CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-xiv

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

BANKING STANDARDS

WEDNESDAY 21 NOVEMBER 2012

RT HON GEORGE OSBORNE MP, RT HON GREG CLARK MP, SOPHIE DEAN and JOHN KINGMAN

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

on Wednesday 21 November 2012

Members present:

Mr Andrew Tyrie (Chair)

The Lord Bishop of Durham

Mark Garnier

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

Examination of Witnesses

Witnesses: Rt Hon George Osborne MP, Chancellor of the Exchequer, Rt Hon Greg Clark MP, Financial Secretary to the Treasury, John Kingman, Second Permanent Secretary, HM Treasury, Sophie Dean, Deputy Director Banking Reform Bill Team, HM Treasury, gave evidence.

Q1024 Chair: Thank you vey much for coming to see us this morning, Chancellor. There is quite a lot to get through. Can I begin by asking you whether you think the structural reforms-indeed, any structural reforms-of banks can make a contribution to improving standards in banking?

Mr Osborne: Thank you for inviting me. I will answer your question, but can I just introduce my team? We have the Financial Secretary to the Treasury, Greg Clark; John Kingman, who has just returned to the Treasury and is the Permanent Secretary who takes responsibility for financial issues; and Sophie Dean, who is the deputy director in charge of the Vickers Bill-the banking Bill-that we are introducing next year.

The short answer to your question is that I think structural change can help prevent abuses of standards and can help change a culture in the banking industry, which contributed to a banking crisis in 2007-08.

Q1025 Chair: Are the Vickers proposals on structure the best ones for improving standards and culture?

Mr Osborne: I think they are, for this reason: when I came into this job two and a half years ago, there was a dispute in our country about how best to respond to what had gone wrong in the banking industry and, obviously, the huge impact on the British economy. There was agreement that we needed higher capital liquidity requirements internationally, and that was proceeding at an international level through the Basel committee; and there was large, though not universal, agreement that we needed to change the system of supervision, and that legislation is before Parliament today. Where there was no agreement was on the structure of the banking industry. I well remember, in my previous job as the Opposition spokesman, going to a Mansion House dinner and hearing the Chancellor of the Exchequer say one thing and the Governor of the Bank say something else, at the same time that the then Prime Minster was saying a third thing and the chairman of the regulator was saying a fourth thing. So creating the Vickers Commission, and trying to bring together all the disparate voices into one place where we could try to form a consensus and get to the best possible solution, was the approach I undertook.

The answer that John Vickers and his commissioners came up with, and the Government’s response to that, is the best approach to the issues that arise from the structure of the banking industry. I do not think it is the only thing that we have to do to improve the standards and culture of the banking industry, which is why I asked Parliament to establish this Commission.

Q1026 Chair: Since Vickers reported, we have had a string of further scams-I won’t list them all, but there were quite a few-suggesting that problems of standards and culture in banking are much worse than we had all thought; indeed, that is why, along with your opposite numbers in other parties, you have created this Commission. The Vickers terms of reference did not even mention standards and culture. Is it just a happy coincidence that he has ended up at exactly the right structure for dealing with the cultural problems?

Mr Osborne: I think he is looking at two particular issues. One is, how do you make sure that banks are better able to withstand losses? That is not the principal part of this legislation, because that can be dealt with in other pieces of legislation and European legislation. He is also looking at how you make it easier to resolve a bank that fails. That was the central part of his remit.

If you look at the broader question of how you can address a culture in banking-and, by the way, there was a culture in retail banking as well as investment banking, because we had the problems with HBOS and Northern Rock, and we have the problems today with payment protection insurance and the like-and how you address all these problems, I would merely point out that this is one part of the answer, but I think it is the right structural change. It is not the only thing that needs to change, and I hope this Commission would look at other issues, like the standards we expect of the profession-for example, in the medical profession or the teaching profession we expect certain standards and those standards are often administered by the profession, so how can we create something similar in the banking industry? I would not say that this is the whole answer at all to the standards and culture question, but I think it is the structural component of the answer.

Q1027 Chair: But how was it that Vickers managed to arrive at what you are now describing as the right structural answer when you didn’t even ask him the question?

Mr Osborne: Because I think he was addressing the broader question of how we prevent what had gone wrong from happening again. It was clear in his terms of reference that he was addressing the need to create a more stable banking industry, one that supported the British economy rather than endangering it. I think everyone accepts, and accepted when Vickers was set up, that one of the issues around stability was the culture of the industry. I think what has happened, particularly with the LIBOR scandal, which of course led to Parliament creating this Commission, was a deeper concern about standards across the profession of banking. As you say, there have been other scandals, so it is quite right to look at what more we can do. The one thing I would say to the Commission is that I would be very wary of unpicking a consensus that has been arrived at.

We have spent two years getting to this point. We set up the Vickers Commission, they took evidence from 150 people, there were 1,500 pages of written evidence, we have had a Green Paper and a White Paper, we have had parliamentary debates in both Houses, and we are now on the verge of introducing groundbreaking legislation-in which, by the way, the rest of the world is increasingly interested. I don’t think this is the point to say, "You know what, let’s go back to square one."

Of course, you will be free to do whatever you choose to do as a Commission, but I would just say from my point of view, we have reached this point, we have got agreement, we are fundamentally going to change the structure of British banking. We have got that consensus. Let’s get on and implement it and legislate for it, instead of getting to the top of the snakes and ladders board and then going all the way down the big snake that takes you to the bottom again.

Q1028 Chair: There seem to be two happy coincidences now. One is that Vickers got to the right answer without having been asked the question. The second is that, after he had produced his report, somewhat altered by Government amendments, it has arrived at a consensus that is also exactly the right solution for dealing with the problem of standards and culture in banking. Say one more word on that if you want.

Mr Osborne: I don’t claim, and I haven’t claimed this morning, that this is the whole solution to the standards or culture issue.

Q1029 Chair: But you have said it is the right structural answer for dealing with standards and culture in banking.

Mr Osborne: Well, I have been following your debates and I have listened to-

Q1030 Chair: That is exactly what you just said on the record only a moment ago.

Mr Osborne: I have been following your debates and you have had some incredibly impressive and intelligent people before you, such as Paul Volcker and John Vickers. You are correctly asking them about the overall approach to the structure of the banking industry, whether you should separate the banks, whether you should have the Volcker rule and so on. All I would say to you is that we have reached a consensus in this country through the Vickers process. We have the rest of the European Union interested in doing something similar through the Liikanen report. You have the OECD saying, "Isn’t it interesting, this ring-fencing idea? Perhaps the rest of the world should follow it."

I would say that I don’t think personally that this is the right moment to tear up all the work that has been done over the past two years. We have lots more to do on improving the standards and culture of the banking industry-a huge amount more to do to improve it. There is plenty of space that has not been trodden over by others, but I would just caution Parliament about starting all over again, because that would inevitably delay things. We have got to a good place where, broadly, we have a consensus in our country.

Q1031 Chair: Well, we’re going to come on to questions of timing and delay, and also whether it is possible to be clear whether we are in the right place. You will have heard Sir John Vickers’s evidence. When we asked him whether the Bill goes far enough, he said, "It is impossible to answer whether it goes far enough without seeing the secondary legislation." How do you think we are going to be capable of scrutinising the Bill, which is completely devoid of the detail necessary to find out how it operates?

Mr Osborne: First of all, John Vickers didn’t just say what you said. He also went on to say, "The Government’s legislative intentions… are a full implementation of what we proposed" and that we have been "absolutely faithful" to the "broad thrust" to the recommendations of the Vickers report. Obviously, in some senses he is a guardian of his own report and its implementation. Indeed, perhaps you will ask me later about areas where we have clearly departed from the Vickers report at the margins.

When it comes to the balance between primary and secondary legislation, that is genuinely a difficult challenge for Parliament and for the Government. We have to have a Bill that stands the test of time, a Bill that still stands in five, 10, 15 years’ time, after there has been plenty of financial innovation, much of it possibly around trying to game the new regulations. We have to make sure that our legislation is up to scratch and can respond to that and is not set in stone that is then unalterable.

What I am providing to you in draft-and obviously will provide, hopefully, at the beginning of next year, in full, in a First Reading to Parliament-is, in effect, an enabling Bill. I think it is a significant enabling Bill that makes significant changes, that imposes duties on regulators to provide for the continuity of core services, that provides for ring-fencing and has some other things that we can talk about later. But, of course, the secondary legislation is incredibly important. I would expect that to be properly scrutinised by Parliament. I am happy to make sure that the industry also gets a chance and other stakeholders get a chance to scrutinise it in good time. But people should be in absolutely no doubt that the secondary legislation will faithfully reflect our conclusions, our White Papers, our response to the Vickers Committee and it will faithfully implement the Vickers report, except, as I say, in those five areas at the margin where we have come to a slightly different conclusion from Vickers. But the main thrust of the Vickers report will be faithfully implemented in secondary legislation.

If we tried to put that all into a piece of primary legislation we would have hundreds and hundreds of clauses and either this Government or some future Government would be faced with a very difficult problem. As financial innovation went on and the industry adapted to the regulation, and perhaps things started to happen that we did not want to happen or had not anticipated, then some future Government would have to bring back primary legislation with all the length of time that takes and the competition for space in the parliamentary timetable. It is much better to have an enabling Bill and to be very clear about what we are seeking to achieve, and for you to test whether this enabling Bill is fit for purpose.

Q1032 Lord Turnbull: Chancellor, are you erecting a straw man here? We are not asking you to put all this secondary legislation into the primary legislation, for the reasons you state. What we are saying is that it is very difficult to judge the merits of the primary legislation until we see more about the secondary legislation. You have asked us to conduct pre-legislative scrutiny and finish that by December, and only then does the secondary legislation start to appear. In judging whether the principles of Vickers and so on are being fully enacted, we would like to know a bit more about not the actual drafting of the primary legislation, but what is supposed to be happening. The way I would characterise it is you are not just asking us to buy a pig in a poke; you are asking us to buy the poke because there isn’t even a pig in it at the moment.

Mr Osborne: Well, I have described the animal in the various White Papers and the like.

Q1033 Lord Turnbull: But this problem was identified last month in an exchange of correspondence between you and the Chairman in which the Chairman said that we needed more information to make an informed judgment about whether this Bill is right and this correspondence ended by you saying, "I would be pleased to explain to you in more detail how I intend to use these powers when I meet you and your Commission in November", which is now. So we are all ears. Is there more you can tell us about how you are going to resolve some of these key issues that are still floating around unresolved?

Mr Osborne: I hope so. If you ask me about specific areas I will try to give you specific responses. I am in danger of repeating myself. I just wanted to make sure in that letter that a very interesting debate about whether to introduce some sort of Glass-Steagall in Britain, or some Volcker rule in Britain, which was not reopened by this Commission- The Commission is perfectly entitled to ask anyone about anything, but I would argue that my job as the Chancellor has been to present to Parliament a Bill that commands broad consensus among our financial regulating community, our Government and, more broadly, industry and society. This is not the moment-on the verge of introducing the Vickers proposals and the ring-fencing of banks-to say, "Actually, you know what? Why don’t we ditch all this and have Glass-Steagall?" or, "Why don’t ditch all this and have the Volcker rule?"

I have had several conversations with Paul Volcker, and he is a very compelling and interesting man, but we have had that debate. So the letter-I hope that you have not felt that I have been treading on your toes-was just simply to say that my responsibility in the Government has been to produce a consensus. I have a consensus. By all means question whether I am implementing it and whether this Bill is adequate for implementing it and ask me about specifics, but do not reopen the entire issue.

Q1034 Lord Turnbull: But even without reopening the entire issue, supposing we are accepting the principle that we do not have a Glass-Steagall and that, within a banking group, everything that is currently conducted by banks can find a place in a banking group, but it either has to find a place in the ring-fenced bank or the non-ring-fenced bank, there is such a huge amount of play in where that boundary is drawn. That is the bit we are missing your guidance on.

Mr Osborne: I don’t think that’s fair. If you read the original Vickers report and look at the White Paper, and indeed the explanatory notes and the introduction to the draft legislation, we are very clear. Certain things should definitely be in a ring-fenced bank, such as deposit taking. Certain things should definitely be in the non-ring-fenced bank, such as market making and investment banking. There are some issues that Vickers himself recommends be flexible for the industry themselves to work around, such as the provision of SME credit. Where he says, "Let the industry decide; just make sure that your ring fence is very high and non-permeable." You have rightly been asking other witnesses about how we can make it high and non-permeable.

However, we are fairly clear about what we are seeking to achieve. Indeed, written through this Bill, in primary legislation, is the very clear objective for our new regulators-the prudential regulator and the markets regulator-that they have to provide for the continuity of core services. Vickers correctly judged, in my view, that the most important thing is that deposit takers can get their money out. That is the crucial, core service.

Ultimately, what is this all about? It is so that the person doing my job-hopefully not on my watch-when faced at midnight with the decision, "Do you let this very large bank go bust?" has enough confidence to say, "I think we can let it go, because I think that the Vickers Bill-the banking Bill-has provided me with enough reassurance that we can continue to provide core services, so that people can go to cash points and get money out."

My predecessor, when faced with that decision, felt he was not confident that people would be able to get their money out of the cash point the next morning. If, at the end of all of this-the legislation and all the secondary legislation-the person doing my job is still not confident that people will get their cash out of the cash point even when they let the institution fail, we as a Parliament will have failed.

