Evidence heard in Public

Questions 2883 - 2991



This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.


The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

on Monday 28 January 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

Examination of Witness

Witness: Martin Taylor, Chairman of Syngenta and former member of the Independent Commission on Banking, examined.

Q2883 Chair: Good afternoon, Mr Taylor. Thank you very much for coming to give evidence and for sparing the time to see us. You will have seen our proposals on electrification.

Martin Taylor: I have.

Q2884 Chair: Do you think that the banks are right when they say this will create more uncertainty, or do you think that electrification could create more certainty by increasing the likelihood that the banks respect and help the regulator to make sense of the ring fence?

Martin Taylor: Well, I take it that your intention is very much to create more certainty-that the intention is to create certainty that the ring fence will not be breached and will operate properly. That’s something that I very much welcome. I don’t quite understand-I can see why the banks don’t like it, but I don’t see the uncertainty argument as a very strong one.

Q2885 Chair: So do you think that it is likely to create more or less certainty?

Martin Taylor: I think it strengthens the ring fence. I think it makes it more certain that we are serious about the ring fence. It is a very formidable reserve power you are proposing, and one naturally asks the question under what circumstances a regulator really would feel able to use it, but having that power there gives the regulator something that he hasn’t got without it.

If I may say so, Mr Chairman, I have been thinking a good deal about this since you published your report. One of the things that concerns me is the ambiguity that still seems to be around about whether derivatives should be allowed inside the ring fence. I’m taking a lead from your article this morning. Increasingly, I can’t see the point of having a fence round the chicken coop, electrifying it to keep the foxes out and then inviting a family of tame foxes to live inside it. It seems to me to make no sense at all. My views on this have hardened, and I think that if you allow derivatives inside the fence, you weaken it, and even with the electrification proposals, you end up somewhere worse off than Vickers mark 1.

Q2886 Chair: So it should be in the non-ring-fenced part of the bank?

Martin Taylor: Yes.

Q2887 Chair: There is also the question whether it should be outside the banking group altogether, or at least the prop trading aspect-

Martin Taylor: The prop trading aspect, yes.

Chair: We’ll come on to that in a moment.

Martin Taylor: I meant customer derivatives really and what-

Q2888 Chair: We will come on to that shortly. I just want to ask you one other question about our recommendations, if I may, Mr Taylor. The leverage ratio was a major part of your recommendations or the recommendations of the ICB, which we broadly endorse, without fully endorsing. Do you think that the FPC, as we recommend, are the right people to decide what the leverage ratio should be?

Martin Taylor: I can’t think of a better answer. The FPC seems the natural place for that discretion to sit, or at least for the recommendation on the leverage ratio to sit. The FPC, as I understand it, has powers of recommendation and powers of direction. I am not sure whether that would apply to the leverage ratio as well, in your view of the world, but the FPC seems a natural body to make that judgment.

Q2889 Lord Lawson of Blaby: May I follow on with a specific question on proprietary trading? There is, in a sense, a distinction between the purpose of the ring fence and the purpose of a ban on proprietary trading, should one wish to enforce one. The first of those is primarily concerned with the security and safety of the banking system.

Martin Taylor: Yes.

Q2890 Lord Lawson of Blaby: The second is concerned with the culture of proprietary trading and the need to avoid it having any possibility of infecting banks, which should have a different culture. Do you see merit in this? I was struck by the evidence we received from your old bank, Barclays, which wrote to us saying: "Our position was, and still is, supportive of a prohibition on proprietary trading, providing that the definition of proprietary trading was suitably narrow and concise." Do you think it is possible to achieve a suitably narrow and precise definition, to be about proprietary trading as a profit centre-and not in terms of market making, for example-which the regulators can police, or do you think that these are weasel words designed to undermine the whole idea? What is your view, on reflection, of a prohibition on proprietary trading for the reasons I have suggested?

Martin Taylor: I think it comes down to what you started off by saying, which is that you have to ask what you are trying to achieve. We were looking at the trading book as a source of instability in the banking system-whether the banks had too much market risk, whether they were managing it correctly and so on. That was what led to my remark about derivatives and the fence a moment ago. You are more concerned about not polluting the customer culture of the business by having a proprietary business.

Many of the banks-Barclays among them-have, I believe, said publicly that they do not do that kind of thing anymore. That certainly gels and chimes with Barclays’ support for the idea of a prohibition. What I think the banks are talking about is that they are abandoning specific proprietary desks, or internal hedge funds, where you have people coming in every morning and, irrespective of what the bank’s position is elsewhere or what the customer flows are, simply saying, "We like the yen; let’s buy the six-month position and go hard on it."

It is very easy to tell the banks not to do that and it is easy to police it. What is not easy to police, of course, is the banks building up positions that are expressive of a proprietary view by the way in which they build their trading books. The original impulse for a position can come from a customer, but when it has taken on the customer risk the bank then has to decide how much of that it lays off. This is a classic market-making issue. Banks would still have the freedom in market making to take, I am supposing, quite a lot of risk, unless you go out of your way to prohibit that. That does become more difficult.

I have been thinking about this since your report was published. It seems to me that the things one wants to avoid are very long legalistic rule books. Something I know concerned John Vickers when he gave evidence here was the potential for absorbing a huge amount of regulatory time as the regulators go through the banks’ books to see whether these forbidden practices are being indulged in.

I think that if you want to do this, the way to frame it is to ban the outright proprietary desks and to say that you expect the risk positions that arise in the course of normal market making to be kept within reasonable bounds, and let the banks understand that, if they don’t observe that, the regulators are likely to hit them with more capital on their trading book. Do that in a relatively informal way. It seems to me that under the new arrangements that are coming in for bank regulation in this country, there is some chance of making that kind of thing work, without resorting to an enormously complicated piece of legislation.

Q2891 Lord Lawson of Blaby: Thank you. It seems to me, and I will ask if you agree, that if one is going to do it, the time to do it is now, when the banks, as you say, have said that they don’t do it any more. Barclays has said that and HSBC gave evidence that it doesn’t do it any more. Better to rule it out now than wait until they do it again, and then step in. Do you agree?

Martin Taylor: Well, it would be painless if they are telling you the truth, and let’s suppose they are.

Q2892 Lord Lawson of Blaby: Yes. It is probably an approximation to the truth, isn’t it?

Martin Taylor: Yes. They have certainly taken their risk appetite down a lot after the crisis. On the same line of reasoning, I think this is a good time to put in a leverage ratio, when leverage is coming down.

Q2893 Lord Lawson of Blaby: I agree. Sticking to the proprietary point, if one were going to do it, follow the model that you have suggested, would you impose that on all banks, as Barclays would prefer, or on those non-ring-fenced banks-you would obviously not have this activity in a ring-fenced bank-that are part of a group that contains a ring-fenced bank? Which would you do: on all banks or just on the latter, and why?

Martin Taylor: I would certainly do it. It is the default position after 15 months, on the Vickers Commission, that one comes back to taxpayer support. We lived with it so closely. I would certainly put the prohibition in place for British banks that have a ring-fenced business within a banking group. That would seem to me again to be supportive of the philosophy of the ring fence. Whether you would or could do it to foreign banks in London, I rather doubt.

Q2894 Lord Lawson of Blaby: There could also be stand-alone British investment banks, couldn’t there?

Martin Taylor: There could, yes.

Q2895 Lord Lawson of Blaby: So would you do it to them or not?

Martin Taylor: If you didn’t, you would certainly have to watch their capital ratios. If I were at Barclays, I would worry that such an organisation would have an advantage over me, if it were allowed to do things that I couldn’t do.

Q2896 Lord Lawson of Blaby: They are worried. That is why they think it should be for all.

Martin Taylor: Yes.

Q2897 Chair: I just want to be clear. Are you saying, first, that you think that this Commission should recommend a full prop trading ban, along the lines of the Volcker rule, for the UK?

Martin Taylor: I am not advising you to do that.

Q2898 Chair: What are you advising us to do?

Martin Taylor: I don’t think a prop trading ban is necessary.

Q2899 Chair: You don’t think a prop trading ban is necessary?

Martin Taylor: No. We considered it at great length in the ICB.

Lord Lawson of Blaby: You weren’t looking at the culture-

Q2900 Chair: Hang on. Give Martin an opportunity. What is your view about a prop trading ban? So that we can be absolutely clear.

Martin Taylor: My view on the prop trading ban is that I don’t think it’s a bad idea. I just don’t think it will make a huge amount of difference; I certainly don’t think that it will make a big difference to financial stability.

Now, you have been looking, as Nigel Lawson rightly points out, at the cultural aspects of it and you have seen a fair amount of "culture" pass through this room in the last few months. And I quite understand why-certainly looking at some of the scandals that took place over the last few years, many of which involved the behaviour of traders and very many of which involved the behaviour of traders for the bank’s own book-you should conclude that this is a good thing to do. My scepticism continues to be around the application of it in practice, but I have tried to answer the question today in a constructive way, which is to say I quite understand why, as a Commission that has thought about the cultural issues more strongly than I have, it has come to that conclusion. The question then is: how do you put it in? I was trying to say, "This is a way you might think of doing it", rather than giving you the answer that it’s impossible. I think you can do it.

Q2901 Chair: Well, we haven’t come to any conclusion; we will come to a conclusion at a later date in a private meeting, and then we will let you know about our conclusions in due course publicly. In the meantime, in order to help us come to our conclusion we need clarity about exactly what you are recommending. Just to be clear, are you recommending that we should press on the Government a prop trading ban, or not?

Martin Taylor: I am not advocating a prop trading ban and never have done. I think that if you are to advocate a prop trading ban, and I can see why you might want to-

Q2902 Chair: Yes, but that’s hypothetical.

Martin Taylor: The way to do it is the way I am suggesting.

