To be published as HC 1534-v




Treasury Committee

Independent Commission on Banking Final Report

Wednesday 23 November 2011

Stephen Hester and Douglas Flint CBE

Ana Botín and Tim Tookey

Evidence heard in Public Questions 311 - 481



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Oral Evidence

Taken before the Treasury Committee

on Wednesday 23 November 2011

Members present:

Mr Andrew Tyrie (Chair)

Michael Fallon

Mark Garnier

Andrea Leadsom

Mr Andy Love

Pat McFadden

John Mann

Mr George Mudie

Jesse Norman

Teresa Pearce

Mr David Ruffley

John Thurso


Examination of Witnesses

Witnesses: Stephen Hester, Chief Executive, Royal Bank of Scotland, and Douglas Flint CBE, Group Chairman, HSBC, gave evidence.

Q311 Chair: Thank you very much for coming before us this afternoon. May I begin with a question to you, Mr Flint? Your Chief Financial Officer has been quoted as saying that the cost of holding bailin bonds would be £2.1 billion, which is too high to justify staying in the UK. Will HSBC relocate if the Government implements that part of Vickers?

Douglas Flint: I think the figure of 2.1 billion is dollars, not pounds, but it is still a very big number. What Ian was referring to was given that we are essentially funded by deposits, adding loss-absorbing capacity bailin bonds when we do not have them today would add a cost to being headquartered in the UK because the proposals that have been put in front of Parliament are that the lossabsorbing capacity should apply not only to UKbased activities but to the global activities of banks headquartered in the UK. So there is an extra-territoriality in saying we should hold bailinable debt in respect of all international operations. We do not have that debt because we are funded by deposits, so there would be a cost and a spread between raising that debt, which would be quasi subordinated, and placing it in riskfree assets. We estimate that in fairly normal conditions that would be around $2.1 billion post tax; in today’s conditions, it would be a great deal more. That would be a very significant item to weigh up in consideration as to where one would choose as the optimal place for headquarters. It is a hypothetical notion at the moment, but it would be a very huge cost.

Q312 Chair: Okay, but a significant issue to weigh up is quite different from saying it is too high to justify staying in the UK.

Douglas Flint: But we do not have a proposal yet. We only have a recommendation in a report.

Q313 Chair: But anything that costs $2 billion is too high to justify staying in the UK?

Douglas Flint: It is too high to ignore.

Q314 Chair: That is not quite the same.

Douglas Flint: I do not know what other jurisdictions are going to, in the meantime, say they might do.

Q315 Chair: Okay, but it is a bit of a gun to the head to the regulators, isn’t it?

Douglas Flint: It is not intended to be a gun to the head. It is a very big number.

Q316 Chair: Mr Hester, have capital and liquidity requirements, which are being imposed by the regulators to strengthen balance sheets, restricted the amount you can lend?

Stephen Hester: The amount that we can lend in the politically sensitive constituency that I think your question is getting at we have not constrained as a result of those two things.

Q317 Chair: I am sorry to interrupt, but just to be clear, what you are saying is it has had a disproportionate impact on one part of your activities but no impact on another part of your activities. Is that right?

Stephen Hester: The constraint in our UK business lending, which I think is probably what you are driving at, has been our ability to find people who we thought were credit worthy to borrow from us. That has been the constraint, not capital or liquidity. That said, it is the case, of course, that RBS is carrying three times more capital for every loan it makes than it used to-by the way I think appropriately-and the cost of liquidity is huge. You see that in the profitability of the bank and you see that in the current value of the taxpayers’ stake in the bank. I regard it as one of the key building blocks of recovering RBS that those businesses that we designated as core to our future, of which UK corporate is clearly one of the most important and should not be in any way starved of resources, and so we have managed ourselves to ensure that.

Q318 Chair: Do you agree with what Bob Jenkins of the Financial Policy Committee said today-that you can strengthen your balance sheet without reducing lending?

Stephen Hester: Well, clearly I did not hear or see directly what he said. I glanced over reports of what he said.

Chair: It was the front page lead on the FT.

Stephen Hester: But what I think I would say is that the first point is the one I have already made in terms of our continuing willingness to support our core customer base here in the UK and our ability to do it and the fact that we are doing it. Secondly, I did think some of the points being made were surprising. I could not understand how that would be the case. I understand, for example, one suggestion was that we go out and raise some more capital and I would be very interested to see the investor who wants to put more capital towards UK banks. At the moment they are all thinking that is a dumb place to put capital. I think there were some strange things in what he said, but as it happens the result for RBS today is that we are not constraining UK small businesses due to liquidity or capital constraints.

Q319 Chair: Do you put in the strange category of things that he said that you can strengthen your balance sheet by cutting your bonus?

Stephen Hester: Well, I think that, of course, we are into politically difficult territory with a small "p". I think that there is a very legitimate discussion about pay. Certainly, from a business perspective it is my job to make sure that we pay no more than we need to to get a given set of business results. I would make the point specifically on small businesses that if there are large bonuses in banking, which of course is a shrinking thing anyway, it is not in that area of the business. Changing investment banking bonus pools, however desirable it may be, will have no impact on small business lending and, in any event, such bonuses are paid largely in equity, which do not cost capital. Again, it may be an entirely desirable thing to do, but it will not have the impact of making even a penny more available to small businesses.

Q320 Chair: So the answer to my question is yes, it is in the category of strange things that he said.

Stephen Hester: It is in the category of things that are entirely legitimate to discuss but will not have the consequence of adding to lending to small businesses.

Q321 Mr McFadden: He was making a broader attack on the banking response to some of the new regulatory requirements and some of the new proposals that have been made. He says bank lobbying is, "Intellectually dishonest and potentially damaging" and says that, "It promotes fear for an economy which the banks are there to serve and from which they draw their livelihood". What is your response to that?

Stephen Hester: Thank you for asking the question. I think it is an important one and, of course, you are probably getting bored with hearing me here; you have seen me a number of times in the three years since I was appointed. As you know, those of you who have been here for the same period of time on this Committee, from day one when the board of RBS and the Government both asked me to join to help turn around RBS post the crisis, I have been a consistent and a very clear voice in favour of tougher regulation of the banking sector, higher capital and liquidity standards, and I think, if anything, outspoken in favour of the Basel process. You will never be able to find a quote from me criticising the international reforms around Basel or the impacts that they have on banks. Indeed, you will not find a quote from me criticising the extra tax put on the banking industry by the UK. I think that while it is true, of course, each bank must speak for itself about what it does and does not levy, I am clear that part of my responsibility has been to articulate from the point of view of a failed bank what lessons I think we can draw from that.

That is not the same as saying that there can never be a piece of proposed legislation that we would not think is not in the public interest as well as not in the bank’s interest. I have been equally clear that ring fencing would fall into that category, but I think as it relates to myself or to RBS the general charge of lobbying against regulation is not borne out by the facts, as indeed my witness testimony here has shown on many occasions.

Q322 Mr McFadden: Do you wish your colleagues would, therefore, stop saying or hinting that new regulatory requirements would either impact on lending or force them to think again about where their headquarters might be?

Stephen Hester: Well, I think that it is a responsibility of people holding our kind of jobs to articulate publicly and discuss publicly issues, and I think it would be a shame if people felt gagged in so doing just because others did not want to hear what they were saying or the answer. RBS has reduced its borrowing, its balance sheet, during my stewardship by $1 trillion, £600 million, and so somewhere in the world that is £600 million that is not available to whoever was on the other side of that. As it happens, we have not taken that from UK small businesses. We have done it by dismantling other parts of RBS in the way that we all thought was appropriate, but there is no doubt that in aggregate the world is going through a period where it de-leverages, which means less credit is available. I believe that that is a good thing; we had excess before. Clearly, that has its effects and we would be naïve to pretend it does not. The effects will be different with each country, each institution and, of course, each managerial decision.

Q323 Mr McFadden: Would it be fair in simple terms to sum up your response to Mr Jenkins as saying he is just going to have to put up with it? If we have criticisms to make of the proposals we will have to make them?

Stephen Hester: As I say, I have not read his remarks and I have not had the opportunity of a discourse with him, but I think I would simply repeat my position. As it relates to RBS we are not constraining our lending to small businesses for capital and liquidity reasons; it is constrained by demand. But I do think it is part of our duty to appear in front of bodies such as yourselves and give honest answers to questions as put and that is what I hope you would expect us to do.

Q324 Chair: On that lending point, the Citigroup report on Project Merlin concluded: "In aggregate, banks are meeting their Project Merlin targets by making credit available at a high price and on tough terms that few firms can afford to meet". Do you think that is correct? I am asking Mr Hester.

Stephen Hester: I do not think that is correct. The average cost to small businesses of loans from RBS-obviously that is who I can speak for at the moment-in the current year is 3.75%. I do not believe that you would find many businesses who would have a hurdle rate of return on new investment that cannot pay 3.75% in interest rate costs. In terms of whether we are profiteering on the back of that, our small business division makes profits substantially below its cost of capital, obviously to the expense of the taxpayer in this instance, so I do not think that is right that it is the lowest level of interest rates ever for small businesses.

Now, that said, it is the case that there are some areas of lending where banks have had to toughen up. Those areas come broadly under two categories. The first is where there was manifest excess in the past and it is a correction of excess and, indeed, our regulator, the FSA, and I believe public policy, is highly supportive of those excesses being eliminated. Some of the high loan to value mortgage lending was one example, albeit not in the small business area. Property lending is another example where the regulators are massively pressurising the industry, I think correctly, to be more conservative.

The second area where businesses will be finding it tougher is obviously businesses in a number of areas have been weakened by the recession and, therefore, themselves have a more challenging credit picture today to anyone looking at them. As a result, the conversations will feel more difficult. But all I can tell you, as I have said again on every occasion I think that I have been in front of this Committee, it is our absolutely genuine and sincere desire and attempt to make credit available where creditworthy demand exists to small businesses and at prices that are competitive. I believe we have done that. Approximately one in four of UK small businesses use RBS as its main bank. We account for nearly 50% of Merlin lending so far this year.

Q325 Chair: That is why the questions are coming your way on this subject. Could we have a note on the 3.75% and any qualifications that may be important in relation to it? I think that is a very important-

Stephen Hester: The only qualification I have is it is an average so some will lie above and some will lie below.

Chair: You will be able to give generic reasons for why they lie either-

Stephen Hester: Sure, of course.

Q326 Chair: You said that too many small businesses are simply not coming to talk about their finance needs and you are running a three-month programme to have a discussion with them and you launched that at the beginning of the month. How many have come to talk to you?

Stephen Hester: At the moment, because there is a lag of quite a few weeks between phone call to credit decision, I cannot give you any reliable statistics in relation to increased loan applications or anything like that. I am certainly happy to report on it.

Q327 Chair: But how many are having a chat?

Stephen Hester: I do not have a reliable statistic for you in terms of an increased number, I am afraid.

Q328 Chair: It would be useful to have some figures on that, starting with the mere chat all the way through to, as you said, a loan application, because it is a big step forward.

Stephen Hester: Yes. I promise you my own people have been charged with giving me exactly this data, and so I would be very pleased to pass it on once we have some data for you.

Q329 Mark Garnier: Douglas Flint, you came before us in January and February and I talked to you about the possibility of relocating back to Hong Kong or outside the UK. You said to me at the time that every three years HSBC reviews where your location is going to be, but it was this year that you would be deciding where you are going to be. We have a few weeks left until the end of the year. How are those deliberations getting along?

Douglas Flint: I think Stuart Gulliver, when he was up before the Joint Committee, said that we were probably going to push that back by maybe up to 12 months because we will not know the final outcome of the ICB in terms of what is going to be done in the UK. While all the stuff we used to normally do around just simply business climate and tax framework and so on can be done and has been done, the big issue in relation to where the regulatory map falls, ICB, DoddFrank and European directives implementation around the world is still very much a moving target. I think we will not be in a position by the end of this year to draw a conclusion because the regulatory piece will still be fluid.

Q330 Mark Garnier: Of those three things that you talked about, how important is ICB?

Douglas Flint: Well, I think the most important thing that we are looking at is the lossabsorbing capacity point. We have said that publicly on a number of occasions and, indeed, we have talked about it publicly because a great number of market analysts have begun to draw out extrapolations of what they think the costs will be, which is why we said we reckoned it would cost us a bit over $2 billion on an after-tax basis if one were to take or if one were to interpret what had been said in the ICB report. That falls within a range that is broader on either sides as to what market expectations are and, indeed, part of the dialogue we have routinely now with shareholders is simply saying, "Once we know we have a final figure we will be able to let you know what that is and talk to you about how we should respond". But as I said, it is hypothetical at the moment because it is a proposal. We do not know how it will be received when it is considered.

Q331 Mark Garnier: I am quite interested in lossabsorbing capital because you are talking about having to issue £55 billion of bonds you do not want in order to make it-

Douglas Flint: Dollars.

Mark Garnier: Sorry, $55 billion worth of bonds you do not want to buy $55 billion worth of what is meant to be a riskfree investment but, as we know, Government debt is not necessarily risk free, although we like to think, of course, that ours is. That is going to cost you $3 billion a year and yet your loan deposit ratio is 80%, I think. Do you feel that you are being very unfairly targeted with your strong funding model?

Douglas Flint: In a way, yes. It seems perverse in a way that a business model that is very conservatively structured in funding, i.e. funded by deposits, would be disadvantaged by a mechanism that is designed to strengthen the system. The more you are funded by core deposits the more the cost is of raising additional capital to absorb losses. That seems a perverse outcome.

Q332 Mark Garnier: Yet some people would argue that the more deposits you have the more individuals there are at risk and, therefore, there is a better argument for having more lossabsorbing capital. Or do you think that is a fallacious argument?

Douglas Flint: The risk that you take is on the asset side of the balance sheet, but I think stability of being funded by core funding has been for us through history an enormous strength because it means you are not exposed to the vicissitudes of the marketplace in terms of investor preference, debt capacity and all the turmoil that is going on at the moment where markets essentially in Europe are drying up because of uncertainty about what is happening in the Eurozone.