Q1035 Lord Turnbull: But what we have is absolute clarity that deposit taking and proprietary trading cannot cohabit in the same body. Everything else is to play for. Are you simply going to allow the industry to work it out, or do the Government have some views about where various functions-lending, underwriting, lending to large corporates, hedging and so on-will be? If we are trying to get this done by 15 May, why do you have to have the Bill fully through the process of pre-legislative scrutiny before unveiling some of the detailed principles that will fill out the grey area in the middle, which is very large?

Mr Osborne: Well, the first thing that I would say is that it is not just proprietary trading that has to be in the non-ring-fenced bank, so that is a big departure from the Volcker rule. One of the questions that I would have to Paul Volcker is, in the UK, where our banks do not tend to undertake very large proprietary trading operations compared with some of the US banks, would Volcker be, as I think John Vickers told your Committee, seriously inadequate? We are clear that investment-banking activities, market-making and all that needs to be in the non-ring-fenced bank. We are clear about what definitely is on one side, and what definitely is on the other.

You are quite right that there is then a question, particularly around the provision of credit, of where SME lending, corporate banking and the like sit. John Vickers had very experienced people like Martin Taylor, who ran Barclays, and Bill Winters, who was No. 2 at JP Morgan International, who really knew what they were talking about. Their view was that instead of trying to impose a very hard location for the ring fence, we should give some flexibility, understand the fact that among our major banks different business models have grown up for historic reasons, and allow the banks to define where they draw a ring fence within the constraints that I have explained, and then make sure the ring fence is high. I absolutely agree with you that the test of the Bill will be how secure the ring fence is, and how high it is.

Q1036 Lord Turnbull: Does the pre-legislative scrutiny of the Bill need to be completed before the next stage of unveiling the start of the secondary legislation process?

Mr Osborne: First of all, I can give an assurance to Parliament that the principal secondary legislation-the secondary legislation that people will be most interested in-will be available before the Committee stage of the Bill. We will find ways to involve the industry-

Q1037 Lord Turnbull: Not even before Second Reading of the Bill?

Mr Osborne: Well, as I say, what we have tried to do is to sequence this. We are moving at quite a pace to try to get this done. Quite frankly, almost all the pressure I am under at the moment is to get on with it rather than delay it.

The Second Reading debate is an opportunity to discuss the principles of the legislation, whether it is appropriate and whether it is the right answer to the right problem. Then I think you can have a very good Second Reading debate, on the basis of all this information and, indeed, on the basis of the legislation. The detail of how high the ring fence is, how impermeable it is, and all the other issues, which will be dealt with in secondary legislation, I think are appropriately ones for the Committee. If this Commission recommends further ways of scrutinising that secondary legislation, of course I will be very willing to listen to it.

I do not think you have to wait for every single piece of paper before you can have a discussion. As I say, our ambition and our intention is to implement the Vickers recommendations into law, except in the very clearly defined areas where we depart a little from them.

Q1038 Chair: We would like more than an assurance, and we would like more than a blank sheet. We do not need every last bit of detail, but we want more than we are getting now, Chancellor.

Mr Osborne: Well, as I say, if you have specific things you would like to know about, either ask me today, or write to me-

Q1039 Chair: We are going to ask you today, and we will write to you.

Q104

01041 Lord Turnbull: One point, which I hope you will address-you do not need to answer it now-is that there are a number of issues about some things that require affirmative resolution, some that require negative resolution, and some that do not seem to require either. Parliament will be concerned about the particular choices that have been made, and I suspect that you will be pressed, particularly in the House of Lords, but in the Commons as well, to generally push things further up that scale.

Mr Osborne: First of all, you have my assurance that I will listen seriously to your recommendation on that. Secondly, I want to get the balance right. Obviously, it must be something that Parliament is interested in discussing in detail, Greg Clark has the happy job of taking this through in detail after I have done my Second Reading speech, so perhaps I could ask him to say something about how he intends to approach the scrutiny and parliamentary approval of the secondary legislation.

Greg Clark: Sure. It seems that Mr Love and I will be spending a lot of time together over the next few months. It will fall to me to take the Bill through Parliament. I have taken legislation through Parliament before-I took the Localism Bill, which was 189 clauses, through in the last Session. Anyone who served on the Committee that scrutinised that Bill, or anyone involved with it, would have soon noticed that I take the view that if you are putting a Bill through the House and you have got people spending their time on it-as Mr Love and others will be scrutinising this legislation-you should be open to taking on board constructive suggestions, rather than simply repelling boarders, as it were. That has been my demeanour towards the House and its Committees in the past, and I fully expect to act the same on this occasion.

In terms of Lord Turnbull’s point about which resolution procedure should be adopted, we have made clear our intentions. I think the Delegated Powers and Regulatory Reform Committee has been advising you, and I hope that this Commission will offer its views and advice as whether what is proposed is right or should be amended. I will repeat the Chancellor’s assurance that if you have advice on that procedure before we introduce it, we will take it very seriously and have a proper dialogue about it.

Lord Turnbull: Okay.

Chair: You are both honourable men, and we are very grateful for your assurances, but we are hoping that we can rely on more than those before we are done with this process.

Q1042 Mr McFadden: Chancellor, this Commission is very much your creation. You spoke in Parliament arguing for it as the forum for examining the issues that have been raised by various banking scandals and so on and you then gave us the job of pre-legislative scrutiny of the Bill. I suggest that that does not sit easily with your starting point today, which is to come along and say, "Don’t be listening to Paul Volcker. Don’t be trying to change the basic architecture of this." This bird has flown-you set us up to do this, and that will be our job. I want to go on to ask you some questions of detail, but I suggest that if you are worried about the freedom and powers of the Commission maybe you should have thought of that before arguing for it to be established.

Mr Osborne: Well, first, I am obviously very supportive of the idea of this Commission because I proposed it to Parliament. I thought that what had been revealed by the LIBOR revelations at Barclays spoke to broader problems of standards and culture in banking, and I know that you are going to address those after you have looked at this particular component of financial regulation, which is the structural separation and ring-fencing of institutions. There is a huge amount of work which, frankly, has not been covered on the standards of the profession-I made a reference earlier to how the medical profession, for example, seeks to enforce standards among doctors. There is a huge amount of work that the Commission can do, and I will obviously pay serious attention to it.

Secondly, since we had this banking Bill going through Parliament, I thought that the prospect of creating, in effect, a fourth body of Members of Parliament to do pre-legislative scrutiny would be, frankly, ridiculous-we already have the people I am before today, the Treasury Committee in the House of Commons and the Economic Affairs Committee in the House of Lords. We should make use of the talents and expertise before us.

As I say, I am expressing my view, obviously. If the Commission wants to come to a different view, the Commission will come to a different view, but I want you to be aware of the consequences-I am perfectly within my rights to point out the consequences. You would be unpicking a consensus that has been established for two years, you would be unpicking the work that John Vickers and his commissioners did-that work has been accepted, as far as I am aware, by all the major political parties-and we are now on the verge of getting on with it. Now, if you come back and tell me, "You know what, this entire approach is wrong and we should have a completely different approach", of course you would be well within your rights, but I am just telling you that the consequences would be that either you carry the day, in which case we will have to start all over again with a new piece of legislation, or you will not carry the day.

All I am saying is that when I was reading the transcripts of your interviews with Paul Volcker and the like-as I say, I have met Paul Volcker and had these conversations-I was thinking that we have gone over this ground, John Vickers has gone over this ground and Parliament has gone over this ground. If you want to go over this ground again, by all means do, but I hope that, in the process, you do not miss the opportunity to scrutinise what we have got, what we are proposing and what John Vickers has come up with.

Q1043 Mr McFadden: As I say, you gave us the job of going over the ground, and I suspect that if you were sitting on this side of the table, you would not take too kindly to a Chancellor or Government Minister saying, "I want you to look at that, but I don’t want you to look at that", and so on.

Mr Osborne: I am sorry. If you have pre-legislative scrutiny and, say, someone introduces an education Bill, of course, it is perfectly within the rights of Committee that is pre-legislatively scrutinising education Bills to say, "We don’t need an education Bill-this is a total waste of time", or "We need a completely different education Bill". But, actually, there is a fairly useful opportunity to go through the Bill in front of you, what we intend to do with it, through the secondary legislation, and say, "I do not think you are doing this correctly", or "This Bill does not provide the vehicle that you need to achieve what you say you want to achieve". I think that you are trying to inject more conflict than there really is.

Q1044 Chair: Before you move on, Pat, into more detail, on this point, we are not making recommendations, or implying any recommendations in our questions. We are doing no more than asking the questions that anybody would reasonably expect us to ask in pursuit of the objectives that you set out in the White Paper that preceded the publication of this legislation. The legislation contains no objectives; it is silent on the list of objectives that are set out clearly-although in very general terms-in paragraph 1.3 of the White Paper. Quite reasonably, we have gone back to that and are asking the country’s-and some of the world’s-leading experts how they think we can best deliver those objectives.

Mr Osborne: As I said, there is a very clear objective in the Bill, which is that the regulators and the Government of the day can continue the provision of core services in the banking industry in the situation in which a bank is failing. I would say that that is an absolutely crucial objective that, by the way, my predecessor found himself unable to deliver because the legislation that Parliament passed before him was inadequate. If we crack that, I would say that we will have cracked one of the significant problems-not the only problem-that arose during the banking crisis.

Q1045 Chair: Nor, I am sure you will appreciate, will we find it very convincing to be told that we should be wary of unpicking a consensus. Just because something has achieved a consensus does not necessarily make it right, and it is our job to take a look at it. You would agree?

Mr Osborne: Well, it is certainly the case that just because everything has been said does not mean that everyone has said it.

Chair: Right, okay.

Q1046 Mr McFadden: Can I ask you some questions of detail, Chancellor? A couple of weeks ago we had Andy Haldane, the executive director for financial stability at the Bank of England, before us. He gave us some clear criteria on how the ring fence should work. He said that, to begin with there had to be entirely separate governance between the ring-fenced bank and the non-ring-fenced bank. Could you tell us where that is set out in the Bill?

Mr Osborne: First of all, as I say, the Bill is an enabling Bill but we are absolutely clear that the principles that Andrew Haldane espoused before this Committee will be reflected in the secondary legislation.

Q1047 Mr McFadden: So it is not in the Bill at this point?

Mr Osborne: Well, the Bill enables the regulator to establish a ring-fenced entity, to ensure its independence and to impose certain duties and directors and the like, but we are absolutely clear that it will have separate governance; an independent board; separate risk management; separate balance sheets; separate remuneration committees and-as John Vickers added to the Haldane list when he gave evidence-capital and liquidity requirements. We are absolutely clear that that is what we seek to achieve.

Q1048 Mr McFadden: But it is not in the Bill?

Mr Osborne: Well, we have gone over this. The Bill is an enabling Bill. I have to say that if I prescribed all these things in detail in primary legislation, I have no doubt that in 10 or 15 years’ time some clever legal firm will have found some way of potentially trying to get around it, which is obviously what we don’t want. I need to provide flexibility to be able to change the secondary legislation. It is still legislation passed through Parliament, but, again, if you tried to prescribe the Haldane principles in primary legislation, you would leave yourself vulnerable to people finding ways round them, despite the best efforts and intentions of everyone here.

Q1049 Mr McFadden: I want to move on to how they might be implemented, but I just want to get this clear for the record. You are saying that it is the Government’s policy intention to ensure the following, which comes from Andrew Haldane’s list, if you like: entirely separate governance; entirely separate risk management; entirely separate balance sheet management and treasury management; not having debt coming out of a holding company, because that would mix up the cost and blended mix of the two entities; completely separate remunerations structure; and completely separate human resourcing. Added to that list is John Vickers’s point about independence of capital and liquidity. Is it the Government’s policy to ensure all that after the Bill has gone through?

Mr Osborne: The short answer is yes, it is our intention to implement the Haldane principles, with the addition of what John Vickers talked to you about in terms of capital and liquidity.

Q1050 Mr McFadden: And how will you go about doing that? We have a problem that has been put to us by the regulator in its evidence, which is that it is not sure it has the mandate to ensure this degree of separation, because the Bill refers back to the objective of continuity of service. Not everything in Andy Haldane’s list could be justified by continuity of service, so what is your response to the regulator’s fear that it does not have the mandate to put this into practice, because it is not set out in the Bill and is not in the objectives on which the Bill is based?

Mr Osborne: I saw that the regulator said that this week, but I think that the regulator does have the powers to do that. As I say, the overriding objective is the continuity of core services, but we believe that that is entirely consistent with the Haldane principles. There may be moments when you would want the non-ring-fenced bank to provide support to the ring-fenced bank, in order for that to continue, but, again, we do not think that that is inconsistent with the Haldane principles-if I can call them that, because actually they are also the principles espoused in the Vickers report.

Q1051 Mr McFadden: The regulator has said, "should the PRA"-which is the key body here-"choose to make ring-fencing rules that are not mandated in the draft Bill, it could potentially be seen to be acting beyond its remit." What is your response to that?

Mr Osborne: Sorry.

Mr McFadden: The regulator said in its evidence to us-this is from the FSA’s written evidence-"should the PRA"-the successor body-"choose to make ring-fencing rules that are not mandated in the draft Bill"-and we have just agreed that none of these are in the draft Bill-"it could potentially be seen to be acting beyond its remit." So isn’t there a problem here, in that you are leaving all this to a regulator which does not have confidence that it has the powers to do what you have just said is the policy intention, because it is not set out in the Bill?