Q2903 Chair: Even though it is not what you recommend, if we were none the less to press ahead with it as a recommendation, you are now making suggestions on how it might best be accomplished.

Martin Taylor: Yes.

Chair: Okay.

Martin Taylor: And I wouldn’t think it a foolish thing to do by any means. Forgive me-I am not attacking it. I just think that we looked at this a lot, from the financial stability viewpoint, and there were those who said, "What is wrong with the banking system is that people are taking risks for the bank’s own book." We didn’t conclude that this was the principal problem.

Q2904 Chair: Okay. There’s another hypothetical question. You have answered several hypothetical questions, which initially a number of us thought were not hypothetical but were based on what you actually wanted to do. Let me ask you one more; there is very limited value in these hypothetical questions actually, but let me just ask you one more. If we were to come to this unusual conclusion-at least you would see it as unusual, because you-

Martin Taylor: No. Not unusual.

Lord Lawson: You’re leading the witness. [Laughter.]

Q2905 Chair: I never do that. This erroneous conclusion-the conclusion that you didn’t come to and yet you are agreeing is erroneous, yes, the one that you didn’t come to-

Martin Taylor: No, not erroneous, no. It was an option that we chose not to prefer, that’s all. I don’t think that it was a terrible option.

Q2906 Chair: Is it of equal value to the one you did prefer?

Martin Taylor: No.

Q2907 Lord Lawson: Look, it’s not in competition, is it?

Martin Taylor: No, it’s not. It’s neither in competition nor-in my view-of equal value. I said in my evidence to you, last time, that I thought that you could put Volcker on top of Vickers if you were so minded to; that I didn’t see them as being alternatives. I thought you could make our recommendations, if you thought they didn’t go far enough in the direction of culture and of trading-heavens, we have learned about a lot of the things that were going on that we didn’t know were going on when we did our report two years ago. Things have emerged.

Q2908 Chair: If you were making a recommendation to the Government now on what to do in this field, what would it be?

Martin Taylor: Right. I would recommend that they implement the Vickers report in full, including keeping derivatives outside the fence, and I would be very happy to have the fence electrified. That seems to me to be a good addition to the work. A prop trading ban seems to me to be an optional extra, if I can put it that way. There is such a lot of legislation already-

Q2909 Chair: No, the question on the table is really-

Martin Taylor: I think I’ve answered the question.

Q2910 Chair: The question on the table is whether you would buy any option-buy the optional extra? I hope that’s not a leading question.

Martin Taylor: I think I know what your preferred answer is. I think I rest on my position. It seems that there are two things that one looks for in proposing a solution. First, is it going to do the job? Is the intellectual construct right? Secondly, is it going to be possible practically to regulate? Is it going to be something that can be put in place? Our concern-perhaps I should not speak for the whole ICB, but it is certainly my concern and I think we shared this view very largely-was that the Volcker rule did not address what we thought were the principal problems in the UK banking system. We were also very concerned about how it would be applied in practice.

What I have tried to do today is to say-you have had a lot of experience of the cultural issues and you have perhaps come to the following conclusion, although I suppose you may not have had the time yet-that this is a more serious problem than we supposed and that stopping proprietary trading would be a good thing to do. I am trying most helpfully to say to you that were you hypothetically inclined to do this, here is the way to go about it and please do not go about it this way, because it will be a nightmare. However, the new regulatory structure will allow you to do it, and I entirely agree with Lord Lawson that if you are going to do it, the time to do it is when the banks say that they are not doing it anyway.

Q2911 Chair: We have a clear answer on the hypothetical timing question.

Martin Taylor: Thank you.

Q2912 Chair: But I am still not sure that we have a clear answer on the question of whether, given what you know, as we know now, from listening to the cultural arguments, as well as all the other arguments that you have already heard, you are favouring this or not favouring it.

Martin Taylor: If I favour it, I favour it very modestly. If I were a member of this Commission and other members were very strongly in favour of it, I would not try to stop it. It does not seem to me a mistake-certainly not a bad mistake-but it is not something that I would be proposing. Whereas I think-I am sorry to repeat myself-that leaving derivatives in the fence is a terrible mistake, and I have hardened my position on that a lot.

Chair: Okay. We now have the derivatives position very clearly. I apologise to Mark Garnier for having taken part of the questions he wanted to ask.

Mark Garnier: You have softened up the witness up very nicely.

Martin Taylor: I’m absolutely pummelled.

Q2913 Mark Garnier: Well, I am afraid that I am going to carry on.

There is a lot of ambiguity among a lot of people in the general public about the difference between proprietary trading, which is where a bank takes directional bets for the purpose of taking a view on the market in order to enhance the balance sheet, and trading as a principle, where the counterparty is a customer and the bank is trading for its benefit. It is important to make that differentiation, which is why I wanted to step in here.

Trading as a principle, as I see it, is straightforward market making or, in the old form, jobbing, writing derivatives, underwriting new issues and all that kind of business. Prop trading, starting at the extreme and toxic end of it, is straightforward gratuitous hedge-fund management-if you can have gratuitous hedge-fund management-but ultimately for the purpose of no other benefit apart from shareholder value and staff bonuses. The problem is that they merge when you come to something like a trading book, where a market maker can be providing liquidity to the market and facilitating client business, but at the same time allowing his trading book to have a directional bet on it. That is where you have the ambiguity. How do you think you differentiate between those two if you are going to try to extricate prop trading and yet leave trading as a principle in the non-ring-fenced bank?

Martin Taylor: I think the way that the management of a bank would do that, which may be a guide to regulators and supervisors, is simply to look at the volume of risk exposures measured by value at risk or the rather better measures that are coming along now. You can see how big your exposure is and when you see a spike in your exposure, you ask what it is and you ask why it cannot be laid off.

Q2914 Mark Garnier: But it has already happened. Once you have seen the spike, it has already happened.

Martin Taylor: Banks are in the business of taking proprietary risk; that is the problem. The distinction is made between the proprietary risk taken because a trader comes in in the morning and decides to put a position on, and the proprietary risk that arises because a client rings up and says, "I’d like you to structure this derivative for me"-when the bank finds itself the other way round from the client-but in the immediate aftermath the position is just the same, whatever the intention was. One may be more socially useful than the other, but in the end the bank has the same risk position. Whereas an individual bank can hedge a position it has taken on, sometimes the banking system as a whole cannot, because you pass it around to the next bank, which then passes it to the other. That is one of the reasons that the derivatives market grows like Topsy and you get these gigantic notional numbers coming in.

Q2915 Mark Garnier: Yes, you are absolutely right about the banking system taking it on, but what you can actually do is hedge it out of the banking system that we are trying to protect from collapse.

Martin Taylor: If you can find another counterparty, yes. The banking system has taken a fee for finding two non-banks who have an opposite view.

Q2916 Mark Garnier: Yes, that’s right. But the important point is that in that hypothetical situation, if all the banks are banned from prop trading, therefore taking a directional bet, the risk has to be pushed outside the banking system if the banks undertake that in the first place, in order to stop trading as principle turning into proprietary trading.

Martin Taylor: The problem comes, of course, in those phases of the market when everybody wants to be the same way around. You just get a rush and everybody wants to be short of a certain currency. The system as a whole cannot purge itself in that circumstance, however fast you bring prices down. It can be very difficult. That is why the supervision is difficult. However, I think that framing such a rule in terms of a general intention is something you could make work. I’m back to the hypothetical, sorry.

Q2917 Mark Garnier: No, no, I quite understand. I do not want to push too hard on hypotheses and the rest of it. Sir John Vickers said that if you impose a Volcker rule on top of a ring fence-an electrified ring fence-that could lead to a situation where the banks see that absolutely no proprietary trading is allowed at all, which could therefore weaken the ring fence. Do you think that that is a viable proposition?

Martin Taylor: I cannot remember the adjectives that Barclays used to describe a desirable new rule, but I would suppose that if you put in a rule that was sensible, you would not get to that situation. There is danger in arguing from an extreme position. If the supervisor lets it be known that the intention is that the banks should not take on proprietary risk positions, that the position should arise from customers flows and be hedged to keep the total value of risk at a reasonable level, and that it is necessary to report to the supervisors when it goes above that level and explain why, maybe you are beginning to get a sensible regime.

Q2918 Mark Garnier: Coming back to Lord Lawson’s point about behaviour, given the fact that if you impose Volcker and get rid of pure prop trading, and therefore you have trading as principle, which could still morph into a proprietary position-a directional bet-do you not see that that is potentially allowing a risk of behavioural lapse? A market maker might sit there and think, "This thing is going up. I may as well ride the position before I hedge it."

Martin Taylor: I think market makers will certainly do that. Market makers are very often given positions that they do not want, which they know are going to go down before they can hedge them. I do not think that we are trying to prevent the banks making money. That would be the wrong thing for us to do.

Because I have not heard all the evidence that you as a Commission have heard, I do not know-this seems to me an important point; it is not an attempt to sidetrack you-the extent to which the misbehaviour in the LIBOR scandal was the result of people trying to get proprietary trading positions right, à la Volcker, or whether it was simply the endless struggle that these very big organisations have to keep their derivative back books in order, which have probably arisen in the first place from satisfying customer demands of one kind or another. It is not possible to hedge them up perfectly, so banks hedge them imperfectly. Then they have to review them daily for years and years and take out new little delta hedges to make them fit. If you were doing such a thing, you might well be tempted to try to fix the fixes. That would not necessarily be a proprietary trading phenomenon, is what I am trying to say.

Q2919 Mark Garnier: It is a behavioural phenomenon?

Martin Taylor: Yes.

Q2920 John Thurso: Can I come to the slightly different topic of corporate governance? Thank you for your evidence to our panel. Out of that work, and out of our panel on HBOS, led by Lord Turnbull, there is a great deal of evidence to show that senior management executives-let alone the board, and let alone non-executives-actually did not have a clue what was going on in many parts of these huge organisations. Therefore, it poses the question: are the biggest banks just too large and complex to manage?

