To be published as HC 140-v

House of COMMONS



Scottish Affairs Committee

The Referendum on Separation for Scotland: Financial Services and Banking

Wednesday 19 June 2013

Sajid Javid MP, Rt Hon Michael Moore MP, Andy Drought and Paul Doyle

Evidence heard in Public Questions 3387 - 3452



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Oral Evidence

Taken before the Scottish Affairs Committee

on Wednesday 19 June 2013

Members present:

Mr Alan Reid (Chair)

Mike Crockart

Mrs Eleanor Laing

Graeme Morrice

Lindsay Roy


In the absence of the Chairman, Mr Reid was called to the Chair

Examination of Witnesses

Witnesses: Sajid Javid MP, Economic Secretary to the Treasury, Rt Hon Michael Moore MP, Secretary of State for Scotland, Andy Drought, Financial Services and Economic Engagement Team, Scotland Office, and Paul Doyle, Devolved Countries Unit, HM Treasury, gave evidence.

Q3387 Chair: Thank you all very much for coming. I am afraid our Chairman, Ian Davidson, sends his apologies, but he has fallen ill today. I am the Vice-Chair and standing in for him. Thank you all for giving up your time this afternoon. Would you start by introducing yourselves?

Michael Moore: Mr Reid, it is a pleasure to be back so soon after the most recent appearance and continuing on the theme of the "Scotland Analysis" programme. May I convey my best wishes to the Chairman and hope he is back in fighting form very soon? I am sure he will be.

I welcome the opportunity to be in front of the Committee today so that we can explore the issues relating to the financial services sector in Scotland and the impact that independence would have on that. We welcome the opportunity to be here with you this afternoon.

Q3388 Chair: Could you introduce the other members of the panel?

Michael Moore: Sajid Javid is Economic Secretary to the Treasury. He might also be known as the City Minister, in shorthand, and a few other things besides. Paul Doyle is one of the senior officials in the Treasury who works on devolution matters but for these purposes is here because of the "Scotland Analysis" programme, in which he plays a very serious part. Andy Drought is a Scotland Office official who focuses on financial services north of the border and is also very involved in the work that we are doing on this programme.

Q3389 Chair: Could we start off by asking you to give a brief introduction to the paper and the conclusion that you drew from it?

Michael Moore: In this paper we are basically saying two or three things. The Scottish financial services industry is a huge part of the Scottish economy. It is approximately £9 billion of our economic output, which is about 8%. The number of people directly employed in it is in the order of 85,000, with a further 100,000 people indirectly employed as a result of the strength of the sector. There are 200,000 people, which, by anybody’s reckoning, is a huge number. It is a very significant part of the Scottish economy.

It is also a very important contributor to the United Kingdom economy and very much a part of the UK financial services sector. We have a full-scale sector; we are not niche players. We have everything from the banks, which we know very well, through to the life and pensions companies such as Standard Life and others, to fund managers where the latest figures have in the order of £750 billion-worth of funds under management with Scottish companies. There is also the asset servicing sector, which is hugely important. It was the scale of that operation and the fact that it goes across all the different aspects of financial services as we would see them in the UK that was a big part of the attractiveness of locating the United Kingdom Green Investment Bank in Edinburgh when we made that decision last year.

It is important to the UK as well as to Scotland. Independence would have huge implications for the sector, not least in terms of the regulation of the sector and the need to have our own regulator in Scotland under European Union rules. There would be huge implications as we sort out what the currency would be in Scotland-an issue we touched on the last time I was in front of the Committee. We would need a highly integrated sector as well-one where Scottish companies serviced the English market to a huge extent in terms of the ISAs and pensions that we sell from Scotland to England, the mortgages that are sold, and likewise how Scottish consumers buy from England and Wales when they are in the market for mortgages or ISAs.

The regulation is very important. We believe that putting barriers, which a border would inevitably require, between Scottish companies and their customers, or English and Welsh companies and their customers in Scotland, would be bad for competition, choice and costs. In terms of the deposit security issues that arise, whether it is the Financial Services Compensation Scheme or things like the Pension Protection Fund, there are huge areas of retail protection that matter to consumers in Scotland. All of that would be challenged by independence. Thus far, we have not had answers from the Scottish Government, or others who favour independence, to get round the problems that we have highlighted.

Q3390 Chair: What input did you have from the financial services industry itself when you were compiling the paper?

Michael Moore: We had a significant input from organisations such as Scottish Financial Enterprise, the trade body that represents companies across the entire spectrum of financial services north of the border. Individual companies and individuals within the sector-officials and others-had extensive meetings with them. The reason for that was that we were determined to continue the process that we began with earlier papers. We wanted thorough, properly researched papers, which set out all the arguments and all the appropriate facts and figures. We wanted to source those thoroughly so that anybody outside, including yourselves, could examine that and be comfortable that we were using the right facts, the right arguments, and ensuring that, as we did with this paper, we got strong responses from the industry itself saying that these were the right kinds of arguments and analyses to put in front of people in Scotland as we make our choice next year.

Q3391 Chair: What response did you receive from the financial services industry after you had published the paper?

Michael Moore: One of my favourites was one that talked about this being a "fact- packed report". Numerous different leaders of companies with major interests in Scotland commended the thoroughness of the analysis. There are quotations on the record from people such as Adrian Grace at Aegon and Owen Kelly at Scottish Financial Enterprise, as well as others, who have commented on the strength of the analysis we have put forward, basically requesting that the Scottish Government do something similar, which they have so far failed to do.

Q3392 Mrs Laing: Thank you, Secretary of State, for that good overview of the work that has been done. From the facts that you have put before the world in general in your paper, would you say that division of the United Kingdom might possibly put the Scottish financial services industry at risk?

Michael Moore: I would prefer to focus on the opportunities that we have, if I might put it that way round, and people can infer from that what they will. Earlier on I talked about the scale over which Scottish-based companies sell into the rest of the UK market. There are 5 million to 6 million people in Scotland compared with a market of 60 million or so overall.

Scottish firms sell nine out of every 10 ISAs and pensions to customers in the rest of the United Kingdom; that is 90% of ISAs and pensions to people outside Scotland.

Q3393 Mrs Laing: Would you mind if I ask you to repeat that so that we get it absolutely straight? Do you mean that 90% of the ISAs and pensions sold by Scottish financial institutions are sold within the United Kingdom but outside Scotland?

Michael Moore: Correct. The equivalent figure for mortgages from Scottish institutions is 80%-eight out of 10. If you flip it round and look at what we as Scottish consumers enjoy as purchasers of financial services, seven out of every 10 pensions bought by Scottish customers are from non-Scottish firms based elsewhere in the UK. It is seven out of 10 pensions and the figure for mortgages is roughly half.

Q3394 Mrs Laing: It is a reciprocal relationship.

Michael Moore: I think those numbers illustrate quite neatly the highly integrated market that we have and the fact that, without a border between Scottish firms and English and Welsh consumers, or English and Welsh firms and Scottish consumers, we get the best of both worlds. We get a great contribution to our economy, a great choice for consumers and also, when things get tough and go wrong, as they famously did with two of our most famous banks, the UK economy is there to support and protect us.

Q3395 Mrs Laing: On that very point about the banks, would you like to enlighten the Committee, and Mr Javid might like to come in on this as well, on the gearing ratios between banks and the sovereign organisations-I am trying to be as general about this as possible-which back up those banks, and the difference between a bank depending upon the UK state and upon a Scottish state?

Michael Moore: I will provide a little bit of context in terms of the support that was provided at the time of the banking collapse. These are big numbers and it is certainly worth ensuring that we get them accurate in the record. At the time of the collapse, something of the order of £45 billion was put into the banks in Scotland, with a further £275 billion-worth of guarantees and support. That is well in excess of our GDP in Scotland. It was a pretty big challenge to the UK as a whole, but in a Scottish context it would have been eye-wateringly so, and one does not wish to speculate on what might have been the case. I do not think we need to be economists or financial engineers to understand the scale of the challenge that would have faced us.

Sajid Javid: I am happy to come in here. First, it is a pleasure to appear for the first time in front of your Committee, Mr Chairman. Again, I am sorry to hear that Mr Davidson is not very well and I wish him a speedy recovery.

On that particular question by Mrs Laing, one other way to look at it and something that we analysed in great detail in the report is to look at the assets of the Scottish banking system as a proportion of GDP. That is a statistic that is often used to look at the potential risk of a financial system, should it get into trouble.