Mr Osborne: The intention of the regulatory reforms-the abolition of the FSA and the creation of the PRA-is to give them a very wide degree of discretion and judgment. In fact, one of the things that I am seeking to do is move away from thinking that you can prescribe all these things in pages and pages of rules.

Q1052 Mr McFadden: But they believe they don’t have the powers.

Mr Osborne: Well, look, I am happy to consider the case they make. I do not think that that is the case, personally. I know that there have been one or two moments when the regulator has said, "We should have these powers, rather than be granted them by Parliament"-for example, some of the definitions of primary loss-absorbing capacity and the like. All I would say there is that these are pretty fundamental decisions about economic management, and I think they are ones that Parliament rightly will take. The regulator will act within those constraints. They have expressed a different view, but I think it is right that Parliament takes those decisions.

I read what Mr Haldane said to this Commission, and I said that that is precisely what this legislation is going to achieve. Indeed, it is clear in the Bill-in clause 4, which is the key ring-fencing clause-that any ring-fenced body that is a member of a group is able to act independently of other members of the group in carrying on the business of the ring-fenced body. So there is written into the primary legislation the objective here. Obviously, the detail will follow in the secondary legislation.

Q1053 Mr McFadden: There is a lot more detail in Andy Haldane’s list than simply referring to the independence in that clause. Can I leave you with this thought? This is not just an esoteric parliamentary argument about what is in secondary legislation and what is in primary legislation. There is a policy problem here. The policy problem is the banks’ ability-and record-to lobby and to get round things. Andrew Bailey spoke about this very eloquently when he came before us the other day. He talked about banks trying to tunnel under the ring fence. The way that you have set this up is to leave an awful lot of it, as you say, to the discretion of a regulator.

The regulator has told us that they are not confident that they have the powers to achieve the policy aims that you have set out. This leaves a situation down the road where we are asked to approve an enabling Bill in Parliament, where much of the capacity to implement it is given to a regulator, and the banks, with their huge resources and their record of picking away at these things, can start to burrow under, as the regulator fears, this ring fence. The policy problem here is that you are leaving the regulator at the mercy of the banks, and that gives us a problem. If you want cross-party consensus for all this, you have to think about Parliament being asked to give you a blank cheque for the regulator to be left at the mercy of the banks.

Mr Osborne: Well, I would say a couple of things. First, we are creating an incredibly powerful regulator and putting the Bank of England in charge of regulation. Actually, there was not cross-party consensus in the creation of the FSA.

Mr McFadden: No, I am talking about-

Mr Osborne: There was not cross-party consensus. My party had serious doubts about that arrangement. There is now a cross-party consensus on putting the Bank of England in charge and avoiding what the Treasury Committee-when Lord McFall was Chair-pointed out went wrong with Northern Rock. The Bank of England is a powerful institution with a long history and people who are confident in exercising their judgment. They will be able to withstand lobbying from the banks. That is the first point I would make. Your question implies a lack of confidence in the ability of the Bank of England. I think the Bank of England can resist that.

Secondly, there is going to be secondary legislation. The clue is in the word "legislation". It will come through Parliament. I would hope to have cross-party support for all that legislation. The legislation will help us construct the ring fence and make sure that it is robust. Thirdly, I would agree with your presumption that the industry, by its very nature, because it is a free market and there are lots of actors in it, not all of whom adhere to the highest standards, will seek ways to get round the rules. That has always been the case; probably it will always be the case. For that reason, I come to a different conclusion.

I would warn against creating a kind of Maginot line in primary legislation that is absolutely right for 2012-absolutely impenetrable to all the weapons that the banks have and that the industry has in 2012-and then find out in 2022, let us say, that the banks and the industry have completely bypassed it. As a Parliament, I would say we have got to give ourselves the flexibility to give the regulator the weapons it needs. Of course this requires confidence in the regulator-absolutely-but I would say we can have more confidence, frankly, in an empowered Bank of England than we can have in a tripartite arrangement.

I think that going with the grain of the culture, self-confidence and institutional excellence of the Bank of England gives us the best assurance we can have that we have a regulator that has the power to keep the banks in check.

Q1054 Mr McFadden: But, Chancellor, you are making a different point. You are saying that it is better to have this in the Bank of England than in the structure that we have had. That is a different question from the one I am asking. I am raising evidence that has been put to us by the people who will be doing this job. They are saying, "We are not sure that we have got the powers to have a clear ring fence, because the Bill does not give us them." That is a different point from the one that you have just made.

Mr Osborne: I can assure them that they will have the powers to enforce the ring fence, to ensure that it is impermeable and to do all the things that they need to do. What I am saying is relevant. You express concern-it is a perfectly reasonable concern-that our regulatory system and, frankly, our Government and our Parliament, can be vulnerable to lobbying by the industry. By the way, sometimes they lobby with good reason. It is an important industry that employs an awful lot of people and you cannot just ignore their requests, but you also need to have the self-confidence as a state to turn down those requests. The way we have changed the regulatory system gives us a regulator that will have that self-confidence.

Q1055 Chair: Chancellor, in talking about a Maginot line in primary legislation, you are again raising what Andrew Turnbull described a moment ago as a straw-man argument. We do not want you to tell us exactly how you are going to put all your second legislation out as it would be if it was translated into primary legislation; we want to see the colour of the secondary legislation so that we can judge the effectiveness of the primary legislation on which it depends. We are not getting that detail. Pat McFadden has just referred to one particular area where the regulator is saying that he, too, feels that he needs reinforcements-and he would like those now.

Mr Osborne: As I say, I think I can reassure the regulator and the Commission. If you want me to specifically address that point even further, I will do so in writing.

A couple of things that have been said to your Commission are worth bearing in mind. Martin Taylor sat on the Banking Commission, but also ran Barclays bank, and he said, "What we want the regulators to have in mind are principles of operation for the ring fence, which I hope the legislation will enshrine so that they can respond to changing practices in financial services." You also had very good evidence, which I read, from Davis Polk and Wardwell, which is a US law firm experienced in implementing Dodd-Frank. They said: "Any ring-fence model should be implemented with regulatory flexibility…it is not possible to anticipate all potential interactions and outcomes. Thus, building in flexibility for regulators is a prudent approach". I completely agree. I want to ensure that regulators feel that they have that flexibility-

Mr McFadden: And power.

Mr Osborne: -and power to do what they need to do. There is a danger that we as parliamentarians and as the Government of the day think that we can anticipate all possible scenarios. Bitter experience tells us that we cannot.

Q1056 Chair: Well, you have promised us more of the detail in writing, and we feel that we are not getting very much of it at the moment, so we will continue to press.

Mr Osborne: Can I also stress my commitment that the important parts of the secondary legislation are all available as Parliament is scrutinising the Bill?

Chair: We need to look at that now in the context of the primary legislation. We have already been around this argument several times this morning, Chancellor, and it has not gone away.

Q1057 Mark Garnier: Chancellor, a bit earlier you were responding to concerns raised by the Chairman about the lack of clarity in terms of what is on the face of the Bill. You referred to the continuity of provision as being core to the whole Bill, yet the policy document talks about curbing incentives for excessive risk taking, improving the resolvability of banks that do get into trouble and minimising the risk to taxpayers. Why have those two objectives not made it from the policy document to the Bill?

Mr Osborne: As I say, the response to the banking crisis has involved a number of things. We have created new regulators and given them new duties and requirements. The Bill addresses a very particular problem: the structure of the banking industry.

Again, I come back to a very real-world example of recent years: my predecessor did not have sufficient confidence, when it came to the Royal Bank of Scotland, that he could carve out the bit that was crucial to people getting their money out of RBS cash machines, so he had to bail out the entire institution. I want to make sure that no one again faces the very difficult position that he was placed in. Therefore, because of the risk that if you have too many objectives there is a lack of clarity, the overriding objective of the Bill, and all that flows from it, should be that you can let a bank fail, but that the key services that are essential to the functioning of our economy and financial system-above all, the ability to get money out of the bank and out of the cash machine-can continue.

Q1058 Mark Garnier: I think we would all agree with that-that’s absolutely fine-but the problem is that the FSA is already worried, as was brought up by Mr McFadden, that the Bill does not provide clarity of its objective. It also raises the important point that having more clarity in the Bill should also help avoid the dilution of the reform objectives over time. You very rightly said earlier that the Bill must stand the test of time, but it appears to us that it stands a test of time, but not necessarily every test of time. The problem is that we have, as we discussed, an incredibly powerful banking lobby.

I made a note last night of the people who would be keen to influence the Treasury in terms of future secondary legislation: the PRA; the Bank of England and its Governor; possibly the FPC within that; the banking industry lobby, very ably helped by some of the finest legal brains on the planet; the Financial Policy Committee, if it wants to come in; the media responding, or otherwise, to events; consumer groups; Parliament, either through the Treasury Select Committee or otherwise; and the FCA. So there is a whole range of people who will have a vested interest and what concerns me is that the continuity of service, while in itself a very noble objective, actually provides an extraordinarily broad remit in the Bill. With just that objective, all these people could interpret various elements within it and yet have a very wide range of ability to change secondary legislation at some point in the future.

Mr Osborne: First of all, I do not think that adding a load of further objectives would clarify the situation; I think that it would add to the complexity of what we are asking to be done. Obviously we have created these regulators with clear objectives to promote the soundness and stability of the financial system. I do not know whether we are going to come on to talk about it, but in certain other respects we want the FCA to have regard for competition or have competition in its primary duties. So we have a number of objectives that the regulators are addressing. This Bill, or the bulk of the Bill, addresses a very particular issue, which is the structure of the banking industry and dealing, in effect, with the too-big-to-fail problem. I think it is important to have a very clear focus on the objective, rather than a load of objectives, and the objective is to allow core services to continue even when we allow a bank to fail. You would muddy the waters if we created more objectives in this legislation.

Government and Parliament will have other objectives for the regulation of financial services, and I hope, as I said to Mr Tyrie earlier, that this Commission looks at broader issues of standards, culture and the like, but with the Bill, let us keep it very clear what we are asking the regulators to do.

Q1059 Mark Garnier: Again, I do not disagree with that, but I am trying to put myself in a position where we have a similar hearing in 10 years’ time at which we could have a completely different set of Ministers and a completely different set of people in the Treasury-indeed, a completely different Treasury Committee and a completely different Parliament. In 10 years’ time, as Paul Volcker pointed out, we could have a very different banking environment. He said, "Anyone can put a lasso around the banks when they are on the brink of bankruptcy"-as they kind of are now-"it is when they are doing well that you cannot get them under control."

There is absolutely no doubt in my mind that the current thought that is going through all this-in Parliament, in the work that we are doing here and in what you are doing the Treasury-is very fresh in the mind, but in 10 years’ time, we could have a very different set of people and thought process going on. That is exactly how we could walk blindfolded-or open-eyed-back into the same problem that we have now. We are trying to make sure that the Bill addresses every test of time, and to achieve that, without necessarily going into too much detail, we could have far greater clarity of the objective of the Bill by having more detail.

Mr Osborne: Again, this is the debate. I basically agree with everything you are saying in your prognosis of the potential problem. Obviously, we are all very alive to what went wrong, because it happened four or five years ago, and we are still living with the consequences of it today, in a very real sense, and its impact on our economy. You are entirely right that, in 10, 15 or 20 years, we will have forgotten about it, potentially.

We have to make sure that we have put in place the tools that mean that, although it has dropped from the front of the minds of parliamentarians and the like, our regulators are still fully armed and equipped to do what they need to do. That is a risk with whatever approach you take. By the early 1990s, the institutions had found ways round Glass-Steagall, and that was one of the reasons why it was repealed by Bill Clinton’s Administration. There is no guarantee that, if you go for some other approach, that will not happen.

Equally, I would say to Paul Volcker is that his definition of proprietary trading might look really good in 2012, but it might not look so good in 2022. Whichever approach you take, you have to have flexibility to address changing practices in the industry. With the basic objective-you have to be able to allow a very large institution to fail-I cannot really foresee any circumstances in the future when that should not be a very prominent concern. All people doing my job and similar jobs elsewhere are going to sit in the shadow of Lehman Brothers for a long time, so they will have to have confidence that we have really cracked this problem.

Again, you have to imagine the situation in which someone doing my job is really ready to allow this bank to fail at midnight, and the market is open and what is going to happen. This Bill is about addressing that problem. It is not about addressing everything that went wrong in our financial services industry. It is not about addressing all the regulatory changes that are required. There is other legislation doing that, and we await further recommendations from this Commission. The basic problem of "too big to fail" will be with us for a long time unless we address it, and I think that the Bill addresses it.

Q1060 Mark Garnier: You referred in your answer to the risk of people lobbying and things changing. Of course, everything you try to do is to mitigate risk and to limit risk as best you possibly can. One of the risks that I see is that the flexibility is extraordinarily wide. Essentially, the ring fence can go anywhere from what John Kay was suggesting in terms of narrow banking all the way through to what Volcker was suggesting in terms of cutting off-not quite so aggressively-the prop trading side at the other end. That is an enormous amount of flexibility and can have any number of permutations within it.

Is not that allowing just a little too much risk into the Bill-that there could be so much flexibility in the future? I have not put too much thought into it, but if you look at the building society model in terms of the conduct of business, could it not be the case that that gives you quite a good framework, in the loosest sense, of what a ring-fenced bank could look like? Even defining a ring-fenced bank in loose terms would be better than leaving it simply from deposit taking at one end to prop trading at the other end.