Martin Taylor: I think the one-word answer must be yes.

Q2921 John Thurso: In that case, we need to look at how to recommend either that they be big and simple or that they be small and complex, but the answer must lie in finding a matrix of simplicity, size and subsidiarity that is smaller and easier to understand for board members going forward.

Martin Taylor: Broadly, yes. The concept of complexity is itself quite complex, in the sense that some complexity is trivial and mere complication. One of the difficulties in banks-

Q2922 John Thurso: You make a very valid point. I am not talking about complications; I am talking about complexity.

Martin Taylor: There is, of course, a wood for the trees issue in managing these. What you have to understand if you are trying to manage a big bank is what sort of things would cause you a great deal of difficulty if they happened, and work out what you would do if they did and how you would put your position right before they do. Sometimes, that seems to have proved to be beyond people. It is hard.

Q2923 John Thurso: I am grateful for your candour on that point, because it is critical. There is not much point in our recommending a large raft of improvements to corporate governance if, at the end of the day, we think that really large and complex institutions are actually ungovernable. It is like designing an aeroplane that can fly, but not very stably, and recommending improvements to the ailerons when actually you ought to scrap it and design another one.

Martin Taylor: I agree with you.

Q2924 John Thurso: Going on from that, there is an obvious way of doing it, which is simply to say in a recommendation, "You just cannot be this big, end of story." However, if we were to say, "All right, you can choose to be that big, but we think that either the regulatory architecture or the capital structure should be a fairly great disincentive," what might be the disincentives, or the incentives not to be big but to be more simple? What are the appropriate incentives that we might look at?

Martin Taylor: Two answers immediately come to mind. You are probably aware that until recently-I do not know what the rule is at the moment-the Americans had a rule that a bank could not be above a certain percentage of the deposits in the country. There was a cap on size, and the banks lobbied against that intensively, as they lobbied against out-of-state banking and Glass-Steagall, and all the rest of it, and so became enormous and blew up. You could just go back to that rule. It was an arbitrary ceiling, but that is the first thing you could do.

Secondly, the GSIFI work, as it was then called, in the context of Basel III, which was happening at the same time as the Vickers Commission was sitting, went a little bit this way, saying that, in the case of the very big banks, because of the risks that they posed to financial stability internationally, they should carry more capital than they would have had to if they had been smaller. If you really pushed that through, the banks would have to prove to themselves that the operational efficiencies from being bigger outweighed the higher capital cost. That is quite a difficult thing to do.

The banks lobbied against that by saying, "Well, everybody should be GSIFI", rather as they say everybody should be in a proprietary trading ban.

Q2925 John Thurso: But to be clear-this is a terribly important point and your comments are helpful in promoting that debate-it is not simply size. You could be very big and very simple.

Martin Taylor: Yes.

Q2926 John Thurso: It is the complexity. You could actually be medium sized and incredibly complex, which might be even more dangerous than very big and simple. It is the complexity of having what were, 20 or 30 years ago, five or six completely different businesses all under one umbrella, all run by one chief executive, and a selection of the great and the good on the board. They just have not got a prayer of understanding what they are being asked to manage.

Martin Taylor: At the very least, you need extremely good management in each of the businesses, and you need a dynamic understanding of the correlations between them, which are, to some extent, stochastic.

Q2927 John Thurso: You made a good point in your written note in evidence to the panel, which says, "Don’t turn the board into a policeman." If a board is going to be part of the management, then it has to understand it.

Martin Taylor: Yes.

Q2928 John Thurso: Therefore if it is big and complex, by default it ends up being a policeman, because that is its most important role. So if you want a board-stop me if I am reading this wrong-that works the way a board should, as a proper supervisor and partner with management to getting things done for all the stakeholders, it has to be one they can understand and work with. If it tends to get to the point where all their worrying about is what might go wrong, they end up becoming the policeman that they should not be.

Martin Taylor: I think the longer I spend on boards, the more convinced I become that the fundamental job of boards is to prevent major error. That does not mean necessarily being a police force, because that is looking for minor error, usually, but it is stopping the crazy acquisition, the over-leverage, the promotion of the wrong people-that sort of thing, which is what gets businesses into terrible trouble.

In order to do that, boards need some combination of detailed knowledge of the business-but they will never have as much knowledge as the management has-and instinct. I do not think it matters what the industry is; a chief executive who is going off the rails looks pretty much the same anywhere. It is being able to identify that coolly and recognising that things are sliding out of control.

It seems to be a difficult job, doesn’t it, if you just look at the difficulty that some very able people-apparently able-have had in performing it.

Q2929 Mr McFadden: Just to carry on the same theme for a minute, Mr Taylor. We are quite used, on this Commission, and on Select Committees, to people coming in, saying, "It was really bad a couple of years ago, but we have made this change and that change, and we’ve fixed it all now." I want to probe bank boards a little bit through that lens.

On fixing things, bank boards usually say things like, "Well, we’ve got this risk committee now and this audit committee", or, "We’ve appointed a group risk director and he or she reports directly to the board; they used to be a bit more junior." This kind of stuff is said. When you look at the types of reforms like this that have taken place on bank boards, are you not struck by the fact that this looks a bit like fiddling while Rome burns or moving deckchairs around, or some metaphor such as that?

Martin Taylor: I would certainly agree with you that with these structural elements, although they may be useful, there seems to be an idea out there that somewhere there is an ideal way of governing companies. We keep changing the corporate governance rules to get closer and closer to this holy grail, but we would be wrong to imagine that if we ever got there we would solve these problems. If you look at the financial crisis, there were human misjudgments made on a massive scale by people inside and outside the banking industry, all over the place. No one stopped the banks doing what they were doing. The boards, supervisors, Governments-everyone was carried away with the feeling that things were all right. I do not think that any number of risk committees will stop that. We are trying, at last, with the FPC, aren’t we, to do some serious macro-prudential regulation, which seems to me to be a jolly good thing to try-it is very difficult but worth trying.

Q2930 Mr McFadden: I think our constituents would be quite shocked to find that it is not uncommon for someone to be chairman of one company-I am not talking about a small concern, but a big household name-perhaps chairman of another and to serve on a bank board, supposedly with important supervisory and guidance functions. That person is supposed to be able to do three, four and sometimes five of these things. Is it at all realistic, given the complexity and importance of these organisations, to have people doing this on a commitment that is, on paper, for 25 to 35 days a year?

Martin Taylor: In my evidence to John Thurso, I suggested that it would be a good idea to have smaller bank boards-that is, fewer directors, pay them better and get more work from them. I think you would have more chance of having a good outcome. I do not pretend that that would solve all the problems. I also think that smaller boards have a psychological advantage, in the sense that people who are members of a small group feel more responsible for what it does than members of a very big group do-they feel more responsible for the choices.

Q2931 Mr McFadden: We found a more insidious effect of the current regime, which is constructive ignorance-senior directors almost find it in their interests not to know what is going on in the bank. When the FSA and CFTC come calling, what they do is follow e-mail trails, and they want to know who was in that group chat room when fixing LIBOR or whatever it is was discussed. When we asked the FSA, for example, about the UBS situation, "Why didn’t you speak to the senior directors of the bank?", all of whom told us that they had found out that their own bank was involved by reading it in the newspapers years after investigations had begun-again, I think that the public would find that shocking-the reply from the FSA was, "Well, the trail went cold. We follow the e-mail trail and, when it stops, we don’t go any further up the chain." So it is almost in a bank director or senior executive’s interest to say, "I don’t want to know what’s going on over there." That is a terrible state of affairs, when ignorance is to the advantage of the senior people running the bank, in case they are implicated with the regulators.

Martin Taylor: Yes, it is a bad place to have got to, isn’t it? It is a corrupt place to have got to, and we should not have got there. I think that this issue of people being able to escape responsibility by saying that they did not know something was going on, rather than having to go because they should have known, is just the wrong way around. We need to return to a situation where the people who run businesses want to know everything that is going on that is off beam and where people get in trouble for not telling them.

We are just learning-this is not just to do with banks or Parliament and the Freedom of Information Act-about all this stuff about e-mails, electronic records and the trace we all leave in our lives now. People are getting caught out by it, and all these things could be discoverable in court at any time. What you do, of course, is make people much more nervous about committing all kinds of things to any kind of hard media. A lot of governance goes informal. It is commonplace in board meetings for people to say, "This is an informal meeting, so we are not going to minute this part. No papers will be circulated." This is a self-defence to an excessive legalism, and I know it happens in Government too. People obviously do not write things down if they are going to get into trouble.

Q2932 Mr McFadden: It does happen-we call it "Government by Post-it note"-but it is a slightly different thing from complete constructive ignorance, where you do not want to know what is going on in your organisation. It is one thing for two Ministers to say, "Let’s talk outside the room," and another thing to say, "I definitely do not want to know what is going on in my Department."

Martin Taylor: I agree with you. Constructive ignorance is very, very bad, and people who want to behave that way should not be on boards. I am afraid that a lot of people will have taken the message from recent events that a bank board is a very dangerous place to be. One of the things I think I mentioned in my evidence is that we need to be sure that these are jobs that decent, experienced, intelligent people might actually want to do.

Q2933 Mr McFadden: But on this ignorance point, we keep hearing about the "three lines of defence" model, where the person at the front line is supposed to be the first line of defence, the compliance unit is supposed to be the second line and the board is supposed to be the third line. We are in a pretty bad situation if the incentive is for the third line of defence to be absent.

Martin Taylor: Yes, and you wonder sometimes, looking through some of the things that have happened in front of your Commission, whether the second line was absent as well.