To put it into some perspective, the ratio for the UK as a whole would be about 470%, so we estimate it is just under five times GDP. By international standards compared with other major economies, that is on the high side, but, as we have just heard from the Secretary of State, despite that, it was something that was manageable for the UK during the last financial crisis.

We estimated that the same ratio for Scotland as an independent state would be over 12 times GDP. It is one of the highest in the world. You could compare that, for example, with Iceland pre-crisis in 2007, when it was approximately nine times GDP. Ireland was roughly the same, around nine times GDP. If you wanted to take a more recent example, you could look at Cyprus, where it was lower than nine; it was about seven times GDP. I pick those countries deliberately because I think it helps to illustrate what can happen if you are a small country and you have an oversized banking system.

When we prepared this analysis at the Treasury, we were very careful to make sure we used as conservative an approach as we reasonably could, based on the numbers that were available to us, so that when we came up with that number we only included the assets of Scottish registered institutions-the subsidiaries of Scottish banking groups that were registered in Scotland or if their asset base was predominantly in Scotland. When it came to the RBS Group, which would be a good example, we did not include National Westminster Banking Group because it is not registered in Scotland. Even though it is a subsidiary of the RBS Group overall, it was clear to us that the majority of activity is south of the border in the rest of the UK. We have taken quite a conservative approach. Since we have published the analysis, we have issued more information on exactly how we came up with these calculations.

Q3396 Mrs Laing: Those are very helpful statistics; thank you. I recall them being quite dramatic in the report. Could you illustrate them in terms that somebody reading the report without very much financial knowledge would understand regarding the consequences for Scottish financial services?

Sajid Javid: It is a good question. One way one could illustrate it is to look at what happens in a country when the financial system comes under stress. In quite a recent example from a few years ago, when in 2007-08 the UK financial system was under severe stress, as we all now know, the then UK Government intervened. If we take RBS as an example, the UK Government recapitalised the bank with £45 billion of taxpayers’ money. It also provided £275 billion in total of guarantees on assets-something that was called the Asset Protection Scheme.

Those two numbers taken together are clearly huge numbers by any calculation but something at the end of the day, as we have proven, that was affordable by the UK state overall in order to stabilise the banking system. If that situation had occurred and it was an independent Scotland that had to come up with the £45 billion plus the £275 billion of guarantees, those two numbers would represent more than 200% of Scotland’s GDP. Anyone looking at it independently would say that it would be hard to see how that could possibly be achieved if it is 200% of your GDP. That is just to capitalise one bank. I am not including in that, for example, a lot of help that the UK Government provided to Lloyds and some other banks.

Q3397 Lindsay Roy: You say you have robust evidence. Is it inevitable that small countries are vulnerable given the high focus that Scotland has on financial services, with the number employed and their percentage of GDP?

Sajid Javid: I would not go as far as saying that it is inevitable that small countries in a situation where they have large banking systems versus the size of their GDP will have some kind of crisis and it is not manageable. If you look at countries that are in similar situations, where there might be different ratios but you could say they are small countries with large banking systems-one could take Hong Kong or Singapore; I have personal experience of Singapore because I worked for a bank for three years there-you often find that countries run structural fiscal surpluses as a matter of policy. They also have what you might call fiscal buffers. A large savings pool might be in the form of sovereign wealth funds or large foreign exchange reserves. They are there to ultimately help protect the financial system if it gets into trouble.

There is also another significant difference. In other small countries, if you expand that to Switzerland, Luxembourg and others, against small countries with large banking systems, without exception you would find that the vast majority of the banks that are registered in those countries are foreign banks doing foreign business. Luxembourg, for example, was mentioned to me when we did this analysis as a country with a large banking system versus the size of the country. That is true, but over 90% of that is going to be foreign banks doing business in foreign countries. In other words, because it is foreign activity, although they are registered in that country, they don’t pose a systemic risk to that particular country. In the case of a crisis, you would not expect the country in question to bail out a foreign bank that is not doing business in its country.

In Scotland’s case, our analysis shows, when I have used that number of 12 times GDP, that we are talking about Scottish registered banks and/or institutions where the vast majority of their business-their assets-is in Scotland.

Q3398 Lindsay Roy: How could they instil confidence and minimise risk? What would they have to do over and above what other bigger countries do?

Sajid Javid: If you had a system that remained of that size-if Scotland wanted to keep a financial services industry of its current size-it would prove extremely difficult to instil confidence. It is not impossible of course, but you would have to set out how you would regulate these banks. You would have to prove how you might be able to intervene if it was required as a lender of last resort.

I know the Committee has looked in the past at the currency issues if Scotland was not to have its own currency. For example, if it was part of the eurozone or if it adopted sterling on a unilateral basis, it would not even have the ability to have a lender of last resort basis. I suspect we will get on to this later, but, if Scotland were independent, it would need its own financial regulatory system, which it would have to establish from day one. It would take time for that financial system to build credibility, including international credibility.

Q3399 Chair: Are you saying that small independent countries with successful financial sectors need to run budget surpluses?

Sajid Javid: I would not go as far as saying that they need to do that. There are various ways they could try and instil confidence, especially if they have had such a system for a long time and they have shown credibility in managing that system. If you look at the evidence of such countries, you will find that most of them run fiscal surpluses or have other large fiscal buffers.

Q3400 Chair: Are you saying that an independent small country like Scotland that wanted to have a large financial services sector would have to have a very conservative fiscal policy?

Sajid Javid: Yes. If the then Scottish Government post-independence-if it happened, of course-was to argue that it could sustain a large financial services sector like other countries, and it uses the countries I have mentioned as an example, it would be reasonable for others to deduce that that means it has decided to run a very conservative fiscal policy running surpluses and it intends to build up buffers. Then one would have to ask how that could be done in the context of public expenditure and public services. Would the aim be to cut back on public service provision to try and provide these fiscal buffers?

Q3401 Mrs Laing: I want to go back to the point about 200% of GDP and the gearing ratio between the assets of the state that backs up a bank and the assets and liabilities of the bank. I recall a few years ago, when questions were asked about the likelihood of a financial crisis in an independent country the size of Scotland, a parallel was drawn with Iceland, Ireland and so on, and it was said, "But this is a hypothetical question and it won’t happen." Now we have seen problems occurring in Iceland and Ireland, and it has been very sadly proved that it can happen in Scotland as well.

If separation had already taken place and the Royal Bank of Scotland, for example, had continued as a Scottish bank but the same financial crisis occurred as occurred last year, is it right to interpret the answers that you have just given me as saying that the Scottish Government simply could not have done anything to rescue the bank, that the Scottish Government could have stepped in to rescue the bank but the implications for public spending in Scotland would have been very significant, or that the banks would have to have turned elsewhere and possibly even still to the Bank of England as a rescuer or back-up?

Michael Moore: Mercifully, those were not the circumstances we faced. We were part of the United Kingdom. We saw over the course of a fairly dramatic year or 18 months what was happening, from Northern Rock through the banks to Lehman Brothers and beyond. It was a really traumatic period. I do not want to get drawn into speculating on what might have happened in different circumstances, but I hope that, by setting out, as Sajid and I have both done, the scale of support even just for one of the banks, RBS, and illustrating what that level of support represents as a percentage or multiple of how much we create in wealth every year in Scotland, we are showing that this has been very challenging.

I have seen very little from the Nationalist side of the argument to suggest that they have a system of regulation in prospect, never mind one they were advocating at the time, which would have prevented this or coped with what happened. We have seen a dramatic change in the scale of these banks over the last few years since the collapse, and the state taking a major shareholding in both banking groups. We have been able to manage that process. It has not become a crisis where people were queuing outside RBS branches or elsewhere to get their money. I don’t dispute or discount that it was very painful for very many families across Scotland and the rest of the UK whose jobs were lost as a consequence, but the contagion that would have been far beyond that is something that we prevented.

It is worth remembering that, at the time, the First Minister and others were talking about "light touch" regulation being the best way to do this. I am afraid that was wrong. It is important that we get this right, and I believe that the scale of what we have in the UK has been proven and is something that we should maintain.

Q3402 Mrs Laing: You are being very polite about it, Secretary of State. The fact is, is it not, that, had separation already taken place and the "light touch" regime been implemented by a Scottish Government standing alone, then the consequences for not just the bank, but the people employed by the bank, those who had savings in the bank and those who were dependent in other ways on the bank in Scotland, would have been nothing short of disastrous?