Mr Osborne: First, I do not accept that the proposals could allow simply the Volcker rule. We are very clear that market making, investment banking and hedging is in the non-ring-fenced bank. That would not be the case with the Volcker rule. Again, the commission looked very carefully-so did the Government when they received its report-at whether to expand the requirements or the functions that you put in the ring-fenced bank. There has been a good debate about whether, for example, the provision of credit to small businesses should be prescribed in legislation as being in the ring-fenced bank.

Vital as the provision of credit to small businesses is in the wider economy, if you are faced with that situation at midnight and you are worried about people getting money out of a cash machine at 7 o’clock the next morning, you are not actually worried that the small business at 7 am cannot get the loan from that bank, because there are other places it can go to to get that money. There aren’t other cash machines that will pay out money at 7 am. So the provision of small business credit, which is incredibly important and a big issue for our economy, is not something that you have to ensure continues in this institution that you are trying to resolve. There are other sources of it. Again, John Vickers looked very carefully at whether to have this flexibility and where to put the ring fence. He thought that was appropriate.

It is also the case, as I mentioned, that we don’t have a huge number of large banks, sadly. I would like to see many more, and we could talk about that. If you draw the line in one place or another, however, you are taking quite an arbitrary decision about which particular bank, for historical reasons, falls on which side of the fence. John Vickers’s conclusion to that problem-having looked at it very carefully; it was one of the things his commission spent the most time looking at-was to provide some flexibility within the bounds, but I think that the bounds are pretty good. We know what we want to protect absolutely, which is vital for the functioning of the economy. We know what we absolutely don’t want to have to protect, and that goes much wider than Paul Volcker’s definition. But in the middle-in the grey area, as the Committee has put it, of small business lending and large corporate lending-we should allow institutions to make their own decisions, subject to the approval of regulators, of course. If we try to draw an exact line now, that would be a mistake.

Q1061 Mark Garnier: I agree with the "exact line". You make an interesting point about having many more banks. More could be done on competition, particularly with the PRA having a mandate on competition in terms of authorising banks. Obviously, the FSA is looking at its process of how it authorises new banks, but it is a very serious problem and we need to do something about it.

I do not think that anybody is necessarily specifically saying that we should have a hard and fast rule on day one that needs primary legislation to change it in the future. What people are worried about, as I have said before, is that at some point in the future, with a different set of people, the memory of this appalling financial crisis will have moved very much into the long distant past. I am not a historian myself, but I completely recognise that if you are a good historian, you don’t necessarily make the mistakes of your predecessors. You learn by other people’s mistakes and don’t make them again. The problem is that we see time and again that people do make mistakes that have been made before. We fear that this may be the case in the future.

My final point is on the negative resolution. We will have an incredibly strong lobby in the future and potentially we will have an absence of memory-who knows, we may even have a different Chancellor. We will have a lot of different people in the future, and the negative resolution strikes me, as a relatively inexperienced parliamentarian-I have been here for only two and a half years-as not a terribly robust way of addressing secondary legislation on something that is so important in this country. It is an industry, and the financial services and banking industry is vitally important to the economy of this country.

Mr Osborne: First, just on the competition question, I don’t know if this is the appropriate session to have that discussion, but I would be very happy to talk to you about encouraging more competition in the banking industry. We are legislating in the House of Lords to amend the Financial Services Bill so that the PRA will be required to have regard to competition. The amendment is going down this week, or has just gone down. We have listened to the debate, since that legislation is creating these new regulators with duties. We have implemented John Vickers’s recommendation on the Financial Conduct Authority and competition has been put into its list of duties, so we have listened to that.

Secondly, I don’t know whether we will talk about it more today, but one of the reasons for introducing a de minimis limit on the implementation of Vickers, which is one of the five areas where I have departed from the Vickers report-although not from his interim report-is primarily for competition reasons. These are quite onerous requirements. They are appropriately onerous for large institutions. If you impose them on the small institutions, you are not making them any safer, but you are potentially creating a barrier to entry, and that is why we have gone with the de minimis, and I think John Vickers is satisfied with that.

On the use of the negative and the affirmative mechanisms, I will, I think, ask Greg to say something, as he is the person who will actually take this through Parliament.

Greg Clark: I think it is essential to have proper parliamentary scrutiny of these matters. This is, as the Chancellor says, secondary legislation. There needs to be a consideration of whether something is so technical and immaterial to the consequences that it requires the use of parliamentary time, but those that do need it should have it. It is probably worth saying that we have made a commitment to make available the draft statutory instruments for consideration by the Bill Committee. That is even before those SIs then get debated, and it is probably a full year before the actual statutory instruments are put forward to Parliament for debate. There will be a lot of opportunity for Members of both Houses-every member of this Commission is such a Member-to look in a great deal of detail at the SIs over the course of a year. It is not that it needs to be over and done with in a few weeks.

On the point of the mechanism used, which obviously is a matter for the Bill itself, I am very open to a conversation and recommendations as to whether you think that we have the balance right in terms of what is the procedure envisaged.

Q1062 Mark Garnier: My final question: while I completely appreciate your statement on statutory instruments over the next year or so, do you have every confidence that the negative resolution method will still be the best method in 10 or 15 years’ time?

Greg Clark: On the negative resolution method, one of the discussions and debate that we need to have over the next few weeks is whether we have the methods right for each of the powers that are proposed. That is something that we need to take a view on. As I have said, we need to reflect and take advice from you and from the Delegated Powers and Regulatory Reform Committee on it. In terms of whether it is right to proceed by setting the principles and having a good debate about them to make sure-going back to what Mr McFadden said-that the powers are there in the Bill to provide for the flexibility and for the regulators now and in the future to operate robustly, that is the discussion for now. I fully expect to appear before members of this Committee in different capacities over the course of 18 months to look at the detail of the drafting of the SIs and to take the same demeanour on the drafting of them.

Q1063 Chair: We have no plans to be here in 18 months. We will be pressing in the next few weeks and months to make sure that the measures and intentions of this legislation at the start are not subsequently watered down through measures taken in the Commons with the negative resolution or even with an affirmative procedure that does not get enough scrutiny. It is a major issue. Although we have not yet discussed this as a group, I am pretty confident that we will want to make recommendations on that.

Q1064 Lord Lawson: Chancellor, before I ask my questions, may I correct you on a point of history?

Mr Osborne: That is normally a bad start.

Q1065 Lord Lawson: You stated that President Clinton had repealed in the 1990s Glass-Steagall because it had become ineffective. That is the precise reverse of the truth. He repealed Glass-Steagall in the 1990s because it was so effective that Wall Street bankers were lobbying him intensively to have it repealed because they were frustrated in what they wanted to do by the fact that it was still effective. Having got that out-

Mr Osborne: We need to summon President Clinton.

Q1066 Lord Lawson: No, you can take my word for it. I would like to clear the ground in one important way. It was an excellent initiative on your part to persuade Parliament to set up this Commission, but you suggested very early on that we should hesitate, which is an understatement, before unpicking a consensus. The consensus was that there needed to be a structural separation between retail commercial banking and investment banking. That was the consensus. I am delighted, but some of us had been calling for this structural separation well before Vickers reported and, indeed, well before you very correctly set up the Vickers commission. That is the consensus. The question is how you make that structural separation effective. Do you need to full complete structural separation a la Glass-Steagall, or will the ring fence do the job? We are concerned about seeing what will be effective in implementing the consensus. It is a very important consensus. We are not undermining it. We are not burrowing away at it. We are not unpicking it. How can we make this important consensus effective?

You say, "If you go further, there is no consensus." Well, I am not quite sure what you mean by that. The only sense I can make of that is that some bankers would not like it if we went further. There might not be a consensus among the banking community. There would be some bankers who would agree, but there would be other quite powerful bankers who would disagree. Of course, that sort of consensus is less important than what is in the public interest. That sort of consensus is less important than what is right for the economy. Indeed, it may be that the motives that some of the bankers have for not wishing to go further would give rise to considerable doubts as to what they have in mind.

If I may say, we are not about unpicking the consensus; we are about how to make effective this very important consensus of the need for separation, which is reinforced by the cultural problem that you quite rightly asked us to look at. The Bill is about that, and you say that it all has to be in secondary legislation, because the financial system very creatively will evolve over time and what is right in 2022 may be quite different from what is right in 2012. I agree with that. There are many things where you will need that flexibility. Secondary legislation of a particular type is the right way forward. However, that is not true of everything.

May I take one example that I attach great importance to-it was one of the examples that Pat McFadden mentioned-which is the treasury function? It is absolutely vitally important, if you are going to make any sense at all of the ring fence, that there is no group treasury function whatever and that there are two treasury functions-one in the ring-fenced bank and one in the non-ring-fenced bank, which are completely separate. There is no way in which the evolution of the financial system is going to make that irrelevant or outdated.

Can you reassure us-I hope you can-that the legislation will make it absolutely clear, with no possibility of amendment by secondary legislation, let alone by Treasury powers, that there will no group treasury function and that will be one treasury function for the ring-fenced bank and one for the non-ring-fenced bank. That should be absolutely on the face of the Bill.

Mr Osborne: May I address both points that you make? First, on the definition of the consensus, you have argued forcibly for many years that there should be a complete separation of the banks, and you have done so in many articles and speeches and the like. As it happens, Alistair Darling, who also did your job, actually does not think that we should necessarily be going for structural separation. He made that clear when he was Chancellor. There is therefore no general agreement that it is only the bankers who are resisting going further. There are many people. I only use Alistair Darling because he comes from the other end of the political spectrum from you. Of course, there are many people in the Conservative, Labour and Liberal Democrat parties who wonder whether this is necessary. I do not accept your characterisation that, basically, everyone wants to do one thing and it’s a bunch of bankers who don’t.

Lord Lawson of Blaby: That was not quite what I said.

Mr Osborne: I do agree we have a consensus that some form of separation is required. That consensus has been created through the Vickers process, but Vickers specifically looked at what form of separation and specifically addressed the question of complete separation. Indeed, it was part of his remit to look at that issue. He looked at it and rejected it. When asked by this Commission, he rejected it again and, indeed, other people who have come before your Commission have rejected it. So I would say to you that there is a consensus about structural reform and that you need to pull apart investment and retail banking in some way, but we also have in this country a consensus of how that is done. As I said, a consensus is not something that everyone agrees with, and no doubt you will go on arguing that you need to go further, but I think we do have that consensus. It is interesting that when Vickers first produced his report, the reaction across Europe and other parts of the world was, "Why is Britain doing this? It is irrelevant, unnecessary and so on."

What I have detected in the last year and a half is that the international consensus has shifted in our direction. I would think that John Vickers, his commission and Britain can take some credit and some thought leadership in this space. You see the Liikanen report-which is slightly different in its application, but very similar in its prescription, which is the ring-fencing of banks-coming up with a similar view. As I said, the OECD, the IMF and other organisations are all looking at something similar, so we have led international opinion in thinking that this is the best possible way to go.

On the treasury functions, we are absolutely clear that these need to be separate. They have separate balance sheets and, as I say, the principles that Andrew Haldane espoused and that you are talking about should be clearly applied through this legislation.

Lord Lawson of Blaby: On this question of full separation versus the ring fence, I explained why some of us feel that the ring fence is not enough, even though I commend you for your part in setting this up and leading the world as you pointed out-that’s great.

Mr Osborne: I said Sir John Vickers was leading the world.

Lord Lawson of Blaby: Right. Okay, there may be some disadvantages in complete separation, but there may be advantages. Many of our witnesses have pointed out the problems there are with the Vickers ring fence. What to your mind makes you feel that the advantages of full separation are outweighed by the disadvantages?

Mr Osborne: For me, there are three reasons. The first is not terribly fashionable and I don’t think has featured much in this Commission’s investigations, but there is a very considerable cost to the industry in what we are doing. We made it clear that there are going to be several billion pounds of set-up costs and several billion pounds of ongoing costs of implementing the ring-fencing. I have taken a judgment-Parliament will have to see whether it agrees with me or not-that this is a price worth paying and that it is outweighed by the broader economic benefits that greater stability will bring. However, there is a cost to the industry, and exactly the same Members of Parliament who get up and say, "You must screw the banks down" are the same people getting up and saying, "We’ve got to get the banks to lend and when are we going to do it?" I have to have a regard for the cost on the industry of the regulation that I propose to Parliament.

As the impact assessment makes clear, this legislation is a significant cost. I think that full separation would be an even greater cost and I’d have to justify it. I would be prepared to do so if I thought it was bringing benefits that outweighed that cost. That is the first thing. As a Parliament, we have to have regard to costs and obviously the bias of Parliament is always to regulate and pass laws than sometimes to think about the cost of all that. I think we have tried to highlight to the Commission and to Parliament the cost of what we are doing, but you would have to justify, as I say, imposing further costs.

You then come to the question of what additional benefits full separation would bring. Of course, that depends on whether you can make the ring fence high and impermeable. That is absolutely the intention of the legislation, and I believe that it can deliver that. I do not think, even in a separated world with different institutions and given the connections within the financial system, that you have completely assured yourself that a totally separate institution is not in some way connected with an investment bank that causes all sorts of problems. If anything, I think this approach is better, because you are really on the case of looking at the connections between the ring-fenced bank and others. As I say, with the Volcker rule, there are questions about some of the activities that would remain in the retail bank.