Q2934 Mr McFadden: I think that is true, yes. May I just ask you a slightly different final question? The first round of questions was about your involvement in the Vickers report, and you said you had hardened your position on derivatives being inside the ring fence. I would like to ask you a bit more about that. Why have you hardened your position? This was something specifically referred to the Commission by the Government, because they could not make up their mind on it, but you have clearly made up your mind very firmly. What has driven you to that? Before you answer, in the banks’ evidence to us, the reason they said they wanted this within was to serve their customers-be it small businesses exporting or farmers dealing in euro grants and so on-who often wanted to hedge on interest rate or foreign currency risks. Their argument was, "If you take this away, you are just causing needless grief and hassle to customers." What is your response to that?

Martin Taylor: I think that is a ridiculous view-not yours, sir, but the banks’. We made it perfectly clear in the report that we wanted the banks to be able to provide these services to their customers, that they simply would not be the ones who wrote the derivative. The derivative would be written in an investment bank, either part of their group or elsewhere, and they would be acting as agents. It would be outsourced, in a sense.

What we were trying to do was to keep these customer-driven derivatives off the balance sheet of the ring-fenced bank. Why did we go to that position? First of all, one of the crucial points about the ring-fenced bank was to make it easy to resolve. If you put any derivatives in, you make resolution more difficult straight away. Secondly, one of the ways the banks want to get over the ring fence, in a sense, is to make it the same on both sides. If you start putting derivatives on both sides of it, the distinction begins to vanish. They want to get cheap funding for their derivative businesses. The ring fence is designed to prevent the taxpayer guarantee, and therefore the cheap funding, from going to the trading businesses, so let us try to put the trading businesses back where the taxpayer guarantee might be felt to be. We can argue about that. I can see why they want to do it, but the customers can adequately be served without noticing the difference by the banks acting as agents. I think that is quite clear. We also felt very strongly that a prohibition was a very easy rule to write, an easy thing to do and a simple position to defend, whereas when you start saying that perhaps you are going to put in this kind of derivative or that kind of derivative, you are beginning on the path that we do not want to go down.

When this was being reviewed, after we published out report and the banks put in all their objections-the ones they had not put in before-there was a rather complex argument, which I cannot quite recall, about the fact that there might be some advantages in resolution if the customer derivatives were in the same place as their accounts. I was more concerned at the time about the leverage issue. I thought, "This is going to be all right. The supervisors will make sure that they are just simple derivatives and it will be okay." I have been struck by the conclusion that you, or certainly your interim report, seem to be reaching. Of course, we suspected this, but you have drawn our attention to all sorts of ways that the ring fence might be undermined. You talked about the need to electrify it. It just increasingly seems to me that selling the pass on this one at the beginning is the kind of unforced error that we will really regret. I can imagine us looking back in 10 years, thinking, "Why on earth did we ever suppose it was a good idea to allow single derivatives in the ring fence? Look at the mess we’re in now."

The derivatives business, partly because of the constant struggle to hedge, grows like Topsy. This is the convolvulus of the banking system. Once you put customer-driven derivatives into the ring-fenced bank, you will have a bigger balance sheet than you care within a matter of five years. I think it is a terrible mistake-a category error. I am angry with myself for not perceiving it more clearly when the proposal was first put forward.

Chair: Thank you. We are short of time. We have three lots of questions to get in.

Martin Taylor: I must give shorter answers, Mr Chairman.

Q2935 Lord Turnbull: Suppose you are back in Barclays. You have a ring-fenced bank and an un-ring-fenced bank. Why is it at all difficult to sell to a customer the loan and then send a message to another part of the bank running a different account plan? From the customer’s point of view, it doesn’t look any different, does it?

Martin Taylor: I don’t think so.

Q2936 Lord Turnbull: Okay. What else can go wrong around the ring fence? On the one hand, you say that people might be trying to get into the ring fence to get cheap funds, but the capital requirements of the ring fence are higher, are they not?

Martin Taylor: Yes.

Q2937 Lord Turnbull: So, once they are set up, banks might claim that it is inconvenient, and can you illustrate ways-which would undesirable-in which they might try to move business one way or the other?

Martin Taylor: I hope we have tried to stop them doing most of it. For some sorts of business, we do not mind where they go. If the bank wishes to advance a loan to a corporate client, and people depend on where it has more deposits, it can come from either side. I would imagine that with the large corporate clients, you would have a loan agreement that would say that the bank was able to advance the money indifferently from either side of the business.

The thing that we were most concerned about, and one still has to watch out for it, is using the ring-fenced bank itself to supply ammunition for the traders, because this, of course, is what has been going on in the universal banking models until now, with some of the distressing consequences that you have observed. We have tried to stop this by having limits on the exposure. The exposures are not zero, but they are more severe than would apply with a third party.

Q2938 Lord Turnbull: On a completely different question, we have one virtually nationalised bank and one heavily public sector owned bank. We could simply follow the policy of gradually selling shares back, so that they become fully owned again.

Do you think that, with either of those two, we should take the opportunity to improve the structure of, and competition in, banking by breaking them up and selling them in bits?

Martin Taylor: I am reluctant to give an off-the-cuff answer to that question. I think that there are a number of policy choices that the Government could make, particularly with RBS, and I genuinely do not feel qualified to say which is the best. It depends really on your objectives. I would like to have a feeling that the Government recognised that there were policy options and were thinking along those lines, rather than simply saying, "Our job is just to get the business back into the private sector at some stage, as is."

This was a very unpopular view at that stage, but given that the Government had all sorts of objectives for the banking system, I did not understand why they did not simply nationalise RBS completely two or three years ago and use it as a vehicle to do what they wanted to do, but I think that has been passed-

Q2939 Lord Turnbull: That option must still be available.

Martin Taylor: It is still available.

Q2940 Lord Turnbull: It cannot be that expensive to buy the remaining 15%.

Martin Taylor: Alas, no.

Q2941 Mr Love: I am going to apologise to you and come back to proprietary trading.

Martin Taylor: I was afraid someone might do that.

Q2942 Mr Love: I do that, because I fear that when the Commission has its review of what it is going to recommend, we will find people on both sides saying, "Martin Taylor was in favour of proprietary trading," or "Martin Taylor was against it," so I want to press you a little.

You were very clear about the view taken by your commission, which was specifically on financial stability grounds, where you thought that proprietary trading was insignificant. As you have indicated, we are looking at it from a different perspective-that of standards and culture. If you were taking into account financial stability, but looking at it from a standards and culture point of view, how would you come down if you were a member of this Commission? I accept that you have not been involved in all the sessions, but I think that you have got a flavour of what we have been hearing over the past several months.

Martin Taylor: It has been quite a strong flavour from time to time-extra hot.

What do I not want to happen? I do not want us to ban proprietary trading and imagine that the problem of bank-client, agency-principal conflict has been solved. However you frame this, banks are, in their own way, highly leveraged, highly expert organisations that are trying to make money out of the financial flows in the economy, and most of those financial flows come from their clients. There is sometimes a tiny flavour of proprietary trading being wicked because there is not a client involved-client flows by helping the client1. Banks have always made far more money out of client flows than out of any naked proprietary trading desks.

I think that banks can still get into trouble by abusing their leverage and their market-making position. We are trying to make it harder for them to be over-leveraged, which has to be a good thing. If the supervisors make it clear that they will put more trading capital requirements on banks that have larger open positions, we will see a different business model.

In a sense, what is happening is that the supervisory community is trying to force a different business model on the banks, and particularly on the universal investment banks, and the banks want to change as little as they can get away with, so they lobby against every change. We need to ensure that the industry is strong and viable. There is no point cutting off every avenue to financial success for a bank; that would not be a clever thing to do. We want to protect them from their own worst impulses. Curbing their trading excesses is obviously a good idea. Whether a ban on proprietary trading as such is the best way to achieve it; that is what makes me uncertain. The distinction between proprietary and customer trading is not as stark as it is sometimes made out to be-that is why Martin Taylor is havering.

Q2943 Lord Lawson of Blaby: It could be harder-

Martin Taylor: Could be, yes. No, I am not hostile to it.

Q2944 Mr Love: You said earlier that Volcker had over-sold the ban on proprietary trading. I think that that is what you are saying here.

Martin Taylor: In my view, yes.

Q2945 Mr Love: Let me just ask you two final questions, which relate to whether we could electrify proprietary trading-in other words, do the same as we are doing with the ring fence so that the regulator would be allowed, if he felt it appropriate, to ban proprietary trading for an individual bank. In the review process that will take place, we could specifically ask them to look at proprietary trading. As has already been indicated, the banks say that there is not an awful lot of proprietary trading going on, but we suspect that when the economy turns, it may well increase. Could there be a role for the regulator or the review process to re-look at this on a regular basis?

Martin Taylor: I think the way for the regulator to do that would be to calibrate the capital against the degree of market risk being run, and let the bankers know that if they increased their market risk appetite rapidly, their capital would go up even more rapidly, so it would become, at the margin, less and less profitable to them. I understand that in the new macro-prudential world, that kind of idea is on the table, and I certainly would not be hostile to it.

Q2946 Lord Lawson of Blaby: May I raise one other issue? There has been a lot of concern about the inadequacy of the IFRS accounting standard when it comes to banks. It is suggested that perhaps that is part of the reason, or maybe a minor reason, why the auditors’ input into alerting this approximated to zero-in fact, it was zero. Have you thought about that, and are there any changes in accounting standards as they affect banks that you would like to see?

Martin Taylor: It is not so much the standards as what people do with them. I think there are three areas that are possibly dangerous. These are all huge issues, as you well know. One is the way that, in the bubble, people were using mark-to-market accounting to increase their profits as asset prices rose in the boom and then paying out the unrealised profits in cash, which weakened the balance sheets of the institutions as they did it. One could even say that there was a certain amount of what you might call "Lance Armstrong banking" going on, where people were putting in place fancy instruments that only they could value.