Michael Moore: I cannot imagine what it would have been like. It would have been terrible and a very awful position for people to be put in. I am simply saying that I cannot speculate on the specifics of what could have happened, but we got a rather bitter taste of it within the context of the UK’s economy and the UK’s financial protection arrangements. I don’t think you require very much imagination to think what would have been the case if we had been an independent country.

Mrs Laing: Thank you very much. Can I ask Mr Javid some more on that, Mr Chair?

Chair: Are you dealing with questions 3 to 6?

Mrs Laing: I am being called to order. I thought that the Secretary of State had pretty well answered most of those questions.

Chair: I am not sure about question 5.

Q3403 Mrs Laing: Let us look at the niche player. You said, Secretary of State, that Scotland is not a "niche player" but in fact offers a "full service" in the financial services industry. In what way is that significant?

Michael Moore: It is significant because of the great opportunity it presents for employment and wealth creation in Scotland. Those are two really important features of any economy. I highlighted earlier the scale of employment, with the best part of 200,000 people whose jobs are dependent on or arise from it. It is not just in the obvious places. Our analysis is that 40% of postal services in Scotland arise from the financial services industry. Any of us who have a pension or a life policy understand the mail that comes through our door for what we have, never mind what people are trying to sell us. That, maybe, is not such a stretch. Some 30% of the accountancy sector in Scotland is focused on financial services, and that goes right across the whole country.

To bring it down to city level, some of Mr Crockart’s constituents in Edinburgh are part of 55,000 people who are employed in financial services. Perhaps Edinburgh is well known and synonymous with financial services, but Glasgow is not so obviously so, and yet nearly 49,000 or 50,000 people in Glasgow have jobs that are linked directly or indirectly to financial services.

These are big employers and they have a presence in all the different sectors: the banks, on which we have been focusing; the life and pensions companies such as Standard Life, which was mentioned earlier on; fund managers-once again among which Standard Life and others are big players; and also asset servicing. I hope I will not be called up by them when I say that they are basically what we might regard as the back-room operations, which are phenomenally and hugely important in terms of the paperwork and everything else that goes on, as we know to our cost if they get it wrong. They are a big employer as well. Across the suite of financial services, products and jobs, we are very well represented.

In Scottish Financial Enterprise and TheCityUK, we can work together in promoting Scotland and the UK overseas as a financial services hub. That is brilliant news for all of us.

Q3404 Mrs Laing: We touched on the point about the financial services hub, but how important is the Scottish sector of the UK financial services industry to the hub status of the United Kingdom?

Michael Moore: I believe it is significant. I certainly believe that major international corporates-we can think of different companies like Citi, BlackRock and others who have their logos emblazoned at Canary Wharf or in other bits of the City but which also have strong presences in Scotland-are attracted to the UK because of our strong single regulatory environment and the tax arrangements that we have across the whole of the UK. They can be blind to which bit of the UK they are putting it in because they do not have to worry about different regulators, different tax systems or other issues that arise from it.

Scotland has done rather well out of that. There is competition between all parts of the UK to land these high profile, quality jobs. I have spoken to many of the leading figures in the sector who are from overseas companies. They talk initially about taking a tentative step into Scotland to do some back office work because it is cheaper in terms of the costs of locating in Scotland, both in property terms and the cost of salaries for the individuals concerned. Over time, they have developed those businesses into the full range of jobs. It is not just back office jobs that they have in Scotland; they have key parts of the business at all levels. Senior management and others are located in Scotland as readily as here in London. That is great news if you are in London because you can promote the whole of the UK, including Scotland, as part of your offer to international investors. It is also great news for Scotland that we are part of that package.

Q3405 Lindsay Roy: You have spoken about robust regulation. We have covered some of this already, but can you give a brief explanation of how financial services are regulated?

Sajid Javid: Yes, I can. Very briefly, we have a single regulatory structure throughout the entire UK, including Scotland. Recently, the Government have changed the regulatory system somewhat, but prior to the changes it was what was described as a tripartite system. Basically, you had the FSA, the Bank of England and the Treasury working together.

It is fair to say that, following the financial crisis, some weaknesses were detected in that and there were some detailed changes recently made and legislated for last year. The highlights of the current regulatory system are that you have the Financial Policy Committee, which is part of the Bank of England, which oversees the general stability of the economy and possible systemic risks. Then you have the two regulators: the Prudential Regulation Authority-the PRA-looking at prudential risk and bank capitalisation in other firms in the financial sector and at the prudential policies they have; and you also now have the FCA, the Financial Conduct Authority, which looks at just that-the business, conduct and compliance of all financial firms.

It is also fair to say that, despite the changes that the Government have made, Britain’s financial regulatory system has always been held in very high regard, and that remains the case today.

Q3406 Lindsay Roy: You argue that the Scottish financial services sector benefits from being part of the UK. Can you explain why that is?

Sajid Javid: Yes. Although Scotland, because of devolution, has certain competencies that do not exist on a separate basis in other parts of the UK, one thing that has not changed is that Scotland enjoys the same financial regulatory system as the rest of the UK. For the entire UK we have one financial regulatory system. We also have one tax system, which is obviously very important when it comes to financial services. When companies develop markets and create financial products, they would always need to look at their interaction with the tax system. For example, we heard earlier from the Secretary of State about ISAs. In practice, this means there is a single market for financial services across the UK. Whether you are a financial services company based in Scotland or Bristol, it does not matter because you can sell your products throughout the UK and be confident that the rules, procedures and compliance activities that you need to follow are the same and also that the tax treatment would be the same throughout the UK.

If Scotland were to be an independent nation, it would be required to have its own financial regulatory system. In fact, if it were then later to become a member of the European Union, under EU rules, it would be required by EU law most certainly to have its own independent financial system.

Q3407 Lindsay Roy: What would be involved in setting up that independent regulatory system?

Sajid Javid: Scotland could decide to adopt the system I have described that exists in the UK today or something of that nature. It could decide to take a different approach. However, it is worth highlighting that the Scottish Government have already said that they believe that the approach the UK has taken is the right approach. Scotland would have to build that system from scratch, so it would need its own regulators for conduct, prudential and financial stability. It would need to put that into place. It would need to make sure that it fits in with its legal system. It would also need to make sure that it fits in with whatever tax system it intends to have. That system would also have to abide by a number of different European directives. Scotland would have to decide how to implement those directives and whether they would be minimum harmonising directives or maximum harmonising directives. It would have to create this system from scratch. It would be a very big task for any newly independent state to do.

Q3408 Lindsay Roy: That would require considerable investment and time.

Sajid Javid: It would require both of those and considerable expertise. The expertise point is a serious one. We have seen world wide, because of the financial crisis, that many countries suffered shocks to their financial systems between 2007 and 2008. Many countries either have or are in the process of looking at changes they need to make, to make sure that they are better set up for such potential problems in the future. They have also changed regulators.

For example, in the UK, because the term of the current Bank of England Governor was ending, we had to find a new Governor. As we all now know, Mark Carney is coming in as the Governor. He has been universally acclaimed as one of the best people we could have found for the UK, for our central bank. Scotland would also find itself competing for global talent, and that is not something that can be brushed aside and thought to be easy.

Q3409 Lindsay Roy: It would come at a significant cost.

Sajid Javid: There would be significant cost and none of the economies of scale that we enjoy today, as a nation, of having a single regulator for the entire UK. Clearly, if Scotland was to create its own regulatory system, which it would have to, then it would have to incur those costs and those would be passed on one way or another to industry. That would inevitably also help push up costs for financial products.

Q3410 Chair: Why couldn’t Scotland simply replicate the regulatory system that the UK had in place at any particular time?

Sajid Javid: It could try that. It is fair to say that every nation would want a financial regulatory system that suits its own national interest and its own purposes. If you have more asset managers than bankers, you want to make sure you have the right proportionality in the system. Even if on day one an independent Scottish Government tried to replicate it, over time you would find it would most certainly drift away from the rest of the UK system.

Q3411 Lindsay Roy: You also suggest that sharing prudential regulation would be difficult. Why is that?

Sajid Javid: At a practical level I just don’t see how it can work. First, I believe the current Scottish Government have said that, if they achieve independence, they would want to join the European Union. In such a case, European Union rules would require them to have their own independent regulators, so they would not be able to share them with any other country.

