolkit is much richer than it was before, and you have insured depositor preference. So the retail depositor in your question has masses of protection.

Q74 Chair: We have read your report and grasped all those points. My concern is that however well you designed it, I am just trying to clarify whether you think there is a risk of brand contagion. If it is a non-negligible risk then we are still left with the problem that ring-fencing carries that separation does not.

Sir John Vickers: Yes, and we do address that point.

Chair: I am trying to identify the scale of that.

Sir John Vickers: We do address that point and we note the possibility of the risk in that direction. On the other hand, there may be times when it is UK retail that is in trouble. One could have a hypothetical world in which there is some slump in house prices and mortgage books are under water, where the world generally is doing fine and BarCap is doing fine and can bring resources to bear to augment the resources.

Chair: Yes, I have understood that.

Sir John Vickers: The reputational point does cut two ways.

Q75 Chair: It cuts two ways, but in the painful direction, I am just trying to clarify your view is that there is a negligible or nonnegligible risk of brand contagion?

Martin Taylor: The difficulty with the hypothetical question and the reason I was so reluctant to answer it at the beginning is that when you talk about BarCap getting into trouble that could mean any one of a number of things. Everybody has Lehman Brothers in their memory. It was quite a recent event. I think that the synapses tend to connect up. Lehmans was an investment bank; BarCap is an investment bank; Lehmans got in trouble; BarCap could easily get into trouble. Lehmans did not have 17% to 20% of lossabsorbing capital. It was not following the new liquidity rules. There are all sorts of things that make it more difficult for BarCap to get into the sort of trouble in future that people have done recently. You cannot rule out some colossal fraud or something like that, but the scale of things that would have to go wrong to put the retail bank in jeopardy in the minds of sensible people I think are so huge that we should not frighten ourselves.

Q76 Jesse Norman: Mr Chairman, may I just ask one very quick question on corporate governance? You talked about the ringfenced entity, but you have not made any recommendation about the compensation arrangements for the head of the ringfenced entity though, have you? That person will continue to have their comp set by the chief executive and the chairman of the board presumably of the-

Martin Taylor: No, by the board of the ringfenced bank.

Jesse Norman: The board of the ringfenced bank, okay.

Martin Wolf: Sorry, this point is so important. I think we accept that there is the logical possibility, but it is very important also to stress that not even the most important form of contagion is brand contagion. In a crisis there is extremely powerful crossbrand contagion. Put bluntly, if any of the major Britishbased investment banks were to get into very serious trouble, this would make people nervous. Having a system that indicates that you can manage such crises, that you have a system for managing such crises that is reasonably well prepared, reduces the likelihood of mismanagement, is far and away the most likely way of minimising the danger of contagion, broadly defined.

Q77 John Thurso: Martin Wolf, what assessment have you made of the impact of ring-fencing on growth in the economy, if any?

Martin Wolf: Well, this follows from the discussion we have had on the effect on the cost of funds and, therefore, on the interest rate that might be paid. Our view, I think, is we do not have our own growth model. Growth models have been developed by others who have analysed this question, the Bank for International Settlements most notably. The Institute for International Finance has done this, too, but I find it basically a piece of lobbying. We can argue about that, but if you look at the BIS type of work, which is very extensive, and you put in the sort of cost of funds effects that we have looked at, which we have discussed already, the effect on the growth of the economy is essentially so small that you could not possibly notice it. There is so much else going on. Certainly, my view would be if you analyse moderately sensible models, the effect on borrowing cost is so small, I do not think you could measure it.

Q78 John Thurso: On a scale of positive, negative or neutral, the answer is neutral?

Martin Wolf: No, no, no. I have assumed we were talking about the growth in the short to medium term. In the long term, I go back to what John was saying, which is-God knows we have experienced this in spades-the impact of our measures in our view will be to reduce very significantly not only the likelihood of but above all the cost or impact of a crisis and it is absolutely clear. But that is part of the growth and we have lost so far about at least five years of growth.

Q79 John Thurso: I am sorry, I don’t actually understand any of your answer. In the medium term, say in the next five years, will what you have suggested have a negative, a positive or a neutral impact on growth and the economy?