Q2947 Lord Lawson of Blaby: Are you talking about mark to model?

Martin Taylor: Yes, super-performance. That is with one area. Really the blame was with the boards for allowing the unrealised profits to be paid out, although of course everyone told them that if they did not, all their talent would leave. That is No. 1. No. 2 is the obsession for net present valuing everything, so that the old matching principle has been completely abandoned. This is making company accounts very difficult to interpret. For example, if a company realises that it will make a small tax saving every year for the next 12 years, it is required to roll those numbers up. Although it gets the cash over 12 years, it must roll the whole lot up into one parcel and put it into its accounts straightaway, so the P and L gets more and more out of sync with the cash book.

In the banks, this was particularly an issue with the derivatives book. People could write a long derivative and take out the fee stream to the client, which might have been 20 or 30 years, roll it up into one number and take out half the money upfront. That was enabled by the accounting practice, and even encouraged by it, but I do not think it was caused by it.

The third thing is something I remember from my time at Barclays. In the ’70s and ’80s, there was an awful lot of cushioning in the accounts, and people effectively had secret reserves and provisions all over the place, so you couldn’t really see whether they had any money or not. The accountants tried to outlaw this, and their intentions were good, but we got to a situation when you would extend a loan to a risky client-if you had a lot of risky clients, you knew for certain that 10% of them would not pay you back-but you weren’t allowed to reflect the risk in the credit book until the actual failure took place. What we tried to do then at Barclays-I think Barclays still runs some version of this, but it can’t put it in its accounts-was to try to compute the embedded risk in the book, so when it looked at its capital and dividend policy, it supposed that those losses had been taken all the way along, rather than waiting for the crash. I think that is just prudence, and I do not see how you can run a bank without doing that, but the accountants say that it is illegal, so you cannot put it into your accounts.

Here are just three elements where current day accounting practice makes the business even harder to run that it would otherwise be.

Q2948 Lord Lawson of Blaby: When Sir David Tweedie was before one of our Sub-Committees this afternoon, he said that that is totally untrue and that you could always provide for expected losses under the system, but no one else has said that, so he must be wrong.

Martin Taylor: He was not at Pricewaterhouse-it would never let me.

Q2949 Lord Lawson of Blaby: Anyhow, do you think these problems are serious, and do you think they can be solved?

Martin Taylor: I think they are serious. Whether they need to be solved by people, by changing the accounting standards, or by having people understand their own accounts and behaving better, I’m not sure, but they are certainly serious.

I am sorry, Mr Chairman, I have spoken too much.

Chair: Not at all; that was why we brought you here.

Thank you very much indeed for coming to give evidence. It has been extremely clear and very thoughtful, and we have benefited a lot from it.

Martin Taylor: At your service; thank you.

Examination of Witnesses

Witnesses: Giles Andrews, Co-founder and CEO, Zopa, and previous Chair of P2PFA, Theresa Burton, CEO and Co-founder of Buzzbnk, Tony Greenham, Head of Business and Finance, New Economics Foundation, and Andrew Robinson, CCLA Investment Management and Chair of CDF, examined.

Q2950 Chair: Good afternoon. Thank you very much for coming to give evidence to us on this interesting and new aspect of this topic. I am not quite sure who will want to pick up this question first. Can I begin by asking whether you think that if we got more diversity into retail banking we would raise standards in banking?

Tony Greenham: Shall I pick that up? A good way of answering that question is to consider the difference between competition and choice. They are not necessarily the same. The diversity of banking institutions which can focus on different segments of the economy, different customer segments, different sorts of customers, different geographical areas, different industries and different sorts of clients, and focus particularly on those areas, gives an additional, genuine choice to potential customers. That does not exist if you simply have a series of very similar banks competing, which is effectively the situation we have had for some while in the UK. We have by international standards a remarkably homogenous banking industry: very concentrated, large national players, very few local banks if any; and they all tend to prioritise chasing the same customers. That leaves large areas, I would suggest-it remains to be quantified what the gap is-but it definitely leaves areas of the economy, sections of society and geographical areas underserved.

Q2951 Chair: So was that answer yes, because the homogeneity in banking would be broken down by the greater diversity that would come with this new type of banking?

Tony Greenham: Yes.

Q2952 Chair: Is there anybody who disagrees with that?

Giles Andrews: I do not disagree but I could make another point in addition, which is I think one of the things that new entrants bring is almost an obsession on value-in other words to try and provide a different kind of value to consumers; and the homogeneity speaks to providing a service that is very consistent. The innovation, if you like, in trying to provide different kinds of value to consumers, is ultimately good for consumers.

I think the homogeneity of the structure also tends to lead to some herding behaviour, which isn’t always in consumers’ interests. You can see that at one level by some of the more famous mis-selling scandals, recently; but even in our case, where we are not trying to compete across banking as a whole, but in a narrow area, there are certain practices, I think, that you could argue were anti-competitive, which are helped by the similarity and the lack of numbers of the players exhibiting those anti-competitive behaviours. I could elaborate further if that is helpful.

Chair: Maybe will have an opportunity to draw out some more detail in a moment.

Q2953 Baroness Kramer: Could I just say to those giving evidence in this session that for a number of people on this Commission this is a relatively different area of discussion from that which we focused on before. So if people could include in their responses something of the flavour of what it is you actually do, what the area you are representing today does, that might be quite helpful in getting some sort of grip on that.

I think there is a real interest in understanding whether the kind of alternate providers that you are looking at, or are aware of, or represent, are filling gaps and vacuums, or whether you are in some way a direct competitor to the existing banking structure, and one that could have the consequence of forcing that to change.

Tony Greenham: I think the answer is both. I think it is useful to think of the potential universe-just thinking, now, about loans-of lending opportunities as being in three segments. There is one segment of pretty straightforward, good propositions, with good credit history, good collateral, perhaps, and that is well known; and these the mainstream banks find relatively easy to process through their centralised business models. Then there is a group of people whom it is not economically viable to lend to, and they shouldn’t receive credit; but there is an awfully large, we believe, gap in the middle, where more knowledge is required, more proximity to the market, more focus on particular segments, perhaps, and this is the area where alternative providers can meet unmet demand. Also, I would say that the disruptive new business models that we are seeing, including peer-to-peer lending, absolutely have the capacity directly to compete for existing business-those customers the existing banks are serving, but not serving well enough.

Giles Andrews: My business, Zopa, is a peer-to-peer lending business that, I agree, is typically serving the same customers that would be served by banks, so we believe we are a direct competitor to what they do and, therefore, to finish your question, could be a driver of change in their behaviour.

Q2954 Baroness Kramer: Theresa, where do you fall in that?

Theresa Burton: Buzzbnk is a peer-to-peer lending platform for social enterprises, charities and community enterprise, and we tend to focus on segment 2 that you outlined, so we don’t see a direct competition with the banks. More, we see this huge gap that we need to try to address, especially as the high street banks tend to withdraw from those sectors and move more to the safer ones. So our focus is on helping those communities and that more direct type of lending.

Andrew Robinson: My first job in the UK was to set up a charity. It was the first of its kind, and all it would do was lend money to not-for-profit organisations in depressed urban areas that couldn’t get a loan from a bank. Despite having viable plans they were just a bit odd and couldn’t get through the credit scoring systems that were there. I think there was also a subtext there of a deep disbelief that they could ever pay back, because of the types of people that were involved in the project, and that would be everything from BME women, not-for-profit organisations, micro-enterprises and so forth. So it is absolutely, in the UK in 1994, about filling the gap. One of the things also filling the gap around personal credit provision in the UK is credit unions. I am from Canada, and 17% of Canadians now use a credit union as their primary financial services provider for all products, including insurance and mortgages. The credit union just looks like a bank, essentially. Some 46% of retail lending was SME lending.

Tony Greenham: I think 46% of adults are actually a member. They may not use the credit union as their primary provider.

Andrew Robinson: 17% use it as a primary, but 46% are a member of a credit union. Credit unions are definitely seen to be direct competitors. If I take that on a bit further, when I was working with NatWest, we wanted to create a partnership programme with credit unions in England, because less than 1% of English people had an account with a credit union. We were written to by Ulster Bank, who said "Why would you do that? They have 40% of the personal savings market over here. Why would you want to encourage competition?" So, to answer the question, the policy response to the growth of alternative finance providers in the UK has largely been dominated by gap-filling, but abroad, in places with more supportive environments, these providers absolutely rise up to compete head to head with banks and force those banks to become more interested in markets where, perhaps, they would not see low-hanging fruit.

Q2955 Baroness Kramer: Could I just ask one more question? Giles, you mentioned innovation early on. Could you give us your view of innovation in the traditional banking sector and what your sector is bringing to the picture?

Giles Andrews: In terms of the way we have chosen to innovate, Zopa was the world’s first peer-to-peer lending business. We connect people who want to save money; we allow them to lend it to people who want to borrow. We have taken a very small part of banking. Banks provide a very wide range of services, from current accounts to credit accounts and even investment banking products, as Martin Taylor was explaining. We have said that, actually, there is a small part of banking which is simply about making a loan for a fixed period of time-probably three, four or five years-and matching that maturity and repayment profile against someone else who is looking to make a saving. By doing that, and eliminating the entire treasury function of banks, with the matching of maturities, lending long and borrowing short, and the kind of things that got Northern Rock into trouble, you have reduced an enormous amount of complexity at the bank to an incredibly simple, easy-to-understand thing. By doing that you can strip out a lot of the people, the costs and the risk. If you lend only in matched maturities, you are taking away a fundamental risk in banking. That allows us to offer better value to consumers. We have innovated by cutting things out, rather than by doing anything. Lending and borrowing is hardly an innovative activity in and of itself.

