CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 860-i

HOUSE OF COMMONS

HOUSE OF LORDS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

SUB-COMMITTEE J-PANEL ON MIS-SELLING AND CROSS-SELLING

MIS-SELLING AND CROSS-SELLING

WEDNESDAY 9 JANUARY 2013

SUE EDWARDS, PETER VICARY-SMITH and DOMINIC LINDLEY

ANGELA KNIGHT CBE

CLIVE BRIAULT

JON PAIN

PETER DAVIS

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

Sub-Committee J-Panel on mis-selling and cross-selling

on Wednesday 9 January 2013

Members present:

Lord McFall of Alcluith (Chair)

Mark Garnier

Mr Andrew Love

Mr Pat McFadden

Lord Turnbull

Counsel: Adam Tolley

Examination of Witnesses

Witnesses: Sue Edwards, Head of Consumer Policy, Citizens Advice Bureau, Peter Vicary-Smith, Chief Executive, Which?, and Dominic Lindley, Principal Policy Adviser, Which?, examined.

Q1 Chair: Order. Welcome to the first session of our sub-committee on mis-selling. We have five evidence sessions. We are here for the long term, which will be four hours anyway, and you are here for three quarters of an hour, so we wish your answers to be crisp and informative. If I interrupt you, it is because we have such a long session later on.

First, thank you for the evidence that you have given us; it has been very helpful. I know that you have been involved in this issue for many, many years, so we are interested in looking at the time-line aspect of it, but also at the information so that we can best use that in our further sessions. If look at that long time line, in September 2005 CAB wrote and sent to the OFT a report that was a super-complaint about PPI, calling it a "protection racket". You had a report as early as 1995 on mortgage payment protection. Which? has been involved, in the late 1990s and I think you had a paper in 2002 on that issue. So, given that you were in at the beginning of it, we are interested in getting your feel for why this was allowed to go on for so long, what the response of the industry was to it and how we end up in a situation in which the latest estimate is that it could cost £25 billion, according to a report in The Times the other day. Sue, can I ask you, since yours was the earliest report?

Sue Edwards: We wrote the report in 1995 because we were concerned about the reforms to social security legislation, to cut the amount of money that people got to help with their mortgage if they were unemployed. The cuts were intended to encourage people to take out insurance to pay for their mortgage if they were unemployed or became sick. We did not have much evidence on mortgage payment protection insurance but we had a lot on payment protection insurance, and not a lot on mis-selling at that time but a lot on exclusion clauses and on the problems that clients were having in getting their claims administered. They might have been entitled, but it took forever to get the claims in payment, so they ended up in mortgage arrears and at risk of losing their home. We felt at that time, because insurance was not at all regulated, that there was a need to tighten up self-regulation of the sector and for the Government to consider regulation. Also, the reforms needed to better consider how insurance could dovetail with state support.

There was not a lot of change after we wrote that report and, certainly over the last few years of the 1990s, we began to see an increase in the number of people coming to us with consumer debt problems.

Q2 Chair: You called it a protection racket. Why did you call it a protection racket as early on as 1995?

Sue Edwards: At that time, we did not see the great evidence of mis-selling that we were seeing in the late ’90s and early part of the last decade, but it was often going hand in hand with irresponsible lending of consumer credit. People were encouraged to take out credit that they could not afford, and then they were sold payment protection insurance whether they liked it or not, whether it was relevant to their circumstances or not. They were often people, perhaps on benefits, who were told, "Yes, well, you need this loan and you must have this payment protection insurance," even though the bank knew at the time that their only income was benefits.

Q3 Chair: Peter, over to you.

Peter Vicary-Smith: We first warned about PPI in 1998, and again in 2002, 2004, 2005 and 2007. Our reports were fairly consistent: we said that this is a poor product and is being sold badly. Those two things, to my mind, lie at the heart of the problem with PPI. It was a too-high-a-margin product but, as a very-high-margin product, there is the risk of problems. One Lloyds PPI product had an 87% margin. That encourages people to try to sell more and more, whether appropriate or not. You also had some strange dimensions, such as PPI only covering for five years, but the payments being made over the full period of the loan-a 25-year loan, where you are paying for the PPI over the 25 years but are only actually covered for five years of it. So, poorly designed products, and the second thing that goes alongside why it is such a problem was the sales process, with poorly designed remuneration. An Alliance and Leicester salesman at one time would be earning six times as much personal commission for selling a loan with PPI as for selling a loan without PPI-lo and behold, PPI was mis-sold. So, badly designed remuneration, and also then pressurised sales tactics the other way. With that same Lloyds product that I mentioned, with the 87% margin, if salesmen did not sell 50% of the loans with PPI, their bonuses were reduced by 25%. In other words, there was incentivisation to sell more and punishment for selling less. It is the combination of those two or three elements of sales practice with a poor product that gave the issues, to our mind, around PPI.

You asked about the timing and why this went on so long. We were all highlighting the problems with this for many years before the regulator took action. The FSA took over responsibility for PPI, I think, in 2005. In the same year, I think your Committee, Mr Chairman, had Sir Callum McCarthy before it to ask him about PPI, and yet, the regulator took a further two years to take enforcement action. It was not until 2009 that it banned single premium PPI, despite thematic review after thematic review. I would argue that the regulator stepped in far too late and far too ineffectively once a problem had been clearly identified.

Q4 Chair: In the 1990s, there was the ABI and General Insurance Standards Council-that was the regulator-and then in January 2005, it was the FSA. Just quickly, did you notice any difference between the two regulators in their approach?