Martin Wolf: It won’t be implemented in this period so I would suggest it would have zero impact.

Q80 John Thurso: Anybody like to venture an answer to the simple question?

Sir John Vickers: I would vote for neutral for the reason just given, in the next five years.

Q81 John Thurso: Broadly neutral. In your answer to Michael Fallon, you said that you would expect it to enhance lending to small and medium enterprises, which I would expect to be positive for growth. Are you discounting that in your answer?

Sir John Vickers: No, when I said I would vote for neutral that was because of the timeframe for your question, which was the next five years. As you know, our recommendations carry with them a timeline of full implementation within seven and a bit years from now. In response to Mr Fallon, I was thinking of that further future not the next five years.

Q82 John Thurso: Let me rephrase. You expect nothing to happen until implementation. Once you have implementation, it will be broadly neutral but you would expect it to help lending to SMEs?

Martin Taylor: I think what we said was that we expected the supply of credit to SMEs to be affected, if anything, in a positive direction and the price might be very slightly higher.

Q83 John Thurso: Why would you expect that? How will that happen?

Martin Taylor: Because of the way the ringfenced bank is set up, which will have-

Q84 John Thurso: More money will be available?

Martin Taylor: The SME business will be a considerable part of the ringfenced bank’s activities.

Q85 John Thurso: If I may, just pushing this a little further, what we are saying is that compared to today, where some of the potential available credit is capital that is being used in, say, investment operations, that capital cannot be used for those other things and, therefore, is available to the SMEs. That is the simple point?

Martin Taylor: Correct.

Sir John Vickers: Not just the capital, but the retail deposit base is very important.

Q86 John Thurso: By simplifying the operation to a High Street commercial retail operation, you are concentrating the mind of the banker on lending to those customers with the capital and resources available, assets available, and he or she is no longer tempted to go flirting off on an investment market. Is that broadly it?

Martin Taylor: That is certainly the intention. If I may add one more thing to your question about growth, the financial industry has been a big source of the volatility of the growth numbers in Britain and the instability of our economy. If we can make the financial industry less unstable, there is a chance-I look to Martin Wolf for support-that we may make future growth rather less volatile and that would be an extremely good thing for investment and for the SME market and for the people operating SMEs.

Q87 John Thurso: Broadly, what we are saying is as these kick in, funds that at present are probably seeking a higher return at the investment end would be more available within the ring-fence to the SME?

Martin Taylor: Yes, but it is important to stress, as I think Martin Wolf said earlier, what a tiny proportion of the bank’s balance sheets SME lending represents. It really is a low single figure per cent, I mean 1% or 2%.

Q88 John Thurso: Which might be why it gets ignored.

Martin Taylor: SME, it is a very small amount, 3%. It is hard to be sure that any impact on the total balance sheet of any kind at all will automatically have a similar impact on that number because it is such a small part of the whole.

Martin Wolf: Like lending to house mortgages. It is difficult to predict.

Sir John Vickers: The same logic would apply to household as to SMEs.

Q89 John Thurso: I am sorry to pick the nits on this, but I need to understand it because my start point in all of this was full separation. The ring-fence looks to me like a relatively elegant compromise that may do the job I am after but I want to make sure of that. What we are saying is that traditional business that is done by the High Street bank, commercial, retail, lending to individuals, mortgages, the whole range, will have available to it specific capital that currently might be being made available to other parts of the business that will be outside the ring-fence, which are more profitable but more risky?

Martin Taylor: Correct.

Sir John Vickers: More profitable in the good times.

Martin Wolf: Whether they are more risky, that depends, of course, but we are preventing-

Q90 John Thurso: As an aside, if the Government wanted to do something today on that, it could nationalise the rest of RBS, split off all the investment stuff and get shot of it and immediately put a new retail ringfenced bank into play today. We could do that in two months or whatever. Is that a correct assumption?

Martin Wolf: Definitely not in our terms of reference.

Q91 John Thurso: Can I move on to another subject, then, Sir John-

Martin Wolf: The UK Government is not the sole owner of RBS, so there are issues there.

Q92 John Thurso: Again, I think it has over 75%. It could, therefore, do a takeover on whatever terms it likes.