Secondly, if this were to happen in theory, it is hard to see how it could work in the interests of Scotland. Any regulator can only be accountable to one Government. Our regulatory system is rightly accountable to the UK Government and ultimately to Parliament. You mentioned the PRA, Mr Roy. It is hard to see how the PRA could be both accountable to the rest of the UK Government and separately to a Scottish Government. I know of no such arrangement in the world.

Q3412 Chair: In essence, you can’t have divided loyalties.

Sajid Javid: Yes; I would agree with that.

Q3413 Mrs Laing: I want to follow up that question because this is a very important line of investigation that Mr Javid is explaining to us. On this point about Mr Roy’s question about accountability to one Government, would it be the case that, if at some time in the future an independent and separate Scotland decided to replicate the financial services rules currently undertaken by the UK Government and to replicate the taxes so that they would be competitive in the world market, as we have just discussed, and supposing they pegged the Scottish pound to the UK pound, as the First Minister has suggested they would consider doing, would that mean that decisions taken about Scotland’s financial services structure would be taken outside Scotland and there would be no accountability for those decisions to the Scottish people?

Sajid Javid: First of all, you have put a lot of assumptions, and I can understand why you have had to do that, in the question, such as if they keep using sterling unilaterally and they essentially keep the same regulatory system they adopted. The first thing that arises in my mind is that, if you are going to do all that, why did you bother becoming independent? That is the first question many Scots may ask in such a situation.

Mrs Laing: They are asking, Mr Javid.

Sajid Javid: To answer your question further, even if Scotland were to do all the things you have said, it is hard to see how it would still be as stable and safe as the current system. By way of example, I could use the currency point. You said, in your example, that they would unilaterally adopt sterling. As the Chancellor has said, it is very difficult to assume how they could keep sterling otherwise, unless they were unilaterally adopting it. Even in such a case, because it would not be their national currency, in that it would not be regulated by them and it would not be the currency of their central bank, there would be no lender of last resort.

You could look at Cyprus recently. Cyprus is a small country with a small population. It has an oversized banking system and effectively does not have control over its own currency because it is a member of the eurozone. When the banking system got into trouble, one avenue that was not open to Cyprus, because it did not have its own currency, was that it was unable to recapitalise its banks with its own currency because it did not have a lender of last resort. As a result, Cyprus had to go to the European Central Bank and so forth, and we all know what happened after that. In Scotland’s case, it would face similar problems.

Michael Moore: There is a fundamental problem here. Every time an obstacle is put in front of the Scottish Government-not deliberately and not created for the sake of it, but it is just the reality of what international rules such as European Union membership require-they wish it away. They say, "It will not apply," or, "We will get round that." We have heard suggestions from Scottish Government Ministers recently that they would pay the Bank of England to be the lender of last resort. I can’t begin to imagine how that would work.

Q3414 Mrs Laing: Would the Bank of England accept payment to be the lender of last resort?

Michael Moore: I don’t know that there is any precedent for this idea. It is a good example of how, when they are confronted with a real problem-it is not the politicians on our side of the argument but serious financial people who are raising it with the Nationalists-they come up with a superficially attractive option, without telling us how it would work, or, more importantly, if the rest of the United Kingdom would accept that as a reasonable basis on which to continue the relationship.

Q3415 Lindsay Roy: Is it not the case that, when they ask awkward questions, they have been accused of scaremongering and there is no response?

Michael Moore: My take on it is that the whole purpose of our "Scotland Analysis" programme, Mr Roy, is to set out the arguments and the analysis of the facts and figures, and let others judge if we are making the right points or not. As we have already said, the response from the financial services sector to this paper illustrates that we are getting that right. We have had no serious credible critique of it saying that we have got it wrong.

Q3416 Lindsay Roy: But you have been accused of scaremongering.

Michael Moore: Which, I think, is to miss the point. Those who charge us with scaremongering or talking Scotland down, or whatever else, simply do not like the fact that we are raising serious issues. I am very happy to listen to the considered detailed case that is made, but, every time something is brought to our attention and we challenge it, it crumbles. We need a better debate than that.

Lindsay Roy: I accept that.

Q3417 Mrs Laing: I want to explore a little further the point about the lender of last resort. I appreciate that a lot of people in Scotland-and indeed in the rest of the United Kingdom but particularly in Scotland-ask me and others like me these questions. They are quite difficult questions and it would be helpful to get good answers on the record. I want to ask you a very simple question. What is a lender of last resort? I just want to get this on the record.

Sajid Javid: In a general sense, it would be a nation state’s central bank that is responsible for issuing the currency of that nation state.

Q3418 Mrs Laing: At present is it the case that the lender of last resort-the central bank for Scotland-is the Bank of England?

Sajid Javid: In effect, if you look at what happened in the recent financial crisis, the lender to RBS and Lloyds was the Government, but one could see that the British Government had this flexibility partly because Britain has its own independent currency and therefore has much more freedom to make these types of decisions.

Q3419 Mrs Laing: There is some misunderstanding about this. Although the Royal Bank of Scotland, the Bank of Scotland and the Clydesdale Bank print and issue their own bank notes, is it the case that the issue of those bank notes and the value of them is still regulated and controlled by the Bank of England?

Sajid Javid: Absolutely correct. They print those on licence. It is done with very strict agreement with the Bank of England and is in the full control of the Bank of England.

Q3420 Mrs Laing: If Scotland became a separate country and decided to adopt the euro as its currency if it became part of the European Union, or if it decided not to adopt the euro but retain the pound and to peg a Scottish pound to the value of the pounds issued for the rest of the United Kingdom by the Bank of England, would it be the case that there was no control over that currency in Scotland?

Sajid Javid: Over which currency?

Mrs Laing: Over the Scottish currency, because either it will be the euro controlled by European institutions or the pound controlled by the Bank of England and the UK Parliament.

Sajid Javid: If it was a Scottish pound introduced by the Scottish Government and that is a separate Scottish currency, if I have understood you correctly, that is ultimately an issue for the then Scottish Government. It would have no linkage to the Bank of England or to the continuing UK.

Q3421 Mrs Laing: Does that mean that, in Scotland, at that point there would be no lender of last resort?

Sajid Javid: It really does depend. If there is a Scottish currency with a Scottish central bank, then the Scottish central bank could be a lender of last resort, but it depends on how that was set up. There are many different variations. I would hesitate to give you a very black-and-white answer on it.

Q3422 Mrs Laing: Would that bring us back to the examination of the gearing ratios about which we were asking you earlier, where you mentioned a figure of 470% gearing for the UK, whereas it is something like 1,200% for Scotland alone?

Sajid Javid: Yes, more than 1,200% for Scotland alone.

Q3423 Mike Crockart: First of all, apologies for having to nip out. I was presenting my private Member’s Bill-the Communications (Unsolicited Telephone Calls and Texts) Bill. I do not need to say that but it is good to get it on Hansard as many times as I can.

I want to ask one question about the shared regulatory structure first, before moving on to the implications of the UK domestic market. Yesterday, in Scotland, the BIS Select Committee took evidence and looked into a very similar subject, looking at the implications of independence for financial services. We took evidence from Professor David Bell from the university of Sterling. When questioned about the ability to share regulators, he seemed to suggest that one of the potential answers to this that is certainly being advanced by the Scottish Government is a franchise model. Do you have any knowledge of how a franchise model would or could work-or not?

Michael Moore: So far we have not seen very much detail on such an idea. The legal experts would pore over any proposal, but I have a pretty clear understanding that the European Union would require Scotland to have its own regulator. Whether that was "the Bank of England (Scottish franchise version)" to make it sound like it was what we used to have before, or some new form of copying mechanism that was suggested earlier on, I don’t know. When I was last in front of the Committee, we were talking about the currency paper and we touched on this regulation point then.

There seem to be two different ways to argue this. One is that we could copy everything, just listen and see what had happened in London, and then immediately pass the same legislation through Scotland without question, not applying any critical faculties to it or taking account of any differences in the structure of our financial services relative to those in the rest of the country. We could do the same thing, which would be very easy and would save the cost of policy officials and everything else. It would apparently save businesses having to see how different the regulation was. I think that would be very cumbersome and there would be many steps along the way not to do it quite right or to decide to do it just ever so slightly differently. Over time I am confident that would diverge greatly, so I do not think that stacks up as taking away the risk, because it would still remain and it would not be practical for very long.