Q333 Mark Garnier: How easy do you think it would be to raise $55 billion worth of lossabsorbing capital?

Douglas Flint: I think it would take some time. I think it would be difficult and I think at the moment it is very difficult to speculate how difficult because investors do not have clarity as to what the terms and the structure of such an instrument would be, i.e. the fact that it would be bailinable I think is easily recognised. The fact in what conditions and what terms and who the obligor would be and all that kind of stuff is not certain to them. I think in particular the notion of lossabsorbing capacity at a group level is somewhat confusing to us in the sense that within the ringfenced bank one can understand what that means, but to hold capacity, because we are headquartered in the UK, that covers the entire global operations of the group seems to us to create the contrary of a ringfence concept. It seems to create a nexus between the UK Treasury and all of our operations around the world, which seems the reverse of what the ring-fence was trying to do.

Q334 Mark Garnier: You are giving me a very convincing argument as to why you should leave the UK. Discuss.

Douglas Flint: That is a conclusion that you are drawing from what I am saying. What I am saying is I think that the primary lossabsorbing capacity proposals have, I think, some unintended consequences both as to cost and in terms of their structural implications for a business that would be headquartered in the UK, which would be disadvantageous.

Q335 Mark Garnier: What are the good reasons for staying in the UK?

Douglas Flint: Multitudinous. The UK set itself out 20, 30, 40 years ago to be the most attractive location for international business and the international financial system responded to that. Time zone, language, the cluster effect of the fact there are 500 banks in London, the expertise that exists here in legal services, trusts, accounting, custodianship, financial exchanges, transportation and so on and so forth, absolutely huge. The sanctity of law is a huge element of a financial system and English law is a major benefit to the UK as an international jurisdiction. In terms of a place to do business, it has enormous advantages.

Q336 Mark Garnier: Should you choose in the space of the next 12 months to relocate, where would you relocate to?

Douglas Flint: I think again that is hypothetical because it would depend upon what regulatory changes are enacted elsewhere in the world. Having said that, it would undoubtedly be a place where we have a considerable presence because I think a group like ours has to be located in a jurisdiction where we have a significant presence.

Q337 John Mann: Mr Hester, you have been there for three years. How many of your top people, or those earning bonuses or decentsized bonuses, have you brought in from outside the financial sector?

Stephen Hester: Certainly, none of my top team were in their current jobs prior to me arriving. Roughly half have come from inside RBS, been promoted or changed in different ways, half from the outside. I cannot immediately think of anyone I have hired without financial services experience. In fact, I think the FSA would not allow me to even if I wanted to. Of course, there may be some areas like IT specialists or something like that, but one of the many areas in which regulation has become dramatically more intrusive is the FSA’s vetting of candidates and financial services experience is very important. Similarly, my chairman in restocking the board of directors of RBS, which is dominated by nonexecutives, has again sought to have people all of whom have some financial services experience in addition perhaps to some others. Again, that is both a business and a regulatory requirement nowadays.

Q338 John Mann: The reason for asking is that you and others in your industry are very prepared and regularly willing to tell us how you have to pay these huge bonuses in order to attract the best. But my observation is that there is a shuffling of a pack within the industry and, therefore, it is rather a limited pool. Another thing that you are keen to tell us is that we have to give you enough time for what some people would regard as rather modest changes that Vickers is proposing-in fact, until 2019. Isn’t the truth that there is no good reason, if we chose to do so, that they could not be brought in a lot quicker-in fact, some people would say within two years?

Stephen Hester: What I have said in the past, which I would say to you again on the subject of this timetable, is that I think there are three different moving parts. The first is how long it will take you and the regulators, whatever nexus there is depending on how you go about legislation and how much is done by Parliament and how much is done pursuant to secondary legislation and how much by the regulator. The first is how long will it take you to have the rules set out in a completely clear, unambiguous and tested way? Of course, that is up to you. I cannot know what that is. I would observe that the US, which has been attempting some similar sorts of things with DoddFrank, two years later is nowhere close to getting to the point where it is clear what has been legislated in terms of following it through. I think there is a time amount that is under your control in that sense.

Once the things that are under your control are done, then I think that there are two things that, if you like, lie on our side of the fence. The first is adjusting our business to be able to function inside and outside a ring-fence. My guess is that a lot of that can be done from the time that we know the answer within, let’s say, a couple of years that we know exactly what we are aiming for. The second is that there is a phenomenal amount of what I sometimes call plumbing changes that will probably be required to enact in particular the ring-fence. That may mean moving many millions of UK customers across legal entities, perhaps even different sort codes, different contracts, enormous IT systems change, some level of disruption, and then perhaps, using Douglas’ example before, some very considerable market activity. If, for example, HSBC has to raise £50 billion of new capital, there may be a number of years in which those kinds of things take place. These are the moving parts, which is why my own judgement is that it will not be a question of getting to the last day of the period and then everything happens on the last day. Things will happen all the way through it, but it will take the full period to sensibly cover each of those three points. That would be my judgement but, of course, a big part of that, the first part, is in broadly the authority’s control.

Q339 John Mann: Change is difficult, but it did not take the banks very long to change to the new environment when taxpayers in this country and across the world had to bail out the banks. The change came very rapidly. Indeed, there was an extraordinary change within banks in order to cope with new risk profiles, new business operations, new people, new banks, et cetera. I put it to you that in that timescale if that change had taken as long then we would have been in a bigger problem. Therefore, it does seem incongruous that you cannot change quicker. One commentator said this week that really what would be a lot better would be if we had dictatorship rather than democracy to facilitate change. As you will know, Mr Flint, the Communist Party of China just put its edict out about those businessmen who take too much money out of China should now be deemed to be traitors to China. I wonder in terms of where you locate what your perspective is in terms of how quickly such change would come if you were in China.

Douglas Flint: I think you need to distinguish two things. You are absolutely right that the financial system responded very quickly to the aftermath of the financial crisis of 20072008 and the regulatory response and the bailouts that took place, in particular by very quickly eliminating whole business streams. Securitisation, structured credit, leveraged arbitrage activities were simply closed and that is relatively easy to do very quickly. You are just eliminating business. What you are talking about here is taking a business that is within a single legal entity and carving the individual business streams and, indeed, the individual customer relationships with the bank and placing them within two separate legal entities, which is a significantly more burdensome task than saying, "Don’t do that activity with that customer" or, "Cut that activity out altogether". You are splitting the activity. Effectively, you are creating two new banks out of every bank that exists, and that is a significantly greater challenge than changing the business activities done within the single legal entity.

Just to take the illustration that Stephen made, one of the things the industry is grappling with, and we are certainly grappling with, is something as mundane as what to do with sort codes. A sort code is a destination that defines the branch to which your account is attached and the number of the account. The vast majority of our businesses will end up with activity on both sides of the ring-fence, so are they going to need to have two different bank accounts, two different sort codes, two different destinations, and just how that will work is a non-trivial question for something that is really very mundane. It is very different from saying, "Here is a banking product or an activity you should not do" as opposed to, "You can continue to do all these things but do them in different legal entities".

Q340 Chair: Before we leave the location issue completely, so I can plant the thought with you and then come back for the answer in a few minutes, in a word or in three words in a few minutes’ time I will come back and ask both of you, particularly you, Mr Flint, the three issues that at the moment would be most influential in deciding where you would want to locate. What three things have led you to see Britain as somewhat less attractive than it had been during that buildup of the 34 years that we were talking about in your earlier answer? I will give you a moment to think about it, but in the meantime, John Thurso.

Q341 John Thurso: Mr Hester, I want to ask you about the investment banking side, but may I first pick up on one thing you were saying earlier, which was about Merlin and lending to smaller banks and so on. How confident are you that the message you obviously are putting out at the boardroom level is actually going down into the regional offices and that they are following the lead that you are giving?

Stephen Hester: I think that I am confident as to the majority. I can never be wholly confident. We deal with millions of customers and we have 100,000 people in the UK dealing with them directly and indirectly and so, of course, not every single one of those will always dance to the tune that we would like them to. An example yesterday, and it happens to me all the time, I was up in Nottingham yesterday, spent a lot of time with our business clients as well as our staff in the East Midlands. There was absolutely no doubt whatsoever in my mind that from staff member after staff member at the most humble levels of the organisation that they are very clear of our message in terms of concentrating on customers. The world is complicated for them because they also have to grapple with credit issues and with customers who maybe are not able to pay us back, with a whole set of regulatory and other challenges, so I think it is entirely possible that mixed messages arise. Obviously, we are doing our best is all I can say, and every day that goes by we identify new things. A year ago, the bank set up a business task force to address about 20 specific issues to try and make the small business lending area better. One of them was effectively what I will call a small business ombudsman who can receive complaints from small businesses about lending and pass them on to see if the banks are dealing with those things properly. The most recent report of the small business ombudsman, I think for the period since March-I may be wrong; it was the first one that they did-showed that RBS-as I say, RBS accounts for roughly a quarter of small business relationships and 45% of lending-accounted for 8% of complaints about bank lending. Of the complaints that were upheld, which I think in the period was a total of 11, RBS accounted for only 4%. Those statistics give me comfort that we are in the right direction. I can never tell you that we have it absolutely right; of course we have not.

Q342 John Thurso: I know one of my colleagues is going to follow up on that so I will thank you for that extensive answer. What I really wanted to get to was the ICB proposals and how they affect the investment banking side of the business. For a universal bank such as yourself, is there anything in the proposals that makes it more difficult to compete with foreign banks in the UK or makes it easier for foreign banks to compete in the UK?

Stephen Hester: I think that it is clear-by the way, I think it is even public policy-that one of the aspects of the ring-fencing part of the proposals will be to shrink the scale of domesticowned investment banking beyond what it otherwise would be. Obviously, not many people will like that as an outcome, but I think that will be an outcome.

Q343 John Thurso: May I just double check? You think that that is actually an objective of what Vickers has said, to shrink the domestic investment bank?

Stephen Hester: I do. It is not a stated objective. I think it is nevertheless a public objective. Whether it is or is not, I think that will be the outcome. By the way, there are some other things that are going to force that direction. We recently announced our third quarter results and at least as it relates to RBS I made a series of statements about strategy evolution of RBS. As you may know, we halved the size of our investment banking operations when I arrived three years ago. I said in our third quarter that there would be a further evolution of strategy and that there would be a still further reduction in our investment banking operations that will result in part from regulation and in part from market and investor changes-these things all blur together but they go in the same direction-after a further reduction in investment banking.

Q344 John Thurso: If UK banks, as you say, are being pushed out of that business, does that mean the business simply will not be done or does it mean that that creates a gap that will be filled by people coming in from outside, a sort of "Wimbledonisation" of UK investment banking?

Stephen Hester: First of all, I do not think it is black and white. I am talking about a reduction as opposed to an elimination. Secondly, it seems to me that there are all sorts of changes going on around investment banking. Most of them are going to have the impact, I think, of investment banking shrinking from perhaps what its peak level might have been as a per cent of GDP or whatever it might be, whoever it is owned by. I think there will be extra shrinkage from the UK, which is the only jurisdiction ring fencing. But there will also clearly be some substitution that some other banks that are capable of offering their whole product line in a unified way to customers without the complexities of dealing with a different side and chopping it up will gain business. Some of that will be located in London and some may not be. I think we have made clear we regard this as a done deal. As it happens, we have gone in that direction anyway. The vast majority of RBS is UK and retail and commercial banking. We will need to go further, though.

Q345 John Thurso: Do you, Mr Flint, concur with that analysis? Do you think it is inevitable that investment banking in the UK will shrink as a result of Vickers?

Douglas Flint: I do not think it is inevitable it will shrink. I think the platforms across which the activity will be done to an aggregate will tend to be broadly the same. I think the platforms across which it will be done may be different and, indeed, I think that ought to be a policy objective of regulatory reform to say which parts of the financial system, be it the insurance companies, fund managers, alternative fund managers, banks and so on, are best suited to take this particular risk and to organise financial regulation in a way that directs or incents that to go to the right place. I think one of the issues that should be considered in all of that is what happens in a stress condition. While one level might be relatively indifferent as to whether the activity that the major corporates do through London is done by a Britishbased bank or a branch of a foreign bank, what was absolutely clear in the crisis of 20072008 and is becoming increasingly apparent today that in a world of constrained risk appetite banks are drawn back to their home market to use their capital and liquidity for home customers. I think one of the things the UK needs to reflect on is take the absurd example if we had no domestic institutions and you have a global funding crisis and all the banks take their money home, then who funds the companies in Britain? You can see it today in all the regulatory challenges that have been made in terms of cross border exposure that risk has increasingly been concentrated, as you would expect, in domestic markets.

Q346 Michael Fallon: Mr Hester, the Independent Commission has costed its proposals at a maximum of £7 billion. Goldman Sachs now say £9.6 billion. Who is right?

Stephen Hester: Sadly, none of us know for certain and none of us will ever know because we will never know the counterfactual. I have often said I think it is a done deal, but it will be put into action and we will never know what would have happened otherwise. It is my own judgement that the Independent Commission is likely to have underestimated the amount but, as I say, this is going to be a very hard thing to prove one way or another.

Q347 Michael Fallon: But if you do not know, how does the Government know? They can do the calculation.

Stephen Hester: They can come up with different estimates. All I am simply saying is that I think that the ability to apply certainty to these estimates is extremely low, especially given the unusually uncertain external climate we have across many things. But in any event, I think it is unusually low. I have not had the benefit of all the bank submissions that the ICB received. I only know where RBS’s thinking lies. There are many different scenarios but we broadly believe that they have underestimated the costs.

Q348 Michael Fallon: What is the cost to RBS, then?

Stephen Hester: Again, I do not think that there is a useful single number I can give you, but what I can do is illustrate for you some sensitivities to it. For example, for every 10% more capital RBS were to carry, that would be in capital cost terms £5 billion to shareholders or, depending on your hurdle rate of return, maybe £750 million a year of pretax profit equivalent. The running costs, the implementation costs, for RBS alone may be somewhere between half a billion and a billion pounds in addition to running costs. There will be lost business costs of customers who are put off by the complexity that is being put upon them and go elsewhere; they are very hard to estimate but obviously you do not need big percentages for them to add up. These are the sorts of areas, and then funding costs, which will be higher, which lead us to our belief that that is an underestimate. However, as I say, I think this is largely a done deal. I believe that we in the industry can adapt to these things and that is what we are shaping up to do.