Sir John, in answer to the point raised by David Ruffley earlier, which related to what Lord Myners said about why doesn’t HSBC up sticks and go to Paris, is it not the case that the French could not afford them, given that banks go home to die and if it had a problem it would go home to die in Paris?

Sir John Vickers: That begs a number of questions about the French fiscal position, which are not just beyond the terms of reference but beyond me in other ways too. I think looking at it from HSBC’s perspective, because we did look carefully at the passporting issue we see a rather small incentive to do that, particularly given how we have pitched our recommended levels of capital and lossabsorbing debt. Moreover, there are some pretty formidable practical, legal and reputational obstacles to an organisation-

Q93 John Thurso: The short of it is it was not a sensible suggestion, was it?

Martin Wolf: It is not an easy thing to do. You could ask them. We have looked at it carefully. It is not an easy thing to do.

John Thurso: Thank you very much. I had better stop while I am down.

Q94 Tom Blenkinsop: Following on from Jesse Norman’s earlier question, would you agree that there may be unintended consequences for applying a blanket leverage ratio across all financial institutions, such as encouraging higher risk lending behaviour that generates sufficient returns on capital?

Sir John Vickers: I would give the same general response as before. If we had recommended a leverage ratio with a factor of 10, then the answer might be yes, that is a risk. Instead, we have gone from the Basel figure of 33 and ranged from that to the biggest UK ringfenced entities with a factor of 25, and at that level I do not see that as an undue risk. I have responded before; I do not know if others have-

Bill Winters: I completely agree. I think we tried to calibrate the leverage ratio so that it was really a backstop in sync with the core capital ratio but not overriding, and I think that is where we came out with the scaling package.

Martin Taylor: You are quite right to suggest that there is a question here because if you contrast the behaviour in the last 10 or 20 years of the European banks bound by a riskweighted asset, not constrained by total leverage, they tended to run very large total asset balance sheets, running their risks by taking enormous quantities of relatively small risks. Whereas the American banks, bound by a total leverage ratio, have had to run smaller balance sheets of higher risks. The total quanta of risk run by both institutions has actually been much the same, hasn’t it, if you compare the good ones and the bad ones? We certainly do not feel that the number that we have put in comes anywhere near to making that dangerous.

Q95 Tom Blenkinsop: The reason I ask is I do not think building societies, for example, got us into the situation that we are in at present. Do you think there are any lessons the banking sector could learn from building societies?

Sir John Vickers: We certainly think there are some important lessons from building societies for the banking sector and have drawn attention to them. In particular, there is the question of what risk taking or hedging can the treasury function of the ringfenced bank do. We think it is very educative how it has worked in the building society sector and the mutual sector where that hedging activity does happen. To say you are not even allowed to do hedging derivatives would be to rule out a risk mitigation strategy, and then there is a big question mark: how do you draw the line between risk mitigation and speculative activity? I think the building society model has some very important lessons for the sector generally, and we have referred to that in the report.

Martin Wolf: In fact, we consider we have learnt from it in this regard. The other aspect of it is by and large the building societies, as opposed to the converted building societies, continue to rely very heavily for their funding overwhelmingly on deposits. The evidence has supported one’s prior assumption that that is a more stable basis for funding of lending and that, it seems to me, is a strong argument for the ring-fence.

Q96 Tom Blenkinsop: Just one more question. Did you consider lower cost methods of improving current account switching such as compelling direct debit originators to complete a switch within three days?

Sir John Vickers: In the report on that front we focused in particular on this idea of a redirection service to improve switching so that both in fact and very importantly in terms of customer-consumer perception the risks of a payment getting lost or not going through when the consumer has switched will just be taken care of by a redirect service, taking cost and risk away from the consumer. We think that is a very practical step that could be made within a couple of years from now. We did not look at other particular things such as shortening those payment periods directly. However, we said a number of things about what we think should be the role of the future Financial Conduct Authority. That seems to me a good example of a question concerning competition and consumer choice that would be squarely within the remit of that body, and it underlines what we see as the importance of having a strong pro competitive remit for that new entity to take issues of that kind and many others forward.