Dominic Lindley: Not especially. Our first round of mystery shopping was done in 2002, and we record all the phone calls, so we know exactly what was said during the sales process. The thing that surprised us most about that was that when people rung up to ask for a quote for a personal loan, PPI was automatically included, and often that was not made clear, so this was a product that was inertia sold. That carried on in 20051 and to a certain extent, in 2007. We did report2 our concerns to the General Insurance Standards Council, and unsurprisingly, because they are a voluntary organisation, they did not take robust enough action. We highlighted our concerns to the FSA and said that they needed to take urgent action on PPI, but I think it took them quite a long time to get a handle on the product. A lot of the time they would believe, "Well, it is just a problem with the sales process, and if we just improve the information given to consumers, that will solve it," whereas actually, some of these products were so toxic and so expensive, that they should not have been sold to any consumers-like the PPI Peter told you about, where it only lasts for five years and the loan is paid back over 25 years. The FSA took a hands-off approach to product regulation. If you go back to the Turner review, it said that product regulation was not required because well-run firms will only design good products and well-informed consumers will only buy products that are suitable for their needs.3 It was that kind of attitude that probably led it to take quite a lot-

Q5 Chair: Have you sent us that quote?

Dominic Lindley: Yes.

Q6 Mark Garnier: Can I follow on from what you were saying about these remuneration incentives? I am particularly interested in your thoughts about the rules that have been introduced. In 2007, the FSA made new rules for insurance products, including PPI, which basically was to try and tie it up a bit more. Do you think those rules helped or hindered the case of mis-selling, or of combating mis-selling?

Peter Vicary-Smith: Throughout this period, we saw that what the FSA did just didn’t make a blind bit of difference to what was actually happening on the ground. The margins on these products were so high. They had become such an important part for banks of their retail profits that actually, they were selling them come hell or high water. What we saw in terms of the bank reaction was to drag out the process of compliance, judicial review and so forth, because they were making so much money out of them.

Q7 Mark Garnier: The key thing with the FSA is that it is a principles-based regulation, as you know. Principle 7 is a key one: "A firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading." In terms of customer interests, "A firm must pay due regard to the interests of its customers and treat them fairly." That is obviously very important. Principle 1, on integrity, states: "A firm must conduct its business with integrity." Do you think that by having detailed rules you are giving boxes to tick, rather than saying, "Look, actually, we do not think you are behaving with integrity. Therefore, we are going to fine you for that"?

Peter Vicary-Smith: There are a couple of things in here. One is that I think there was a genuine lack of understanding among some senior people within firms as to what principles-based regulation actually meant. I had a conversation, when it was introduced, with the deputy chief executive of one of the major banks, who said to me, "It is not going to make a blind bit of difference to what I do. I do not go into the bank in the morning in order to treat my customers unfairly."

Q8 Mark Garnier: Do you feel you can name that person?

Peter Vicary-Smith: No.

Q9 Mark Garnier: Can you name the institution?

Peter Vicary-Smith: No, because I have given the title, and it was a side conversation.

Q10 Mark Garnier: But it was a major bank.

Peter Vicary-Smith: It was a major bank.

Q11 Mark Garnier: So that narrows it down to four.

Peter Vicary-Smith: Indeed, it does.

Q12 Mark Garnier: Was it a state-owned bank?

Peter Vicary-Smith: Not at the time.

Q13 Mark Garnier: That narrows it down to two.

Peter Vicary-Smith: But the point was that, if you had one individual saying, "I don’t know what this treating customers fairly means, I don’t try to treat people unfairly, so what am I meant to do?"-

Q14 Mark Garnier: It is a senior individual.

Peter Vicary-Smith: It is a senior individual.

Q15 Mark Garnier: Thank you.

Peter Vicary-Smith: Therefore, to my mind, they were so embodied in a culture that, as long as they did exactly what the FSA told them to and ticked the box, they did not have to worry about anything else. In a sense, what we need is the banks to grow up. The analogy I use is that, when my children were five, I used to tell them what to do. Now they are 18, I expect them to use some judgment of their own interpretation and behave with integrity and so on. But the banks still seem to be happier in the culture in which as long as they comply with exactly what the regulator says, they do not have to worry about anything else.

Q16 Mark Garnier: Yet the banks complain mercilessly about the fact that they have too much regulation. You are suggesting that they are simply infantile in their approach to the principles of base regulation and need to be tied up in knots.

Peter Vicary-Smith: The problem is that the culture of the banks is such that they are not at the moment acting inherently with integrity. We have to address the issue of culture, and that is the issue of professional standards. If you do that, you will probably need much less in the way of formal regulation because you need to guide them to act in a way that the new ethnical standards will encourage them to act anyway. But if it were a bunch of cowboys out there, you will need regulation to prevent them from acting badly.

Q17 Mark Garnier: You need rules-based regulation. You are saying that all banks are in breach of principle 1: a firm must conduct its business with integrity.

Peter Vicary-Smith: The evidence is that there is precious little integrity throughout much of the dealings of the industry.

Q18 Mark Garnier: Sue, do you have anything to add to that?

Sue Edwards: They did try to comply with the rules, but the rules only addressed part of the problem. They did not address the staff incentives that were given to sell PPI. The FSA is now taking action to look at staff incentives, so that might resolve future mis-selling problems.

Q19 Mark Garnier: From what you have seen, do you think it will?

Sue Edwards: I hope it does. I feel that the FSA has changed quite a lot since we started to engage with this in 2004, 2005 where I felt that they were very close to the industry and found it very difficult to understand the concerns of consumer groups, particularly concerns of consumer groups like ourselves who deal with very vulnerable people on very low incomes and may have different concerns to other consumer groups.

Q20 Mark Garnier: From what you have seen of the FCA, do you think that they will carry over the changes that you have witnessed?

Sue Edwards: The other change that the FCA will bring in is one of the things that we said in our reports and which became our super complaint. We actually wanted to see the product itself change. We felt that PPI products did not protect people properly, and that was because of various exclusion clauses. When we met the FSA following our super complaint, we said, "It looks like you are going to take action to change the selling rules, but what are you going to do about the product?" They said, "We are not going to do anything because we don’t think that that is appropriate. We will try to work with trade associations and see what they can come up with," and the trade associations came up with a leaflet for consumers. But now the FCA has product intervention powers so, although there is very little PPI sold now, at least in future the FCA could say, "Take that clause of the contract out."

Q21 Mark Garnier: Going back to all your earlier points and to Lord McFall’s question, you said that they were selling loans to people who should not have had loans in the first place, irrespective of the PPI stuff. That, in itself, is just morally vile, isn’t it?