The other two points I would make have been made in this Commission-by people who, by the way, are very sympathetic to what you are trying to achieve, Lord Lawson. Martin Taylor is a thoughtful person who has actually run a bank and also given a considerable amount of time to thinking about how to run a bank and how banks should be regulated. He is clear that ring-fencing is a better approach than full separation, and he drew attention to the fact that, of course, lots of retail banks failed in this country-HBOS, Northern Rock-and in Ireland and elsewhere. This was far from being just an investment banking crisis, and having an investment banking arm that is able to step in and rescue a retail bank might be an extremely good thing for society and for the economy. We do not want it to happen that-the whole purpose of the legislation is that it is a one-way street, not a two-way street, but the ability for the group to rescue the retail ring fence is a very important additional benefit of ring-fencing.

I also thought that John Vickers and Martin Taylor made an interesting observation that we would risk having a series of highly correlated un-diverse retail banks in our society, and that that in itself could bring risks. Those are all good explanations that have been given. Ultimately, of course, it is a judgment. As I say, I collected together a bunch of people who knew what they were talking about and were highly intelligent. They have come to this conclusion. We agree with that conclusion, and we want to implement it.

Q1067 Lord Lawson of Blaby: As the Chair pointed out initially, Vickers and his committee came to the conclusion-incidentally, I do not think all the members of the Vickers committee are now of that view. It is notable that the Financial Times, for example, has come out for full structural separation, going beyond the ring fence. As the Chair pointed out, Vickers looked at this without really looking at the cultural dimension, because that was not within his terms of reference. He acted within his terms of reference very properly. We have different terms of reference, and we have to look at the cultural issues. There is a difference between the trading culture of investment banking and, basically, the relationship culture-I am simplifying it, but that is what it is-of retail banking. It is difficult to see how two totally different and diametrically opposed cultures can co-exist in a single corporation responsible to a single group of shareholders. The reason I make that point is that revisiting this-not to change the consensus, but to build on it-is necessary if we are given this cultural and behavioural standards remit that you have given us.

Mr Osborne: As I always have, I admire the way in which you have taken the remit and used it to say, "Well, perhaps we can take a completely different approach to all of this." What I would say to you, first of all, is that the culture has been a problem. There is a cultural problem in retail banking, as well as in investment banking. There are Members of the House of Commons here: we have constituents and we are deluged with people. Small businesses complain about some of the interest products they have been sold. Payment protection insurance was mis-sold. There have been a series of mis-selling scandals in retail banking and that is partly driven by an incentives system, which Martin Wheatley talked about recently in a speech. I think you paint too rosy a picture of the culture in retail banking in your characterisation of investment banking and retail banking culture. The cultural problems go wider than the structural issues.

One of the biggest cultural problems has been the feeling that, if you are running a very large bank, there is no way it will be allowed to fail. People will have had that feeling with good reason, because they would have looked at recent evidence. We have to try to change that. That is a significant change to the culture, and I think this Bill does that. There are other cultural problems across the industry: we need to look at incentive structures in retail banking, as well as in investment banking, and, as I say, we need to look at the way-without repeating myself-the industry regards the status of a banker and professional banking, and raise the professional status.

Chair: We have got that aboard. Thank you for that evidence, which you have already given us earlier this morning.

Q1068 Mr Love: Chancellor, can I come on to the location of the ring fence? It has been put to us by a variety of witnesses, including the FSA, that they believe that where you have a banking group, it should be required to locate its retail and SME lending within the ring fence. The argument that they give-contrary to one you were giving earlier on this morning-is that if this very important activity of SME and retail lending goes into the non-ring-fenced bank, should that get into trouble, the political pressures will be such that it will have to be rescued. How do you respond to that particular concern?

Mr Osborne: I just think it is on a slower fuse. I don’t deny that the provision of credit is an incredibly important function in our society; I just don’t think it is the immediate consideration you have. I am sorry to keep coming back to this midnight decision, but I think that provision of credit to small businesses is something that can be done by a number of institutions, and a small business can go to a number of different places.

Under our reforms, it is possible to have small business lending within the ring fence, and I suspect that, actually, quite a lot of institutions will want to do that, because they will want to match retail liabilities with retail deposits, but, on the advice of John Vickers, we have given them some flexibility. I think you have to be very clear about what is the absolutely essential thing that has to be operating the next morning. If there is a branch that is not able to give the small business that loan next morning, it is very unfortunate, but I am not sure that it is the absolute, essential, core service that you are seeking to protect that next day.

Q1069 Mr Love: But one of the primary features of the split is that the investment banking arm, if I can call it that-the non-ring-fenced part of the organisation-would be allowed to fail if we got into those circumstances. If banks choose, as you are suggesting, to put retail lending and SME and very small business lending, which are critically important functions for our economy, into that non-ring-fenced section, surely they will not be allowed to fail?

Mr Osborne: As I say, I think we would allow them to fail, frankly, because the most important thing-let us come back to RBS-is that the next day, if you have an RBS bank account, you can go and get your money out. If you cannot-and we saw a tremor of that with Northern Rock-then we are in an incredibly dangerous situation. Vital as it is that we have credit provision in our economy, I draw a distinction between that and being able to go into your branch the next day and secure that loan. We want people to be able to get loans across our economy, but it does not have to be from that RBS branch. I would draw that distinction.

I think, as I say, the test of this legislation-and hopefully it will never be put to the test, but I suspect that it might be-is whether a Chancellor doing my job in the future would feel confident to do what my predecessor felt he could not do. Anyone doing my job or anyone who is the US Treasury Secretary is going to be sitting there, for as long as this generation is alive, thinking, "Well, the last time they let a bank fail-Lehman Brothers-Armageddon unfolded, and the last time we felt confronted with the RBS choice, they felt they had to bail it out." We have to get to a place where people doing my job and other jobs like it are confident that they can allow a bank to fail.

Q1070 Mr Love: Let me make another argument that has been put to the Commission in relation to this. If you end up with a very narrow ring-fenced bank, it will inevitably be concentrated in lending for housing. It will be very correlated and it will not be diverse. These are the very circumstances that led to the high-risk failures in the past. Aren’t you concerned about that?

Mr George Osborne: I think that is precisely why you do not want it to be too correlated. I think if you prescribe where credit comes from, you are risking being too correlated. People, within reason, will want to raise wholesale funding and lend it to businesses. People want to collect deposits and lend to businesses. There are increasingly institutions-this is one of the challenges for regulators at the moment-that are not banks and are lending money. Credit provision happens in a number of different places. I agree that you do not want to have all your credit eggs in one basket, if that is not too inelegant a phrase.

Q1071 Mr Love: May I come on to-you mentioned it earlier-the de minimis exemption? Sir John Vickers, when he came, said that he accepted the rationale for having an exemption, but was concerned, when they looked at this again after your White Paper, that the exemption you were suggesting was too high. How would you respond to that concern?

Mr Osborne: I do not think that there is an exact science. I think that it is just a judgment, if you have a de minimis, of where you apply it. We have chosen £25 billion. That means that currently 90% of the banking industry will be in the ring fence. Liikanen went to a much higher league when he came up with €100 billion. As I say, it is not an exact science, but £25 billion is our estimate of where we think the right place to cut off is.

One of the things that I think is wrong with the banking industry at the moment is that it is extremely difficult for new entrants. The obstacles to creating and building a small bank are considerable. I am trying to do all sorts of things to increase competition in the banking industry. The FSA will be coming forward with further ideas, in the next couple of months, on how to make it easier for institutions to get banking licences and create a bank, and how we can make it easier for people to grow banks. We are looking at things such as the Payments Council and the potential for oligopolic-if that is the right word-practices to emerge in the Payments Council that basically stop new entrants.

We are doing all these things, but at the same time, I would hate to impose, though this legislation, an overly restrictive, too low de minimis that runs completely counter to that policy. That is our assumption. Of course, I am very happy to listen to your advice. As I say, it is just our best estimate of where we think that should be drawn.

Q1072 Mr Love: But don’t you accept that this is not just a technicality? Where you set it is very important. If you accept the importance of where you strike the de minimis, should it not be in primary legislation, rather than us doing as you have suggested?

Mr Osborne: The only thing is that you would presumably have to be able to uprate for prices. I am not sure you would want to put a number in primary legislation, because then it really would become out of date over time.

Q1073 Mr Love: One of the suggestions you are making is that it could either be a number or a proportion of GDP. It seems to me that setting it against a GDP total would give you the flexibility that you are looking for, and it could therefore be included in primary legislation.

Mr Osborne: As I say, I am very happy to think about that. We can certainly discuss and try to get to an agreement on how we do this. One of the areas where I have departed from the Vickers report is in suggesting this de minimis, and if there is agreement on that, we can then discuss what it should be and how it should be applied.

Q1074 Mr Love: One of the disagreements that Sir John highlighted when he came before us was this issue about whether or not the area outside the EEA should be included. You were suggesting a slight amendment, but it was significant enough for Sir John to be concerned about it. How do you justify that?

Mr Osborne: Again, I hope that I have been quite open in the five areas-we are covering a couple of them now-where I disagreed. I basically agree with John Vickers’ Commission on the substance here; again, it is the issue of implementation. I asked the question: do we really want a ring-fenced bank that is unable to lend to a small business that is trying to secure an export order and invest in another country, or do we want British banks to be unable to lend money to non-European investors into the UK, which would be the implication of the restriction he imposes on the EEA?

I think a better approach, because I do not think that you want to shut ring-fenced banking or retail banking out of supporting exporters from Britain and investors into Britain, is to look at the branches and subsidiaries and at where they are located. We are very clear that if they are outside the EEA, they should not be in the ring fence.

Q1075 Mr Love: Finally, let me come on to the issue of derivatives. This is an area that you asked us particularly to look at. Can you just summarise for us the reasons why you felt it was appropriate to refer this to the Commission?

Mr Osborne: I think it is genuinely a very difficult question. It is something that we need further advice on. The problem is that derivatives sound like a very complicated and scary thing to lay people. I mean "lay people" in the financial services sense, Bishop. You think that derivatives are very complicated and exotic instruments that should not be in a plain vanilla ring-fenced bank, but some derivatives-or many derivatives-are absolutely plain vanilla parts of operating a global economy.

If you are a farmer who wants to hedge your income or protect yourself against fluctuations in the euro-sterling exchange rate, you go to your local branch in rural North Yorkshire and buy yourself a derivative. You may not know that you are buying a derivative, but you are. Equally, a small exporter in the west midlands who wants to sell something to another country, and has budgeted for a certain amount that they are going to get and wants to hedge against the currency risk, will again buy a derivative. It may not look like a derivative to them, but that is what it is.

Derivatives cover a whole range of things, including very complex, exotic and obscure things and hard-to-price instruments. What I sought to do in the White Paper was say that perhaps we can allow simple derivatives in the ring-fenced bank. I am not sure that I want the ring-fenced bank to be only a salesman for derivatives. Again, that will have an implication that we will all have to be aware of: it will make it a more expensive product. That farmer in North Yorkshire is going to have to pay more, I suspect, for a derivative product if it is not originated by the retail bank or the ring-fenced bank.

Can we draw a distinction between simple derivative products and more complex derivative products? Can we trust that judgment to the regulators, or should we just say that all derivative products should not be in the ring-fenced bank? As I say, we should all be aware that there is a price to that. The products are probably more expensive. It is possible that a small business would not therefore be able to get that product through their retail bank; they would have to start to interact with an investment bank or some other business. That is a complicated issue.

I can well understand the other argument, which is that you are trying to make this all as simple as possible to resolve, so you do not want any derivative instruments in the ring fence. It is a genuinely complicated issue, and one that this Commission should, I hope, look at carefully. Bear in mind that not all derivatives are the most exotic things that the traders in the City of London and Wall Street are operating with.

Q1076 Mr Love: I think we are well aware of that. Both Sir John Vickers and Martin Taylor suggested that we should not go down that road. There are a variety of issues: it is very difficult to define simple derivatives; this is the thin end of the wedge; and it is much easier to have these things outside, rather than inside. What would you say to those arguments? I think you made the prudential case for having these things in.

Mr Osborne: That is the prudential case, but there is a cost to what we are doing. You and I, as Members of Parliament, have to go to our small businesses, farmers and whatever-I am not sure how many farmers you have in your constituency, so let’s stick with the small businesses-

Q1077 Mr Love: Would you be surprised to hear that there are not too many? But there are lots of small businesses.

Mr Osborne: Let’s go to the small businesses in our constituencies. We have to say, "Look, for reasons of financial stability-belt and braces-we have taken the decision that the end result of all this is that the instrument you buy from your bank to help you with your export order to the United States is actually more expensive for you, and that’s going to hit your bottom line." I am happy to say that, if we come to a view that that is the right thing to do; it is just worth exploring whether we can separate out the more exotic and complex derivatives from the very plain vanilla ones that are used by hundreds of millions of people across the world every day. We have come to one view; John Vickers came to another. It is one of those five areas where we disagreed, but on this, we are very open to suggestions that we have not got it right in the White Paper, and that is why, specifically, I have asked the Commission to look at that.