Chair: I have a few questions I would like to ask about peer-to-peer lending, but I hope Mark Garnier is going to get them in first.

Q2956 Mark Garnier: Giles Andrews, may I carry on with this subject, because I am interested to learn more specifically about the peer-to-peer lending market? At the moment you are doing private customer to private customer. Is that right?

Giles Andrews: Yes, we are. We are in the process of launching a small business arm by focusing initially on sole traders. Sole traders behave mostly like private consumers, so the fundamental credit risk-

Q2957 Mark Garnier: They are micro-businesses.

Giles Andrews: Yes. There are 3.5 million sole traders in this country, ranging from plumbers to window cleaners to hairdressers to barristers.

Q2958 Mark Garnier: I am trying to get a flavour of how this works. Typically, what size would a lender be and what size would a borrower be? Are you matching a lender to a borrower, or are you pooling these loans?

Giles Andrews: It is hard to describe a typical lender, because they vary from people lending £10, which is the least you can lend-our biggest lender is lending just under £1 million, and the average is about £5,000. The average loan, coincidentally, is also about £5,000, and you can borrow up to £15,000. It is an unsecured loan. It is typically to buy a car, a kitchen or something like that. On the pooling side, we have direct relationships between lenders and borrowers over very small amounts of money. As a lender, we divide your total lending into units, typically of £10. You do not lend into a pool, so there is no pooling or collection of risk; you have direct risk exposure, but you have it to a number of different borrowers.

Q2959 Mark Garnier: So what it essentially means is that a little bit of your loan could default on you, but it would only be a small part. You are not taking a 100% bet on one individual.

Giles Andrews: No, typically you are lending to at least 200 or 300 different people, which allows us at least to provide accurate predictions. The overall level of credit losses is not reduced by our diversification, but it at least enables us, if everyone is lending to 200, 300 or 400 different borrowers, to provide very accurate information on what level of risk an individual is taking and therefore how the risk can be priced.

Q2960 Mark Garnier: That makes complete sense. How do you assess the borrowers? One thing that a bank would do is assess the borrower’s ability to repay the loan, but how does that work with your borrowers?

Giles Andrews: We use many of the same techniques. We buy credit data from the same people that they buy it from.

Q2961 Mark Garnier: From Experian?

Giles Andrews: Actually, we buy it from Equifax and Call Credit, but Experian is another name. We put them through our own internally generated risk models, scorecards and algorithms. We also introduce from the very beginning a much more human side to what we do. There was a great fad in banking in the ’90s and pre-credit crisis where consultants were saying that banks should automate everything because computers make better credit decisions than people do, and banks have stripped out an enormous amount of their human side.

That is particularly relevant to the SME sector, because banks are unable to make human decisions to lend, when humans make the best decisions on lending to SMEs. Someone goes to kick tyres or count parts in a warehouse. We have re-introduced quite a lot of that, which is very economical for us to do at scale. It involves a simple phone call, where we can establish, we think better than any algorithm can, the likelihood of that person re-paying. It starts with identifying them very thoroughly. Our underwriters are very highly trained in asking questions about the use of the funds and things like that.

Q2962 Mark Garnier: When you come to do your business lending, have you got an idea of what the typical loan will be and what your limit will be on unsecured loans?

Giles Andrews: We will start out doing the same as we do now.

Q2963 Mark Garnier: So you will be lending, instead of to an individual, to someone-

Giles Andrews: We already lend to sole traders, but we do not lend to them for their business. If a window cleaner says they want to buy a new kitchen, we evaluate them in terms of stability, based on how successful they have been and for how long they have been self-employed. The actual loan purpose, though, is not connected with the business. There is an additional risk. If you lend to someone for business purposes as well, you are introducing further risk. We want to tread gently and grow that side of the business slowly. We will start as close to what we do now as possible.

Q2964 Mark Garnier: What is the potential size of this market? I am interested in how big what you and your associates do is in terms of the value of the market, and where you think it is getting to.

Giles Andrews: If we deal with the consumer side first, we believe that the market is £19 billion of new lending each year. We have achieved in the region of 1% of that.

Mark Garnier: That is you alone?

Giles Andrews: Yes. Peer-to-peer as a whole is probably 1.5% of consumer lending. We have done that without any advertising or promotion. No one has ever heard of us, including some members of this Committee, I suspect, before this sitting.

Q2965 Mark Garnier: You are on telly now.

Giles Andrews: I think that that represents the opportunity. Given that we believe that we have at least as good, if not a better product, there is no reason why we could not take significant share from the incumbents, because five players have got the other 99%.

Q2966 Mark Garnier: I appreciate that. I have a question about competition, because one thing the banks do not like is competition coming in. Presumably it would not take much from the banks to snuff out what you are doing, if they suddenly decided that they wanted to have a go at you. Have you had any thought about that?

Giles Andrews: It is difficult. It is the classic disruptive technology. What does an incumbent do when faced with a disruptive entrant? To compete with a disruptive entrant, they have to discount their pricing significantly across the board. They cannot just compete with the customers that might otherwise go to the disruptive entrant. Often the most sensible thing for them to do is to ignore it, because it might go away. It is classic behaviour. Look at the people building railways and the big competitive industry fights that you have had over the past hundreds of years. Typically the incumbents do not respond, because it is uneconomic for them to do so until such a point where they have to respond, by which time they have lost some momentum.

Q2967 Mark Garnier: But they still have very big balance sheets. £19 billion lending per year, when you think about-

Giles Andrews: But the beauty of the model is that the balance sheet is completely irrelevant. Zopa has no balance sheet and has no need of one.

Q2968 Mark Garnier: But the point is that they do. If, say you had 50% of that £19 billion lending market, which would be £9.5 billion, by the time you look at the big four banks combined-

Giles Andrews: But if we offer 2% or 3% better value, then they would have to offer 2% or 3% better value across their entire personal lending book, which would have an impact on their PNL of many hundreds of millions. Their shareholders would not thank them in the short term and it is unlikely that they would do it.

Q2969 Mark Garnier: One other risk to your model is on the regulatory side. I do not mean this in any disparaging way, but inevitably there will be a little bit of a scandal at some point where someone will pick something up and put it across the red tops. That may lead to a regulatory backlash and a reputational backlash as well. What are your thoughts about regulation and the potential that something may happen that may cause you a problem?

Giles Andrews: We have really confused regulators for about three years now because we have been calling for regulation for our sector for just those reasons: out of fear of something going wrong in the future and there being a backlash either at consumer level-because something has been captured in the press-or at regulatory level, and they may react too fast to something that happens. We have been saying we believe that there are certain parts of our business that it would be helpful to regulate, so we formed a trade association to-

Q2970 Mark Garnier: Are you regulated at all?

Giles Andrews: No, we are not. We have a consumer credit licence from the OFT, but we are not regulated for any of our lending activities by the FSA.

Q2971 Mark Garnier: And do you want to be?

Giles Andrews: There was a Government announcement just before Christmas that they are planning, in 2014, to regulate peer-to-peer lending, so we have got a big job to make sure that that regulation is fair, appropriate, proportionate and does not kill the innovation. But there is no reason why it should; the only reason a regulator would damage our business is if they tried to assume that we were doing something that we were not. We do not take deposits so we do not need to be regulated as a deposit taker and we do not manage investments so we do not need to be managed as an investment manager. There are certain things, however: we hold client money; we need to lend responsibly; we need to have credit policies that are consistent and transparent; and we need to talk to customers fairly. None of those things should damage our business. If anything, a regulatory seal may help us to build trust and grow faster.

Q2972 Mark Garnier: You are associated with a trade association. Could you remind me of its name?

Giles Andrews: It is called the Peer-to-Peer Finance Association. It currently has three members: Zopa, Funding Circle and RateSetter.

Q2973 Mark Garnier: Presumably, together you will try to work out a regulatory framework?

Giles Andrews: We have come up with one. We abide by a set of principles and operating standards and we have politely told the regulator what they are. I am sure that they will not adopt them wholesale but it is a starter for ten, yes.

Q2974 Mark Garnier: Just out of interest, have you had many people come forward to your three-man association with a view to starting up in this? Is this an area where there is a lot of interest in terms of potential newcomers coming into the marketplace?

Giles Andrews: Yes. It is a business where people are launching businesses, certainly quarterly. I would not say monthly. I do not know whether that feeling is shared by the other witnesses?

Witnesses: Yes.

Giles Andrews: There is a lot of activity in the sector.

Q2975 Chair: Theresa Burton, you have not had much of a look in so far. Is there anything you would like to add on the basis of what you have heard before I bring in Pat McFadden?

Theresa Burton: One of the things I want to point out for Buzzbnk and our focus is that, we, ourselves, are a social enterprise and we are owned by the Esmée Fairbairn foundation and the Tudor Trust. Our goal is to help build the social investment sector in the UK. Therefore I see us as a potential pipeline in helping get these organisations off the ground. We might be more associated probably with early stage financing, the more equity-like finance than lending, but it comes in because some of the organisations we work with cannot necessarily do shares or might not want to do them right away. So we are in a blurred area between equity and lending and donation. We would basically look at what we are trying to do in addressing this gap, in building a more robust community for these organisations, which potentially then go on to become mature enough to lend from and become customers of the banks and from Zopa and Funding Circle. That would be our perspective. I know Andrew that has done lots of work on trying to understand that gap.

Q2976 Chair: Do you want to add anything, Mr Robinson or Mr Greenham?

Andrew Robinson: You asked about the demand for Zopa business, and the area that most concerns me-BIS has now nailed some research, which is probably the best it can get-is that there is a place where no banks compete. That is about £5 billion to £6 billion. I know Baroness Kramer has seen some press. I was on a panel on Friday with the BBA, and they were saying there is an enormous supply of capital; there is just nobody who wants to lend in that place. I love the soundbite: "Just get out of the way then and be honest about what you do not do." That gap is about £5 billion to £6 billion, according to BIS research. According to some other research in 2012, they reckon there is about £925 million of required financing that the banks will not do but that the alternative lending sector, which focuses on market failure, has only £200 million of capital to lend. That is about what they are doing every year. That is the only thing I would add about demand.