Sue Edwards: Yes. We did a big piece of research on why we were seeing this big increase in people with consumer debts a few years ago before we did our super complaint because we had always thought that debt is a problem when people’s circumstances change. We found that people were in debt because their circumstances had changed, but they had borrowed so much that only a very tiny change in their circumstances had just tipped them over the edge.

People were thinking, "What can we do with all these letters saying, ‘Look, lovely holiday’? Yes, I would like that. I will just sign this piece of paper and get my credit card and a bank loan," and not being encouraged to think about whether they could afford it, and the bank was not doing any real checks on whether they could afford it. It was not unusual for the bureau to deal with people with 20 credit cards or 10 bank loans, and owing £50,000-plus.

Q22 Mark Garnier: On a much, much wider point, among people who seek advice from you-and Peter, your members-do you find that there is a sufficient level of financial literacy among the wider population, or do you think that there is a case-this is another thing I am rather excited about-for increasing financial literacy among the population?

Sue Edwards: There is a case for better financial skills throughout the population-not just financial skills, but how to be a savvy consumer. We are trying to play a part in educating people about how to use financial products and services safely and fairly. I think the financial services industry also needs to do their bit. They need to market and sell products that will actually meet people’s needs, rather than just products on which they can make a profit.

Peter Vicary-Smith: I would agree that there is a need for greater financial literacy. That is, of course, a long-term game plan. The reason why there is a need for greater literacy is in part because the products that are presented are needlessly complicated. When you had HSBC before you, you mentioned-with great panache, I thought-the 162 pages of terms and conditions. That is the problem. There is no need for things to be that complicated. These are simple products on the whole. If they were designed as such and sold fairly, openly and simply, there would be less need for education. But you need both, if you like.

Mark Garnier: You will be pleased to hear that HSBC promises they will be reducing those 167 pages down to just 45 pages of tightly-typed A4.

Q23 Mr Love: When Citizens Advice made its super-complaint in 2005, what did you realistically expect to gain from that?

Sue Edwards: We wanted to draw attention to the problem-it is a big problem-and we wanted some action. In the years before that we tried to work with the banks. We tried to raise cases that we had seen of mis-selling PPI with individual banks. We talked to trade associations about whether baseline products could be improved, but nothing really happened. The new regulator indicated that it was interested in looking at PPI, so we made the super-complaint to give impetus to that. It was not just about looking at mis-selling aspects; we raised other aspects in our super-complaint, but only the mis-selling aspects were looked at. Nothing has yet been done about the administration of PPI claims and baseline products.

Q24 Mr Love: Consumers Association can presumably make super-complaints. Why didn’t you? Why were you beaten to the punch on this one? You had been making a lot of publicity in relation to the mis-selling. Why didn’t you turn to this format? Were you concerned that it might not deliver what was necessary?

Dominic Lindley: Certainly from our point of view it was almost a twin-track approach. There was the OFT who would ultimately refer it to the Competition Commission, who ultimately had the power to unbundle the PPI from the loan and make sure that they could not be sold together. We were also very much focused on the FSA. The Competition Commission and the OFT were clear up front that their remit was not mis-selling, whereas we focused on the FSA and tried to get some urgent action to get them to prevent mis-selling. That is why we did a succession of mystery shopping and communicated that to the FSA. Consumer groups have very limited resources in comparison to the industry, so it is always important to focus our resources on areas where we think we can get quick improvements.

Q25 Mr Love: Can I come back to you two? It ended up taking three years and four months for the Competition Commission to finally issue a report. Did that surprise you or was that part of your calculation? Were you primarily interested in publicising the issue rather than gaining the changes that the Competition Commission could bring about?

Sue Edwards: We wanted swift action. That was the only time that we have taken a super-complaint to the Competition Commission. The super-complaint resulted in a market study by the OFT, which took over a year. When it went to the Competition Commission, they seemed to start all over again. So it was like nothing happened for many years, then finally there was action when the Competition Commission reported.

Q26 Mr Love: I will ask both of you this question. Should the organisation that makes a super-complaint have some follow-up procedure? Recognising the experience here, do we need some changes in the whole super-complaint procedure in the sense that currently it relates only to competition-as Dominic has already said-it does not relate to mis-selling? Are there changes that would make this a more efficient procedure in terms of rooting out inefficiency and mis-selling in the marketplace?

Peter Vicary-Smith: My feeling would be that super-complaints have a particular role to play. They are a great tool for consumer groups to use on issues around competition; we have just done a successful one on credit card surcharges. I think that, rather than try to widen the role of a super-complaint, I would be more tempted to say that we need a regulator that is proactively looking at products with big margins where the problems are most likely to arise, stepping in early to prevent these problems and then responding to evidence that the CAB, ourselves and others are giving about what is happening in the market. Then, the ideal situation is that we do not want to make a super-complaint; we want the problem sorted before you get to that stage because they are often slow, cumbersome vehicles. My feeling would be to keep it focused where it is.

Sue Edwards: Super-complaints can be made on consumer protection issues, too, but there are changes afoot; the FCA will have power to deal with super-complaints whereas the FSA does not have that power. Of course, the new competition and markets authority will change the super-complaint process again, and we understand that the procedure will be much shorter and more focused. Hopefully, in the future, things will be better.

Q27 Mr Love: Peter, some of the changes that you were suggesting about the regulator having powers to intervene on products and so on are already in train. We are told that the FCA is going to be much more proactive than perhaps the FSA was. What changes are necessary in order for them to be really effective in this area?

Peter Vicary-Smith: The main change, I would say, is a change of mindset. It is to recognise that its role is not to sit there and sort out a problem out after the event, but to look spontaneously at problem areas, try to prevent problems developing, deal with things that are emerging quickly and then hold those who have done wrong to account in a serious way.

One of the things that always strikes me is that the only individual held personally responsible through fine for PPI mis-selling was the chief executive of Land of Leather, a sofa shop-nobody within the financial services industry on a personal level. That, to my mind, makes me ask: where is the accountability within that structure?

Sue Edwards: The main thing that the FCA needs to do is to take consumers’ concerns seriously. I think that we have seen a big change with the FSA over the last few years; they have begun to take our concerns seriously and to seek out our opinions in a much more focused way. I feel confident now that they will do that in the future, too.