Q349 Michael Fallon: This came out two months ago. If it is a done deal you must have done some base cost assessment of what the total cost is going to be to your bank. You cannot just talk to us about sensitivities. You must have made an estimate.

Stephen Hester: There is no singular number that has been presented to our board of directors or to management. There are a whole range of sensitivities under the headings that I have just been discussing with you that are putative in terms of what might be the case some years down the line, which lead me to the broad judgement I have given you. But there is not a single piece of paper that says, "RBS cost is X".

Q350 Michael Fallon: It sounds very vague. Well, Mr Flint, one reason for the difference between the Goldman estimate and the ICB estimate may be exactly the lossabsorption buffers that you were talking about earlier. What is the total cost to HSBC of all this? You told us $2 billion for the absorption buffer, but what about the rest?

Douglas Flint: Again, I have the same answer that Stephen does, which is that none of us know where the final regulation is that will implement the legislation that will give effect to the ICB proposals, so it is all hypothetical. We do not know yet finally what the final construct of what will go into the ringfenced bank, what will not go into it, how the funding structures will change, whether in fact the ICB’s proposals on removing joint and several liability for pension schemes and VAT reform, both of which could be quite big costs. The coordination of the ring fencing with the work that is already well under way with the Bank of England and FSA in relation to recovery and resolution planning and, in particular, in a ringfenced bank scenario what service relationship will be between the two parts of the bank and what resilience that will have to have and what duplication that will have is still not clarified. It will be a matter of consultation, so all of these things will have/could have significant impact on cost.

Q351 Michael Fallon: Apart from the lossabsorption buffers, where you have a particular problem because of the nature of your bank, what is likely to be the single most expensive part of Vickers?

Douglas Flint: Well, I think the second most troublesome part at the moment as we look at our business in the UK is the nexus between liquidity, capital and leverage. If I illustrate very simply, the ICB proposal said that the core equity of a large bank should be 10%. We have no challenge to that. It says that the leverage ratio of a systemically important bank should be 4.06%, call it 4%. In order to get the capital and the leverage in the same place, the average risk weighting has to be 40%, so effectively 10% of 40 is the 4% on the leverage issue. Because we have a very conservative balance sheet in the UK in relation to small business lending but, more importantly, to the shape of the mortgage book, we find the capital that the risk weighting requires us to have is considerably less than the leverage ratio. In other words, the more liquidity we have in the bank, which is a good thing, and the less risk we take in the bank, which is I think a good thing, means that the constraint is the leverage ratio and you end up having to put a lot more capital into the bank for the leverage ratio rather than for the risk or for liquidity. This means that you are faced with reducing your returns or shrinking your business. That combination seems to be one that we are having discussions with at the moment, but it seems to be a curious outcome that if the ringfenced bank ends up being very low risk, it becomes very uneconomic.

Q352 Michael Fallon: All right, Mr Hester, can you be less vague on this? What is the single most expensive part of these proposals for you?

Stephen Hester: I think that I would divide the proposals into three buckets of cost. The first is what I will call the extent to which the proposals effectively agree with the direction of international reform but go a little bit further, which is largely around issues of capital and capital structure and bailin and resolution. I think that those will be pretty costly but, as I said before, they happen to be things that generally we are supportive of notwithstanding the fact that they are costly. I think that they could be easily comparably costly to the ringfenced part of the proposal, which of course is the bit that no other country is following and the first bit that many other countries are following. But the cost of ring fencing is the least easy to estimate because it requires a whole series of behavioural guesses as to how customers will behave when being able to do business simply with JP Morgan or Paribas or Deutsche Bank in an uncomplicated way with a UK bank and how funders will behave. Then, as I have said before, the third and smallest bucket-but still hundreds of millions of pounds-is the implementation cost of the whole thing.

Q353 Chair: Just following up on Michael Fallon’s questions, perhaps it would be helpful if you-as banks, you must have done assessments on best and worst case assumptions about the cost of these proposals and with respect to partial or full implementation of them-could send us, both of you, your best assessment of the costs based on reasonable assumptions for each part of the composition of that cost? We could then take it from there.

Mr Flint, I wonder whether you have had time to think about that relocation question I asked you in a few words.

Douglas Flint: In a few words, okay. You asked me the three most important elements. I think in order of importance, the most significant impact is the PLAC, the primary lossabsorbing capacity. Again, I differentiate between whatever we do in the UK for UK activity done through a UK bank, that is entirely a matter for the regulators and legislators here to legislate on and the industry will absorb that cost or pass it on. What is done to headquartered companies is simply a cost of being headquartered here. The best estimate of the cost of being headquartered here and having to have lossabsorbing capacity for our business outside the UK is a bit over $2 billion after tax.

The second most costly element of being headquartered here is being required to pay the bank levy on our balance sheet outside of the European Economic Area, and that is another $400 million after tax.

I guess the third thing that would be of influence is the whole area of level playing field superequivalence. In their testimony to you, John Vickers said, "We tried to make a distinction between domestic business and international business" and Bill Winters said, "But where we thought the international proposals were wrong we also went further". I think there are some elements of that that would be unique to the UK financial sector structure and so on, but I think clearly one of the factors that we will take into account is as to whether Europe and within Europe the UK offers a level playing field for all or some of our activities or whether it has become very superequivalent in the way it has applied regulatory change. Those will be the three areas: PLAC, the levy and superequivalence.

Q354 Chair: I note that the 50p rate has not appeared in that list of three.

Douglas Flint: No.

Q355 Mr Mudie: Since Lehmans we have had a procession of bankers coming to this Committee and speaking wonderful words about how they are helping small and medium enterprises, and yet when we go back to our constituencies we hear differently. Now, you have done it today, but your trade union, the British Bankers Association, have just issued a survey that they paid for, the biggest ever survey on SMEs, over a million surveyed. Half a million said they were not even thinking about it at the moment because of the state of the economy. Of the remaining half a million, 250,000 businesses blame the banks, their lending terms and processes for their reluctance to borrow. Your trade union again found out in the last three months 70,000 SMEs had applications for overdrafts turned down. In the same three months, 54,000 SMEs were turned down for a loan. That is between July and September, 54,000. Now, one in six applicants for an overdraft are turned down; one in three applicants for a loan are turned down. Can you see the difficulty we have in this Committee at the gap between what is said to us and what is being said out there and what your trade union has confirmed-that it is desperate out there for small businesses? Go on, Douglas, you were poised to say something.

Douglas Flint: What I can say is that we recognise the difficulties that exist in the economy today. We are approving the same high proportion-about 80% of credit applications that come through our system. I think the business taskforce in terms both of mentoring and offering an appeals service to small businesses has been very well received. I think regrettably, and this is maybe something that collectively we need to do, there is an element of misunderstanding of the role of bank finance among some small businesses. What we do is fund working capital. We fund the acquisition of premises. We fund the acquisition of businesses either from other companies or companies themselves. As an industry, we are not particularly keen on funding losses. We are not particularly keen on-

Q356 Mr Mudie: You seem to do it with other banks very easily. That is what gets me. All the money you have lost in the past few years has not been to small businesses; it has been to fellow bankers and fellow financial corporations. You are all very well taking a risk when it is white collar, but if somebody is actually producing something you seem to regard it as high risk. The last Government came under some criticism because although the rescue of the banks was done over a weekend, the lack of detail over the arrangement, the agreement, allowed the banks to be able to say anything they liked because there was nothing written down. But Merlin was written down in February. Now, this is the last quarter of the year. Mr Hester, what is RBS’s share of that £76 billion to small and medium enterprises, the additional lending that-

Stephen Hester: As I said to you, as far as we can tell so far this year RBS accounts for between 45% and 50% of Merlin lending to small businesses.

Q357 Mr Mudie: No, may I just stop you there? I heard that and was pleased with it, but this is Project Merlin. You agreed to do something, five of you. You agreed to spend an additional £76 billion for small and medium enterprises. That was in February. What is your target? What is your share of that £76 billion? That is all we-

Stephen Hester: It is currently running in the high 40%.

Q358 Mr Mudie: No. Well, Mr Flint, what is your share of the £76 billion? Five of you went in, made an agreement to lend £76 billion additional. Now, you surely got in another room and said, "Well, how the hell do we divvy this up?"

Douglas Flint: No, there is a schedule. Yes, there is a schedule that sets it out.

Q359 Mr Mudie: Yes. I am just asking you, what is your figure? It would be very, very interesting. We will do it with the next two. Tell us what your figure was as part of that £76 billion.

Douglas Flint: No, we can, we actually publish it. We publish it in our interim report and our quarters.

Q360 Mr Mudie: Well, tell us.

Douglas Flint: I cannot tell you the number off the top of my head. It is a public figure.

Q361 Mr Mudie: Do you know your figure?

Stephen Hester: We publish it every time. I have just given you-do I happen to know the percentage? No.

Q362 Mr Mudie: I know you published it. You have published a lot but what is the figure?

Stephen Hester: It is between 40% and 50%. In the last nine months it has been running, I believe, between 45% and 50% of the lending being done.

Q363 Mr Mudie: No, that is a percentage, what we are simply saying is what was your share of the £76 billion?

Stephen Hester: Of the lending being done I am talking about.

Mr Mudie: Sorry?

Stephen Hester: Of the lending being done.

Q364 Mr Mudie: Yes, what was your share of that?

Stephen Hester: Well, I am sorry, I am obviously not understanding your question very well. I thought I had just told you that.

Q365 Mr Mudie: Are you saying you are taking 50% of that £76 billion?

Stephen Hester: No, I am saying somewhere between 40% and 50% of the Merlin lending to SMEs is accounted for by RBS. It slightly varies quarter to quarter-

Q366 Mr Mudie: The other four are only dividing up 50% between them?

Stephen Hester: Well, I can only speak for RBS.

Mr Mudie: Again, then, this seems strange to me.

Stephen Hester: If I may, every quarter we publish our lending, not just to SMEs but we publish them to all corporates and on mortgages and everything.

Mr Mudie: No, I am not asking that.

Stephen Hester: There is no great secret here.

Q367 Mr Mudie: Well, there is such a great secret. Are you saying to me that five bankers made an agreement with the Government to lend an extra £76 billion to small businesses and did not make arrangements between each other what your share was?

Stephen Hester: If I may, I think we are on-yes, we each had amounts of that we thought that we could accomplish.

Q368 Mr Mudie: Can you supply the Committee with your stated share?

Stephen Hester: I just want to-

Mr Mudie: Yes, Douglas says. Can you not?

Stephen Hester: George, if I may, RBS and I believe all of the other banks are not actually approaching it in the way that you describe. The way RBS is approaching it is we want to-may I finish?

Mr Mudie: Okay, you are 45%, 50%. You are-

Stephen Hester: May I finish? We want to lend as much money as creditworthy small businesses want from us. If that is more than our target, terrific, we have the money to do it. If it is less there is nothing we can do.

Mr Mudie: There is a bigger question. Stephen, there is a bigger question. There is a bigger question.

Stephen Hester: That is how I am approaching it as Chief Executive of RBS. I am not approaching it as some artificial number.

Mr Mudie: Very good.

Stephen Hester: I am approaching it that it is our responsibility to support our customers. I want to do that as well as we possibly can.

Mr Mudie: Wonderful.

Q369 Mr Mudie: I will come to you, Douglas. Can you tell me how much you lent in total as a bank, say in the last year?

Douglas Flint: Just over $900 billion, between $900 billion and $1 trillion.

Q370 Mr Mudie: Say that again?

Douglas Flint: $900 billion to $1 trillion.

Q371 Mr Mudie: How much do you lend to small businesses in the UK? I would be very happy if you would supply us with a number.

Douglas Flint: I will supply you the number. It is a public number.

Q372 Mr Mudie: Lovely. Could you give us how much do you lend?

Stephen Hester: Why don’t I just write to you with the numbers rather than guess and give you the wrong numbers?

Q373 Mr Mudie: You see, the Government, with a great deal of support in turn-not the speed at which they are doing it-have got into the business of seeking to rebalance the economy. You will support them in not doing it through public expenditure, so they are looking for you to actually finance the growth of exportled businesses. Have you two, in your respective banks-you are talking about leaving the country, which is bad-but before you leave it do you have any stated policy or stated work going on in terms of rebalancing your lending policies?

Douglas Flint: Absolutely. One of the segments that we believe we are competitively advantaged in because of our network is import/export business. One of the things we have been doing with SMEs this year, partly in pursuit of meeting our Merlin targets, is saying to small businesses, "If you increase the number of export markets to which you export, we will give you reductions in your borrowing rate".

Q374 Mr Mudie: The Chairman wants me to stop, but I just want to show you the TISCO financial stability report. Half of the stock of bank lending in this country goes abroad. Half of it. The biggest part of the other goes to banks and other financial corporations. The next one goes to households, predominantly mortgages. The smallest part in that whole thing is non-financial corporates. Now, do you not see the task that the Government has and you have? That is why I would welcome you putting on record your share of lending to UK small and mediumsize enterprises. It would be very good if you put additionally to the Committee your objectives in terms of rebalancing that so we can rebalance our economy. Does that make sense?

Douglas Flint: Yes, it does. We will send you that.

Q375 Mr Love: This lending to small and mediumsize enterprises is an issue of considerable concern so I want to continue to press you on these matters. The most authoritative report published on lending to small and mediumsize enterprises is done by the Bank of England, based on figures provided by your banks. In the last report, which is dated in October, they suggested that lending to SMEs is more negative than the position six months ago, and that the growth rate was now at -5% up to August 2011. How do you square those figures with the very positive figures you are giving about Merlin? Mr Hester?