Tony Greenham: May I define what we mean by "alternative providers"? I should have introduced that at the start. I should possibly place myself in relation to the other witnesses. The New Economics Foundation is an independent economics policy think-tank. I am a former banker, but I do not represent any particular section of the banking industry.

In our research, however, what we have discerned, looking at this country and other countries, is that there is generally-not in the UK, but generally-a broad range of alternatives to what we would recognise as shareholder-owned commercial banks, which dominate our banking market. There are various forms. There are co-operative banks, which are particularly prevalent in Europe. We have one co-operative bank, but it is a national one; it is a bit of an oddity. There are credit unions, which Andrew has already mentioned and which, particularly in North America, have significant market shares. There are public savings banks, which are models we see in Switzerland and Germany but also elsewhere. And you also have, in the US and in this country, the community development finance institutions, which hopefully some members of the Committee have come across, and, again, Andrew has mentioned them.

In addition to those four forms, we of course now have these new models, which are represented here, of crowd funding and peer to peer. We would argue that the more of those you have in your banking system, the healthier it is for customers and for the economy. That is the evidence our research is telling us. It seems to me that it should be an explicit objective of banking policy in this country to encourage a much greater degree of diversity of provision across all of those potentially different forms of bank.

Q2977 Mr McFadden: I am very interested in what you have been saying about crowd funding and peer-to-peer lending, but-this may be more for Mr Robinson and Mr Greenham-I really want to ask about those more traditional forms of mutual lending that are smaller in the UK than they are in some other countries. I want to explore why that is the case.

You mentioned credit unions and the Canadian experience, Mr Robinson. We have credit unions here, but they are a small player on this pitch. From your experience, why do you think they are so much smaller in the UK? Is there a legal or regulatory change staring you in the face that might change that position?

Andrew Robinson: Why don’t we let the think-thanks start on that one, because they have done specific research, and then I will talk more practically about things on the ground.

Tony Greenham: Absolutely. Partly an accident of history and partly regulation: the credit union movement here only started in the ‘60s and ‘70s, and regulation came in later. In North America, we are talking about the beginning of the 20th century. On the mutual movement, the irony, of course, is that the UK is where mutual financial institutions were born. We have lost that sector as a result of various developments, including the demutualisation of the building societies and the gathering-up of all the local trustee savings banks into one national bank that was then taken over by Lloyds. We have lost that diversity. I think that is a series of cumulative policy decisions or market developments that we should now regret. In other countries, they have tended to protect those mutual sectors in one way or another. The question is, "Well, it’s gone now, so how can you suddenly magic a large mutual sector out of thin air?" It is very difficult. When the building societies were demutualised, that was 100 years’ worth of capital. The cumulative savings of over 100 years were given away, essentially.

However-and this is where, Andrew, I am sure, will have some ideas-we do still have a mutual sector and the credit union sector is potentially ripe for growth. There are, again, things that we can learn from other countries, and I would emphasise one thing, in particular, that we have observed through all those different forms I mentioned-co-operative banks in Europe, credit unions in North America, and savings banks in Germany, even. They operate on a model of a network of local banks that collectively own back-office functions and share in central services that allow them to access the economies of scale and efficiency that you can get from having a large national organisation, but in terms of governments, their local roots, and the focus of management, there are 320 separate local savings banks in Germany, but they are all part of one system. Equally, the credit unions in both the US and Canada are locally focused institutions, mutually owned by their members, but they all have central services institutions that provide liquidity services, marketing services and all sorts of central support. So the model of networks of local institutions combining to get economies of scale crops up again and again elsewhere, but we have no equivalent here.

Q2978 Mr McFadden: So what you’re saying is that yes, credit unions exist in the UK, but they are very small and local, and what we lack is that central, back-office, shared-services organisation that could increase the scale.

Tony Greenham: I think that’s right. There have been some moves in this direction, and it is the right direction to go-to build that sector. Andrew, perhaps you would like to add something.

Andrew Robinson: There was severely constraining legislation until very recently, where they could only accept clients, or members, from very narrow postal code areas, and it is only in the last decade that they have been allowed to move out and grow in size. Fundamentally, it is about a lack of welly to market their services. The problem with alternative providers is that they have a history here which has meant that they have been seen more as gap fillers-community projects in the back of a community hall.

There are new models developing. In Scotland, there is Scotcash in Glasgow, which is a partnership between banks, housing associations, and I believe a credit union is involved. It is a significant institution that is doing some brilliant work there. They are leapfrogging over a lot of development barriers through working progressively. It would not have happened, however, without the council showing significant leadership and bringing resource to bear on it.

Q2979 Mr McFadden: Can I ask you a final question? Perhaps this is one for you, Mr Greenham. One of the biggest changes on the high street will be the Co-op taking over a large number of branches from Lloyds. What potential do you see in that development for changing the picture on the high street, in terms of the offer to customers?

Tony Greenham: Well, we should always welcome a significant new challenger bank. I have no doubt about that. I think it is helpful that we improve the diversity by that challenger bank being a customer-owned one. However, it does not solve the issue of introducing locally focused institutions. The Co-op-unusually for co-operative banks across Europe-is a nationally focused institution, rather than a collection of local co-operative banks. It will certainly have an impact, I hope, on competing for those customers who are currently being served. It will introduce more competition and choice, but I do not think it will make significant inroads into what we have been trying to describe here as the unmet demand, not because that demand is economically unviable lending that should not take place, but simply because the institutions-the large banks-are structurally not set up to meet that demand. I do not think that the Co-op doubling in size by itself answers that unmet demand.

Q2980 Baroness Kramer: We all hear the name Wonga on a regular basis, usually with some political fury following. I would assume that anybody who can repay a loan at Wonga’s interest rates can reliably repay a loan at a much cheaper rate. Is this the company that, if you like, has largely managed to fill the gaps that you have been describing, Tony? Is that the gap that you are trying to cover, where the Wongas of this world have moved in, and, because they face no competition, are able to offer services, but at most extraordinary prices?

Tony Greenham: It might be useful here to separate personal lending from business lending. Certainly they have moved in to meet that unmet demand, perhaps, for personal lending. Credit unions cannot really offer a payday loan product, because the cap on the interest rates that they are allowed to charge makes it almost impossible for them to offer that product commercially, unless they can cross-subsidise it somehow.

Personally, I think that the heavy marketing of payday loans is itself a kind of market distortion, and there should be serious consideration as to whether it is helpful to have vigorous marketing of high cost credit that does not come with attached debt advice, financial information for consumers, and the sorts of obligations that would make that market more akin to a true market, if you see what I mean. There is a danger here of consumers being bamboozled and encouraged to take on excruciatingly expensive short-term credit that they would be ill-advised to take on.

Q2981 Baroness Kramer: But if you were going to compete that out of the system, what would you need to do to create a competitor?

Tony Greenham: If you go down the high street in Brixton, you will find several high cost lending shop fronts there. A lot of venture capital has gone into that industry. They have huge marketing budgets. They can get premises on the high street. You will also find a branch of London Mutual Credit Union in Brixton, which has a shop front and is an excellent institution. However, it does not have anything like the marketing budget or the large injection of capital from anywhere, least of all venture capitalists, that would enable it to compete in a level way on that marketing push.

Andrew Robinson: On that point, Unite has done some research on its members. Recent research says that 82% of members are so low paid that they are not basically able to eke out to the end of the month. Of those, some 12% to 15% are using the likes of the brands you have chosen and three of our other well-known ones.

I work for a fund manager at CCLA. We manage money for charities and local authorities. One of our major competitors has taken a significant position in one of the payday lenders, because they are going to make supra-normal profit from the investment that they make. It seems to me that if competition in areas of disadvantage is not there, people will come in and take advantage of that situation.

Tony separated out small-business lending from personal lending. In fact, there is research on money shops and pawnbrokers. There is one significant well-known brand that since 2006 has gone from 168 shops to 450, and within their portfolio they are lending to SMEs. They claim, "There is strong demand for short-term small flexible loans", and the price that they are getting is deeply attractive.

When you make the kind of returns that you do in that business, you can afford to pay Kerry Katona to come in and be your poster girl to market to that exact group.

Theresa Burton: Although right now we do not lend to individuals I would like to point out that there is no incentive for those organisations [Pay Day Lending] to solve the problem or help contribute to solving the problem-helping to solve the problem is debt advice or micro-savings plans. They do not really have an incentive to put themselves out of business. At least with some of the other structures, where you have deposits or some type of savings, there is also an incentive for the organisation to have the savings side of it.

Q2982 Baroness Kramer: Tell me if what I am hearing is correct. If I am looking at somebody like Giles and the companies that you would represent as an association- Funding Circle and RateSetter-capital is not your issue?

Giles Andrews: Yes.

Q2983 Baroness Kramer: Growth is based on your business plans and strategy. But for those who are trying to fill the gap of services to those who are more disadvantaged, capital is a major issue. Is that right? If that is the case, is there a mechanism that you can see that you believe would be appropriate and that we ought to think about in policy terms?

Andrew Robinson: Yes. When I started in the UK, in the first term of the new Labour Government, there was a tremendous focus on social exclusion, and that morphed into financial exclusion. One of the social exclusion working groups was a Treasury-led one, which was interesting because it cut through quite a bit of the fandangling between different Ministries around business in deprived areas. They came up with a solid list of things that needed to be done. That led to something called the Social Investment Task Force, which created another solid list of things that needed to be done.