Q28 Mr Love: I understand that the bill for PPI is now estimated to be around £10 billion, but there are suggestions that, if you project this forward, it could be £15 billion. Did the FSA get it right in the way that it determined this issue, or should it look again at redress on this particular product type?

Peter Vicary-Smith: There has been £13 billion set aside already by banks and building societies to compensate consumers and I would be surprised if that is the end of the story. The FSA clearly got it wrong in terms of how it managed the process of the problems of PPI. Then, the banks also got it dramatically wrong both in terms of how they designed and sold the product and the extent to which they dragged their feet and were dragged kicking and screaming to start the process of redress. Since then, some banks have responded well to try to get ahead of the game and get this problem behind them; others have continued to obfuscate and deny.

I was struck by the ombudsman’s comment that where claims have come to her where the bank has said that the person does not have PPI, in 25% of cases she finds that they do have PPI. Within some institutions there is still a mess in trying to sort it out. If the banks are serious about wanting to get this problem behind them-as they should be, reputationally and financially-they have got to engage with the process of sorting out the backlog of mis-selling.

Q29 Mr Love: This is one of the bundled products, and there are number of others on the market; indeed, there are emerging products of this nature. How do we ensure that we do not have a problem similar to the one we had with PPI with the other bundled products? I know that the Competition Commission can force their separation, but how does the regulator make sure that we do not have mis-selling?

Peter Vicary-Smith: My initial view would be that if the regulator is seeing a bundled product, that should be one of the first things they look at, because the bundling is there for a reason. What we often find-particularly if you think of packaged accounts, for example-is that bundling consists of putting in a load of benefits that consumers either do not need or have anyway. If you look at some of the stuff you have in there, you have travel insurance, which is often very bad value, and often people are covered under their own insurance policies anyway. You often have identity theft insurance and ID fraud insurance; we have been attacking the sale of that insurance since about 2005, I think, on the grounds that, actually, your consumer protection rights cover you, anyway, so it is a completely useless product. When you are seeing things bundled together, one the first things the regulator looks at is, "Do we have a problem coming here?"

Sue Edwards: In terms of packaged accounts, the FSA has taken action and has put new rules in place, but I am not sure that that will tackle the problem, because the rules are about the sale of the insurance products but often there are other products in a packaged account. Again, the bank staff are incentivised to sell that type of account and not others. We see people who go into a bank branch and say, "I would like your basic bank account, please, because I need to pay my benefits into it," and the bank says, "Oh, no, what you need is this account-it’s much better," but does not say that that account has a charge for those other products. That is too expensive for them, and they end up overdrawn and in further debt as a result, when all they wanted was to have a product that allowed them to take control of their money.

Mr Love: That is one of the areas we are looking at.

Q30 Lord Turnbull: In your briefing you say that over £40 billion of PPI has been sold, and you think that maybe £15 billion might get paid back. Have you ever tried to estimate what would have been the true, fair value of the product sold? Is £15 billion the right amount to be paying back?

Peter Vicary-Smith: It is hard to disaggregate what would have been a fair sale from an unfair sale, if you like. I do not think we have looked at trying to estimate the fair selling. We are clear that if a bank can show that they have sold a product fairly, and that the selling process was appropriate, then if people have bought the product, they have bought the product. My mind goes back to endowment mis-selling, where a number of institutions, including my own IFA, resisted claims against them and could prove that they had abided by what they needed to and had sold fairly.

Q31 Lord Turnbull: But you can disaggregate two abuses. You start off with a legitimate product, such as the old mortgage insurance: it made sense to insure against that kind of product and you did not have to buy the insurance from the person who was selling you the mortgage. The first abuse is that something is being sold to you that does not reflect the true actuarial value of the risk, but, on the other hand, the bank knows what that is: they have the figures for the history of claims, but the customer does not. That is why you have these huge margins: people have been charged too much even if it is the right product for them. The second abuse is that it is not the right product: it has been sold to people for whom it is unsuitable. An example is selling it to someone who is in a nice, stable job and who gets good sickness benefits and so on: why do they need it? Both of those come into play.

We have talked about the people selling in branch offices. Can we talk a bit about who is actually designing these products? Who is writing the 115 pages? How far was this absolutely cynical-did they know that they were writing clauses into those 115 pages that would deliberately knock out people that they would be selling the product to?

Peter Vicary-Smith: My view is that those individuals were either incompetent or venal, and I do not know which of the two. Either they innocently designed really bad products, or they deliberately designed really bad products. Either way, that does not give me confidence in that institution.

Q32 Lord Turnbull: One thing that institutions could institute is a red team and a blue team. The red team designs a product and takes it to the blue team and says, "Would you ever buy this?" If the answer is, "No, knowing what I know with the information available to the provider, I wouldn’t buy this," and they go ahead and say, "Well let’s sell it anyway and we’ll see if we can get away with it", is there any sense in which people said, "It’s not a great deal, but as long as they’ll buy it, let’s sell it"?

Peter Vicary-Smith: I don’t have specific evidence of that, but I fear how you characterise the process is probably accurate. You have a team designing a product and saying, "Can we sell this?" What I would rather they had is a team saying, "OK, what are the needs our customers have? Let’s design a product that meets those needs". I have a marketing background. That is what I used to do in those jobs, not go round trying to design a product and working out who I can flog it to.

Q33 Lord Turnbull: There seems to be two tests missing. One is designing something which is purely over-priced and the other is someone testing it from the point of view of the company saying, "What will this do to our reputation if it becomes apparent that we have exploited the asymmetry of information to the degree which we have done?" It is surprising that banks allowed that to happen with that risk.

Peter Vicary-Smith: They would certainly say they stress-test products and so forth now.

Q34 Lord Turnbull: By stress-testing products, what they mean is that they’re not going to blow up in their faces and they make a loss on it; not that it is going to blow up in the face of the customer.

Peter Vicary-Smith: That is exactly right and the trouble is that if you have a product with an 87% margin, the temptation is going to be there to find someone to buy it.