As we sometimes hear from the SNP, the alternative is that they would buy into the lender of last resort and we would share the Bank of England. The Bank of England and the regulatory arrangements that are in place at a UK level would be part of a foreign country, as far as Scotland was concerned. They are governed by this Parliament. I am absolutely confident, although they keep saying they will keep things that the UK already has, that what is not proposed is that Scottish MPs would still come to Westminster. I have not heard that being suggested, although maybe that will be the next step. I would be interested to see how the English, Welsh and Northern Irish would react to that. Without MPs at Westminster, I don’t know how we would effect the legislation that oversees the Bank of England and all the other financial regulators.

If you separately had an inter-governmental contract or arrangement between an independent Scotland and the Bank of England, again, how much influence would you be able to negotiate with the Bank of England, assuming that the rest of the UK thought that was an acceptable arrangement? If you make a very generous assumption that the rest of the UK thought that was in any way feasible, then the question would arise of how many people Scotland would have on the governance of the Bank of England. How much influence would we have? I have seen nothing that persuades me that that is a practical option. Nobody in the financial services sector has stood up and said, "That works for us."

It seems that the Scottish Government are flailing around looking for a solution, and every time they come up with one there are more obstacles they have created at the same time.

Q3424 Lindsay Roy: Would this be a quasi-colonial relationship?

Michael Moore: It is a question you might wish to put to them. We have to face up to the reality that we would require a separate regulator under European Union membership rules. If we didn’t, we would have to negotiate an opt-out from that requirement within Europe, plus negotiate with the rest of the UK to give us membership of this new regulatory environment. At what cost, we do not know.

Q3425 Mike Crockart: You have covered a little bit of this already and there has also been evidence submitted to a House of Lords Committee on this. It is particularly to do with how dependent the Scottish financial services industry would be on English customers. The evidence in the House of Lords was that it was 94% of Scottish insurers’ sales and 84% of mortgage sales. Why would setting up an international border have an effect on these sales? Could they not just continue?

Sajid Javid: Our analysis shows that, in the Scottish financial services industry as a whole, approximately 90% of their customers are located in the rest of the UK. A company might be based in Scotland but the vast majority-nine out of 10-of their customers are in the rest of the UK. To be more specific, as we heard earlier, for Scottish banks and building societies, nine out of 10 ISAs are sold to customers in the rest of the UK. For pension companies, nine out of every 10 pensions are in the rest of the UK. For Scottish banks, more than eight out of 10 mortgages are to customers in the rest of the UK. That shows very clearly, if you look at the numbers and nothing else, how dependent the Scottish financial services industry is on customers in the rest of the UK.

If you break that up a bit more and say that the entire UK population is approximately 60 million-5 million of that, roughly, is Scottish, and 55 million in the rest of the UK-if you were a Scottish financial services company and post-independence you find that 90% of your customers are now in a foreign country, you would certainly look at what the best strategy was for that company going forward. It would be common sense to focus on your largest group of customers, which now happen to be in a foreign country.

As we have just heard about the regulatory system, the importance of that is that now, because it is a foreign country where you find 90% of your customers are under a different regulatory and tax system, number one, you absolutely have to invest resources to cover two regulatory systems if you want to continue serving Scotland and the rest of the UK. It might be that some companies think it is not worth having investments in two different systems; they might as well focus on the 90% alone and not worry about the other 10% because it is too small a business proposition for them. If you are going to focus on both countries, you have to have two groups of specialists, including compliance officers, lawyers and tax specialists, and it will most certainly push up your costs.

I would say that, if you look at the current set-up in the UK, we have a very integrated financial services market. Despite the fact that financial services, to some degree, are part of the European single market, the EU rules can have a very limited impact because each country, as we have heard, is required to have its own regulatory system. In addition, taxation is not a competence of the EU. These are very important to financial services. Taken together, it means there is not full integration between EU countries, but inside and internally within every EU country there is full integration. If Scotland was to separate off, then clearly it would be a separate country with its own system.

Today, in Britain, we don’t see many Italian, French or German banks or asset managers offering products to UK customers. The reason, as I have just given, is that that would mean they would have to deal with an entirely different regulatory and tax system from their domestic one.

Q3426 Mike Crockart: That was going to be my next question. Is the financial services industry as a whole more or less likely to be able to sell outwith the country that they are serviced or regulated in? Is there evidence, for example, to show that consumers are quite happy to buy a fridge from any provider in any country if it is going to be at the right price? Is that not also true for financial services? Do people generally stick to buying financial services in the regulated area in which they are living?

Sajid Javid: One could say that financial services, by their very nature, are not commoditised products. They have to be created in a way that is suitable for the environment in which they are being sold. Number one among that focus must be the regulatory environment that you are operating in to make sure you meet the rules and regulations of that country and also within the tax environment in which you are operating.

Clearly, in the case of independence for Scotland that would change. The financial services companies that are based in Scotland would find that, if they want to keep catering with products to the rest of the UK, they would have to adopt a different team of people, at least to look at the regulation and tax in that country, and they could not sell exactly the same products between two foreign countries.

Q3427 Mike Crockart: I accept that, but what I am trying to get down to is whether there is a psychological barrier, if you like. What drives people in the way that they buy financial products?

Michael Moore: Safety and security, and confidence that they will do what you want or need them to do at the time of crisis, whether it is a pension, an ISA or whatever. Picking up on your instinct that people want to buy from their regulated area, a recent YouGov survey said that over 80% of people think that buying a product from across a border is riskier. That goes to the heart of it. When we buy financial products-and I don’t think I am just speaking for myself here-we are looking for straightforward products that will do what we need them to do with the minimum of risk.

Sajid was just making the point about the cost of regulation and the need to be regulated in both markets. Standard Life estimated that the cost of regulation in the UK context for all its business for the whole of the UK is in the order of £40 million per annum. That is a big, chunky number. One could say it shows that good regulation doesn’t come cheap, but to the extent to which you have to replicate that-and that is just one organisation-it needs to be taken on board.

Q3428 Mike Crockart: We have already touched on the next question a little. I am trying to tease out the differences between the UK domestic market and the EU single market. How does the UK domestic market in financial services compare with that EU single market? What are the major differences?

Sajid Javid: The key difference is that the UK market is a true single market. It has a single regulatory system and a single tax system. It is not just something that has been created in the last few years, but, as we know, there has been a single market for many decades. That means that it is a market, as we have seen, whether one is buying a mortgage or a pension, that is all integrated. Pensions are important. Even when it comes to pensions, again, they are slightly different from some other products. The nation state’s welfare policies towards a state pension and the types of relief that are given for the tax system of pensions are very important. That will impact on what kind of pension someone might purchase. They might partly rely on the state pension in retirement. Again, if you have two independent states and two separate policies, even pension provision gets affected.

The EU’s policy in terms of creating a single market and having a better single market in products that include financial services is through a series of directives and regulations. Typically, these directives are what we refer to as minimum harmonising directives. That means that the EU would set a minimum for each national regulator to meet in a certain market-for example, the mortgage market. There are now and again-they are rarer-what are called maximum harmonising directives, where the EU sets the maximum regulation one can put in place. Within those constraints, there is a vast difference between nation states within the EU in how they regulate their financial systems. No doubt, if Scotland were to be independent, it would have to have its own regulators under EU law if it was part of the EU as well. Even though on day one there might be some similarity between the rest of the UK and Scotland, it would most certainly change and diverge over time.

Q3429 Chair: I want to move on to consumer protection. Could you please explain how the present UK system safeguards the interests of consumers, especially in cases where financial firms fail?

Sajid Javid: First of all, you are safeguarding consumers in such cases where failure-or where one might be worried about failure-is absolutely critical to the success of any financial system. It might be best to explain that by way of one of the most important financial products, and that is the provision of a bank account for your day-to-day bank account services but also for individual savings.

In the UK at the moment we have the FSCS-the Financial Services Compensation Scheme-which is set up by law. It is required that all banks in the UK and all deposit-taking institutions pay into this. One can call it a sort of rainy-day fund where, if things really went wrong, this fund would be used to compensate individual savers up to a maximum of £85,000 each. That is also a requirement of the EU. There is an EU directive that requires all member states to have their individual deposit guarantee scheme. If Scotland were to become independent, under EU law it would not be able to share this with the UK. It would have to have its own independent deposit guarantee scheme.