Q1078 Chair: You came out strongly in favour of more banking competition; in particular, you argued earlier that we need to find ways of getting new entrants into the banking sector. As you know, the Treasury Committee has been pressing vigorously for this for years. A major obstacle, of course, is that people cannot get banking licences, and that is why the Committee has supported giving the PRA a secondary objective, subject to that of financial stability, of promoting competition, so that it takes into account the effects of its decisions on competition. You have come forward with an amendment in the Lords that is well short of what we have asked for, and which is no more than a have-regard obligation. As we know, have-regard obligations mean the exact opposite of what they say: they mean that those involved will have no regard to competition. We know that from experience, because we have seen what happened to the have-regard provisions of the Financial Services and Markets Act and the way the FSA treated them. Will you look again at this issue? If you are serious about competition, it is vital that we get this right.

Mr Osborne: I think it is fair to put the other point of view. You can certainly ask-I think you have the Governor of the Bank coming tomorrow-

Q1079 Chair: I am asking you to take another look at it. I know what the Governor is going to say. We have already had a quick chat with him. What we would like to know is whether you are going to look at this again.

Mr Osborne: I have to say I think we have listened to the Lords debate, we have listened to the Select Committee-

Q1080 Chair: You have been listening too much to the Governor again, haven’t you? That seems to be the problem.

Mr Osborne: Well, I don’t agree. I am not sure the Governor would have necessarily put forward the amendment to have regard to competition. We have listened to the House of Lords and the Select Committee, and we think this strikes the right balance.

Q1081 Lord Turnbull: Can I follow up one point that arose out of your exchange with Mr Love? This is the bit where you are talking about whether SME lending should be in a ring-fenced bank. You argued that the impact on families of not getting money out of a cash machine was immediate, but that the impact on SMEs played out in a slower time. I have to say I think that is complete nonsense. If you are an SME and you have to pay the wages at the end of the week, and have a major supplier to pay and possibly even a tax bill, not being able to get access to your overdraft or an extension to it seems to me to be completely bizarre.

Mr Osborne: There is a misunderstanding. The overdraft, I agree, is essential. I was talking about the provision of additional credit. I agree with you that they must have access to the overdraft, which is part of-

Q1082 Lord Turnbull: That is part of SME lending, is it not?

Mr Osborne: That is part of the ring fence. Sorry, maybe I have not made it clear. Access to the overdraft is part of the ring fence. What I am talking about is credit initiation and future lending-

Q1083 Lord Turnbull: They may want an emergency extension, because the one feature of SMEs is that they do not have lots of alternative sources of funding. You claim that they could go elsewhere, but that is a feature of large corporates-they can always go to the commercial paper market and all sorts-and SMEs are very heavily dependent on bank credit.

Mr Osborne: But I think, Lord Turnbull, that you would not want to say that the only place that an SME could get credit was from a ring-fenced institution, because that would proscribe them from going to a wholesale funder who is able to provide credit.

Lord Turnbull: No.

Mr Osborne: I am not saying they cannot. First, I am saying that access to overdrafts is absolutely part of the ring fence-prescribed by the ring-fenced activities-and, secondly, I suspect that there will be many institutions at the end of this that will put their SME credit operations into the ring fence, but if you are saying that the only providers of SME credit must be those in the ring fence, you are blocking off a whole load of other providers of SME credit.

Q1084 Lord Turnbull: No. I am challenging the idea that somehow the impact on an SME of being denied credit plays out in slower time, because in my view it plays out just as immediately. If you went to an audience of SMEs and made that statement, I think you would be howled down.

Mr Osborne: When I say slower time, I mean weeks and months; I do not mean tomorrow morning. Again, when you are faced with that decision, you have got to make sure that the cash machines are operating, that small businesses can get access to their overdrafts and so on-that, I agree, is part of the essential core services of the banking system. Credit initiation is an incredibly important part of the banking and financial system, but as I say, it happens in many places. SME credit can be in the ring fence, and I suspect that many-perhaps all-of our banks will put it into the ring fence, but the flip side of what you are saying is that only ring-fenced entities can-

Q1085 Lord Turnbull: No, I am not saying that at all; I am simply challenging the statement you made that, somehow or other, first, SMEs have other sources of credit and, secondly, the impact on them is less immediate. I think that both of those are the opposite of the case.

Mr Osborne: As I said, I think there is a misunderstanding, which I am happy, if it is my responsibility, to correct. I completely agree with you that if access to overdrafts suddenly stopped at 7 o’clock the next morning, it would be extremely serious. That is why it is in the ring fence. I am talking about credit initiation, future loans and the like.

Q1086 The Lord Bishop of Durham: When you said "lay people", Chancellor, you did not say "male lay people"-the present situation I am facing.

I have a passing comment to make, although it is not part of the pre-legislative scrutiny. If you want a lot more banks-we listened to Andy Haldane and he said that any bank over £100 billion in total size has no additional economies of scale-then surely the easiest way to get us lots of small banks is to break up the big ones. We might come back to that on another occasion.

Mr Osborne: First of all, may I congratulate you on your appointment?

The Lord Bishop of Durham: I am not sure that you can.

Mr Osborne: I thought I had a difficult job, but over the past 48 hours I have seen that you have a much more difficult one, and I wish you very well, personally, with that.

The Lord Bishop of Durham: Thank you very much. I did not want to go into that; I am just signalling that I will come back to that issue at some point.

Mr Osborne: Very briefly, if we aggressively broke up all our big banks, I am not sure that society would benefit from it and, actually, there are still a lot of other big banks out there operating in other countries. What I have tried to do is balance it. It is important for the UK that our largest private sector industry, financial services, thrives, survives and grows. It employs very large numbers of people across the United Kingdom. I want Britain to be the home of big, successful banks. It would be a real shame to say to the likes of HSBC that they cannot locate themselves in the UK. I think that would be a mistake for us as a country. That is my personal view, and the view of the Government. We have to strike the right balance. We want to be a home to successful financial services, but we want those services to be safer.

Q1087 The Lord Bishop of Durham: Absolutely. We will come back to that. You obviously have an army of straw men available for deployment at any useful moment. You have just used three.

If I could put a question to Mr Clark, the Financial Secretary. I have a couple of questions on the secondary legislation. First, many of the witnesses have said that the ICB’s recommendations to increase loss absorbency will be the main things that will improve stability and resolvability. We know that you intend to align the use of these powers with the pending European legislation. How confident are you that the recovery and resolution directive will produce requirements in line with the ICB recommendations?

Greg Clark: It is an ongoing discussion as you are aware, Bishop. We have a clear view that we should be operating according to a similar playing field across Europe. We are in the middle of that, we are arguing very strongly for that case and we think we have good prospects of succeeding.

Q1088 The Lord Bishop of Durham: Are there any signs that there are going to be any significant divergences?

Greg Clark: At this stage it is too early to say that. Our case is clear that it should be conducted in that way.

Q1089 The Lord Bishop of Durham: Okay. So it is basically too soon to know?

Greg Clark: Yes.

Q1090 The Lord Bishop of Durham: Secondly, earlier in the week, Lord Turner was saying that when we come to ICB PLAC requirements and the exemption of overseas operations, the burden of proof should be on the bank to demonstrate that it merited having this exemption. Is that how the secondary legislation will be formulated?

Greg Clark: This is again something that the Commission will look at. Again, it is quite a difficult one. We obviously want to make sure that, where we are putting regulatory requirements on banks for their operations in this country, that pertains to their resolvability in this country. We need to be satisfied that there is no risk to the UK taxpayer from their overseas operations, so that is the judgment.

Q1091 Chair: I could not tell whether that was a yes or a no.

The Lord Bishop of Durham: Could you have another go?

Chair: We want to know whether the answer is yes or no.

The Lord Bishop of Durham: All I am asking is, do you agree with Lord Turner?

Greg Clark: At the moment, the judgment is proposed to be with the Treasury. We would make that assessment in consultation with the-

Q1092 The Lord Bishop of Durham: It is not the judgment, it is the burden of proof. Who has to prove that this is merited?

Greg Clark: At the moment, as Lord Turner said, it would be for the bank to prove it.

Q1093 The Lord Bishop of Durham: So that is the way you are going at present?

Greg Clark: Yes, but we will take advice from this Commission and others on that.

Q1094 The Lord Bishop of Durham: Okay. I come to the issue of leverage ratios, Chancellor. One of the things that is becoming clearer and clearer is that there are a large number of unforeseen consequences around how you define capital and how you ensure that gearing is at a reasonable level. If you have a straightforward leverage ratio, you are open to people just increasing the risk profile of their portfolio. If you have a complicated system of risk-weighted capital under Basel II, to some degree, and certainly Basel III, you end up with people gaming the system significantly. We have not really had a clear answer as to which way that goes. What we do see is that a leverage ratio is an important back stop. You seem to be going for a lower leverage ratio than the ICB’s recommended level.

Mr Osborne: That is true. I do not disagree with the ICB. Indeed, I strongly agree with them. We need a leverage back stop. The disagreement is about what the rate or the level should be. There should be a back stop for the very reasons you say, Bishop. We should acknowledge that there are differences in capital-frankly, UK gilts are slightly less risky than Spanish property loans-so there is merit in risk-weighting assets. But you are absolutely right, and I think the Commission is right-we agree with this-that there should be a back stop, and the leverage back stop is it.

Our concern with the 4% ratio was twofold. One was that, instead of being a back stop, it would become something of a front stop because there would be some institutions-arguably the least risky institutions-which would find themselves falling foul of this leverage ratio. So it would not be binding so much on the big universal banks that people are most concerned about; it would be binding more on some of the lower-risk operations and might have the perverse effect of forcing them to become riskier.

Secondly-and I know this is not the most fashionable thing to say in the UK Parliament-I think we have to have a regard to what is going on in the rest of the world. We have to try to keep our industry competitive with the rest of the world as well; we have to get that balance right. When the rest of the world is agreed-and we agreed through the Basel Committee to a 3% leverage ratio-I think we should try to do these sorts of things internationally. Since the UK is a big promoter in international circles of international standards implementing Basel and so on, it seems a bit odd if we then depart from that international consensus.

Q1095 The Lord Bishop of Durham: When you have been looking at these levels and at how this is going to be implemented, one of the questions is obviously about the effect on credit availability. One of the areas that was creating problems-as you are very well aware-was increasing lending, particularly in the SME sector, but more widely, across the country. Are you saying that you think a 3% ratio is more likely to make it easier for the banks to lend or are we going to end up with lower lending continuing?

Mr Osborne: There are lots of reasons why lending is impaired and, of course, one of those reasons is the regulatory burdens we have imposed as an international community and as a domestic Government. I would say that that is because we do not want to get back to the levels of lending in 2007-that was a bubble; froth that was unsustainable. You have to restrict that, and that is why higher capital liquidity and leverage requirements do have an impact on credit availability. It is then a question of judgment and balance about where you put that.

Our assessment and application of a 4% leverage ratio to some institutions would suggest to us-I do not want to get specific about these institutions, but they are not the ones that people have been most concerned about over the last three or four years-that they would find that they would fall foul of it and it would become a front stop, not a back stop. So if there is an argument for increasing the leverage requirement, let us try to get that done internationally-but absolutely impose the 3% back stop.

Q1096 The Lord Bishop of Durham: Finally, a very straightforward question: new section 142J of the draft Bill gives the Treasury powers to direct how the regulator sets PLAC requirements.

Mr Osborne: Yes.

Q1097 The Lord Bishop of Durham: Why are there no principles in the draft Bill to guide how this power is used? Does this not undermine regulatory independence pretty significantly?

Mr Osborne: This is a significant economic decision; it is right that Parliament is involved in that decision. It will be set out in the legislation-without re-entering the debate about secondary legislation-but I think we are entitled as a Parliament to say, first of all, that PLAC will be applied to certain institutions and, secondly, how we define that PLAC. I am clear it has to be equity or tier 1, tier 2 or unsecured longer-term debt. We have set out in the White Paper what we think those requirements are. But again, it comes down to a broader question: do you give complete freedom to the regulators to make decisions that have a very real economic impact on our constituents, or do you ask Parliament to be involved and consulted on that decision? Here we have tried to get the balance right, where Parliament will prescribe certain minimum requirements and hard definitions, and then it will be up to the regulator to go ahead and impose them.

Q1098 Chair: The question is whether they should be involved or consulted-no one is disputing that-or whether the Treasury, in practice, should decide this and issue instructions to the regulator, particularly, in view of the advice we had only on Monday, that the regulators find it difficult enough fending off lobbying; it would be even more difficult for politicians.

Mr Osborne: It is a balance. Obviously, most regulators, not just in financial services, probably come before these parliamentary Committees and ask for more and more powers. That is what one would expect them to do. We have a question: are there any constraints on those powers? Here the constraints are actually to ensure that this PLAC is really applied and that there really is a loss-absorbing capacity imposed on certain institutions, that there are certain non-negotiable components of that or definitions of that. It is a classic choice in a democratic country of how much power you give to independent institutions and how much you reserve for the elected and non-elected elements of Parliament.

Chair: And we will be looking carefully at that question in the Commission.

Q1099 Baroness Kramer: Chancellor, I just wanted to pick up on a question that the Lord Bishop addressed to Mr Clark because we would be interested in your views on it. It is on the issue of loss absorbency and whether the default should be that it applies on the group basis with the ability to exempt non-EEA subsidiaries, but only once the group has demonstrated that it is safe to do so. The answer that we got from Mr Clark was rather ambiguous. It is another area where the regulator in the conversations we had the other day emphasised that in a sense the regulator needs to have parliamentary backing behind him in order to be able to stand up to the pressures that come from the banking institutions. Will this start from a presumption of guilt that the group should be the basis for loss-absorbency capacity or from the presumption of innocence where the regulator has to try to prove the case? I think it matters.