All these interventions, in part or whole, have been slowly followed through; some have not completely. So there is a well-documented list that we can submit to your people to say what those are, without boring you. Further work was then done by the Community Development Finance Association, the trade body for these mission-driven intermediaries. They have a simple list of asks of six things. It is what you would sort of expect, looking at the infrastructure and focus.

In terms of focus, it is very interesting that the Bank of England used to have a domestic finance unit, which looked at the health of the regions. One of the things in the mandate of the Bank of England before it was given its independence was the fair and effective functioning of the UK financial services market. That has gone now from the Bank of England. I was talking to someone once and they said, "Well it went to the Treasury for a bit." When I looked at the document, there wasn’t really any substance behind the fairness of markets.

It is about the focus. One of the asks is, "Will the new financial control authority take an interest in this particular aspect of the market-the disadvantaged?"

Baroness Kramer: I think that the specifics might help us more.

Andrew Robinson: Okay. Here we go. I have the list.

Baroness Kramer: At this point, perhaps the answer would be to put that on paper and make sure that that comes to the Committee, unless there are various members who want to ask more.

Andrew Robinson: I will put it on paper.

Chair: Is there anything else any of you would like to add? Andy wants to come in.

Q2984 Mr Love: I do want to come in. If I can follow that up, in the papers submitted to us by Mr Greenham, he talks about a public service obligation on private banks. What do you mean by a public service obligation, in the context of the disadvantage that you have talked about-the £5 billion to £6 billion that is not available to people in communities? What is the public service obligation?

Tony Greenham: I would argue that the banking industry has a clear public interest element. There are many ways you could describe it. Not least, it is expressed by the implicit subsidy that you mentioned in your first report, which we calculated most recently to be £34 billion. The state guarantees the means of exchange, and the means of exchange-bank deposits-are created by banks. That is the deposit-creating sector. Without that functioning, the whole economy goes down. As to the implicit guarantee, we have seen it expressed: we saw it in 2008 very vividly, with a £1.2 trillion bail-out. There is a strong public and utility function in banking. That means that an entirely for-profit system, with no public service obligation on it, is unlikely in theory or in practice to meet all the needs of the economy.

The question is how you make sure that that public interest is served. It seems to me that, in practice, there are generally two routes, which I mention in that paper. What seems to work reasonably effectively in the US is that the large commercial banks are incentivised to co-operate, to capitalise and to build the capacity of the community finance sector-those institutions that have the skills and the knowledge to tackle financial exclusion and to ensure that all opportunities get the finance they deserve. That is done through regulatory measures, the Community Reinvestment Act being the primary one.

The other option is that you try to ensure that your banking system has within it institutions that serve a social as well as a purely financial objective. Many other countries have that; for example, in Germany they have the local savings banks, which I have mentioned already. They operate on a commercial basis-they actually performed extremely well after the financial crisis, with much more stable profits than the mainstream banks-but they are obligated to give a bank account to everyone in their region.

Q2985 Mr Love: I want to stop you there, because I want to focus on the first of those two. The Community Reinvestment Act is predicated on two bases: the first is disclosure of what the banks in this country call confidential, market-sensitive information; I would like you to respond to that. Secondly, there is the idea that banks should reinvest in the areas where they raise their money: why should that be the case? Again, I would like you to respond to that, because the banks would say, "We should reinvest our money where the biggest returns will be gained."

Tony Greenham: Let me take that second point, if I may; perhaps Andrew would like to respond on the point about disclosure and whether that is commercially confidential. The point about reinvestment is also about the deposit guarantee. Banks have this extraordinary guaranteeing of their liabilities in the form of the deposit guarantee. Part of the rationale behind the Community Reinvestment Act is that the state is already guaranteeing those deposits for them, and there is therefore a public interest in how that funding is being applied in lending.

In terms of the idea that they should allocate the capital where they make the most return, it is entirely rational for any individual bank to ignore the north-east of England in favour of the south-east.

Q2986 Mr Love: Or be in favour of international rather than national?

Tony Greenham: Indeed. It is entirely rational, and we should not blame them for that because they are simply acting in a commercially rational way. However, for the economy as a whole, it is clearly sub-optimal if commercially and economically viable opportunities in the north-east go begging because a national bank or international bank can find a couple of basis points more by focusing its attention elsewhere.

Andrew Robinson: It is absolutely right that, if a financial institution gathers deposits from one area and then only lends in productive areas, the area that it has taken the deposits from is denuded of investment, and who is left behind to lend? It is the types of organisation that we have just described. My whole experience in 20 years in Britain is that there are opportunities in these communities, but there are transaction costs associated with getting the credit into them in a way that is safe, sustainable and so on.

Mr Love: I want to come on to that.

Andrew Robinson: It is being done. As to the track record of the lenders, the one I set up is still going. Over 15 years I think it has lost 5% of its grant capital. No investor in the fund has lost any money, but attracting capital from the banks has been incredibly difficult. What they say, fundamentally, is, "You are asking us to lend you money as a CDFI that you are going to lend on to propositions that we would not normally lend to." We are saying, "Yes, we are. Look at our track record." There is just a breakdown of logic here, where the credit departments are not interested in providing wholesale finance. Abroad, where there are data, financial institutions are forced to engage with these, if you like, sector experts-spatial area experts, disadvantaged area experts-and finance is packaged with different layers of grant, quasi-equity-type funding and debt, they are developing an expertise, but there is a kind of forced partnership where the banks are engaging with those intermediaries. They do not have to do, and they are not in any measurable or meaningful way.

Q2987 Mr Love: But you have a very diverse sector. When we were up in Birmingham, we met Aston Reinvestment, which is one of the largest, but there are some very small ones. You have got £200 million on loan and a £6 billion gap. How optimistic are you that you can build a movement to address the need?

Andrew Robinson: Mr Obama has just come in, in the States, and is absolutely committed to scaling up the sector. He has put in place a $1 billion a year guarantee to raise 30-year money at very low cost to invest in these intermediaries. That allows banks to come in and engage, in the way that they do, and has significantly boosted it. The infrastructure is also there, and you have disclosure, so that policy makers can make better policy and that subsidy can be applied in a more honest way than it is now for economic development and community development. You have a whole infrastructure there: you have people in banks, and in the regulatory system-at the Treasury-who focus on this. Their job is to address the point that in a consumer society, where everyone needs credit, not to have it has some pretty nasty outcomes.

Q2988 Mr Love: I have one final question.

Chair: One question, and a quick reply, if possible.

Mr Love: Community investment tax relief has been subject to a consultation. It has not really done the job that it was intended to do. With a Community Reinvestment Act and a tax relief for investment in CDFIs, we could move the sector on fairly substantially. What has gone wrong with CITR?

Andrew Robinson: It was designed at a time when banks were enormously profitable, and therefore it would have been an attractive thing for them to take advantage of. They have not been interested in the tax relief, but the people who have taken advantage of the tax relief are wealthy individuals who, as part of their tax planning, became aware of it through these very small CDFIs trying to promote this thing. It is there and it is in all their tax returns, but nobody knows about it, so public awareness is an enormous issue.

Q2989 Mr Love: Why is the rate of tax lower than that for venture capital trusts and enterprise improvement?

Andrew Robinson: I am not an expert on it, but in terms of what the community development finance says, it is absolutely less attractive and far more bureaucratic than either of those two initiatives, which could maybe be looked at.

Q2990 Mr Love: So what has happened to the consultation that was carried out by the Treasury? It started about a year ago. Do we know the outcome of that?

Tony Greenham: No.

Andrew Robinson: No.

Q2991 Chair: Thank you very much for coming to give evidence this afternoon. I am sorry that you had a bit of a wait for the beginning of the second session. We have picked up a lot in an area that many of us are reasonably unfamiliar with.

You wanted to make a last point, Giles.

Giles Andrews: May I make two points? I will try to be as brief as I can.

The first, as I see it, is about a market failure in the savings market that speaks to banking standards. The bulk of savers’ money is kept at very low interest rates, which is a result of inertia in the savings market and the lack of transparency around banks that offer incentives to recruit customers and then do not tell them that savings rates have fallen from the 3% that they were promised when they joined to 0.1%-as I found out about my children’s savings account very recently. An obligation on banks to inform their customers that promotional events have ended would be very good for competition and for consumers.

My second point is around how a business such as Zopa is actually disincentivised from doing the kind of lending that we have spent a long time talking about, because of a perverse tax treatment. May I just explain that? If Zopa lends currently in a very prime world, where there are very low credit losses, our lenders have to pay tax on the interest they have received gross. If a lender lends money at 7%, suffers a 0.5% credit loss and makes a net 6.5%, he pays tax on 7% and then suffers his credit loss afterwards, and the fact that he suffered a credit loss after tax does not really matter.

If you then move that into a world of more inclusive lending-economically, we simply cannot do that, because of this tax incentive-and lend money at 15%, with an expected credit loss of 8%, the lender would pay tax on the gross amount of 15%. A reasonably high proportion of our lenders are higher-rate taxpayers, so they would pay tax at 6%. They would then suffer predicted credit losses of 7% or 8%, and they would be left with nothing.

The tax incentive, which is in statute-we are talking to the Treasury, as you might imagine, about trying to amend it-is very clear: because these are private individuals earning interest, they have to pay tax on the gross amount they are not allowed to offset. In terms of reasonable expenses to offset against that, a credit loss is a pretty reasonable expense to offset against an income stream.

Until that is changed, a business like ours will never be able to undertake inclusive lending in disadvantaged areas. We have a huge amount of interest in doing so from our lenders, but it makes no sense for them to do so. [Interruption.]

Chair: That is an appropriate moment for us to call proceedings to an end. Thank you very much indeed for coming to give evidence.

[1] Witness clarification: “…..whereas client-related flows are thought to be virtuous because they help the client”

Prepared 12th February 2013