Stephen Hester: Clearly, I am not in possession of the bank’s statistics and so I have read the report as you have but do not have the statistics behind it. I believe, and I could be wrong, that the bank are referring to the amount of drawn loans and what Merlin refers to is the amount of loan facilities committed. Now, let’s take overdrafts just as one example. Clearly, banks have no control whatsoever of how much of an overdraft is used by a recipient, be it an individual or a company. We know they can draw as much of their overdraft but they do not have to. For two years, probably three years in a row but two years definitely in a row, the companies at RBS Bank have paid down their overdrafts-in other words, used their overdrafts less than before, not because we have removed the overdraft; they simply are using less. Why are they using less? Because they are unconfident about the demand for their goods and their services. When you are unconfident as an individual or as a company you tend to pull your horns in and be more conservative about your budget and so on and so forth. This phenomenon, which you see, by the way, across the developed world, is that in times of lack of confidence from businesses in selling their goods and services, they try not to get more indebted. In fact, they try to pay down debt and you see that most indisputably with overdrafts where the banks have no influence whatsoever. It is entirely up to a company whether they pay back their overdraft or not, and they have been paying it down. I believe that the difference is that the actual amount of money that companies are has gone down. The amount of facilities available to them has not. They simply are not using those facilities because at the moment they do not have the confidence that that money will help them sell more. All of the surveys, and a survey was quoted earlier on, every survey of business says by far the most important thing in whether businesses expand or not is whether they think they can sell more of what they make or the services they provide, by far. Until companies are more confident that they can sell more of what they make, they are not going to borrow a lot more. Nor, by the way, should we want them to.

Our job is to try and remove obstacles. We are doing an imperfect job and we are trying to do it better, but the provision of finance is a hurdle in the race, and the race is about selling more of your goods and services and having the confidence so to do. I think that is the difference between the figures.

Q376 Mr Love: I want to come back to the demand issue because I think it is an important one, but let me just clarify. What I think you are saying to us is that the more accurate figure is the amount of money drawn down rather than the facility made available, and I think that is an important distinction that was drawn out by the Governor of the Bank of England previously; thank you for doing that for us.

I wanted to come on to Mr Flint because the British Bankers’ Association who did a similar study but for just small businesses-that is business that have turnover of up to £1 million-in a survey up to June this year showed that the growth rate for lending in that particular sector stood at -10%, not -5%. Is there some bias going on in the banking system towards even smaller businesses rather than small and medium businesses?

Douglas Flint: I don’t believe so. I agree with what Stephen says that the big issue is one of confidence and our statistics are identical in the sense that people are using overdrafts less and they are saving more because they want to be more resilient heading into a more difficult economic climate. If I look at our own small-business lending in the UK, perhaps 30% of that lending was either secured on property or was for the purchase of real estate, a typical use of bank finance. Property prices have fallen quite dramatically in the UK so even if volumes are the same on an annual basis, the amount of money lent would be less because the businesses being financed are less expensive. So some of the fall in the stock of lending is simply that the asset prices being paid for real estate is less, which is a good thing.

Q377 Mr Love: Let me come to the demand issue because I want to come back to Mr Hester. You are right that the survey shows the demand for finance remains muted, but the report then goes on to say that respondents felt discouraged from applying for finance for reasons such as issues with the process of borrowing from banks or an anticipation of refusal. RBS has gone out of its way to suggest that it is trying to overcome those things. Do you think you are doing enough to overcome the reluctance on the part of at least some respondents from small and medium-sized enterprises to the signals that are being sent by the banking industry at the present time?

Stephen Hester: I am sorry to make a trite reply. I think we are never doing enough. There can never be a moment when we are doing enough. We are trying hard. We are constantly reviewing the things that we are doing; trying to take account of feedback. One of the reasons that I quoted to you, the survey that the banks have set up, the small-business ombudsman, when companies complain to them clearly that is an opportunity to understand what is going wrong and that is why I pay attention to the answer.

A year ago we wrote to every single MP in the House of Commons giving a business hotline and asking MPs like yourself to send us people who are complaining to you, who feel that we have turned them down, so that we can have an independent group review those things. The Chairman referred to an initiative we launched two weeks ago in terms of low-cost, fixed-rate, no-fee finance. We are constantly trying to eliminate obstacles we put in the way that are not appropriate obstacles. At the same time we have a responsibility to lend responsibly but we are trying to do it. I would be the first to say we are imperfect but I think we are making progress and the macro statistics say we are doing a decent job. My ambition is to be thought of better than doing just a decent job.

Q378 Mr Love: Let me remind both of you that according to all the studies small and medium-sized businesses, in many senses, remain the engine of the economy. If growth and employment opportunities are to come back into the economy it will be through small and medium-sized enterprise. So this is an incredibly important discussion. I noticed earlier on, Mr Hester, you mentioned about whether they were credit worthy businesses and of course that is a critical judgement and many would say you are too harsh in your judgements. Some would say you need to be prudent. There is a difficult judgement there, I accept, to be made. The Governor of the Bank of England is always telling us that only banks can make those judgements because they are the only ones with the experience. But let me say finally, the Bank of England report then goes on to say that some small firms were reluctant to approach banks out of concern for an increase in the cost of existing borrowings or a reduction in their overdraft facilities and that as a result had resorted to the use of personal loans instead. How big a factor is that for you? Are some of the businesses not wanting to come in case they upset their existing credit facilities that they have? Is there evidence that this is happening and how harsh are you being on some of your businesses?

Douglas Flint: I don’t recognise that. Indeed I think one of the very positive things that has come out of the business task force which all the banks signed up to, many more than the five that are in Merlin, was a mentoring scheme and the BBA together with the banks, together with BIS and other government departments are taking a roadshow round the UK going to all the trade associations of small business and saying, "This is the way we are doing it; come and get a mentor; come and be guided as to how better to present your financial affairs to be more successful; to be more confident that you will reach the criteria the banks are asking you to do". I believe the take-up of that service and the efficacy of it has been very strong. It only launched this time last year so we are early days in terms of following through but we in the industry believe that that is doing a very good job. I am simply not familiar at all with the move away from using banking facilities to personal facilities. Indeed the advertising the banks are all doing, and certainly we are doing, in relation to encourage small-business lending is more than we have done historically.

Q379 Mr Love: May I interrupt you, because I am being pressed? Let me just ask you this, Mr Hester. A lot of these reports about the banks’ failing as far as lending to small businesses are coming from their own organisations, the Federation of Small Businesses and others. What discussions are you having with them to clear the decks and recharge at least the possibility of agreement on where we are as far as small-business lending is concerned?

Stephen Hester: I think each of us, both through the industry it is true as well, but each of us individually, engages all the time. I mentioned my trip to Nottingham yesterday. My lunch was with the CBI in the East Midlands and there were about 60 CBI members-most of them the small-business end-who came; I was the speaker and we had a whole series of discussions. We are constantly affiliated with the Chambers of Commerce around the country, which is a very important way of reaching small businesses collectively and I am sure my colleagues in other banks do similar things.

Again I certainly would not begin to say that we have reached perfection. Of course in stressed times people are more stressed and their difficulties and problems come out and, as you say, there are very difficult judgements on creditworthiness where honest people can disagree. All I can say is that we are doing our best and where we see shortfalls we are moving to try to correct them to the fullest extent that we can.

Q380 Jesse Norman: Mr Hester, I cannot let the moment of your being here pass without asking if you can give us some update on the bank’s exposures in the Eurozone because that is a source of great concern to everyone around this Committee, I am sure.

Stephen Hester: We published results about two weeks ago for the period to 30 September, so I don’t have an update since then. I don’t think it has changed very much since 30 September. We showed that our exposure to sovereign debt in the so-called peripheral Eurozone was negligible in our context anyway and I think, from memory, 75% reduced from the previous year-end.

We do have meaningful lending to companies, in particular Italy and Spain. Our major peripheral exposure though is in Ireland where we have the privilege of being the third largest bank in Ireland through Ulster Bank, the largest in Northern Ireland, and of course that has been a very expensive experience for our shareholders. That exposure, though, is not really cross-border-does Ireland fall out of the Eurozone-it is largely domestic-property lending which is hurting. That would be our major exposure. As I say, I think Ireland’s problem is not its membership of the euro or its ability to compete in current exchange rates. They are successfully running a balance of payments surplus. Their problem is working out of the domestic property bubble.

Q381 Jesse Norman: I think you said at one point that you had a £40 billion exposure.

Stephen Hester: Including Northern Ireland, yes.

Q382 Jesse Norman: Have you taken write-offs on that?

Stephen Hester: Yes, billions of pounds over the last several years.

Q383 Jesse Norman: I would expect so. What is it standing at now?

Stephen Hester: The total write-off, I can write to you with the number. I am afraid I don’t have it with me.

Q384 Jesse Norman: The total exposure.

Stephen Hester: The total exposure to Ireland?

Jesse Norman: Yes.

Stephen Hester: It is still between £40 billion and £50 billion including Northern Ireland. From memory it is about £35 billion in Ireland itself. A lot of that is domestic mortgages

Q385 Jesse Norman: Thank you very much. Very quickly, if you would not mind, there is an equal sum on the funding side, given the number of banks that are being funded by the ECB in Europe and the shortness of the money markets and the increasing constriction. How is that affecting your funding side?

Stephen Hester: I would say as follows, that at RBS-I think in common with other UK banks but we had a particular need-we were able over the last three years to transform our balance sheet and funding position for the good. It is not a finished product so we want to go further still but we were able to report figures at the end of September that showed not only a so-called core Tier 1 capital ratio of over 11%, which was in the high end of the group, but in balance sheet terms, that our total liquid resources, having once been £200 billion short of our short-term borrowing is now £30 billion more than our short-term borrowing. So on all what you might call the external ratios, our position is a strong one.

Having said that, banks are part of a system that relies on confidence, economies rely on confidence, and I would be wrong to in any way sound complacent. RBS funders have nerves about the system and therefore about RBS, as funders of all banks do. We have experienced shorter maturities and closing of some parts of wholesale markets. All of us must regard the current situation in global markets with utmost gravity regardless of the fact that some banks are in a relatively better or worse position and be cognisant that slips of confidence for whatever reason are very dangerous things in this environment. That is as true as we now know for governments as well as it is for banks.

Q386 Jesse Norman: Thank you. Apropos Vickers, may I ask this quickly of each of you. You have gently skirted round the issue of implementation for obvious reasons. It seems to me not impossible that it could take Government a year or two to put in place the regulatory structure that implements Vickers. Does that mean we do nothing for the next two years on it or what measures will you be taking over the next two years to prepare yourselves for something that is somewhat of a moving target, especially given that it is implied that capital funding is off the table at the moment?

Douglas Flint: In terms of a business model we have already begun to reflect on which business lines, which products, will not make sense with the capital liquidity structure that will be in place post the ring-fenced bank environment. We have begun to look at the operational challenges in separating the banks and just the sheer logistics of the communication of that, the organisation of that, all within the constructs of a recovery and resolution planning framework that is, as I said also, under way. I think that will go on irrespective of how quickly the legislation comes out. But how we ultimately operationalise the ICB proposals will depend on what the enabling legislation is and then how the regulators take that enabling legislation and turn it into detailed regulation. There is a lot that we will be able to do in advance but the final piece will obviously have to await final regulations.

Q387 Jesse Norman: Is it possible to think that the bank could be forced to split as a result of the ring-fencing arrangements that are being put forward?

Douglas Flint: The ring-fence will require two separate legal entities; a ring-fenced bank and a non-ring-fenced bank.

Q388 Jesse Norman: But you do not think that that split could become closer to a full scale demerger?

Douglas Flint: That has not been remotely proposed and I think it would be disadvantageous because it would add a cost. At the moment there is an acceptance, albeit there isn’t final guidance as to how shared services will work and clearly the payments architecture, the whole operational architecture and so on, shared services, that are one at the moment would be much more efficient shared between the two banks than them both having to stand alone.

Stephen Hester: My belief is that while banks can and should come in all shapes and sizes, the specifics of the ring-fence while they have the impacts we said, I do not think themselves will lead to a change in terms of a total structure.

Q389 Jesse Norman: It would not be likely that you would want to sell the RBS investment banking business or anything like that?

Stephen Hester: I think if we do it would be for reasons other than the ring-fence and that is certainly not in our plan. Nor, by the way, do I think that there are lots of buyers, either.

Q390 Mr Ruffley: May I begin, Mr Flint, on the non-ring-fenced investment end of your business? I was puzzled because the ICB said that it would not, in relation to that bank, impose higher equity to risk-weighted asset ratios on the grounds that it would damage international competitiveness, but then it went on to say that it would require more primary loss-absorbing capital. Is that not a radical inconsistency?

Douglas Flint: Because we are a G7 global systemically important bank I think they are saying that we should attempt to centre everything we do through the UK in any event, and we certainly would not disagree with that. I think the non-ring-fenced bank will be demonstrably and-if these proposals really are going to carry the benefit that they intend-quite explicitly, standing on its own two feet in relation to its capital and its funding and its loss-absorbing capacity.

Q391 Mr Ruffley: What I am driving at is the non-ring-fenced bank; the ICB was conceding that if it imposed a higher equity to risk-weighted asset ratio on you it would impact adversely on your international competitiveness so it decided not to do that. Yet for loss absorption it does want to impose higher requirements on your non-ring-fenced bank. What is going on there? Have you asked them about that?

Douglas Flint: The bail-in proposals in Europe are not yet finalised nor indeed the bail-in proposals internationally and they may have been in some way anticipating where theirs might go. My personal view is that the UK should not have a specific loss absorbing capability for the non-ring-fenced bank in the sense that it should be explicitly you are on your own rather than saying we are going to ensure that there is a certain framework because again that seems to me to create a nexus between the UK regulatory architecture and the Treasury and what was designed to be separated from the ring-fenced banks. If the non-ring-fenced bank is explicitly designed to be "you are on your own and you make your own judgement on risk and you lend accordingly" then it should be demonstrably stand alone with the capital market providers making their own judgements on that structure, the business model, the management capability and so on and so forth.

Q392 Mr Ruffley: Is it fair to say that your competitors probably take the same view?

Douglas Flint: I won’t speak for them.

Q393 Mr Ruffley: May I just turn to Mr Hester? The ICB places a lot of weight on bail-in debt. Which investors are going to be attracted to that kind of debt, in very general terms?