In the UK, it is fair to say that in some sense, as some people have often observed, our own retail banking sector is concentrated when compared with some other countries. If we put some numbers on it, six banks account for approximately 75% of retail deposits. Although there is a degree of concentration, there are clearly more than one or two banks operating in that space. That means there is a diffusion of risk within the system and that, if one bank were to get into trouble, it is reasonable to assume that the scheme would work as intended and the other banks could pick up and help with the compensation.

During the last financial crisis in the UK, the Financial Services Compensation Scheme required a short-term loan from the UK Government of approximately £20 billion, which it subsequently paid back. That is a demonstration of the fact that, even when you have such a scheme in place and it is well diversified, there may still be a need for an ultimate backstop, which there clearly is. The backstop in the UK is the UK Government, and that is why these deposits of up to £85,000 are often referred to as Government guaranteed-because of that backstop.

In the case of an independent Scotland, this situation would change dramatically for Scottish individuals. First of all, it would need to set up its own scheme from scratch. Secondly, and very importantly, it would be dominated by two banks. The two banks in Scotland-the Royal Bank of Scotland and Bank of Scotland-would account for almost 100% of deposits. One rationale of these guarantee schemes is that you have a diversification of risks. That is very difficult to achieve when you only have two institutions. That obviously means that, if one were to get into trouble, it is difficult to see how the other would pick up the slack on its own. If the other institution were not able to pick up the slack and help, then the backstop would have to be the Scottish Government. Again, as we referred to earlier, given the size of the Scottish banking system at 12 times GDP versus less than five times in the UK taken together, that would put a tremendous demand on the Scottish state.

Q3430 Chair: You mentioned that the UK Government had to lend £20 billion to the Financial Services Compensation Scheme. If Scotland had been independent, have you worked out, as a percentage of GDP, what the Scottish Government would have had to lend to its equivalent of the FSCS?

Sajid Javid: Yes, I believe we have published that number, and these numbers refer to the size of the deposits that are guaranteed as a proportion of GDP. For the UK as a whole, that is 58%, and for Scotland, under our analysis, it would be 116%; so it is more than double.

Michael Moore: I would underline the point we were making earlier about people’s perceptions of risk and what they want from financial services products, and the fact that people are concerned where there is risk involved. This protection scheme does a huge amount to take away the concerns and the worries that people have and is fundamental to underpinning the single market that allows Scottish consumers to buy products from English-based providers and vice versa. It seems to me that it is a pretty basic requirement and a fundamental underpinning of what we have at the moment.

Q3431 Chair: In an independent country like Scotland with these two large banks, would there be any way at all that that risk could be offset by some pooled sharing agreement with some other country or countries?

Sajid Javid: That would not be possible, Mr Reid, under EU rules. The rules quite clearly state that each country must have its own independent deposit guarantee scheme.

Q3432 Chair: If Scotland became a separate country and it had these two large banks, what practical impact do you think that would have on the cost of financial products such as mortgages and insurance?

Sajid Javid: Because of the situation we have described, one could certainly read into it a heightened sense of risk. Taking one who had a deposit in a Scottish bank and a Scottish guarantee scheme compared with the current system that such a depositor would enjoy, one would sense that it is of higher risk because they would look at the fact that it is two banks and not six well diversified banks. If they looked beyond that and said, "Look, even in the worst case the state would have to step in," in Britain and the whole of the UK taken together we have a well diversified base and a strong economy that can stand behind these deposits. Given the ratios we have discussed regarding the size of the sector to GDP, one would legitimately question the ability of the Scottish state to help in such a situation.

If I take another financial product, looking at defined benefit pensions, as you know, in the UK we have the Pension Protection Fund, which again ultimately provides a degree of protection should one of these funds be unable to meet their liabilities. Similar to the deposit guarantee scheme, that works on the rationale of a well diversified pool of defined benefit pension schemes that belong to that so that there is a self-insurance scheme within the PPF. If Scotland were to become independent, there is absolutely no reason to believe it would remain part of the PPF because that is a UK-wide scheme. If it were then to set up its own version of that, it would be on a much less diversified basis.

In our analysis, we did a rough calculation of the number of Scottish schemes in the current PPF, just by looking at their address. Roughly speaking, we worked out that approximately 7% of schemes in the PPF could be Scottish in nature. If Scotland was independent, the group that makes up that 7% would have to become part of some other scheme. Someone who had a Scottish defined benefit pension would possibly look at that and think that the risk to them had potentially increased.

Q3433 Chair: What alternatives would be available for people living in Scotland who wanted to take out mortgages or insurance or invest in a pension scheme, if they felt that investing in a Scottish-based scheme was risky for the reasons described? Would they still have the opportunity to invest in a scheme based in the UK or another EU country?

Sajid Javid: There is nothing to say that a Scottish national, if Scotland were a separate country, could not invest in products in a foreign country or get a mortgage from a foreign country as long as there were providers in that country that were willing to enter the Scottish market. That is important because, if your business is predominantly in the rest of the UK, for that firm to offer mortgages, pensions or savings products into the Scottish market-and for the reasons discussed Scotland would have its own regulatory, tax and welfare systems-that company must be willing to incur the extra costs of operating in what would be a small economy, and not present economies of scale.

If you just look at basic economics, you would think that the costs of providing those products would increase in terms of the admin costs, the bureaucracy and the compliance costs. You could also potentially assume that, if there was an assessment of heightened risk in the Scottish economy because of what we discussed with regard to the deposit guarantee scheme and the size of the banking sector, it may even lead to higher interest rates than the rest of the UK. For argument’s sake, even if they had the same currency in the rest of Scotland, you could still see a situation where there are higher interest rates. That could make a huge difference to the Scottish consumer. Our analysis showed that just a 1% higher mortgage rate for a Scottish household would mean additional payments on the mortgage in interest of up to £1,500 a year.

Michael Moore: I would pick up on that point. If you are based in Rothesay and wanted to buy your pension from a provider in London-

Chair: That was exactly the question I was going to ask; so great minds think alike.

Michael Moore: I will not go further down that line. After independence, one obstacle I foresee is that many of these financial products depend on your tax status. The great benefit of investing in pensions in the UK is that you get tax relief because you are a UK taxpayer. It would require fairly significant concessions and agreements from the rest of the UK to allow people in Scotland to buy into a pension from the rest of the UK and get that tax treatment; or Scotland would have to offset that in a way to make up for the fact that the taxpayer based in Scotland was not going to get the benefits that other taxpayers buying in England would get.

You can see that you might not get quite substantial tax-beneficial treatment, and it is not just pensions but could be ISAs or whatever other savings products there are, or you would have to introduce a huge amount of complexity to match that tax efficiency in the Scottish context. Working your way through all of that might persuade most consumers to stick to their domestic market.

Q3434 Chair: You have answered the question about pensions, but what about savings or insurance? If I am resident in a separate Scotland and I want to put my savings in a bank in, say, London, would I be covered by the UK regime or the Scottish regime?

Sajid Javid: In that example that you have given, Mr Reid, there would be nothing to prevent a Scottish national from taking their savings and putting them into a UK bank. If it has a different currency, they might have to think of the currency risks. If it has its own currency, it would be a big assumption to assume that UK banks would take deposits in a foreign currency. If you were able to get over that hurdle, there would be nothing to stop a Scottish national putting a deposit with a bank in the rest of the UK, unless the Scottish Government legislated to stop it, assuming it had a free capital market. If they did so, that would be governed by UK regulations, but that does not necessarily mean that the rest of the UK may not, in anticipation of that, change some of its own regulations because it would be quite a dynamic process.

Q3435 Chair: You are basically saying that in an independent Scotland, if I want a financial services product, I am going to have to pay more for it one way or another than I do at the moment. Is that what you are saying?

Sajid Javid: One way or another there will be much less choice for the Scottish individual, and less choice in any market often means higher prices. On the deposit example, most, if not all, UK banks would require anyone opening an account with them on the mainland UK to be a resident in the mainland UK. It is quite possible that UK banks would not take deposits from a Scottish national because they would be a resident of a foreign country.

Q3436 Chair: How do you think lending to small businesses would operate differently in an independent Scotland?

Sajid Javid: Similarly, Mr Reid, if Scottish independence meant less choice for small businesses, so if there were fewer banks operating and offering products in Scotland, less choice would potentially lead to higher prices in terms of loans and other small business financial products.