Q35 Lord Turnbull: But in any of these investigations has anyone been able to document an e-mail exchange or a boardroom where anyone has expressed any qualms about selling a product that is that overpriced and that defective in relation to the needs of the customer?

Dominic Lindley: From our point of view, these are the kind of internal documents which the banks just won’t provide to us. They may provide them to you in terms of the product approval process.

Q36 Lord Turnbull: Should we be asking the FSA whether they have discovered anything, because they have access to these?

Peter Vicary-Smith: An interesting question that you might ask is that HSBC came out of the single premium market before others, so why did they come out in 2007, whereas others didn’t come out of it until 2009.

Q37 Lord Turnbull: Did they stay in the regular premium market or come out of it altogether?

Peter Vicary-Smith: What I hear is that there were concerns about the ability to sell the product fairly that caused them to move out. I have only heard that as hearsay, but it would be interesting to ask why did they come out in 2007.

Q38 Lord Turnbull: Am I right in saying that, in the case of pensions mis-selling in the 80s and 90s, insurance companies were required to go back over all their customers, while in this case banks are being required only to respond to people who claim. In other words, inertia is still on their side?

Peter Vicary-Smith: Yes. Some banks are doing more than that. I believe that Barclays are writing to all the customers they sold a product with PPI to. So some are doing more than others and being proactive about it.

Q39 Lord Turnbull: In terms of what the FSA is requiring, it is only requiring a response to claimants.

Peter Vicary-Smith: Yes, and that is part of the difficulty which gets you into the question of how quickly the industry can get this behind them, because they then have to wait for that claims trail to catch up with them.

Q40 Lord Turnbull: They are then vulnerable to this whole claims manufacturing industry.

Peter Vicary-Smith: They are indeed, yes.

Mr McFadden: I just want to ask about the design and profitability of this, both in terms of the product and from the point of view of the people selling it. You mentioned a few figures. You said a moment ago that there was an 87% margin on this. Tell us more in simple terms about how this was designed and why it was so attractive to banks.

Peter Vicary-Smith: Dominic will have some details that I don’t, but part of the problem with this product is, because of the number of exclusions, the pay-out rate was incredibly low. Therefore, if the pay-out rate is low, the margin is very high. Those were written in. You talked earlier about the things that you suddenly found that you were not actually covered for when push came to shove. That makes it a poor-value insurance product. I can’t remember the actual pay-out rate.

Dominic Lindley: It was between 11% and 25% for a PPI, compared with a motor insurance pay-out rate of around 80%. Of the money that comes in in premiums, how much goes back out to consumers in claims? Very low for PPI; relatively much higher for motor insurance.

Q41 Mr McFadden: In a normal market like that, if I were selling something and the profit rate was 85% there would be competition. Somebody else would come along and say, "I can sell this and make a 50% profit. It could start like that and I could still make a lot of money." So on and so forth. We would eventually get to a competition-driven market price. Why did that not happen here?

Peter Vicary-Smith: Because they were sold at the point of purchase. "Can I have a loan, please?" "Oh yes, we will include this and make that fully protected. Is that all right?" You have just bought PPI.

Q42 Mr McFadden: You have, but why did no bank say, "These guys up the road are selling this product at X-price and are making such a big profit. We can sell the same product and still make a tidy profit, but we don’t have to charge that price."? Why did the normal rules of competition not drive down prices?

Peter Vicary-Smith: It is because you don’t know who has taken out a loan. The person who knows who has taken out the loan is the one making the loan to them. At the point at which they made the loan they sold the PPI. Therefore, there was no space for anyone else to come in because the transaction had already happened. That is why the separation that happened more recently-the separation by the regulator of the loan from the PPI process-was a very important step in that. Because that could have helped with the dynamic of competition coming in.

Dominic Lindley: From our point of view, the banks that had the point-of-sale advantage were probably selecting the products based on the amount of commission that insurance companies were willing to pay to them. The Lloyds example that Peter mentioned had 87% commission. A bank sells a policy with a £10,000 premium; £8,700 of that goes straight to the bank in commission.

The other thing is that these products were immensely profitable in terms of a single premium added to the loan. Again, a product sold by FirstPlus, part of Barclaycard, a consumer went in to borrow £90,000 and the PPI was sold that added £22,500 to the loan amount and that loan was then paid off over 25 years. Because that is a single premium product a lot of the profit will be taken up front in year one.

That led the banks to these really poor-value products that really should not have been sold to anyone. If the consumer becomes unemployed or sick during the five-year PPI term they are unlikely ever to get-they can’t get-more benefits from the product than the actual costs they are going to pay over the loan. It is the definition of really useless insurance. The banks were more interested in the amount of commission they could get from the product providers, rather than thinking about what their customers needed.

Sue Edwards: We were told by someone that they were using the profits to subsidise the credit they were providing. What they were interested in was competing on the APR and types of loans and credit products they were offering, but not on the PPI because that was just an adjunct.

Q43 Mr McFadden: Customers could say no, couldn’t they?

Sue Edwards: It was very difficult for them to say no, in our experience. People may have said, "I have had a heart attack and suppose I get ill again." They were told, "Oh, no, don’t worry. You have to have the insurance to get the loan." They felt they had no option. They were not given any information about the product before they took it out. They were just told, "Sign here. You will not be able to get the loan unless you take this out."

Peter Vicary-Smith: In our mystery shopping some of the things that our mystery shoppers were told include the following. Abbey: "As a responsible lender we must ensure payments are being made." Alliance and Leicester: "Because the loan is unsecured, insurance needs to be taken out." Egg: "I don’t have the ability to give you a quote without insurance. They are always quoted with." Sainsbury’s Bank: "We strongly recommend you take the cover." MBNA: "PPI will cover you in any eventuality." That was the process by which they were explicitly or implicitly telling customers they had to have this kind of product.

Also, it was often not called PPI. In our mystery shopping, we had it called "protection", "loan protection", "fully protected", "payment cover" cover, and, in one instance, "our excellent insurance". So even if people were told that there was something being added on, which was not always the case, they were often being sold a product without even knowing they had bought any insurance along with it. But even if they were told, how are they meant to know that that is PPI? Or how are they meant to know whether they do or do not have to have that kind of cover?