Stephen Hester: I take a somewhat more sympathetic view on this subject in favour of the ICB than many do, perhaps at odds with current market realities but be that as it may.

It seems to me that it ought to be the normal order of things that if a company goes bust, once the shareholders have lost their money, the debt holders start losing some money in rising order of seniority. That has been difficult to apply in the banking industry because of the particular damage to the financial system of allowing liquidation of banks and overnight administration not being well developed. So the whole point of the resolution, and an essential complement of that is bail-in legislation, is to do this.

Q394 Mr Ruffley: I understand the concept, but who in the real world is going to be attracted?

Stephen Hester: Personally, I believe that in the fullness of time investors in bank credit will consider it just as normal that they should lose money once the shareholders run out of money as they do when they invest in any other credit. But I quite appreciate that in current very stressed moments and with most investors feeling that governments are inherently hostile towards their interests if they are investors in banks, particularly in the UK, that it may be some years before investors are persuaded of that case and that case can be made worse to the extent that there are protected classes of creditors above them. So of course one of the ICB proposals is to protect all depositors, which then leaves a certain category of debt investor more isolated than they might be in another company; and there are pros and cons of doing that. So I think in current market circumstances there is a wall of denial on this subject, but that said I think we ought to aim for a position where this is just normality; if you invest in banks as a debt holder you are treated the same as if you invest in any other company as a debt holder.

Q395 Mr Ruffley: May I put the same question to Mr Flint, except to say that of course there are no voting rights for holders of this debt? One of the virtues, say the ICB, of holding that kind of debt is it will enable them to impose disciplines on the bank, but if they do not have any voting rights it is not going to be that attractive. Just to repeat the question: what kind of investor do you think might come across, hove into view, and start showing an appetite for that kind bail-inable debt?

Douglas Flint: The same investor that you see with subordinated debt. I think one of the deficiencies of the past crisis has been that subordinated debt that did not respond in the way that it was expected to or designed to do. I am entirely with Stephen in the sense that the bail-in debt should reflect the risk that the creditor is being asked to take and the pricing should reflect that and clearly the discipline comes from the valuation by the debt provider on the business model and the degree of capital and so on and so forth and how much they are prepared to risk. I think a separate but really important issue is it is a very different issue between that debt should bail-in, which I think is an absolute given, and then what will define the category is the circumstances of when it will bail-in. Is it on resolution when the businesses fail and you are trying to find the least-cost way of winding the business down or is there a trigger that can be enforced by a regulator or whatever and what are the criteria to judge it? That makes a very different consideration.

Then the final and really important point for policy framework, which is where the ICB went differently from where the Financial Stability Board and the Basel Committee have gone, was to suggest that there should be a minimum threshold of bail-in debt; that is the 7% and the top of the 10%. Those other bodies have said it should be sufficient and that should be a dialogue between the regulator and the institution, again depending on all the unique characteristics. The danger of there being a defined amount, particularly when the bail-inable debt can be as short in duration as just over a year, is that you potentially create a trigger in markets that are very difficult from a funding perspective that banks breach their required quantum of bail-in debts and you get a spiral effect of you now can’t pay dividends, you can’t pay performance payments-that probably wouldn’t happen anyway-but more importantly you are going to make a real signal to the market as to whether they want to fund you. Whether the trigger impact of having a defined threshold is an attractive policy perspective, I really would question, in fact I would say it is not.

Q396 Mr Ruffley: I understand. Given the state of the markets, what is the ability of your bank to raise additional capital to meet the high capital adequacy proposals in the ICB?

Douglas Flint: We already have on a Basel II basis core equity well in excess of requirements, and we believe we will generate organically our Basel III requirement in equity. We have, in fact, just last week raised a substantial amount of long-term debt; so I think we have been privileged to be one of the few issuers that has been able to access the market for long-term debt in the last several weeks. The total market issuance has been very modest.

In terms of equity we do not need to go to the market for equity. I think that in a world where the vast majority of banks in Europe and in America are trading substantially less than book value and the uncertainty over the regulatory environment as well as the economic environment with the added complexities of Europe, I think it is a very difficult market for anybody to issue equity into.

Q397 Mr Ruffley: Do you think that is a flaw in the ICB proposal?

Douglas Flint: A flaw because?

Q398 Mr Ruffley: Where is the higher adequacy going to be provided?

Douglas Flint: The essence of banks’ stability, and indeed the ability to fund growth and take risk, is the flow of capital not the stock. An awful lot of attention has been given to the stock of capital, but the real strength of a financial system is its flow. Does the system generate a flow of capital that enables those that have been providing it to be remunerated appropriate for that capital; for there to be sufficient left over to fund growth and there be sufficient on top of that for a cushion for unexpected risk? So the flow is far more important than the stock and today the majority of banks in the world are not meeting their cost of capital, which is why they trade at a significant discount to book value. As long as that continues I think the ability to generate capital is going to be very constrained. I think that the flow of capital should be a primary focus.

Q399 Andrea Leadsom: Again, it is impossible to let the opportunity pass. Mr Flint, you were saying earlier that it is the loss-absorbing capacity that is the biggest consideration for your bank in whether to stay located in London or not. Are you discounting altogether the prospect of a financial transactions tax coming from the EU, or are you including that in your calculation?

Douglas Flint: We certainly never discount anything that has been put forward. I think there have been very strong statements made by this Government, and indeed by many governments in Europe-which we would absolutely embrace-that the financial transactions tax is not an attractive thing at all. I don’t think it is effective; I don’t think it works. I think it would be very disadvantageous for Europe in the broadest sense of the economy. So, yes, we are not assuming in our calculations that we are responding to there being a financial transactions tax.

Q400 Andrea Leadsom: So if there were to be a financial transactions tax, would that tip you in favour of relocating your headquarters? Firstly, if there were a financial transactions tax that included the UK, and secondly if it excluded the UK but was limited to the Eurozone?

Douglas Flint: I should think the financial transactions tax would be less to do with where the headquarters was but activity was done through Europe; so it would have a significant impact on what activity was done through Europe. I think it is not necessarily impactful of where our headquarters is.

Q401 Andrea Leadsom: So it would be as bad to be imposed within the Eurozone as within the Eurozone and the UK?

Douglas Flint: Yes.

Q402 Andrea Leadsom: Mr Hester, would you comment on that?

Stephen Hester: I think that with all taxation it is seldom a free lunch, I think it is a legitimate job of politicians to decide what taxes they want but to understand what the consequences are. Clearly if that tax was levied there would be some consequences both in terms of who bore it-passing it on to people who have pensions and so on and so forth-and in terms of reduced market activity and liquidity. Whether those are right or wrong choices I think is a matter of political philosophy as opposed to some technocratic answer. Clearly, it is not going to influence whether we are headquartered in Edinburgh or not.

Q403 Andrea Leadsom: May I just lead you slightly and ask if you agree that it would have an adverse impact on savers, investors, pension funds and so on?

Stephen Hester: I believe that it would be passed on to users of the relevant markets. Obviously there are many users of relevant markets but ultimately it comes down to saving. As I say, I am trying to stay out of the controversy on these issues of tax. It is legitimate to debate where you want to raise tax. You just have to understand that there is a consequence to it.

Q404 Andrea Leadsom: Would you agree that one of the consequences could be for the euro area to lose a significant volume of transactions? Would it be the natural reaction of banks to put those transactions outside the euro area?

Stephen Hester: Clearly if you have a tax like that and don’t do it globally, then there are all sorts of dangers in terms of distortion of markets and movement of activity. We shouldn’t be too precious about it because obviously we have stamp duty, share taxes, here in the UK and I think sometimes people are a little too precious on this being an extraordinary idea that has no merit whatsoever but nevertheless very clearly what it does is it has the influence of passing on costs, often to pension funds ultimately and to savers, and of moving activity to places where that tax is not present.

Q405 Chair: We are almost done with the first session. It has taken rather longer than anticipated but we do apologise; we are going to have to ask you to stay on a little longer. We will adjourn now for 15 minutes and resume.

The Committee suspended for 15 minutes for a Division in the House.

Q406 Andrea Leadsom: I think it was you, Mr Hester, who talked about the plumbing in a bank and how the ring-fence was actually going to complicate things because of sort codes and so on. So, turning to the subject of switching, the ICB proposes the Payments Council sorts out a redirection service that is going to cost up to about £800 million. Would it not solve, bearing in mind the ring fencing idea is a10-year aspiration, the complexity of having two sort codes and so on to move to a full account portability situation making the investment in a new shared infrastructure and creating a new unique identifier for each bank account that you would not then have problems of inside and outside the ring-fence and, of course, from a customer choice and efficiency point of view, it would mean that consumers, small businesses could switch banks far more easily? Do you not agree that rather than spending £800 million now on a system that would simply improve things but would not solve the issue of sticky accounts, that it would be better to move to full account portability?

Chair: I realise that is quite a big question. I would not like to-

Andrea Leadsom: You said only one.

Chair: But we would like a quick answer.

Stephen Hester: The quick answer is I am no technologist. I do not see how that would solve the issue of people having to have multiple accounts across Europe because they have to do business across several legal entities where today they do not. So, I do not think it would solve that issue. However, I, if you like, I am instinctively sympathetic towards the cause of portability and it certainly is something I have no philosophical objection to. To me, these are practical and technology issues as to where the bounds of benefit versus cost lies.

Andrea Leadsom: Thanks.

Q407 Chair: Mr Hester, what steps have you taken to protect the most vulnerable people affected by your decisions on ATM machines?

Stephen Hester: I think what you are referring to is in relation to ATM access to basic bank account holders.

Chair: Yes.

Stephen Hester: And so what we have done is, of course, to start with we have the biggest ATM network in the whole country that is accessible to basic bank account holders. Secondly, we have just signed up to distribute product through the Post Office which is a loss-making thing for us to do but obviously extends by whatever the number of Post Offices is nowadays, the access. And thirdly, we either have or are in the process of communicating with basic bank account holders who may be in an area or a remote location that is served by neither of those two options within a reasonable distance, and our intent would be to make what I would call exceptions to policies in respect to people who, in a legitimate way, are just simply not close enough to one or the other of those sources.

Q408 Chair: Have you published the cost saving?

Stephen Hester: No.

Q409 Chair: Would you be prepared to undertake to do so?

Stephen Hester: I am not very sympathetic to doing so, so I would certainly take it under advisement and reply to you but I think that-

Chair: You will understand this is a matter of considerable public interest. You are, effectively, a publicly owned bank and you are taking a decision with respect to a policy that is closely related to social policy.

Stephen Hester: Yes and, of course, one of the philosophical issues-

Chair: I would not normally ask a private firm to disclose what you might consider to be commercially confidential information.

Stephen Hester: Let me take it away and see if we think we can do something that is helpful to you.

Q410 Chair: But you are not considering reversing that decision in the light of the concerns being expressed about it?

Stephen Hester: That’s right.

Q411 Chair: Do you think that the reductions in ATM access for basic bank account holders will have general implications for free banking services?

Stephen Hester: Well, you know, there are some conflicting pressures in financial services. There are a whole series of people and regulators who dislike cross subsidy and would like every product and every customer to stand on their own and not be subsidised by other customers or other products, and so there is that stream and then there are other people such as you, just now, who would like us to cross subsidise. Of course, each person has their own view.

Chair: I have not said that, Mr Hester.

Stephen Hester: No, well that was my impression from your question.

Chair: What I have done is try to extract the logic of your stream.

Stephen Hester: But there are lots of people who would like us to cross subsidise. There is often not much agreement among those people on who should be the beneficiary of the cross subsidy, and who should pay for it just as importantly. So these are things that we struggle with all the time because clearly the business of banking does involve elements of more than one service being provided to different groups of people. I would say generally the direction that we are trying to go is to improve transparency, such that people have better knowledge of what they are buying when they buy it, and on an on-going basis, so the decisions can be as well informed as possible and to avoid, if you like, trying to have one group of customers artificially subsidise another but inevitably, in our kind of business, these are not perfect lines that one can draw.

Q412 Chair: I understand. Mr Flint, are you committed to the continued provision of banking services including unrestricted access to other banks’ ATMs for all your account holders?

Douglas Flint: That is our position at the moment, yes.

Q413 Chair: When I used to work in the Treasury and we were actively examining a change in tax and we were asked about it, we would say, "We’re not considering it at the moment". I am just wondering whether you would like to go a bit further than that?

Douglas Flint: I have never had the privilege of working in the Treasury, so that was not the disguise of my reply. I think we look at the entire service proposition that we produce for the customers right across the spectrum from basic bank account all the way up to Premier and beyond and seek to be competitive in the marketplace, I think that is the guiding principle.

Q414 Chair: Do you both remain committed to keeping cheques? Mr Hester?

Stephen Hester: I think that we should keep cheques for so long as they are viewed as an important bit of what we do by an important number of people, and that seems to me to be for a considerable period of time yet. Of course, it is the fact that more and more of us are doing business online and using telephones and so on.

Q415 Chair: Have you got a chequebook?

Stephen Hester: I do have a chequebook

Chair: What about you, Mr Flint?

Stephen Hester: And I use it, I use it less than I did before.

Douglas Flint: Yes, I do.

Stephen Hester: But nevertheless, and certainly for the foreseeable future, it seems to me that if enough people are going to want cheques, that is the thing that we should provide and that is our intention.

Q416 Chair: What about the cheque guarantee card?

Stephen Hester: I am afraid I do not have a briefed position on that.

Chair: Well, perhaps you would like to come back on a briefed position and once you have been briefed on it, perhaps it will be influenced by what Mr Flint has to say on the same subject.

Douglas Flint: There is no question the chip and PIN and the debit card have been very beneficial for customers and for retailers. There are increasingly few retailers now who accept cheques even with a guarantee card; that is the reason why it is no longer really used. I mean, the retailers do not like it, whereas the debit card with a PIN is a much more secure and a much more effective guarantee of a transaction. So I think technology has enabled customers to be better served and better secured and retailers too, which is why they have moved that way.