Q97 Mark Garnier: Just going back to this ring-fencing and potential problems of cooling of liquidity and capital, presumably the whole point of the ring-fence is to stop money being moved from the ringfenced entity into the universal bank in order to protect obviously that ringfenced entity. What is the provision for moving capital from the universal bank into the ringfenced bank? Is there a free valve going in that direction?

Martin Taylor: When we talk about moving money we have to be careful to distinguish between moving capital and simply making loans from one to the other by having exposure, if you like. Movements of capital are governed, or at least are limited, by the need for each of the organisations-in terms of the ringfenced bank a slightly higher number-to keep capital at a certain level. Clearly, the directors of the ringfenced bank could only move capital across by a dividend if they had enough capital for themselves. So that is capital. On lending exposures-

Q98 Mark Garnier: This is liquidity?

Martin Taylor: Yes, and the ringfenced bank having more deposits than it needs, to what extent can it lend to its sister organisation. The answer we came up with there was that it could lend to it exactly as it could lend to a third party in the market. It is limited-

Q99 Mark Garnier: It is exactly the normal counterparty risk?

Martin Taylor: It is actually slightly tighter.

Q100 Mark Garnier: The reason I ask is because one of the criticisms that has come up from a number of people is that assuming that the ringfenced bank is successful and assuming it is doing a very good job, then it will end up with a pool of liquidity in it. As you have just so rightly said, then it needs to lend that because that is what banks do. They have a balance sheet with the customers attached and they need to lend that money out. But is there not a possibility that if you find yourself with trapped liquidity in that bank and it is, therefore, going and lending it out you might not get back to the same problem that we have had in the past, which is back to irresponsible lending because they have to get it out?

Martin Taylor: But you won’t have liquidity traps because whereas some elements-

Q101 Mark Garnier: It has to go somewhere, doesn’t it?

Martin Taylor: No, let me explain. Some elements of the ring-fence are absolutely rigid. You have to have personal current accounts and SME current accounts in the ringfenced bank. You may not undertake trading activities in the ringfenced bank, but others are flexible. For example, lending to large companies, large nonfinancial companies, which is a huge asset class, can go on either side of the ring-fence. We did this deliberately in order to stop liquidity being trapped.

Q102 Mark Garnier: Just to be clear, are you saying that you could bring a huge corporate customer, say pharmaceuticals, into the ring-fence-

Martin Wolf: They would be from the ringfenced bank.

Sir John Vickers: European nonfinancial.

Martin Wolf: Let’s suppose you have surplus funds beyond your normal SME mortgage and other loans in the retail ringfenced bank. You can lend to BP. This is an example. You can lend to very, very large corporates within Europe who have a demand for this. The likelihood of trapped funds with no outlet seems to us to be extremely low.

Martin Taylor: The head of the Association of Corporate Treasurers made a speech saying that this was a great danger of the ringfenced bank, but he made the speech two weeks before we published the report. One can quite literally say that he did not know what he was talking about. We have been particularly careful to stop that because it is indeed dangerous if you do not let this valve out.

Sir John Vickers: Some forms of full split might have given rise to that problem as well, among others. If I could just say one thing in response to your previous question-

Martin Wolf: The same problem with the arrangement in the full split.

Sir John Vickers: -about the flow. Money can flow in various circumstances. If the ringfenced bank is comfortably meeting all its requirements, then dividends can be paid, as it were, over to the parent or rest of bank. I think you had a question, what about the reverse; is it completely unrestricted in the other direction? What about the rest of the bank to the ringfenced bank? That partly depends on the corporate architecture of the rest of the bank. There are all sorts of different ways in which that could be done. There may be, and typically would be, constraints on the different elements of the rest of the bank in terms of capital requirements, so it is not unrestricted, typically it would not be unrestricted going into the ringfenced bank, because of the regulatory landscape as it applies to the rest of the bank.

Q103 Mark Garnier: As long as they meet all their liquidity requirements?

Sir John Vickers: Exactly, exactly.

Mark Garnier: That is very reassuring, thank you.

Q104 Chair: In sum, the trapped deposits argument is a nonproblem; that is what you are saying?

Sir John Vickers: We believe so, given the flexible design that we recommended.

Martin Taylor: We think it has been solved.