Q3437 Mrs Laing: I want to look further at the issue of the relative size of the banking sector to the state in which it operates and the issue of the lender of last resort. It has been suggested that the Scottish banking sector would effectively be too big for a separate Scottish economy. The figures that we have looked at this afternoon certainly seem to back that up.

When things went wrong in Ireland and Iceland, other countries stepped in to rescue the banks, including the UK. Wouldn’t the UK do that if Scotland were a separate country and banks got into difficulties?

Sajid Javid: It is impossible for a UK Minister to answer that question.

Mrs Laing: I understand that.

Sajid Javid: My responsibilities are for the entire UK, and that question could only be answered, if Scotland became independent, by a Minister for the continuing UK.

Q3438 Mrs Laing: I appreciate that. As I asked that question, I suddenly realised that you could not possibly answer it. What if, at some point in the future, you were the Minister making the decision? We can’t have what you say in Hansard today putting you in a difficult position.

Michael Moore: I will offer two quick observations on that. Sir Mervyn King observed that banks are global in life and local in death, or words to that effect. The problems come right back to home base when there is a crisis and suddenly all your friends internationally are maybe not quite as obvious as they once were.

If you were to look at the way in which different countries that have got into difficulty have had assistance, Ireland had assistance from the European Union and also some support from the UK. In Iceland, there was a slight difficulty in the relationship between us and the Icelandic Government at the time of the crash there. Cyprus has had very serious challenges in terms of getting its support from outside.

You might make a case that shows that in each instance international support has been found, but examining any of the detail about the experiences those countries had to go through to get that support would put most people off wanting to leave that to chance. There is no common approach to the treatment one might get. There is no agreed way in which that would work, but to agree an approach and to have that certainty would place potential costs on the country that was offering that potential support. If Scotland were looking to the rest of the UK to do that in an organised fashion, then clearly that would have to be negotiated and worked through.

If, in Scotland, we were to decide to be independent and just take a wee chance that, come that moment, of course England and Wales would bail us out, I don’t think we would be regarded as good faith neighbours. I do not think people would regard that as being particularly prudent or something that instilled confidence in the new relationship that we were to have with the rest of the UK.

Q3439 Mrs Laing: Or indeed properly and truly independent.

Michael Moore: Time after time we come back to this question. We were teasing this out with the Bank of England issues earlier on. What kind of independence is this that is being offered? Every single time there is a problem, half of the solution at the very least is, "Oh no, things will stay the same but we will have more choice"-ill-defined.

Mrs Laing: It reminds me of-no, no, I won’t go down that path.

Sajid Javid: Can I add to that? As well as speaking today as Economic Secretary, I can also leverage on my own experiences when working for over 20 years in the financial services industry in many different international jurisdictions. One thing that is quite obvious is that the most important thing for the success of any financial system is confidence in that system. Confidence begins with having a regulator and a regulatory system that is well respected so that a state can show that, if things were to go wrong-and things can go wrong for any country at any point in time because financial markets, by their very nature, are volatile and one can’t predict their future-you have a regulatory system that can cope, that is able to manage the system effectively enough to keep some level of stability and can engender some confidence.

It also relies on having a state that can show that, if things went wrong and if the financial regulator was not able to spot something, the state has the means to intervene if it was required to do so. No state wants to do so, but investors and participants in global finance will often look and say, "Does the state that I am operating in have a sensible regulatory system, and does it have the ability to intervene financially if the worst thing happened?" In the UK’s case, despite recent problems, we still have a very reputable financial system worldwide, and clearly the UK economy remains by far one of the largest economies in the world with substantial resources.

In the case of Scotland, as we have seen before, first of all, it would have to create its own financial system from scratch, and, even if it turned out to be one of the best in the world, it is going to take years to build that credibility. It is not going to have that credibility from day one, by definition. It would have to create that from scratch.

Secondly, as we have seen, if the banking system had its current structure, it would be so big that it would put a question mark over its ability to intervene. Going back to your question, Ms Laing, if Scotland were to say, "Actually, don’t worry about the fact that our banking system is so big, because look at Ireland, Iceland and Cyprus: when they got into trouble, the global community helped," I don’t think that would be a very confidence-building measure.

Q3440 Mrs Laing: We all appreciate the importance of the confidence that you talk about. That would take some time to build, as confidence does. It would effectively be impossible for a newly separate Scotland to have a system in which the rest of the world could have confidence because, being new, it would be unproven.

Sajid Javid: I would say it would be extremely difficult. An independent Scotland would have to build that confidence from day one. Again, if we look at the experience of other small nations with large financial systems such as Singapore, Switzerland and Hong Kong, these are all countries that have built that confidence over many decades, if not centuries. It will take a considerable amount of time. These are countries that have also been in many ways stress-tested, so they have faced financial crises in the past. If you take Singapore and Hong Kong-the Asian financial crisis in the late 1990s and the recent financial crisis-these are countries that have been tested, and, because they have well respected regulators and these fiscal buffers that I talked about earlier, you could say that they have passed these tests. As an independent Scotland would be a new country without this history of managing these affairs directly itself, it would be tested.

Q3441 Mrs Laing: I was going to do the Lady Bracknell quote about being careless, but it would seem rather careless to throw away the confidence that the Scottish financial sector currently enjoys in the world in general. Let me put it a different way. Would it seem rather careless to throw away the confidence that the Scottish financial sector enjoys at the moment as a result of being part of the UK regulatory body, and replace it with a new regulatory body, which would be unproven?

Sajid Javid: Yes. An industry professional, when they read this fact-packed report-which I agree with and so am happy to repeat it-said that they could see all the downsides but they could not see any upside for Scotland.

Q3442 Mrs Laing: That was my next question. What would be the upside? Can you give us the upside of a separate Scotland having a separate regulatory regime, a separate tax regime, a separate currency and separate financial institutions?

Michael Moore: Generous-spirited as I am, I am struggling to see that-given the structure of the market, the consumer choice and strength and stability that we have as a result of a single regulatory environment. We are essentially being invited to wing it under a new regime without detail or anything. As Sajid has said, confidence is at the base of all these arrangements. You cannot wing your way through things as serious as this.

Q3443 Mrs Laing: If a separate Scottish Government recognised the points that you have both made about confidence and decided to adhere to the current institutions of the UK pound and the UK regulatory regime, could Scotland then truly be described as independent?

Michael Moore: There are a lot of ifs and buts in there, if I may say so, but it is a journey we are invited to imagine ourselves going along in terms of leaving the UK but staying part of the regulatory system, staying part of the currency and staying under the ambit of the Bank of England. It seems to me that we are leaving all of this but coming back to use all of the facilities that we have left behind. It just doesn’t seem credible to me. I have yet to hear any independent third party say they believe that that would represent something better for Scotland, assuming it was workable at all.

Q3444 Mrs Laing: I have one other question about a speculative future. Would it be likely, in facing the possibility of the uncertainty that you have both described and the lack of confidence in a new system of regulation, that some Scottish financial institutions might move their headquarters elsewhere?

Michael Moore: Again, if I may say so, a lot of things are being lined up behind each other there; there are a lot of assumptions. But the issue of where institutions are based has to be a live one where there is either regulatory uncertainty or just simply a different regulatory arrangement from the one that we have at the present time, however certain that is and however quickly it earns its credibility, as Sajid said. Others in the financial services sector who are the players in industry have highlighted this as an issue for them. Small countries don’t tend to have big banks and there are all sorts of issues around that. It is clearly an issue we would have to face up to. I would not wish to create the circumstances where anybody went on to consider where they were based.

Q3445 Mrs Laing: If that uncertainty were to be created, and I don’t want to put too many ifs into this, the purpose of my question is to try to answer the people who say to me, "I work for a Scottish bank," or, "I work for a Scottish financial institution," or, "I am based in Edinburgh and the work I do depends on the financial institutions and their strength in Edinburgh and Glasgow." When people say that to me, they ask, "Do you think that if Scotland was a separate country things will continue as they are for us now?" Surely the answer, from all that has been said this afternoon, has to be, "We simply could not give that guarantee, and, if your job is at risk, it is at risk."

Michael Moore: Independence is a major decision for all of us. That is why both sides of the argument are spending so much time setting our their arguments and why we, as the UK Government-one of Scotland’s two Governments-are putting out the positive case for the UK: why it is good for Scotland and all of us who live in Scotland to be part of this great United Kingdom.