Q417 Chair: When one sees reports about the state of the commercial retail banking market, one has the strong impression that the banking sector is still pretty dysfunctional; that is that normal banking conditions have not resumed for a whole variety of reasons and that in the absence of that, it is going to be extremely difficult-if not impossible-to secure a sustained recovery. Do you both agree with that analysis? Mr Hester?

Stephen Hester: Would you mind being a little clearer on what you mean by dysfunctional so that I can answer your point properly?

Chair: One can describe dysfunctionality in a raft of ways, one of which we have discussed today, which is SME lending, another is the inter-bank market, the very distorted bond market, the difficulty of the cost of funds for banks. We can carry on with a long list of unusual characteristics in financial intermediation.

Stephen Hester: So, I guess it seems to me that of course we will be in unusual times, number one, for so long as the envelope of rules in which the industry does business is changing and until those changes are embedded and, secondly, while conditions in international and domestic economic terms are themselves unusual. So your guess is probably as good as mine as to how long those two things will extend. All of that said, you know, we service every day 40 million customers.

Chair: Yes, I am just trying-

Stephen Hester: Those 40 million customers are doing business with us in the way they always have.

Q418 Chair: My question though is just very straightforward. It is whether you share that description of the current condition.

Stephen Hester: I think, I think there are many things that are unusual and even distressed about current market conditions and unusual about the amount of change going through the banking system but I also think that we have 40 million customers who are doing the usual things with us all day every day and being serviced and that is our job to give them-

Chair: I think in the course of the afternoon we have picked up that point, Mr Hester, we really have. Mr Flint?

Douglas Flint: I think we are in very dangerous times in terms of the visibility of what happens next, so I share your concern. I think on a micro level what Stephen says is right. On a macro level, the industry is faced with the changing regulatory framework, the application of the whole macro prudential regulation around the world, possible changes to taxation, the whole uncertainty of what is happening in the Eurozone and, within that, the transmission mechanism that the banking system represents in terms of being able to provide a sustainable supply of finance adequately capitalised to promote growth, to promote risk absorption and to do so within a competitive landscape. That is an extraordinarily complicated backdrop to capitalise the system within, because those who provide the capital have got very little visibility as to the structure of the industry, its regulation and its return profile. So I think we are in particularly unusual times, which is why one can see increasing concentration of activity back into national markets and a significant de-leveraging.

Q419 Teresa Pearce: I have three very short questions. The first is on ATMs and my constituency, Thamesmead. Thamesmead has 50,000 people and not a single bank, so this is very relevant to them and they are likely to be basic account holders. When somebody who is not one of your customers makes a cash withdrawal from one of your ATMs, you get a payment? Is that right? So if somebody who is one of your bank account holders draws money from an ATM that is not one of yours, you have to make a payment, but then doesn’t that work the other way round?

Stephen Hester: Yes.

Q420 Teresa Pearce: So when you have costed how much this is going to cost, are you taking into account what you get as well as what you pay?

Stephen Hester: Well, obviously if there are customers there is only one-way traffic but any action another bank takes, and so on.

Q421 Teresa Pearce: But you would get payment for people who weren’t your customers who came to your ATMs?

Stephen Hester: If they do, yes that is right.

Teresa Pearce: Right, thank you.

Stephen Hester: And that being of course part of those economics is why we are able to maintain the largest network in the country of ATMs.

Teresa Pearce: Sorry, I just wanted to understand.

Stephen Hester: But certainly, if I may say, we would be very happy to engage with you directly in your constituency MP capacity on the provision of ATMs and so on in your area.

Q422 Teresa Pearce: Thank you. I realise you have been here a very long time, but I want briefly to ask you about cheques. I completely agree that not many people go into a shop now and pay by cheque, and it is not welcome if you try to, but there is one area where cheques are used quite a lot and that is in charities.

Stephen Hester: Yes.

Teresa Pearce: I visited a local charity. Over 60% of donations come by cheque and I ask you to consider that-that you look not just at the retail sector but at other areas where cheques are actually widely used, because it would affect them quite badly.

Douglas Flint: I know. We are looking very actively at that and, indeed, I think we were the first and many have joined us now, and although it is mostly for smaller donations, we allow people to pay through ATMs. So when there is a natural disaster or something, we open the ATMs to people who are making small payments through that, but I agree that the charitable sector is one that is particularly vulnerable to cheques and we are thinking very carefully about that. Cheques are continuing, but that is a principal focus for the cheques, yes.

Chair: Thank you very much for coming in for us this afternoon. I am sorry this section has been rather longer than planned and interrupted, but what you have given us is extremely valuable for our inquiry into these considerations.

Douglas Flint: Thank you very much.

Teresa Pearce: Thank you.

Examination of Witnesses

Witnesses: Ana Botín, Chief Executive, Santander UK, Tim Tookey, Interim Group Chief Executive, Lloyds TSB, gave evidence.

Q423 Chair: Let us begin. Ms Botín, you have said that the cost of the ICB proposals will be significant for your customers, so you presumably disagreed with what Robert Jenkins-the newly appointed member of the Financial Policy Committee-said as reported in the Financial Times today and with his remarks that have been published. He has more or less said that view, and I quote, is, "Intellectually dishonest and potentially damaging". Is there anything you would like to say in response to his allegation?

Ana Botín: First, I would like to say we are absolutely supportive of the overall goals of the ICB papers and proposal in terms of making banks less likely to need taxpayers’ support and we strongly believe that no bank should be too big to fail. But having said that, we do believe that the ICB proposals will not help lending and potentially could have significant consequences on the availability of lending to certain companies, certain services and, in general, be an additional cost on the economy.

Q424 Chair: Well, is that agreeing with him or disagreeing with him?

Ana Botín: I believe that lending will be less available, other things being equal, if the proposals get implemented in the strictest sense. It is also true that there is flexibility introduced in the report, so we are confident that that would be taken into consideration.

Chair: So he is wrong.

Ana Botín: Yes.

Q425 Chair: Could I ask you, Mr Tookey, about the share price, which seems to have fallen quite a lot? What proportion of that do you think is attributable to management issues?

Tim Tookey: Good afternoon, Chairman, members of the Committee. I think it is very hard to say, actually, or attribute any element of the share price reduction to some of the management issues in Lloyds at the moment. I think there are a number of factors that are affecting the whole banking sector, and is affecting price to book that is a common measure for the appropriateness or otherwise of a bank’s share price. Clearly, the issues around the UK economy-concerns over that-are at the forefront of investors’ minds. When they look at Lloyds, we are a UK retail and commercial bank. This is where the vast majority of our business is and, therefore, our health is dependent upon that of the UK. Clearly, there are other issues in Europe as well as regulatory uncertainty. So, Chairman, a variety of issues are impacting on our share price at the moment.

Q426 Chair: I have the figures for the main five banks that show that, broadly speaking, they have fallen by 8% less on average, taken as an average, than Lloyds suggesting that there is an 8% fall attributable to this management issue. The reason I ask is that you are partly government-owned and, as an organisation, responsible to its shareholders for keeping an eye on these issues. What discussions have the board, or have you, had with UKFI about this?

Tim Tookey: Well, I am not quite sure over which period you are referring to that share price data but I am sure it is correct.

Chair: Since the announcement of António Horta-Osório’s leave of absence.

Tim Tookey: Okay. Thank you for clarifying that. What I do know is that in the second week of November our share price actually outperformed banks and I shared that data with our board only last week. I think that outperformance was a recognition of the progress that we are continuing to make in the business in reducing the amount of risk that is in our balance sheet. We continue to operate with a very satisfactory capital and funding position. The business continues to make good progress with our core business performing very nicely and continuing to be profitable in the third quarter of this year.

Q427 Chair: The average, excluding Lloyds, is 15%. For Lloyds it was 22.5%.

Tim Tookey: I am sure your figures are correct, sir.

Chair: Well, I hope so. I have not checked them all myself but I can provide you with them but my question to you about was UKFI.

Tim Tookey: I have not had specific discussions with UKFI about our recent share price performance?

Q428 Chair: What about your Chairman?

Tim Tookey: I cannot speak for our Chairman and whether he has had any of those discussions.

Q429 Chair: But you have, indeed, raised that with him?

Tim Tookey: With our Chairman?

Q430 Chair: Yes, you have not asked your Chairman whether there have been any discussions with the Government about this through UKFI? Have UKFI been involved in this in any way is the question I am asking you?

Tim Tookey: I have not specifically asked our Chairman whether he has discussed our share price with UKFI and members of the Treasury, but of course we are in regular contact with both UKFI and the Treasury about some of the management issues within Lloyds and, of course, we made sure that there was appropriate and regular contact as these issues were emerging both with UKFI and the Treasury to make that our principal shareholder work was duly informed and we got our announcements to market as quickly as we reasonably could.

Q431 Chair: Okay. I will ask this question slightly differently. Has the leave of absence and its consequences of António Horta-Osório from Lloyds been discussed with UKFI by Lloyds?

Tim Tookey: Yes, it has.

Q432 Chair: On how many occasions?

Tim Tookey: On several occasions but I would not necessarily claim to have been present or involved in all of those discussions, but I would say on several occasions.

Q433 Chair: And are they playing an information role or a role that you would describe as shareholder-activist?

Tim Tookey: I would not describe it as shareholder-activist. I would say they are supportive of the actions that the board is taking to ensure that we have adequate management control over our business every day and they wish to be kept informed and we are keeping them informed and this mirrors the discussions that we have had with many of our largest shareholders as the owner of our business and it is very important for us, as a board, to demonstrate that we are in control of the business day-to-day and that is exactly what we are doing. That is why I was referring to our third quarter results releases that I think gave the market a lot of comfort about the momentum of the business and we were very pleased to outperform other banks in the second week of November in terms of share price.

Q434 Mr Mudie: A number of members of the Committee have raised the question of lending to SMEs. What is your target figure under the 2011 agreement on Project Merlin?

Tim Tookey: We have never actually disclosed the overall target for ourselves within Merlin.

Mr Mudie: That is why I am asking.

Tim Tookey: But I would like to give you some idea of the shape of it.

Mr Mudie: I just want the amount of it.

Q435 Mr Mudie: With the last two witnesses it was like pulling teeth. They have agreed to write and tell us. I think that was part of the problem, they did not know. You have signed an agreement with the Government, there are five of you, £76 billion. What is your share? If you do not know your share, that would be alarming?

Tim Tookey: I do know our share.

Q436 Mr Mudie: You know your share? What is your share?

Tim Tookey: Our share of that for SME lending is just under £12 billion for this year. We are on track to meet that with £9.6 billion having been lent in the first nine months of this year.

Mr Mudie: Good.

Tim Tookey: I am very pleased to say that is actually net growth in our lending position in what the latest Bank of England reports show was actually a declining market.

Q437 Mr Mudie: That was a great step forward for mankind and bankers but you were still how much below that £12 billion? You said it is a figure below £12 billion. What is it then? It is in the Financial Times this morning as rumoured to be £11 billion.

Tim Tookey: No, it is £11.7 billion which is why I have described it as just less than £12 billion.

Q438 Mr Mudie: £11.7, that is lovely. Now, your figure for next year in the same Financial Times is supposed to be £12 billion?

Tim Tookey: Yes, that is right. We have today announced a target, a gross lending figure to the very important SME sector of £12 billion next year and we have also said that we would like to maintain a net positive growth in our lending to SMEs, which would be a continued strong performance that we are managing to achieve this year.

Q439 Mr Mudie: Now the other figure we would like from you is your gross lending as a bank.

Tim Tookey: £32 billion in the first nine months of the year.

Q440 Mr Mudie: What was it in 2010? That would give us a better idea of your total.

Tim Tookey: The £32 billion was all of our corporates and SME figures. I do not have to hand the equivalent figure for 2010 but I would happily provide that figure to you afterwards.

Q441 Mr Mudie: So you could give us your 2010 lending figure and your 2010 SME figure?

Tim Tookey: Yes, I could provide that to you.

Q442 Mr Mudie: Do you have a rough proportion?

Tim Tookey: I know that our SME figure this year is higher than that from last year. I cannot recall the corporate figure for last year, I apologise.

Q443 Mr Mudie: Yes. Now, your trade union boss, I call her, Angela Knight, may have just done you a disservice by having a survey of a million SMEs and there are the figures-I have put them on the record before so I will not bore you with them-but the two key figures is in the last three months one in six applicants for an overdraft have been turned down and one in three, one in three rather than one in six, who have put in for a loan in the last three months, have been turned down. Out of the million, 250,000 have said they have because of the bank’s terms and their processes-have given up the ghost. Now, it strikes the Committee that Project Merlin is more in spirit than in actual practice.

Tim Tookey: I can assure you that Project Merlin, certainly within Lloyds, is very real indeed. We have diverted significant additional resource to the SME sector in the current year and we have materially increased our level of activity supporting businesses. If I may, I will just give you some further statistics that the Committee might find useful.

By the end of this year, we will have held over 700 specific events out across the country for SMEs, explaining the services that Lloyds can provide and providing generic financial information and financial advice, perhaps in inverted commas would be appropriate, to SMEs. That has led to us supporting in the first nine months of this year just over 95,000 SME start-ups that brings the total we have done since the start of 2010 to a little bit over 200,000.

This is not something we do from London. This is something we do out across the whole regions. The SMEs are, as we all appreciate, right at the heart of the UK economy and, therefore, we provide the support locally through our SME centres.

Q444 Mr Mudie: Wonderful. Now I do not need to take you through the same pulling of teeth. Could you just supply the Committee-because I know Santander has a good record and a good history of this-with the same figures we have asked of Lloyds and we will leave it at that?

Ana Botín: Sorry, yes. We have disclosed already publicly our figures under Project Merlin. We are on target to meet those figures.

Mr Mudie: Yes.

Ana Botín: For SMEs, the target for this year is £4 billion. We are on track, as of September, around £3.5 billion. That is gross numbers. Our net lending to SMEs in the £12 months ended September 30 was up plus £1.7 billion. The bigger number, the bigger corporate number was £6.7 billion total gross lending and we are on target for that also as of September. So the actual gross lending increase this year will be plus 25%.