Q44 Mr McFadden: So you are saying that in many cases they could not really say no.

Sue Edwards: Yes.

Peter Vicary-Smith: Yes. They could not say no.

Q45 Mr McFadden: Moving from there-profitability to the institution-to the incentives for the individual salesperson, you mentioned some percentages, Peter, in one of the first questions. I want to try to understand what difference this made to someone’s pay packet. If we can use pounds and pence, that would be helpful. From the point of view of the person behind the counter in the bank, I go in, arrange a mortgage, and this insurance is attached to the mortgage. Can you try and give us an idea of the difference to the sales person’s pay packet by doing that?

Peter Vicary-Smith: My erstwhile colleague is looking up that fact for you in our submission as we speak.

Dominic Lindley: There are some extracts from FSA final notices, although, of course, they do not really give it in pounds and pence. In terms of HFC Bank, which was part of HSBC, the attainment of a PPI target penetration rate had a significant impact on bonuses. It could double or quadruple the value of the bonus. Peter has mentioned the Alliance and Leicester example-about six times as much bonus for a loan with PPI as without, and also setting a very high penetration target and cutting your bonus if you miss it.

Peter Vicary-Smith: What you want to get to is: if I am a salesperson, here is my base salary and here is my bonus; what difference does it make? Can we write to you on that?

Q46 Mr McFadden: What I want to get to is: the person behind the counter in the bank-this is a guess on my part-is earning a ballpark figure of between £20,000 and £30,000 a year. By selling these products, how much difference could they make to their base salary? If it is a few hundred pounds, that is not a huge difference in their salary. But for someone on that kind of salary, a few thousand pounds a year would make a massive difference to their behaviour. Those figures might be wrong, but that is what I am trying to drive at.

Dominic Lindley: I have got two more examples and then Peter will explain our banking staff research. At LV, the incentive scheme was up to two thirds of the basic salary, which covered PPI and loan incentives, and PPI incentives were much greater than loan incentives. At other places it was a £20 bonus per PPI sale. Also, there is the other aspect. It is not just the incentive structure; it is that sales culture where, if you do not hit your target of selling PPI with 50% of loans, you are identified as having a training need. It is actively told to you that you have a problem because you are not reaching the sales target.

Q47 Mr McFadden: Were the kind of front line sales service staff that I am talking about given specific targets per month or per week for the number of PPI products that they had to sell?

Sue Edwards: When we did our super-complaint, we talked to Amicus-now Unite-about whether they had any evidence of their bank staff being put under pressure to sell PPI. They said they did not have any specific evidence about PPI, but they were dealing with a lot of cases of members who were put under pressure to sell a very high number of products, which they could not achieve and were facing disciplinary action as a result.

Peter Vicary-Smith: I think we circulated this to the Committee. Certainly if we have not, we can do so. We did research recently among 500 bank staff to see whether things have changed. In that, we found-this is bank staff reporting to us privately about the pressure to sell-that I think 83% said that they felt under the same or greater pressure to sell, and 40% of bank staff were saying that they knew a colleague who had mis-sold in order to meet a sales target. It goes on through, and that is true throughout the industry. That says to me that there are some great changes being made by some institutions-we talked before about Barclays and Co-op having made significant changes to the remuneration structure to remove incentivisation from front-line sales-but the culture needs to change. It is not just the structure of remuneration; it is what you feel pressured to do. That needs to change as well if it is going to impact on consumers.

Q48 Mr McFadden: I am interested in that, because that is at total variance to what the banks claimed when sitting in those chairs, or in chairs in a room like this, a few months ago. They told us that the sales culture had completely changed in the last five years, that this could never happen today, that all these targets had been junked, and that perhaps five years ago staff were under this kind of pressure, but they are not any more. You are saying, Peter, that that is completely contrary to the findings of your recent research.

Peter Vicary-Smith: This is research from November, and I will just give you one instance-this is out of 500 staff, so MRS approved levels, if you like. "I feel pressurised into selling by my manager"-Lloyds Banking Group, 46%; RBS, 31%; HSBC, 33%; Barclays, 30%; and Santander, 25%. So, throughout those institutions a quarter to a third to a half of people are feeling pressurised in that way.

Q49 Mr McFadden: I am conscious of the time, so this is my final question. Almost all the banks are now engaged in some kind of reputation-saving exercise. They are all having an internal conversation about what they can do to restore trust, and so on. That has led some of them to declare very publicly that they have changed their incentive structures for front-line staff. How convincing do you find those efforts so far?

Peter Vicary-Smith: I would say that we have looked in some detail at the Barclays changes and been impressed by them, particularly as we were able to speak directly to branch staff without managers being around. We have been impressed by the changes, but those numbers say to me that it is not enough just to change the structure, you have to change the culture as well. If there is one message I would leave the Commission, it is that the things we have talked about around changes of structure and changes to processes of selling and so forth are very important, but, fundamentally, it is the change of the culture and ethical stance of the banks that is going to make a difference. That means the things that I know the Commission is also looking at around codes of conduct and professional standards and enforcement, because without that, any mechanical changes will have only a limited effect. That is what our research is saying to us.

Sue Edwards: We were very heartened by the move by Barclays and the Co-op, but the proof of the pudding is in the eating. We will wait and see.

Chair: I have three Members who want to come in very quickly, although we are running out of time.

Q50 Mr Love: Very briefly, I would like to ask about two issues. I understand that this shocking 87% margin figure emerged from the Competition Commission inquiry, because they have the power to demand papers and information. Is that power now going to be given to the regulator, and if not, should it?

Dominic Lindley: In terms of powers to demand papers and information, the regulator has that power at the moment. However, the problem with the FSA is that it does not have the power to publish any of that. The 87% figure came out through a court case, rather than being published by the regulator. So the problem at the moment is that, even if the FSA did find a product being sold-this is at a major high street bank, not a sub-prime lender-with that level of commission, it could not actually name the bank because it does not have the power to do so without going through the full process.