Q105 Chair: Let’s sort out one other thing. In response to an earlier question from Jesse Norman you said that ringfenced executive compensation would be set by its board. I think you did, Mr Taylor. Where is that in the report? I have read it fairly carefully.

Martin Taylor: Give me 30 minutes.

Q106 Chair: Perhaps you could try and find it. I thought it would be in the section on the structure of banking groups, which seemed the most logical place, but I cannot find it there.

Sir John Vickers: I took it simply to be an indication of what boards do.

Chair: While you are looking for that, I am going to bring in Andrea Leadsom on competition.

Q107 Andrea Leadsom: Yes, I would like to ask you about the competition aspects of the report and the switchings, focusing on the PCA and the SME market. First of all, I feel you were not nearly radical enough. Clearly, the Commission was minded to agree with the Treasury Select Committee in its desire to see the proposed Financial Conduct Authority with a much stronger competition objective, but you have not really gone that far either. My first question is did you consider, and if so what did you think, about the prospect of reversing the Lloyds HBOS merger?

Sir John Vickers: We thought about that general question but recognised that the facts have moved on. One can’t go back to the situation as it was. We are now talking three years ago from where we are now. Instead, and I think this was the much more practical approach, we focused on opportunities arising from the divestiture under way as a result of the European Commission process in the context of the state aid that Lloyds Banking Group received and we hope made very clear in the final report that we think that the primary aim should be to ensure that a strong new challenger arises on the scene as a result of that divestiture process.

Q108 Andrea Leadsom: But you set a target for that new challenger to have 6% of the PCA market, which rules out a completely new entrant, doesn’t it? That would imply an existing player rather than a new entrant, or do you disagree?

Sir John Vickers: Or an enhancement of the assets to be divested.

Q109 Andrea Leadsom: What consideration did you give? Talking to the chief executive of the only new entrant, so it is not hard to work out who, their view is that the biggest challenge in banking in terms of the single customer view is the IT aspect of it. If you take a conglomerate like Lloyds HBOS now and tell it to divest itself of another 300 or 400 branches or whatever, you are still faced with probably seven or eight different IT systems, so that is a significant handicap to any new player who truly wants to be a new entrant and achieve a single customer view. Did you get into that level of detail?

Sir John Vickers: In terms of IT and so on?

Q110 Andrea Leadsom: Yes. Specifically, to be a new player you have to have a level playing field and if you inherit little odd bits of six or seven different IT systems-and let’s face it, banking is incredibly IT driven, having a customer view and personal current account and SME lending is incredibly important-those hurdles to successfully becoming a new entrant make it nigh on impossible to achieve that.

Sir John Vickers: Are you referring to the different IT systems in the different parts of the Lloyds package?

Q111 Andrea Leadsom: Absolutely. If you say Lloyds HBOS, it could be Cheltenham & Gloucester, it could be TSB, it could be Lloyds, it could be Midland.

Sir John Vickers: Yes, that is right. I think any corporate integration has challenges on many fronts and that is certainly part of it. One that we gave quite a lot of attention to in the final report, more so than in the interim report though I think we flagged it there, was the question of funding gap. It is a completely different point from the one that you are raising but our assessment and evidence pointed to it being quite a big challenge. The question about the number of branches, shares of personal current account market, is extremely important. I think we wanted also to add emphasis to the funding gap point, so that was very much part of the recommendation here.

Q112 Andrea Leadsom: Let me ask the question in another way. Do you have in your minds an idea of who it is that might become this new challenger bank? Did you have in your minds who might take on this potentially poor mix of an esoteric group of branches that probably would not be the most successful in that bank’s set of potential choices to sell off? Did you have a view on who might take up the challenge to become the new PCA 6% of the market provider?

Sir John Vickers: As to the mix of assets and liabilities, not everyone would agree with your description of it, and in particular Lloyds Banking Group. We were careful in what is a developing commercial context. It was not our role, as a Commission, to intervene in that process and think, "Yes, let’s hope it is player X rather than player Y". Rather we focused on the desired outcome for competition and consumer choice in the marketplace. So we have not formed a view, either publicly or privately, about desired acquirers for that or whether it should be an IPO or whether it should be enhanced this way or that. We hope we have stated very clearly the desired outcome of a strong new challenger bank, which we think is important for the marketplace as a whole.