In addition to that, we have incorporated 2,500 new SME customers over the last 12 months which is a significant increase over the previous year and we have supported 90,000 businesses, that is business banking, start-ups and new companies over 2010 and the first half of 2011.

Q445 Mr Mudie: I really should not have asked that question, should I?The one thing that you have left out though is we were after a proportion of your overall lending. If you would supply us with that.

Ana Botín: Yes.

Mr Mudie: And you might get home at an early hour if you just agree to write to us, yes?

Ana Botín: We are still a small player in the SME and corporate arena, as you can tell from the numbers I gave you. Our total commercial balance sheet as of today is about 165 billion mortgages. As you know, our heritage is a building society, so the corporate bank is basically a small business from Alliance & Leicester that we have continued to grow. We have added 70 new relationship managers to our SME business. We have a total of 270 as of today and we are planning to add another 70 in 2012 and another 70 in 2013. That is in addition to the branches that we are acquiring from Royal Bank of Scotland. So we are investing very heavily in that business and I have stated since I arrived that our intention is that Santander UK become the SME bank of choice in Britain.

Mr Mudie: Very good. Thank you.

Q446 Mr McFadden: The ICB recommendations-I want to ask each of you this, I will begin with you, Ms Botín-were intended to relieve the taxpayer of the hazard of insuring the banking system and we have seen the consequences of all that. Do you think the recommendations meet that aim?

Ana Botín: We are broadly supportive, as I said before, of that objective, so we strongly believe that banks should not be saved by the taxpayer and any measures that go in that direction are very welcome. We believe that the additional measures proposed by the ICB need to be carefully evaluated to make sure that there is additional strength being provided to banks. Obviously, there are two broad areas. One is increasing capital and changing the depositor hierarchy and the other one is, of course, the ring-fence.

Depending on how this gets implemented, it could mean-as I have said before- lending is more expensive and less available to small companies and to consumers. Additional capital-and this is important, Santander UK, as an example, went through the crisis with a 6% to 7% core capital. As of today, we have 11% core capital. Going forward, our intention is to work in a range of 9% to 10% core capital. The ICB would require us to have significantly more than that.

On the other hand, the ring fencing, and again we are a very pure retail commercial bank, but we do have an SME and a corporate bank where we provide some services that would be hindered if the ICB recommendations get applied in a very strict way. So we do think that it is questionable and we need to evaluate the benefit versus the cost of these recommendations and we have provided written opinion on this.

Q447 Mr McFadden: Do you think it would have been possible to get the taxpayer off the hook of insuring the banks without something like the ICB recommendations?

Ana Botín: I think that is a very interesting question. Some of the institutions that had more problems were actually very narrow business model banks. Our CEO once described our model as a narrow bank in the broadest sense. So we do deal with all kinds of customers. Santander UK, as you know, the Santander model is geographical subsidiarisation, so we only lend to UK businesses and UK individuals and we believe that offering these individuals and companies a broad range of services makes our business model more stable, i.e. less likely to have a problem and need Government support, and is also a very important service to the economy and to our customers.

So being able to offer all kind of services, we believe, is very important and we have again written this in our submission. For example, allowing SMEs to get services from us for risk management, this is one of the most important points we have made in terms of the potential impact of the ring fencing. I can elaborate on that and give you some examples.

Q448 Mr McFadden: You are an international bank with operations in a number of countries. When you look at the world post the ICB recommendations in the UK, does that make you think the UK is a less attractive place to do business?

Ana Botín: I would like to start by saying we have invested close to £15 billion in this country. Santander Group increased capital in Santander UK by £4.5 billion last year, among other reasons, to continue to invest in our SME business.

Mr McFadden: That is the past. I am asking about the future.

Ana Botín: So we are here to stay. This is a very attractive market for us and we believe we can add value and we have a positive influence on competition and become, you know, a successful entity.

However, it is true that over the last 12 months, and going forward, our returns on equity will be significantly lowered. I mention that our capital has gone from 6, 7 to actually 11 and we are working with a 9 to 10 for the cycle and we believe that is the right amount and we have actually been ahead of regulators in terms of the increase in our core capital, even though we did very well during the crisis with a lower amount, but obviously this is a lower return.

So, what is significant about the ICB is that this comes on top of significant additional capital, additional liquidity, additional regulatory requirements being imposed on banks. I think the question we need to ask ourselves is if we want banks to access private capital, we are competing with other banks in other countries to raise that capital and with other industries. So, I think this is an important question. Obviously, more capital, the less lending, other things equal.

Again, we are supportive of having stronger banks and we are all stronger overall in the UK. We have become stronger over the last few years. The question is, you know, how much more and at what additional cost to lending and to the creation of jobs in the end.

Q449 Mr McFadden: Mr Tookey, do you think the ICB does the job in terms of getting the taxpayer off the hook?

Tim Tookey: Honestly, I am not sure we will ever know the answer to that but what I do know is that this report furthers the debate and provides a much greater degree of distance between the likelihood of that being required than was the case in the past.

I agree with many of Ana’s comments completely around some of the ICB’s measures, and I think I would put them into how it builds on the four pillars that are necessary to increase financial stability in the future and make the chance of taxpayer support ever been needed significantly more remote.

Those four pillars are the increasing levels-so that is quantity and quality-of capital, that is certainly something the ICB talks about; the increasing liquidity requirements for banks operating in the UK; better levels of supervision and regulatory supervision, in particular, that existed pre-crisis and then, of course, importantly recovery and resolution. There the ring fencing is a very important part, alongside other measures, that the banks are working on with the various authorities such as Living Wills, for example.

So I think if we work on those four pillars as being necessary to support greater levels of financial stability in the future, then the ICB’s report is very valuable. But I do share some of Ana’s concerns that if any one of those pillars is pushed too far, then the cost/benefit balance could get out of kilter. So I do have some concerns about the report and how it be used, and how it be used if it was implemented in its completely pure form.

Q450 Mr McFadden: You are a less internationally focused bank than Santander. Again, looking at the world, we assume that the ICB recommendations have been implemented. Does that make the UK a less attractive place to be headquartered or, indeed, to add new teams to manage new streams of business in the future?

Tim Tookey: Lloyds is a UK retail and commercial bank, so there is no question about us changing where we are headquartered. The UK is where our business is and where our heart lies and that is where we will stay.

In terms of international competitors, I think it depends to a degree on what happens with regulatory reform and some of the discussions happening in other territories. Clearly, the ICB report and other regulatory changes in the UK have the possibility of introducing a much tougher regime in the UK than in other European jurisdictions, so that may make it more attractive for some UK people to take borrowings or place deposits with foreign institutions. I think we need to be careful and considered in how we implement the ICB’s recommendations. That is an important part of the consultation process, but we must not lose sight of the fact that the ICB’s recommendations are a thorough, well-balanced and well-thought through set of proposals that now need to be worked through in some detail so that we do, in fact, create the objectives that they quite rightly set out to achieve and that we support.

Q451 Mr McFadden: Do you feel you have to say that because of the ire that would be attracted for any bank to say we think these rules are too much?

Tim Tookey: No, I do not feel constrained by that type of premise at all. I actually believe that the ICB’s recommendations are an important step forward in creating a UK environment that will be more financially stable and I do not think it is right that banks should be put into a position where they should need taxpayers’ support. I think the ICB’s proposals take us a very long way-if not all the way-and I am not sure we will ever know if they get all the way to achieving that, so I support that as a matter of principle.

Q452 Chair: Mr Tookey, when we had our previous two witnesses before us, we asked them if they would supply us with their best estimate of the total cost of Vickers to them, as an institution, on the basis of a number of assumptions about the way it would be implemented, which is still required-a reasonable range of assumptions. Would you undertake to do that for us as well?

Tim Tookey: We have not done any analysis ourselves on what the cost impact on Lloyds would be of the ICB proposals. I think it is very difficult to separate those proposals from the overall impact of increasing levels of liquidity and capital and regulation ourselves, so we have not done any of that work ourselves, so I am unable to share anything.

Chair: We are asking if you would be prepared to prepare something for us.

Tim Tookey: It is something that we could consider but it is not something I have on the stocks at the moment.

Q453 Chair: Would you be prepared to supply the same?

Ana Botín: We are working on the numbers also. As I mentioned before, we are working for the next couple of years with a much lower return on equity already as a result of increased capital, liquidity and other requirements. As I mentioned before, if we are now working with a 9% to 10% core capital over the next few years, the current proposal-again, I understand there is some flexibility and that is what we are all trying to work through-but if you think of us as essentially a retail ring-fenced bank with a small portion outside that we are still trying to understand if there is some flexibility there again. But going to 10 minimum would probably force us to go to 11%, 12%, that would be an additional cost. These are the kind of numbers we are working on. The non-ring-fenced side obviously would need a much higher capital. Then, of course, it’s inevitable that will go to a minimum of 17.

There will be costs and we are trying to work on the numbers and trying to show that it is a business model, there are many other issues that should be taken into account. We have a very low risk-as I mentioned before-balance sheet except for 0.4% outside the UK. All of the rest is mortgages and SME and corporate loans in this country.

So, you know, given that we would be one of the most affected in terms of the additional capital because we are not in the Citigroup as Santander UK. We could be in the 9 to 10 but with the new ICB requirements an additional maybe 10%, 20% core capital, so the numbers are significant.

Q454 Chair: I am sure you both understand why we are asking this question. We are in the business of trying to protect the taxpayer from the implicit subsidy in the banking system and clearly a cost is attached to doing that and it is a reasonable question to want to know roughly what that cost is going to be from those most affected. Without that information it is very difficult for policymakers to make a considered judgement about whether the proposals are the right ones to start with. I recognise the difficulty of calculation but I expect we will persist and I will be very grateful if you would be prepared to go away and think carefully about how you can present that calculation to us.

Tim Tookey: Absolutely. We will take that away, Chairman. We are actually providing some information already to the Treasury team who are looking at the overall cost benefit analysis of this. So we are providing some information to them for their workings. So, some of that work is already underway.

Q455 Teresa Pearce: Thank you. Good afternoon.

Tim Tookey: Good afternoon.

Teresa Pearce: I just want to talk about some consumer issues, mainly ATMs and use of cheques. Your bank, Mr Tookey, wrote a very useful letter to the Chair of this Committee just about how you now charge for withdrawals-you do not charge, you restrict basic bank accounts from withdrawals to some ATMs-and we have an interesting model here because the Lloyds TSB did this in 2006 and the Bank of Scotland is just doing it now and Halifax did not do it at all. When your bank first went down this route with Lloyds TSB, did you consider any other ways of soaking up that cost maybe for basic bank holders? In the letter there are some things you have listed that you now do, which I think are really helpful, like the text back to people to tell them their balance.

Tim Tookey: Yes.

Teresa Pearce: That is a really useful thing to do. It stops them having to go and check their balance. So is that something that you are going to extend to the Bank of Scotland and Halifax as well? Is that good practice that you have done there, are you going to roll it out across all three banks and also did you consider other ways of restricting the costs of basic bank accounts rather than restricting ATMs?

Tim Tookey: Thank you for the question. I am glad you recognised the text back that we found particularly popular with customers not just of our basic bank account but all of our bank accounts have that facility. That is one of the examples of where we actually reinvested some of the savings that we would obtain by the restriction of where those ATM cards would be used. We are reinvesting in providing better products to even those basic bank account customers. And, of course, even with the restrictions that are being put in place and our different heritages have different approaches because, of course, until very recently we had to operate on multiple platforms. We have only, in September, been able to start having all of our accounts running on the same platform. So we have had different reasons for that. Basic bank accounts are an important part of our customer service provision, we opened about 230 basic bank accounts last year, so we are and we remain the largest provider of basic bank accounts in the UK.

Q456 Teresa Pearce: Could I just ask you, one of the things that is listed in here is that you can use the Internet and they can call up.

Tim Tookey: Yes.

Teresa Pearce: When the people call either the Halifax, Bank of Scotland or Lloyds, are the numbers landline numbers, or are they 0845 numbers?

Tim Tookey: I am afraid I do not have the answer to that very specific question.

Teresa Pearce: I just raise it because people who are likely to have basic bank accounts are likely to have pay-as-you-go mobiles and 0845 numbers are very expensive for them.

Tim Tookey: I understand your question. I am very sorry, I do not have the answer we need to that.

Teresa Pearce: Maybe you can take that back and find out.

Tim Tookey: Yes, certainly.

Q457 Teresa Pearce: Your bank company does allow people with basic bank accounts to withdraw money from any ATM. Is that something you are going to continue doing or reduce it at all?

Ana Botín: Yes, we have no plans to change that.

Q458 Teresa Pearce: Thank you. One of the concerns that people have in the restriction of people using certain ATMs is the fact that this at the moment is for basic bank account holders and their concern is that this may be the thin end of the wedge and it might be rolled out to everybody in time. Has there been any feasibility done on that? Are there any more thoughts at all?

Tim Tookey: No, that is absolutely not in our thoughts at all. Even for those basic bank account customers who are not subject to these restrictions, 96% of our existing basic customer account base reside within a one-mile radius of either one of the ATMs that they can use or the Post Office that is available to all of our customers. But I can give you further evidence of the fact that we have no intention of restricting further because actually now that we have completed the integration of the retail platforms that arise in HBOS, we are actually planning to extend the ATM access for all of our branded basic bank accounts to all of the ATMs that sit within all of the brands within Lloyds Banking Group.

So that means that a Lloyds TSB customer would be able to access their cash free of charge not just from Lloyds TSB and the Post Office ATMs as today, but also from Halifax and Bank of Scotland branded ones. We are actually extending the reach of those customers, something we could not do until we had completed the systems’ integration that, as I said, was done in September and we are now starting to work on those plans that I would expect to be completed during next year.

Q459 Teresa Pearce. Okay. Just to clarify that, so that decision has actually been made now?

Tim Tookey: Yes, it has.