Q51 Mr Love: The other issue I wanted to touch on briefly was that a lot of people would say, "Well, consumers can seek their own redress," but these are small amounts of money and people who are generally on low incomes. How do we overcome that problem if the consumer wants to influence the redress directly?

Peter Vicary-Smith: We have argued consistently for a system of collective redress in this country that recognises that it is not feasible for individuals on an opt-in basis to claim redress in that kind of way. There are many things that could be done, and one of the great by-products of such a process would be to cut the parasitic claims management companies out of the equation, which I think we would all like to see. We need greater emphasis or greater support to make that collective redress a reality.

Q52 Mark Garnier: Just a quick question on mystery shoppers. I think you said you were doing some mystery shopping to see what was going on. From what I understand, you would need to get to the point where you are about to take out a loan in order to suddenly find that you have had this thing bundled. Are you satisfied that you were getting a good picture of what was going on through the mystery shopper process?

Dominic Lindley: Yes, I think we were satisfied. As ever with these things, it is only a snapshot because we have limited resources; if we are going to do 100 phone calls to major high street banks, then we are only going to do a few per high street bank. The practice of automatically including PPI was widespread in 2002, 2004 and also 2005 and 2007. The other point that you could ask the banks is that if they had just done some monitoring of their own sales process they would have undoubtedly picked up these issues. Also, if they had thought about why consumers are complaining about PPI-if you go back to the early stages of 2005 to 2007 some banks weren’t even recording why consumers were complaining about PPI. If consumers are ringing up your bank and saying "I didn’t realise I bought the product" and if you are a well run institution with high levels of professional standards, you would think that would indicate a massive problem with your sales process and you would do something about it. Unfortunately, the banks just sort of prevaricated.

Q53 Mark Garnier: The FSA did do some mystery shopping. From what you have seen, are you happy that they got to the bottom of what was going on?

Dominic Lindley: Again, they found the same poor practice that we had found. Where the FSA has also got the power is to review the sales scripts that were being provided to the staff, which again, were quite misleading. Sales scripts involving statements like "I strongly recommend you consider taking out PPI" even when it was being provided without advice, sounds very much like advice.

Q54 Mark Garnier: So in the broadest sense you are quite happy that the FSA is cognisant of what is going on?

Dominic Lindley: The FSA was cognisant of what was going on. I think the action that they took against banks was fundamentally far too weak. If you look at the level of fines they were imposing, Argos was fined twice as much for price fixing of toys and games than the highest fine for PPI mis-selling. HFC were fined 0.4% of the revenue they gained from PPI over the course of their poor practice. The fines weren’t high enough and there wasn’t any action against the individuals responsible. Someone somewhere within those banks must have approved those products, remuneration structures and sales processes and they are not being held accountable. They weren’t being held accountable by the regulators, and they are not even being held accountable by the individual banks. Certainly we would like to see more clawback of bonuses for senior executives that presided over these PPI mis-selling scandals.

Q55 Lord Turnbull: In the Financial Services Bill there were two attempts by the Opposition to insert the requirement that providers of financial services should have "a duty of care" and in the second case, act in the "best interest" of their customers. Neither was accepted and they were not included in the bill. Is this something you think should be resurrected?

Dominic Lindley: Certainly a duty of care is a really important part of any system of profession standards and code of conduct. The main purpose of that kind of message is that what governs acceptable behaviour is not just the letter or the detail of the rules, but what is actually in the best interests of your client. A way needs to be found to bring in that duty of care and those professional standards, be that through a kind of code of conduct or greater action by the regulator. Certainly a code of conduct needs to be very independent of the banking industry rather than just a way of appearing to do something, but not really. It needs to be independent, have a lay majority and be properly monitored and enforced.

Peter Vicary-Smith: You took evidence from various regulatory bodies yesterday, and there were some very clear comments there with those people seeing themselves as having a duty of care and they operate through those standards with all the things we have just been talking about.

Q56 Lord Turnbull: Particularly in the case of the BMC. They made it very clear that they have got these people from the age of 18 or 19, taking them through medical school and so on, so you have to be accredited by them to become a doctor, and you have got to maintain this standard of conduct otherwise you can be struck off or have other restrictions placed on you. In banking, that analogy is very difficult to replicate.

Peter Vicary-Smith: Yes, but I think there are dimensions of what they do which are perfectly possible to carry across.

Q57 Lord Turnbull: We took note of them.

Peter Vicary-Smith: We will write with any evidence we can get on the issue of the size of bonuses in proportion to total.

Q58 Chair: I have a final question for both Sue and Peter. Sue, you mentioned your feeling that the regulator was too close to the industry, and that you were raising these issues in 2004-05. Clive Briault was in charge at the FSA at that time, and he will give evidence later this afternoon. Does that apply to Clive Briault, or was that symptomatic of people at the FSA as a whole?

Sue Edwards: My experience was that that was symptomatic of people at the FSA as a whole. They were doing things without necessarily consulting consumer groups, and they were relying on the fact that they had a consumer panel to advise them, but that meant they had a very limited view of what consumers’ concerns were.

Q59 Chair: Good. Peter, this panel is on mis-selling, and we are focused on PPI, given the limited time that we have, but we hope to use it as an enquiry emblematic of what is happening in the industry as a whole. Given that we have this objective, are there any comments you have for us, or issues that we have to keep in mind in the future as we take further evidence?

Peter Vicary-Smith: Yes, I would say that whether it is PPI, whether it is ID theft insurance, card protection insurance or investment mis-selling, the themes are the same. You have poorly designed products giving inappropriately high margins, you have badly designed remuneration structures, and you have pressurised sales cultures, and those three things are common across all of those products. My view is that if you want to address the root causes of mis-selling in the industry, you need to address all three of those dimensions. So product design, remuneration structures and sales cultures, which basically means the culture, ethics and professional standards of the industry.

Chair: Good. Thank you for your evidence, and also for the written evidence you gave, which was very helpful to us in formulating the inquiry.

Examination of Witness

Witness: Angela Knight CBE, former Chief Executive, British Bankers Association, examined.