Q113 Andrea Leadsom: It is fine to wish for one but if there has only been one in the last 100 years, one new full service UK bank in the last 100 years applied for, and the likes of Tesco Financial Services, M&S Financial Service clearly have not or have chosen not to scale up, you cannot have a policy of wanting more competition but not have any idea of who is going to be attracted to that. On that point you have not really dealt in your report with the issue of diversity of sources of financial services. Do you envisage retailers becoming banks? Do you envisage all sorts of new players, and who are these new players?

Sir John Vickers: I think there is a variety of ways in which the desired outcome could be achieved and it could depend on the nature of the acquirer or it could be a de novo thing, it could even be an IPO; it depends on the portfolio of assets and liabilities, branches, personal current account, the funding gap point. There is a variety of ways of doing it and I think it would have been wrong for us to specify our favourite among that possible menu in terms of doing it.

On the point of diversity, we hope that our recommendations, as a whole, are entirely friendly to diversity in the sector. We have sought to avoid some rigid template that everyone has to fit and that relates to the question we had or the responses about the flexibility of ring-fence design, which I think allows a variety of business models within that architectural framework. It relates too to the questions about mutuals that came up earlier in the context of the leverage cap. So, we hope there is plenty of scope in what we are doing that would be helpful to diversity. I think to go beyond that and trying to engineer particular kinds of diversity would have been a step too far, at least for this Commission.

Q114 Andrea Leadsom: Yes, but I am not talking about engineering diversity. I am just saying it is all very well to say to Lloyds HBOS, "You’ve got 42% of the British mortgage market and now you need to give somebody else a bit of a bite at the PCA market" but you have to have an idea of whether that is an attractive business model for somebody. It is one thing to simply throw it out there and it is another thing to see that it is a realistic opportunity for a new challenger bank.

Sir John Vickers: I agree.

Q115 Andrea Leadsom: We have had endless discussions in this Committee about the fact that the lack of new entrants and the lack of competition is stifling the PCA market and the SME market. They are oligopolies. There are no new players, no choice for personal account customers, no choice for SMEs; they cannot shop around. You cannot just simply say, "We’ll divest a few more branches". Did you look at breaking up RBS where, quite clearly, the taxpayer owns it? You could break up RBS into bite-sized chunks. Who would buy them and did you consider that at all and, if so, what was your conclusion and why?

Sir John Vickers: I am sure Bill wants to come in but if I may make a couple of points, one on Lloyds and one on RBS. I certainly do not think we have made just an abstract recommendation on new entrants. In terms of the funding gap and its importance for a new bank, the need to address that problem strongly is a very important practical point about running a business. If that point is not addressed you have a double problem. The new entity will not be an effective competitor in credit markets to lend. If you have a very big funding gap, adding loans is the last thing you want to do. Secondly, if there is a funding gap problem, the whole competitive and funding dynamic of that entity might have a cloud over it, which would make it a less effective competitor more generally.

On RBS we are at a very different point in the divestment cycle. We do not have the issue to the same extent as we do with Lloyds and personal current accounts and we do not have 100% Government ownership, so there are a number of corporate law points.

Q116 Andrea Leadsom: I think as we have said, that would be achievable under the Stock Exchange rules.

Sir John Vickers: If the facts change then the facts may change, but in terms of the evidence we had before us that is not the situation, so we made our recommendations in the practical context that we faced.

Bill Winters: I wanted to go back to the earlier comments because the overriding objective on the competition side has been to create a level playing field, to the extent that the bigger banks have enjoyed the too big to fail benefit, the subsidy, and we think we have addressed that head on through both the financial stability actions that we have taken, or that we are recommending, and also through the competition powers that we are intending or suggesting be put in place for the new regulator.

To the extent that we have a level playing field, that extends to the way that capital rules are determined for new entrants and you will obviously have noticed that we scaled the capital requirements to effectively benefit smaller entrants or smaller participants in the market at the expense, effectively, of the larger participants, purely reflecting the degree to which the smaller participants are not systemic. To the extent that they are not systemic, we do not need the same level of protection in order to assure ourselves that the taxpayer is not on the hook.