Q460 Teresa Pearce: That’s good. Thank you. Just to move on to the issue of cheques. There was a lot of concern, lots of pensioners’ groups wrote to me about the abolition of cheques and recently there was quite a strong lobby about it and-as we have heard from previous people here-many people do not use chequebooks any more and many shops will not take cheques, but there is one area where cheques are used in the majority of cases and that is with charities and donations. It is a concern to me that-and looking at the future of cheques-we are looking at the retail sector and we are not actually looking at everything. There is a very large charity in my area, it is a hospice, and I think 65% of their donations are made by cheques, and that is something that concerns me going forward, if cheques are going to have a short shelf life, what will happen there. Have you spoken to the charity sector at all about this? Are either of your banks-

Ana Botín: Well, I think the issue of cheques is now agreed that it is now going to be extended, so we-

Teresa Pearce: For now.

Ana Botín: In our case, many of our customers use cheques. Charities and actually small businesses still use cheques a lot and so that debate has ended and cheques will continue.

Q461 Teresa Pearce: So are you saying you think that cheques still have a long-term future?

Ana Botín: I do not know what you mean by long-term. I think, for now, yes. For the foreseeable future it is clear that it is something that people use, businesses like to use and, therefore, as long as that is the case, we will continue. As a sector, I think that has been decided.

Teresa Pearce: Okay.

Tim Tookey: And I agree.

Teresa Pearce: You agree. Good. I am very pleased. Thank you.

Q462 Chair: If Santander can afford to provide access to all ATMs for basic bank customers, why can’t Lloyds afford it?

Tim Tookey: I do not think it is a question that can be narrowed up in terms of affording it. What we have done is reinvested some of the savings that we have made from the restrictions in actually providing product enhancements that are not normally available to basic account holders, such as the text back facility that was previously mentioned. I think it is also important to recognise that each basic bank account that we open we know will be loss making and we balance our commitment to provide basic bank account access to customers. We are the largest provider of such and we opened 230,000-odd such accounts last year and we balanced that commitment with a need to make a return for our shareholders, but we have no intention of restricting the availability of basic bank accounts or ceasing to provide them.

Q463 Chair: Do you publish that cost?

Tim Tookey: No, I do not believe we do. I do not believe we have published it, no.

Chair: I am getting signals from behind you that are rather different.1

Chair: I would be very grateful if you would give us the current value of that and the current value of providing it to all holders as Santander does.

Tim Tookey: We can certainly look into that. As we have done in the past, then of course.

Chair: Thank you very much.

Q464 Mark Garnier: Thank you. In previous evidence sessions, Sir John Vickers described Moody’s downgrade of 12 banks, including your two, as a result of the Commission’s report as entirely benign. Do you agree with that?

Ana Botín: So, well the downgrades are-

Mark Garnier: The Moody’s credit rating downgrade.

Ana Botín: Right. We were actually on a standalone basis upgraded by Moody’s recently but we were then downgraded by most agencies because of the perceived lesser systemic support for all UK banks.

Mark Garnier: Exactly right.

Ana Botín: Right.

Q465 Mark Garnier: Sir John Vickers described that as entirely benign. Do you think that is a rash way of describing it?

Ana Botín: Again, this is a question of degree. I mean it does have an effect. You know, there are many institutions that invest according to ratings, so it does have an effect. I think the overall situation in the world, mostly driven by Europe at this point, together with the downgrades does have an effect on investors’ decisions.

Q466 Mark Garnier: So are you are talking about equity investors or are you talking about people who have had to lend you money?

Ana Botín: Mostly, I would say mostly-

Q467 Mark Garnier: So your cost of funds has gone up as a result of this?

Ana Botín: It has gone up significantly over the last, I would say, 12 months.

Q468 Mark Garnier: So John Vickers, saying that this downgrade was a result of his proposals being benign, is just wrong?

Ana Botín: I would say I do not know if benign is the word but there is an effect.

Q469 Mark Garnier: There is an effect. What would you say?

Tim Tookey: I would agree. There is an effect. I would also agree with Ana. It is very hard to differentiate that element of the general move in the cost of debt finance to banks over the last 12 months. It is very difficult to be discreet and say one particular move cost a certain amount, but there certainly was a cost element.

Q470 Mark Garnier: So there is a cost element. You just cannot work out what it is?

Tim Tookey: Correct.

Q471 Mark Garnier: Following on from the Chairman’s questions about the costs of the figures, we have a little agreement about this-£4.4 to £7 billion costs that ICB had decided it is going to cost on a per annum basis. Goldman Sachs has come up with £9.6 billion. Our previous two witnesses have said nobody can really tell. HSBC told us that actually just the cost of having to issue all these bail-inable bonds and then the cost of them reinvesting that in something else, when they just simply do not need to, is going to cost them up to $3 billion a year. We are now looking at quite substantial costs coming in and that is compared with an implicit guarantee from the Government that again has various different sides. But there comes a point when you look at the implementation of ICB as being greater than the implicit subsidy from the Government. Do you think we are barking up the wrong tree? Ana?

Ana Botín: First, I want to reiterate we are absolutely aligned with the objectives of the Vickers report and what the ICB is proposing.

Having said that, this comes on top of many other increased demands for different reasons on the industry and so, one has to add up all of these and at the margin, the Vickers report and the ICB recommendations, if implemented-and this is very important because I insist also, as I said before-that the flexibility that is introduced in the report is very encouraging, but there is on the one hand the capital, leverage, bail-inable debt issue that is significant. Again, I want to reiterate the point that we have gone from 6%, 7% core capital that did fine for us during the crisis, so it is not only about capital. It is other issues that make banks get into problems. But we have, in spite of that, recognised that we need more capital. The world has changed and so we are increasing that to 9/10. That whole side of it is very significant on top of what has happened already. We are already at high levels of capital. The bail-inable debt is a very significant cost. The depositor hierarchy issue is very important for the UK because we import capital from especially the US, so if it happens, and we do not believe it is necessary, but if it happens it should happen throughout the global financial markets.

Then there is the issue of the ring-fence that is important. Essentially, you know, we do not believe ring fencing makes banks safer per se. However, if it happens, and we understand it is going to happen, we need to consider the effect on our customers and the economy and so we have supported and we have, in our submission, explained how we need to think about the services that the SMEs, small companies, throughout the country require.

And I would like to give an example of the company I visited recently in Castle Donington, near Derby, called Norton Motorcycles. This is a company that is three years old even though the brand is an iconic British brand that Santander has supported. We were the bank that allowed them to be in business. It is only three years old. It exports 80% of its production. A lot of that is to the US, which again relates to the fact of only EU assets and liabilities, this company requires risk management-80%-again, they do not hedge their foreign exchange risk, their margins get to levels where they would probably not be viable. So, very small companies, and this is not hundreds either, it is probably more like thousands of small companies require these services. In our case, if we were not able to provide these services, we would have to buy it from someone else. In a way, what we are saying is if we need to have this service in the ring-fence, and we are supporting that it should be in the ring-fence, we should be allowed to have some amount of market risk. For us, the inventory. Norton Motorcycles has nuts and bolts and pieces and they have some inventory. Our inventory is having some kind of risk and interest rate and foreign exchange inside the bank. What we are proposing is that that be limited and that there be a cap on that market risk as long as this is only because it is needed and required by our customers. This is important because it would change our business model. It is not allowed.

Q472 Mark Garnier: You must feel very sore about the fact that you presumably did not get affected by the crisis because you were lending sensibly and you were behaving very well, oddly enough as was Lloyds until they were persuaded to take on HBOS. You must feel very sore that you were doing a very good job, survived through the crisis, presumably had all your liquidity as well as capital, and now you are being asked to come in and effectively pay the penalty that everybody else’s misjudgement has resulted in.

Ana Botín: It is not really about us; it is about our customers. Again, if our customers do not do well we will not do well. What we are supporting is that we think about the services that our customers need throughout the country. We have already 40 regional business centres and we are serving hundreds of thousands of small companies and businesses that need these kind of services that if we go to a very strict interpretation of the ring-fence would have to be offered by somebody else. Having the proximity and the reach to these-I gave you an example of a three-year-old company; there are many more like that. It is an important issue because, again, if one takes a strict interpretation of the ring-fence this would be outside so we would have to also change our business model.

Q473 Mark Garnier: I am going to come back to the ring-fence in a minute, if that is all right. Mr Tookey, getting back to this cost business, given the fact the implicit guarantee is by all the taxpayers, and generally speaking all the taxpayers in this country are customers of the big five banks, do you think that these increased costs, as a result of Vickers, are potentially a waste of time when it is going to be the same people paying the extra costs to the banks, through extra charges on their personal bank accounts or whatever, as opposed to through the implicit guarantee?

Tim Tookey: I think that is a very tough question to find a simple answer for but, generally speaking, if there is a sensible cost associated with creating a much more stable financial world into the future, which means we are less likely to see the volatility that we have seen in recent years and less likely to see substantial calls unexpected on the taxpayer, then a reasonable cost is worth that. I also recognise that the ICB did not have, in the time available to them, enough time to do a full cost benefit analysis and that is why we are providing-as I said to the Chairman a few moments ago-information for the Treasury. I share Ana’s concerns over some aspects of what may be unintended consequences of the current proposals of the ICB, if they were enacted in the exact form as written in the current report. I think it would be a great shame if some of these things were not developed through the consultation process and addressed in a way that meant the objectives of the ICB report are still delivered but in a way, through consultation into legislation, that means that the services that retail and commercial banks, like-if I may say so with a competitor-we both operate in the UK, providing really critical services to ordinary customers up and down the country every day.

Q474 Mark Garnier: Just turning to the ring-fence and the potential trapped pools of liquidity within the ring-fenced bank, one or two people-the CBI, for example-who have submitted evidence to us have suggested that you could end up with trapped pools of liquidity. Mr Tookey, if you go first, do you think that is a legitimate worry?

Tim Tookey: I think there are some worries about some liquidity issues within the ring-fenced bank. I am not sure I am completely there on some of the discussion points around trapped liquidity, but I think it is very important that the ring-fenced banks are able to attract enough quality and stable deposits and funding from various sources in order to continue during future periods of financial stress to be able to provide lending to the economy. That is one of the critical services, along with payment systems and all sorts of other things, which is the primary raison d’être for having a ring-fenced bank, so you have those key core services available during periods of stress. Having a stable deposit base is very important. Ana made reference a moment ago to bail-in and to depositor preference. I particularly am concerned about some of the aspects of depositor preference in here and what that does to the wholesale unsecured funding markets because those are important funding sources, even for the activities that happen within a ring-fenced bank. We need to be very careful in the implementation of this that we don’t preclude the ring-fenced bank from having access to such sources.

Q475 Mark Garnier: Do you think there is potential that these proposals could be an end to free retail banking, such as it is?

Tim Tookey: Gosh, that is a big step forward. I am not quite sure I can join the dots that quickly. I think what they will do is, through the other measures that are in the ICB’s report-and I am not sure I mean ring-fencing here-increase levels of competition within the banking sector and I think that would act as a considerable force against.

Q476 Mark Garnier: So you think they will increase levels of competition?

Tim Tookey: I think they will increase competition through the switching and transparency mechanisms that are proposed within the ICB. That is why I said I am not quite sure it is a ring-fencing point but the other aspects of the report will certainly increase levels of competition in what is already a competitive market.

Q477 Mark Garnier: It is not very competitive, is it? There are only really five banks. It is not like America with 8,000 banks.

Tim Tookey: I find the UK banking market a very competitive place in which to operate, but I also welcome the aspects of the report that will increase levels of competition and we support those.

Q478 Mark Garnier: I have to say I think you are probably unique that you think that it is a very competitive banking market. Most people agree it is very uncompetitive.

Tim Tookey: I think I am differentiating between concentrated and competitive. I know that in many of the marketplaces and the markets within which we operate within the UK we regard it as very competitive, yes.

Q479 Mark Garnier: Gosh, that is breaking news. Ana Botín, do you feel the ring-fence could result in liquidity pools?

Ana Botín: Again, I go back to the issue of flexibility. I think any economy benefits from different kinds of business models. One of our concerns with the ring-fence is that you are actually trying to change the structure of the banking sector and it is difficult, probably even for any of us who are in this all day, all the time, to foresee all the consequences. So it depends how you break up the ring-fence versus the non-ring-fence, but essentially what you would like ideally is sometimes the consumers have more debt, other times it is the SMEs and corporates, like is the case right now, that have more liquidity. We are at the highest point, I think for 30 or 40 years, in terms of the amount of liquidity on balance sheets of corporate companies, whereas the consumers have high levels of debts, which requires that large mortgage books have to be financed by institutional markets. That is our job, that is the main function that banks do, assign liquidity, take depositors’ money and lend it where it is needed. So I think having that flexibility is very important.

Tim Tookey: Only you lose that with the ring-fencing.

Ana Botín: To a certain degree. Obviously you lose some of that, yes, because you are going to have separate-

Q480 Mark Garnier: Is it fair to say that implies extra costs on the retail-

Ana Botín: Yes, absolutely. We are going to have a higher cost as it is written now, both in the retail ring-fence and a much higher cost on the non-ring-fenced, which is one of our concerns in terms of us providing the SMEs with some of the services they need within the ring-fence because otherwise the cost is going to be much higher.

Q481 Mark Garnier: So, an end to free banking?

Ana Botín: We believe-and we have recently launched examples of this-that what is important is to offer simple and transparent products that add value to consumers. So we have launched a fee-paying credit card, which we are doing very well with. It gives you cash back on petrol and supermarket and retail purchases so we are finding that consumers and a lot of customers like the card. It is a fee-paying card but it gives you cash back. I think we need to find a way of providing value to consumers and to customers and working on that, and banking is definitely one of the areas.

Chair: We only touched on quite a large number of very important issues this afternoon. If either of you think that any of the Vickers or the Basel proposals-bail-in, capital, liquidity or whatever-are inappropriate, it is extremely important that you speak up now, not privately but publicly as part of the public debate about what we are going to do in response to these ideas, in writing if you feel that you have not put your points across this afternoon. Please don’t complain later, after the implementation begins, because I don’t think there will be much interest from Parliament about that.

Thank you very much for coming in this afternoon. I am very sorry that you were kept waiting, first because the initial session was a bit longer than intended and then, of course, because we were interrupted by a vote. Thank you again.

[1] An adviser to the witness confirmed that Lloyds have published such costs in the past.


Prepared 30th November 2011