In that context, financial services and other industry are clearly a big focus. I hope that people recognise as they read our report and the paper that this is a big, irreversible step. Those are the stakes we have here in this big decision. It is for the other side to deal with these uncertainties and challenges that would face us all and set out how they would overcome them. My contention is that, so far, they have singularly failed to do so. I believe that at the moment people are seeing that staying in the UK is a much better option.

Q3446 Mrs Laing: If the people of Scotland decide to stay in the UK, are the current signs that the financial services industry in Scotland will go from strength to strength and benefit both Scotland and the UK?

Michael Moore: It has, and continues to have, great potential. As a Government, our own confidence in the Scottish financial services sector was absolutely underlined by the decision to locate the Green Investment Bank in Edinburgh.

Sajid Javid: If I can add to that, Scotland has a strong tradition in banking and asset management. Some of the best bankers in the world throughout history have been Scottish. During my 20 years working in the financial services industry, I have to say that I have worked with a huge number of Scots representing banks around the world. Whether I was working in London, New York or Singapore, you could always hear the Scottish accent on the trading floor. Scots have a tradition and they are very good at financial services, particularly in banking and asset management. Those are two important examples.

If we take asset management, for instance, Scottish-based asset managers currently manage around £750 billion of assets for UK customers. That is about a fifth of the total assets managed in the UK as a whole. If you were to speak to any Scottish asset manager, at least privately, I think they would tell you that they would be very concerned about what would happen post-independence because 90% of their customers are based in the rest of the UK and now all of a sudden they would be foreign customers in a foreign jurisdiction.

Ms Laing, you may also know that, recently, the UK Government announced in the last Budget an asset management strategy designed to get even more asset managers to locate and/or existing ones to expand in the UK. It is for this reason that, as a Government, we got rid of a tax that asset managers didn’t like called the schedule 19 tax. We are looking and consulting on other measures we can take, such as the abolition of further taxes and removing certain regulations that will help that business expand. That is certainly something we are going to pursue in the UK with rigour because we think this is an area where the UK economy can expand. Again, if Scotland were to choose independence next year, then it naturally would not be part of that strategy because that would be a strategy for the rest of the UK.

In general, it goes back to my point, and I think this is probably one of the most startling statistics of all, that, when you think that 90% of the customers of Scottish financial companies are based in the rest of the UK and then you consider your question, Mrs Laing, about whether firms would look at the structure and location of their services, it has to be the case that Scottish companies would at least look at the structure of how they are set up, where they have most of their people located and base it in some way or another on where most of their customers are. If they are in a foreign country, they most certainly will have to take that into account. My biggest fear is that independence would sadly result in the loss of thousands of jobs in the Scottish financial sector.

Mrs Laing: That was very helpful. Would you mind repeating it?

Sajid Javid: The bit about Scots being great in financial services.

Mrs Laing: Most of us around this table know that.

Sajid Javid: Of course, there are exceptions to that rule but I won’t go there.

Mrs Laing: I freely admit to being the exception to the rule, unfortunately.

Sajid Javid: I wasn’t thinking of you. I was thinking of a certain banker.

Q3447 Mrs Laing: I was thinking of me. In serious terms, of course, there are Scots around the world who have been very successful bankers. The statistic I was going to ask you to repeat is the one about the proportion of assets that are managed within the UK as opposed to within Scotland. It seems to me that that is quite a stunning statistic and that, if it were changed, would have serious implications for jobs and wealth creation in Scotland.

Sajid Javid: The Scottish fund managers manage approximately £750 billion of assets for UK customers. That is approximately a fifth of total assets managed by UK asset managers, which, as you can see, is disproportionate to the size of Scotland in terms of GDP and population. It is disproportionate for the right reasons, because the Scots are so good at asset management and that is a niche that Scotland has. Those Scottish firms, because they have lots of customers in the rest of the UK, will naturally have people based in the rest of the UK, especially in London. That is an important network that Scotland, and Edinburgh in particular, will leverage off to build that business. The important thing is that the headquarters of that business, the key people that run that business and much of the admin and back office work is in Scotland, which creates thousands of jobs. As we have heard, over 85,000 people are employed directly in Scottish financial services. Another 100,000 people are employed indirectly. When I look at this analysis, the saddest fact of all is to think that all of that will be put at risk and thousands of people could lose their jobs.

Michael Moore: Symbolising all of that integration and those close ties was the meeting we had last night in Dover House, the home of the Scotland Office in London where Scottish Financial Enterprise hosted an event. Many Scots were there, as well as people from the City of London. TheCityUK was well represented and the Lord Mayor had representatives there. These are groups of people who work with each other all the time. Many of the people, like us as MPs, who come from Scotland but come to London to work, spend a lot of time in London every week of the year. It is highly integrated and involved. That is something I don’t think we would want to lose.

Q3448 Chair: The final section we want to look at is the currency options for a separate Scotland. If an independent Scotland was using its own currency, what implications do you think that would have for the financial services sector?

Michael Moore: Huge. It is hard to overstate the significance of the currency to the sector in terms of the customers who are buying the products elsewhere in the UK, the extra risks that are attached to a separate currency and the volatility-or variability, to use a more neutral word-and the costs that that brings in, and hedging, in other respects. It would have a major effect on the attractiveness of Scottish-based financial products directly and indirectly. That is acknowledged by the other side of the argument, which explains in large part the desperation to suggest that nothing would change because a currency union would be maintained with the rest of the UK. But that is something that would have to be negotiated, and the terms and conditions of that and what impact that would have on financial services cannot be known at this stage.

Q3449 Chair: If Scotland joined the euro, what impact do you think that would have on financial services?

Sajid Javid: First of all, if Scotland became part of the EU, it would be obliged, unless it managed to negotiate an opt-out, as the UK has, to join the euro. If Scotland joined the euro, there are lots of issues associated with that, but, focusing on financial services, it may to some degree help with cross-border sales between Scotland and other euro countries, such as France or Germany. But, even then, if you observe the cross-border flow in financial products between eurozone countries currently, it is still very much based along national lines with national providers operating mostly in each country.

As far as its relationship would be concerned with the rest of the UK, there is no reason to think why, if Scotland had either the euro or any other currency that is not sterling, it would make any difference to the assessment that the Secretary of State gave.

Q3450 Chair: Another option is for Scotland to continue using the pound, even if there was no agreement with the UK Government about a currency union. If that option was adopted, what implications do you think it would have for financial services?

Sajid Javid: We have answered a bit of that before. If I can repeat the key point, if I have understood you correctly, the situation you have described is where they adopt sterling unilaterally.

Chair: It has been described as the Montenegro solution; they adopted the euro unilaterally.

Sajid Javid: One thing that one could immediately look at in such a situation is that there would be no lender of last resort. As we discussed before, the potential impacts on the credibility and confidence of the financial system could be very significant.

Q3451 Chair: I have a further question. What further work do you intend to do in this area?

Michael Moore: We are continuing to work our way through different aspects of the impact on the economy that independence would represent, as well as highlighting the strengths to the Scottish economy of being as integrated as it is with the rest of the UK. We will be publishing further papers very soon on the economy, but this is a theme we will return to throughout the period between now and the referendum in 15 months’ time. We will be revisiting some of the issues we have touched on here and examining them in more depth, but ensuring that we have a comprehensive picture of the economic issues that are at the heart of this choice.

Q3452 Chair: The final question, which I am sure the Secretary of State will be familiar with, is this. Are there any answers that you have prepared to questions we have not asked you and that you would like to give us now?

Michael Moore: You have done a comprehensive cross-examination, Mr Reid. We have been able to make all the points we were keen to make here.

I will briefly summarise for you. It seems to us that Scotland gets the best of both worlds. We get the great advantages of having a Scottish financial services base that can sell to the whole of the United Kingdom and where Scottish consumers can buy from the rest of the United Kingdom, but we also get the protection on a huge scale, which we have seen demonstrated in recent years. When things go wrong, we have the support not just of ourselves in Scotland but the whole of the country. We should not dismiss those lightly when weighing up the great strengths that we have as part of the UK. These are issues that we will return to and points that we will continue to emphasise.

Chair: Thank you all very much for coming, for your full answers and for giving your time. I am sure that Mr Doyle and Mr Drought, although they may have been silent this afternoon, had a large input.

Michael Moore: They have earned their keep, I can assure you.

Chair: Thank you very much.

Prepared 27th June 2013