Of course, many of these initiatives will make their way into the way that the regulator, the PCA or the competition regulator in the future, approach the detailed rule-writing. So, for example, the use of internal models and the degree to which the buyer of the Lloyds branches will be able to benefit from the internal model credibility that Lloyds itself possesses today that does not naturally transfer to a buyer.

I think we would encourage the regulator to look at the efficacy of the system itself and the people attached to it and not purely at the track record of the acquiring entity, because the acquiring entity may not have a track record, especially to the extent that it is a brand new entrant. But it is impossible to anticipate all the twists and turns that could take place in that divestiture. The important overarching principle is to establish a level playing field on which new entrants can compete in the same way they compete in manufacturing businesses or transportation businesses or servicing businesses.

Q117 Andrea Leadsom: Do you predict then that your report is going to lead to a complete flood of new entrants to the banking sector in the UK? Is that your expectation? Is that a specific outcome that you expect to see?

Sir John Vickers: Do we expect a flood of new entrants? No. I think this is a market that for reasons-

Q118 Andrea Leadsom: Do you expect more than one in 100 years?

Martin Taylor: This is a very difficult juncture.

Andrea Leadsom: Yes.

Martin Taylor: Let’s be realistic about this. All the recent challengers pretty much have failed, have had to be rescued or closed down. The economy is not exactly booming. There is an enormous financial crisis brewing just across the Channel. There is an interest rate structure that makes it almost impossible to make money on the PCA business. It would be simply astonishing if there were a flood of new entrants into the market, as it stands at the moment. I think we would be smoking illegal substances if we were to suggest that that was going to happen, and I do not feel that way.

Q119 Andrea Leadsom: Okay, but it is clear from our recent inquiry that the PCA markets and the SME markets are an oligopoly at work. In terms of the free-while-in-credit current accounts, it is clear that the less well off or those who cannot manage their bank accounts at the end of the month are subsidising the wealthier who can and do not need to go overdrawn at the end of the month. In addition, there is that sense of no consumer choice because you cannot differentiate because it is all free, so free means free. We went to great lengths to try and identify what the banks are making out of this.

But the clear problem with that is that for any new entrant it is just a completely opaque market that you cannot get into unless you are able to buy a very significant market share with all of the funding and deposits that go with it. Likewise, in the SME market, there has been a lot of talk just recently about the vast credit spreads being charged, that you referred to yourself earlier, Mr Taylor, where SMEs-and there was a case just at the weekend of an ex-CEO of a FTSE 100 company lending a substantial amount of money to a bank at 0.5%, going in to try and borrow the money and being quoted a rate of 10% with security. That is the kind of spreads we are talking about and that is because, according to my constituency bag, SMEs cannot shop around. Their bank is the only game in town and there is not any choice. These are very real problems, aren’t they? How do you solve that? It is not clear to me that the ICB report has done anything that is going to structurally change that.

Martin Taylor: We have talked about continental banks, other EU banks branching in in the rather excitable context of HSBC going to Paris but I think it is more noticeable to see what a business like Svenska Handelsbanken has done in providing business in a number of provincial cities in the UK. I wish we had two or three more of those. I remember when I was at Barclays in the 1990s, a lot of the SME competition came from the Scottish banks because the Bank of Scotland, although it was not a branch in England, had corporate loan offices in Leeds and Manchester and Bristol and Birmingham and it was not difficult to find out who the interesting customers were. They were a source of very significant competition. That has all gone of course. But I think a few skilled, medium-sized continental banks are the best hope for this, not retailers.

Q120 Andrea Leadsom: Right. One last question.

Chair: Be very, very quick and a very quick answer.

Andrea Leadsom: You have proposed a new organisation to make switching happen and just talking to a couple of banks recently their expectation is that might cost around £600 million to put that in place. According to your report, it is a, "Let’s see how it goes and if it doesn’t work enough we will do more". Would it not be better to try, in an initial stage, to simply say, "Right, you have to switch accounts within five business days or else" and have some system of fines, not just for banks but also the big standing order providers? Rather than creating a new entity on a suck it and see basis, would it not be better to just give them the problem and say, "You work out a solution. If you don’t we will then come at something far more catch all", like the idea that we have talked about of full account portability? Clearly that has a big cost.