Mr Osborne: We are clear that the firm will have to assure us that the costs of the non-EEA bits of it, were they to fail, would not fall on to the UK taxpayer. That should be clear in the plans that they set out. However, once they have assured us, what I don’t want to have is, hanging over some extremely large and important institutions in our country, a constant threat that that judgment might change, that the regulator might suddenly change its judgment, and that has an almost overnight impact on the business. I think once the firm has assured the regulator, it is then the obligation on the regulator, should it change its mind, to demonstrate that it is right in changing its mind. It is perfectly right that the Treasury is involved in that. We have to have a regard for an industry that employs many hundreds of thousands of people in this country.

Q1100 Baroness Kramer: I would absolutely agree with you that clarity and uncertainty are very dangerous in an area like this. Is that not an argument for making sure that this is clearly delineated on the face of the Bill?

Mr Osborne: Yet again, we get back into this debate. I hope our intentions are very clear. They are clearly spelt out. This is an area where, as everyone has picked up, we are departing at the margins from what John Vickers recommended on PLAC. Let us imagine you have a large bank in the UK that has a very large operation in Hong Kong, say. If you say that that bank has to provide loss-absorbing capacity against the failure of the Hong Kong operation then, by the way, the implication is that if the Hong Kong operation fails, we are going to be on the hook for it. I want it to be very clear we are not on the hook for the failure of the Hong Kong operation. So we have to be clear about that. As I say, I think that is a reasonable judgment. It is ultimately an economic judgment for the Government, as well as for the regulator. I think the onus should be on the regulator. Once the firm has assured us that we would not be on the hook for some overseas operation then it is up to the regulator to prove why it is changing its mind.

Q1101 Baroness Kramer: I think we are going to end up disagreeing on this area, so let me move on to another topic, as I think others will perhaps pick this up later. On resolution-the last bulwark for the taxpayer when it is all going wrong-could I ask you about the bail-in? In testimony that we have heard from a whole swathe of different witnesses across financial services, including the regulators, there is a huge reliance on the concept of bail-in as one of the key answers. As you know, this would effectively mean that the unsecured creditors could be converted effectively to equity to recapitalise the institution as a sort of last protection for the taxpayer, but it is untested. What is your view of relying on a concept, for which we have no track record in history, in such a significant way?

Mr Osborne: I think you raise a very pertinent question. Again, it comes to my-hopefully, hypothetical-situation where a Chancellor of the Exchequer, or whoever is in a similar position, is faced with a question of whether they can bail-in creditors and take the risk that that does not provoke a contagion effect in the economy, or whether they decide instead that it is better for taxpayers to shoulder the loss in an institution.

When the crunch came in 2008, by and large-through not without exception-Finance Ministers and Governments took the view that they could not risk bailing-in creditors. What we are all trying to do, internationally-this is one of those areas where things are being done internationally-is to get to a position where Finance Ministers and Governments feel more confident that they can bail-in creditors. I am absolutely clear that that is where we want to be, and that creditors and bondholders should be bearing the risk if they have unsecured debt. But I completely understand why my predecessor felt that that was a risk that he was not prepared to take.

You pose a good question, which will be put to the test somewhere in the world, at some point in X number of years’ time: do you take the risk? There are examples of creditors being bailed-in, actually, over recent years where it has worked, but there are also examples where, spectacularly, it did not work.

Q1102 Baroness Kramer: Well, could we just explore it a little bit more, because, as you will know, under the current structure of banks, the layer of unsecured bondholders is relatively thin. The primary unsecured creditors are depositors in excess of the insured amount. Those would typically be small businesses and charities, and they might even be large businesses that need to keep large cash balances-the supermarkets may be a very good example of that kind of entity. Are you serious that a Chancellor would be willing to bail-in that group, or are we resting on something that sounds quite convincing in theory but, when it came to that Friday night or Saturday morning, essentially, it would not be particularly workable?

Mr Osborne: We have got to make it workable, and there are several ways of approaching this. First, we have to increase the capital requirements. We have not discussed it today, but I am increasing the capital requirements on large British ring- fenced banks by 3% through this, and the global SIFIs will also have a higher requirement of something between 9.5% and 10% capital, depending on the institution.

Secondly, we have discussed the primary loss-absorbing capacity-the up to 17% PLAC-which is the next tranche that is supposed to be burnt through before you get to these unenviable choices. So you have already bought yourself a great deal more space than my predecessor had at that moment. Then you come to the question of who gets bailed-in, and we are interested in developing more of these unsecured instruments that can be used to be bailed-in, and I think that the banks are as well, because they-rightly, now-wonder whether a Government would step in and bail them out. We are also proposing in this legislation-and, indeed, through the Vickers report-a depositor preference, which they have in the United States and Switzerland, so that depositors are first in line in the credit hierarchy rather than co-equals with some others.

There is a question-I do not know whether you will ask me about it-about whether to include charities, and by extension I suspect you would then want to go to state schools, police authorities, local authorities, pension funds and the like. I just think the more you expand the categories, the less there is a preference being expressed. An important principle in all this is that the ordinary depositor with an average amount of information can be sure that they are protected, at least up to £85,000.

By the way, my predecessor-again, for understandable reasons-felt unable even to enforce that, so he had to guarantee all the deposits in Northern Rock, and when it came to the Icelandic banks, he felt he had to underwrite all those as well. Even to get to a position in which we are saying anything beyond £85,000 is a significant moment.

It was unremarked on that I allowed an institution to fail. I think it was at the end of last year. Ironically, it was the Southsea Mortgage and Investment Company, which was based in Hampshire, and some depositors lost their money above £85,000. We have demonstrated, and we wanted to demonstrate, that we are in the business of protecting £85,000 of deposits, and not beyond that.

Q1103 Baroness Kramer: I come from the other direction on how reliable this tool is. You talked about particular strands of specifically designed bail-inable debt that you wanted to see. We pursued that issue with a number of banks and others who have come before us, and getting a coherent answer from anyone that would give any sense of direction is simply impossible. The point was made-I think, by John Groot-that for an instrument like that you will have to pay a premium of at least 400 basis points. Adair Turner pointed out that you could not let banks hold it because the contagion would bring the whole system down. Others pointed out that pension funds could not hold it, because it would not fit within their portfolios. You are then trying to provide the bail-in capacity of the instruments, not just for UK banks, but essentially for a global sector. That again had the air of a chimera. I am concerned that that is so important in the structure, and it brings us back to the original question, which is the importance of capital. I think others will be asking questions around that area.

Mr Osborne: I think you ask very pertinent questions. The international community must get itself to a place where it is confident that it will exercise bail-in, and that there are instruments to bail-in. We are making progress. We are increasing the buffer before you reach that point. I am not sure how much people will pay attention to this, but we are at the beginning of a process. I know that, by the time we get to the House of Commons and the House of Lords, all sorts of organisations will come forward saying that they are a special case, and need protection as well. They will have very good reasons for why they in particular should be protected.

I am saying at the beginning of the huge lobbying effort that is about to start that the more you have in the preference, the less you have outside, so it is not really a preference. I make that point at the beginning of the lobbying effort.

Chair: We have already heard the lobbying, and we have already understood it.

Q1104 John Thurso: Chancellor, I would like to return to some questions on the ring fence, but first may I clarify what you said in an answer to the Chairman at the beginning? You were talking about consensus, and said that everything has been said but not everybody has yet said it. Are you telling us that there is a cosy consensus, and that we just have to rubber-stamp it?

Mr Osborne: No. If you don’t want to be part of the consensus, Lord Thurso, you can choose not to be part of it.

Q1105 John Thurso: Well, there was quite a consensus up to the middle ages that the earth was flat.

Mr Osborne: Indeed.

Q1106 Chair: And that the banking system was safe.

Mr Osborne: Well, the John Vickers of the day-I think it was Galileo-was going round saying that did not have to be the case.

Q1107 John Thurso: The serious point is that you are asking us to set the legislation that will frame banking legislation for, hopefully, at least one if not two generations. Our view is to treat the evidence that we are getting-I stress the word "evidence"-not as they do in humanities to reconcile two opinions, but as they do in science to arrive at a scientific conclusion. The serious question is, if the evidence were to lead us, would it not be our duty to make that point to you?

Mr Osborne: I have no doubt that you will follow the evidence wherever it takes you, as they say, but I am going to repeat myself. We have got to this point: we have had two years of a commission that was set up with a bunch of people who were highly regarded and thought to have done the job extremely well; they consulted widely; we have had debates in Parliament about it; and we have draft legislation before us. Perhaps you and fellow Members of Parliament at this point want to hit the stop button on the train. Of course I need a majority in Parliament to pass this, and I would be particularly relying on your vote, as a supporter of the coalition Government, John-Lord Thurso. If at that point everyone wants to hit the stop button, just be aware of the consequences. I think we have got to a point where there is broad agreement-but not universal agreement, before Lord Lawson comes in-that ring-fencing is the right way to achieve this operation.

Q1108 John Thurso: Let’s test that.

Mr Osborne: Let’s make sure that we implement it well.

Q1109 John Thurso: The critical point is to test the ring fence to make sure that it is the right consensus or approach for the future. Let me ask you to articulate, as far as the Government are concerned, what the point of the ring fence is. What is its purpose?

Mr Osborne: The primary purpose, as expressed in the legislation, is that the regulators can preserve the core functions of the banking system. It is written in the primary legislation; that is the central purpose of it. One of the primary ways in which it achieves that is by making it a much more resolvable institution. You can take out bits if you are the regulator or the Finance Ministry, but you need to protect and preserve.

Q1110 John Thurso: But to be clear, it is continuity of service.

Mr Osborne: Yes.

Q1111 John Thurso: Not protection for the institutions.

Mr Osborne: No, no. Ring-fenced banks will fail as institutions; it is the services that we need to protect. We certainly do not want to create another category of institutions that are too big to fail.

Q1112 John Thurso: I think it is part of this debate, certainly among the wider public. There is an understanding that we are creating one bit that is going to be preserved, and one bit that will be allowed to fail. That, I think, is rather dangerous.

Mr Osborne: I agree with you that that is a false reading of what we are doing. I agree that it has been reported as such, but that is not what we are trying to do. We are trying to create a simple institution where you can see the interconnections and can see what you need to pull out and protect. We absolutely are not in the business of saying that a ring-fenced institution cannot fail.

Q1113 John Thurso: But it may be a happy secondary result of a well-designed ring fence that it may be more robust and therefore might in part go towards adding safety to the system.

Can I go back to the question of location? At the moment, I think everybody agrees-possibly even Lord Lawson and I agree with you-that the critical thing is that if you have deposits, you cannot trade; and if you trade, you cannot have deposits. That is absolutely a given, whether it is separation or whatever. If you take the narrowest definition of the ring fence, you would have a balance sheet that had only deposits on it. That is possible, is it not?

Mr Osborne: Yes.

Q1114 John Thurso: Right. You therefore have completely separate corporate governance, a completely separate treasury function and a completely separate risk function, which is the point that Pat McFadden was alluding to. How do you manage a one-sided balance sheet with all that corporate governance? What is on the other side of the balance sheet?

Mr Osborne: Again, first of all, there is flexibility.

Q1115 John Thurso: Yes, but I want to explore what happens if you start from the possible, although very unlikely.

Mr Osborne: You can take deposits and you can offer loans. There are some banks in Britain that are probably going to sit almost in their entirety in the ring fence. It is probably invidious to single out individual institutions, but in banks such as Lloyds or Santander, a very large part of what they do now-there might be bits on the margins-just sits within the ring fence.

Q1116 John Thurso: I am not exploring what can be in; I am exploring what could be out. In other words, under the current legislation you could have a bank balance sheet that simply consists of deposits and whatever you choose to do with it on the other side. My question is: what do you do on the other side of the balance sheet? There is all this governance, the risk committee and all the other things; what is the other side of the balance sheet?

Mr Osborne: I am trying to envisage what they would be doing. They would be wondering what to do with their money, I guess.

Q1117 John Thurso: That’s the point. That is why I am trying to point out that, possibly, a balance sheet that has only deposits on it, which is what we have all agreed is technically one possible end of the ring-fence locator, is actually wholly impractical and could never happen.

Mr Osborne: No, no.

Q1118 John Thurso: If you agree that there have to be two sides to a balance sheet, clearly you move to a point where you have automatically put a lot of things, or some other things. Why not legislate for that?

Mr Osborne: Some of the things, such as overdrafts, are in the ring fence and are required to be in the ring fence. In theory, you could run that kind of organisation today, but I am not sure how far you would get. Prescribed in the ring fence there is not just deposit taking, but also overdraft provisions.

Q1119 John Thurso: Yes, but although that activity is on the other side of the balance sheet, I would argue that it would be a very odd institution that had lent all its deposits in overdrafts. That would not be a very smart piece of banking, I would suggest. Therefore, it would in fact be an inherently unstable balance sheet, so there has got to be something else on it. I notice that Mr Kingman is nodding vigorously; have you thought through what may be on the other side of the balance sheet?

John Kingman: I am not certain I fully understand the problem you are driving at. Clearly, you could have a ring-fenced bank whose liabilities were all deposits. It would then have to have assets that would match the liabilities, and those would be loans. They could be loans to individuals, they could be mortgages, they could be loans to SMEs-

Q1120 John Thurso: Which are obviously being subject to the separate corporate governance.