Sir John Vickers: On the evidence we have received, we believe that this redirection service is the right next step, that it can be done in a short timescale of a couple of years and that the industry should get on with it and do it. There will then be a need to take stock and see how that works. Some claim it will be transformative, others say it might not do very much. I think it will depend a lot on the surrounding context of consumer choice with a transparency in effective ways for the ordinary consumer with ordinary financial literacy levels to exercise choice. But who knows, no one can say how well that will work. I think it would be-

Q121 Andrea Leadsom: But wouldn’t you agree that is a big bill?

Chair: I think we really have to move on.

Sir John Vickers: Then there is the question of why not take the further step of account number portability. I do not know, we do not know what the incremental costs of that would be. I think they would be quite substantial, but most of the estimates come from the industry and I think there is a lack of independent estimate of that. What would be the incremental benefit? That question, that last one, partly depends on how well the redirect service works in terms of improving switching. We are completely open-minded about that second step, and whether it would be worth taking. We are persuaded absolutely that the first step should be taken asap.

Q122 Chair: Could I have a couple of quick clarification points on a couple of other things just to finish with? Have you discussed this with the European banking supervisory authorities and, in particular, have you discussed whether their proposals for maximum harmonisation would be in conformity with your proposals?

Sir John Vickers: By "this", do you mean everything?

Chair: Yes.

Sir John Vickers: We have certainly had several discussions with the European Commission, and I think that is particularly relevant to the second part of your question. As we make very clear in the report, we believe that maximum harmonisation is not the right approach in principle because stronger banks in Member State X is good for the community generally and one should not constrain Member States.

Q123 Chair: But you are confident they are not going to stymie this.

Martin Wolf: By the way, that is a Commission proposal, I think, and not a European Banking Supervisory Authority proposal.

Sir John Vickers: Exactly.

Martin Wolf: It is important to differentiate. There are members of that, the board of the EBSA, who are very doubtful, to put it mildly, about that proposal.

Q124 Chair: I have one other question that I think needs to be asked. You have set out very well what you think the minimum capital ratio should be for today and for this environment and for the next few years, but over time this is going to change, isn’t it? Who should be in charge of varying what that is? Should it be the FPC, should it be some other body? You do agree, I hope, that we need flexibility built into this.

Sir John Vickers: I think that has two parts. One is, as it were, through the business cycle there will be a role in terms of macro-prudential regulation for the FPC in the UK to vary the parameters of the-

Q125 Chair: Let’s just set aside the macro-prudential.

Sir John Vickers: Right. The second and I would think much longer-term question is if in 30 years’ time there were to be a review of all this, in the light of the evidence in between, how should that be conducted, by whom and so on? We have set our proposals in the international context and we are very much influenced by where the Basel process has got to, where it is headed and so on. I think internationally the Basel framework will continue to be tremendously important. In that wider context we hope that the measures of this kind would get us on a much sounder footing than we have been.

Q126 Chair: Do you have an answer to Jesse Norman’s question about compensation?

Martin Taylor: Yes, the question is that the Chairman was right, as always, and it isn’t explicitly laid out in the book.

Chair: We don’t have to go around checking all your other advice, do we?

Martin Taylor: No. We were relying, I suppose, on the duties of a board and this board should certainly have an audit committee on remuneration, a bit like the board of a public company. There is an overriding duty that we do spell out to preserve the integrity of the ring-fence.

Q127 Jesse Norman: I think that is a very important clarification, but just for the record your position is that the comp should be set by that board?

Martin Taylor: Yes. The Commission is dead but I think if we had thought to include anything we would have included that and I am sure Clare would approve.

Chair: I thank all of you for coming in today and for the huge amount of work you have put into this over the year that you have been running. It is a tremendously valuable exercise and I think most people would agree, almost everybody would agree, and even the banks would have to agree with Bill Winters when he said this has probably been a more thorough job than anybody else has attempted in this field and a very worthwhile exercise. Of course we will now take further evidence on it and you have other evidence to give elsewhere, whether or not you are calling yourselves the Commission or just individual ex-members of it. We are very grateful that you have come in today and thank you for coming.

Prepared 9th November 2011