John Kingman: Correct.

Q1121 John Thurso: Separate risk management.

John Kingman: Correct.

Q1122 John Thurso: And separate treasury.

John Kingman: Correct.

Q1123 John Thurso: Which we have all decided are absolutely there.

John Kingman: Absolutely.

Q1124 John Thurso: So, by definition, why would a ring-fenced institution, with one half of its balance sheet on deposits, have a large chunk of the other half not inside the ring fence?

John Kingman: I am sorry, I genuinely do not understand what the question is.

Q1125 John Thurso: What I am trying to point out is that, apart from the fact that both sides tend to add up to the same number at the bottom, if you have a balance sheet with the deposits on one side, which are liabilities, and you have assets on the other side, those assets are de facto inside the ring fence. Therefore the statement that a ring-fenced bank can start with just the deposits is simply and plainly a mis-statement.

John Kingman: In that case we are in agreement.

Q1126 John Thurso: Therefore, what I am trying to demonstrate, simply by a piece of accounting, is that on the other side of the balance sheet, you have things, and they are, de facto, part of the ring fence, so the statement that anybody makes that deposits are all in the ring fence is actually wrong. We have other things inside the ring fence-

Mr Osborne: I don’t think we have said that, though. I don’t think we have said that that is the only thing inside the ring fence.

Q1127 John Thurso: A lot of the evidence we have taken has been based on the line that you start with deposits. It is not quite as arcanely technical as it might sound, but there are things on the other side, and if you do not actually know what they are before we kick off, it is a little difficult to scrutinise the legislation. I will just rest my case there and hand back to the Chairman. I am getting tired.

Chair: Mr Kingman wholly agrees. Sophie Dean was whispering something-does she want to say it more noisily? No. John McFall.

Q1128 Lord McFall of Alcluith: Chancellor, I want to go back to the answer the Governor gave to the former Treasury Committee when we asked him who was in charge, and he asked us to define what we meant by that. The Financial Services Bill framework gives the Bank of England responsibility as the main body for resolution. It has to notify the Treasury when public funds are at risk, and then the Chancellor will be in charge, but the Bank of England has set out that when the ring-fence and resolution tools, such as bail-in, are in place, it expects that most bank failures will be dealt with without the risk of public funds. Do you expect the Bank of England to deal with failing banks in future without the involvement of the Treasury, at most just keeping you informed of its actions?

Mr Osborne: The first thing I would say-I have said this to your successor and his Committee-is that I do not think you can entirely prescribe for these relationships, as was clear with some of the things that happened in 2007-08. There is an obligation on anyone doing my job, and an obligation on anyone who is the Governor of the Bank of England, to have a good relationship with each other, so although you can prescribe for when the Treasury is told things, I would hope that a well-founded relationship would mean that the Governor was keeping the Chancellor constantly informed of things that might come to a point where public funds are at risk, and indeed the legislation does back that up. However, we also want to make sure that the regulator is not, for reasons of being absolutely belt and braces, telling the Treasury everything the whole time, which would cause a deluge of information and make it undifferentiated.

I would expect to be kept informed. Despite all that we are doing here on bail-in, ring-fencing and so on, certainly until this regime was tried and tested-people would ask whether there was not always the risk of public funds being put at risk, even if that is what we are trying to eliminate-I would expect the Treasury to be informed. Without reopening our discussions before the Select Committee, we have also given the Chancellor a power of direction that is less nuclear than the power of direction that Alistair Darling felt he could not exercise in 2007-08.

Q1129 Lord McFall of Alcluith: The reason I ask is that given that the Bank of England resolution strategy is dependent on bail-in, which, as Baroness Kramer said, is presently untested, is there not a risk of it discovering late in the process that it will, in fact, not work and, as a result, falling back on public funds without the Government being adequately involved in the planning?

Mr Osborne: That is something we would very clearly want to avoid. We would expect to have been told much earlier by the Bank of England.

Q1130 Lord McFall of Alcluith: But Alistair Darling probably said that at the time of the crisis. What I am driving at, Chancellor, is that we need to move towards a degree of precision here, rather than saying, "Well, we depend on the good will of the Bank of England" and "There’s got to be a good relationship between the Chancellor and the Governor," because we know Murphy’s law applies somewhere at the end of the day. Really, what I am saying to you is this: with the new arrangements you are putting in, are you really comfortable that, as Chancellor, you will be informed and what happened in 2007 will not happen again? It is your confidence that I am asking you about.

Mr Osborne: Look, as I say, I do have that confidence, for two reasons. One is that I think the legislation prescribes that the Bank of England has to tell the Treasury when there is a material risk to public funds. I would certainly expect, for the foreseeable future, that with any large institution that was getting itself into trouble, there would at least be a risk to public funds, and the Treasury would expect to be told.

We also have in the legislation a power of direction, which gives the Chancellor a weapon that my predecessor did not have. He had a general nuclear power under the 1946 Act, I think it was, but that had never been exercised since 1946, so obviously it would have been a huge thing. I would just make this point: Lord McFall, you interviewed all these characters at the time, and what had happened was also, frankly, that relationships had completely broken down. In fact, I was talking to a member of the tripartite committee at the time who said the tripartite committee had never met until 2007. What I am trying to say is you can prescribe for these things in legislation-the Bank is required to tell the Treasury-but there is an obligation on anyone doing my job or, indeed, the job of Governor of the Bank of England to maintain a strong and confidential relationship with each other.

Q1131 Lord McFall of Alcluith: Okay. Fine. I mention that because today in The Telegraph on the way down I read about an esteemed and respected member of the Independent Banking Commission, Bill Winters, who was at the Treasury Committee yesterday. He said that the new system that you have established is actually a more complicated arrangement, with more actors on stage, than the tripartite system. If you are not clear about who is accountable for what, the buck will be passed. The new system could be as dysfunctional as the last, when you had confusion over which of the Treasury, the Bank of England or the FSA was in control. You have established a more complicated system, going from a tripartite to a quadripartite system. That element of responsibility is getting lost in the mush; that is what Bill Winters was saying.

Mr Osborne: I do not agree that we have established a quadripartite system. There are two actors: the Bank of England and the Treasury.

Q1132 Lord McFall: And the PRA and the FCA.

Mr Osborne: What we have given the Bank of England is control over monetary policy, micro-prudential supervision and macro-prudential supervision. They are all in one institution. In the person of the Governor, he chairs the PRA. I am not expecting him or her, on a day-to-day basis, to be deeply involved in every single micro-prudential decision, but I would certainly expect important decisions to be referred up to him or her as chair of the committee.

I think there is now-I am not sure whether this is the right word-a duopoly between the Bank and the Treasury, which will make it simpler. Of course, the obligation on the Bank is to make sure that they manage and structure themselves with these new responsibilities that they are getting next year in a clear way and that they can resolve genuine issues of conflict in the economy and bring them together. They are forced to do that, rather than say, "There is a structure now where that is the FSA’s responsibility," and everything falls between the stools. It can fall between the stools if the Bank does not manage itself well, but I have every confidence that the Bank will manage itself well. All institutions, if they fail to perform their functions, they are failing to perform their functions.

Q1133 Lord McFall: Therefore, you are dependent on confidence. I can say to you that in the past many people have come into the Treasury Committee and expressed confidence and maybe a year later said, "Maybe we should not have had so much confidence." That is what I am alerting you to, Chancellor. I think there are more opportunities to reflect on the issue of who is in charge.

Mr Osborne: Lord McFall, you did the report, "The run on the Rock". I was not there at the time, but as I understand it, the Bank Governor felt that he was told extremely late that there was a problem at Northern Rock. The Government of the day and the FSA felt that the Bank could do more to step in and help with liquidity and the like. I am forcing some of these trade-offs to be made in the institution that is going to have the responsibility-the Bank of England. For reasons we have explored earlier, I also think that it will be a powerful regulator, with the confidence to take on the industry. Yes, there is ultimately a relationship between the Bank, Parliament and the Government over the use of public funds. You could put the entire thing into the Treasury, so the Treasury is responsible for regulating, but I do not think that that would be a sensible step forward.

Q1134 Lord McFall: It is a complexity thing.

Lastly, David Kynaston, a City historian, wrote an article at the end of last month, "Was the Big Bang good for the City of London and Britain?" He said that "a generation ago, the social and financial position of, say, a solicitor in Northampton was not so utterly different from, say, a stockbroker in Sevenoaks; but now, the City…feels like an absurdly privileged offshore island, living in a bubble far removed from the everyday concerns of most people and sucking in many of the brightest and best." In our deliberations on the culture and standards in banking, what should we focus on in the light of that remark? Do you agree with him?

Mr Osborne: I hesitate to talk about the big bang in front of the Chancellor of the Exchequer who brought it about. The financial services industry in Britain has caused many headaches over the last five years. That is why this legislation is going through and why this Commission exists. It is still our largest employer and probably one of the most-I was about to say the most-competitive global industries we have. It employs many hundreds of thousands of people in Edinburgh and in my constituency in the north of England-

Q1135 Lord McFall: I agree with you, but you told us to look at the professional culture and standards. My question is, what should we keep in mind, on the basis of Kynaston’s remark, as we go forward to study the culture and ethics in financial services, which you have charged us to do?

Mr Osborne: Ultimately, the purpose of the banking industry is to serve the country and its economy, rather than endanger the country and its economy. That is why we have a banking industry-to intermediate between the savings and credit requirements of our people; but London and Edinburgh and other centres are also centres of global excellence. Britain has the world’s largest and most international financial centre, and I do not think we want to shut that all down, have that move off somewhere else and have our economy affected by what happens elsewhere.

Q1136 Lord McFall of Alcluith: Chancellor, I would agree-

Mr Osborne: But obviously, the practices in that industry-the culture of that industry-have to be greatly improved, because it was not just a structural failure. It was also a failure of culture.

Chair: We will be coming back to whether there is a trade-off between standards and global competitiveness later on in our work. Some argue there is, and some not.

Q1137 Lord Turnbull: Can I come to this rather arcane subject of fees, and how they are paid for? There are two principles that I was brought up on in the Treasury. One is that the regulatory community should pay for the costs of being regulated; and the other was a very adverse view about hypothecation. These two things are clashing in this case. If hypothecation is to be allowed, it seems that there has to be some connection between the revenue stream and its amount and the expenses. I think you deal with that, because the amount that is taken off or added as a surcharge is only what is needed to meet the expenses. The question, though, is in general it is desirable that the Treasury is subject to the same disciplines as everyone else, that its expenditure is voted by Parliament. Here you are creating something of an exception to that. Are you dividing this into two, in the sense that money that you are paying to international bodies like the FSB-your subscription to it-comes out of this; or is it paying John Kingman’s wages?

Mr Osborne: I must allow the former pupil to take on the former master on this issue. What I would say is it is a question of practicality. We see an expanding role for institutions like the FSB. We think they should do more. That is going to increase UK subscriptions to that, because we are going to have to pay for that; and then the question is, where does the money come from? Of course, it could come from general taxation and the Treasury budget, but since other regulators in the UK levy for the cost of some of their international activity, including on the same institutions, we think it is perfectly reasonable for the Treasury’s subscriptions to some of these organisations to also be paid for by the industry. It comes also to a matter of practicality, which is, in an age of very tight Government resources, that the alternative is us squeezing other areas of activity; and I don’t think that would be sensible.

Q1138 Chair: Like every other Department has to do, we do not want to find ourselves, and I am sure you would not want to find yourself, supporting the Treasury in finding a back-door way to creating its own discrete revenue stream.

Mr Osborne: I will let John say something.

John Kingman: This cannot be used to fund the Treasury. It is quite clear.

Q1139 Chair: It is not clear on reading the White Paper.

John Kingman: The restrictions that we are imposing are that this levy could be used to fund international bodies: the cost to the Treasury of meeting the costs of international bodies that are working on financial stability. I think also-we should not lose any sense of perspective here-the one relevant organisation at the moment is the FSB. The cost to the Treasury last year of our contribution to the FSB was less than £100,000, so we are not talking about gigantic sums; but I think the point is that the levy cannot be used to fund the Treasury itself.

Q1140 Lord Turnbull: I am happy with that reassurance. It is not quite what I think is said here. It talked about expenses. It could be funding you and Sophie Dean’s work, charged out almost on an hourly basis and everything else. That I think is a subsidy to the Treasury’s running cost limit, which would be deeply resented by other Departments, which have not got such a credit. If you are confining it solely to the subscription you have got to pay to the international organisation, I can see the logic of it.

Chair: Chancellor, you have heard clearly from colleagues that we are going to be looking at whether this Bill fulfils the objectives that the Government set for themselves, and we are going to be listening to those who argue for something that may not be exactly the consensus package that you have said on a number of occasions we should be giving special attention to.

What we need in order to accomplish that job is more detail on the Bill. We have been asking for this virtually from day one, and we will be asking for more. On Monday, we asked the PRA to come forward with its views on what might be needed on detail, and while we have been in session, I have received a letter which neither you nor I has had enough time-perhaps you have had no time at all-to digest. I will be putting this into the public domain at the end of this meeting, and it is just an illustration of the extent to which even the regulators feel that nothing like enough detail at the moment is being provided in order to enable us to scrutinise this Bill effectively. I am hoping that we are going to get more co-operation from the Treasury, so that we can do our job.

Mr Osborne: We always co-operate fully with parliamentary investigations.

Chair: Thank you very much. I am sorry this has taken longer than we had expected.