Chair: Angela, welcome to the inquiry into mis-selling. Certainly, I never imagined I would ever be sitting in the Chair again, and I don’t suppose you ever imagined that you would be here. So for our joint cameo appearance, could I hand over to Adam Tolley?

Q60 Adam Tolley: You became the chief executive of the BBA in April 2007 and served until July 2012, is that correct?

Angela Knight: Yes, that is correct.

Q61 Adam Tolley: As I understand it, the BBA is the leading trade association for UK banking and financial services, and describes itself as the voice of banking and financial services in the UK.

Angela Knight: That is correct.

Q62 Adam Tolley: During your time as chief executive of the BBA, is that how you understood the role of the BBA?

Angela Knight: That was part of the role, but the roles of a trade association are quite broad. I will try to list a few of them. The first role of a trade association is that they provide a focal point for handling the issues relating to consultations, proposals and other types of propositions that are put forward for the industry by regulators, Governments and others. So a trade association is a useful point on all sides for marshalling views, looking into technicalities, and creating those responses. I think that is common to most trade associations, and is one of their most valuable tasks.

I think we would see the second role as bringing issues that were developing to the attention of our members. These issues may have been long-distance, such as European questions, they may have been particularly local issues here in the UK, or they may have been proposals that were being developed by regulators or others. But the early bringing to the attention of our members what we saw out there was also part of our role.

A third was effecting solutions, because where possible when issues arise, whether it is from proposals or from what is happening at the moment, if one can provide solutions to that then that is useful for all sides.

At the same time, we had quite an extensive programme of running conferences, seminars and workshops. Again, these tended to be on issues that were coming rather than matters that had already arrived. Of course, all the larger members of the BBA had extensive in-house training programmes and so forth. Nevertheless, being able to bring together, again at an early stage, representatives from what is the very broad membership of the BBA, with those who were considering or were on the way to making changes which would affect how they would do their business, we saw as an important part of our operation. So, put together, that describes as best as I can how we operated.

Q63 Adam Tolley: That is very helpful. In relation to your point about bringing the issues to the attention of your members, did you consider that the BBA had a role to perform in improving or adjusting banking standards as part of that?

Angela Knight: There were some areas that we thought that we had a role in, yes. The financial services industry, as you know, is not only extensively regulated, but has a considerable number of professional bodies, which we are fortunate to have for financial services here in the UK, which themselves set examinations and qualifications and have a large role in the standards area. That is not the case in all aspects of other industries, but it is in the financial world. Nevertheless that means that one still has to consider, as a trade association, whether there are gaps where one can properly act-I do not know whether I could call it filling the gap- but certainly providing some standards or views in particular areas. One such which the BBA had long been involved in was the Banking Code Standards Board. There was a time when the deposit-taking activities of banks were not covered by FSA regulation. There were certainly issues relating to credit as well.

You will know that there is quite an odd mixture between how credit operates and how deposit taking operates, which means that an individual can open a bank account with a bank and then make arrangements for an overdraft, but as soon as that overdraft is used, it falls into credit regulation. That is complicated for individuals. Having a Banking Code Standards Board that covered those aspects of deposit taking which had not been taken into regulation, and set some standards with credit, brought together an area which was important not just for the banks, but certainly for the banks’ customers and we provided the guidance.

That is one area where we did long-term work on standards. As the deposit taking became FSA-able, then we were instrumental in rolling forward the Banking Code Standards Board into a lending code standards board, so we did not end up with lending as an orphan Annie, and kept some standards in there and the guidance in place. We had some others as well. Would you like me to continue?

Q64 Adam Tolley: Sorry to interrupt, but moving to the specifics of PPI, did you consider during your time as chief executive whether the BBA had a role to play in monitoring or regulating banks’ conduct in that field in particular?

Angela Knight: The BBA trade association is not a regulator. We do not have that power as an organisation and I do not think any other trade association has the de facto power to regulate its members. We had, if you like, an indirect role in the Banking Code Standards Board as a sponsor. Of course there were some contractual conditions there. Having said that, this did not mean that we walked away from training issues-standards issues, I should say-in respect of PPI. I think some of those were made clear in the documents that were supplied to you by the BBA. For example, work started before I arrived at the BBA on baseline standards for PPI products. In 2006 there was a lot of work between the BBA and the FSA in order to address some of the standards issues. That carried on in the sales area, and I recognise a number of the points that were made by the consumer groups in front of me. Improvement of transparency of documents-saying what it was that PPI was about in understandable terms-was a rolling process that rolled on into the time when I was with the BBA. As the new FSA standards came in-initially known as ICOB in 2005, and then ICOBS later on-the work that we did moved on from the sales side and standards to the complaints handling side and standards. So yes, we did see that we had a role. It was not an easy role, I have to say. It was quite difficult at the time, but nevertheless I hope that we never walked away from it.

Q65 Adam Tolley: We will come back to the complaints in a few minutes, but just dealing with the strategic aims of the BBA, in its submission to the Commission the BBA said that restoring "trust and confidence" in banking was now the main strategic aim of the BBA. What I wanted to ask you was to what extent the maintenance of trust and confidence in banking was any part of the BBA’s strategic aims during your tenure.

Angela Knight: It was, but I think you have to recognise that the five years that I was there were probably the most turbulent time for the banking industry of the last 100, so a lot of the time we were dealing with the run-up to and the consequences of the banking crisis. At the same time, there were continuing issues that kept arising, and so although you are absolutely right to say, "Did we have a strategic aim, which was about confidence,"-and the answer to that question is yes-you also have to recognise that in that period of time, as for so many of us in the industry, dealing with the daily problems were very significant indeed. When you have some of your major members falling off the edge of the cliff, when we did not know what survival was going to be for the financial industry around the world during the credit crunch and thereafter-then these were the very significant issues.

As far as the trust question is concerned, that was probably vested earlier and not just in the PPI issue per se-to which, quite rightly, so much attention is paid, and you are paying attention to that here today-but in the issue of bank charges, which was the first thing I had to deal with when I arrived at the BBA. That was then the critical issue, and that was one of the major matters that ran through 2007- along with the failure of Northern Rock- and on into 2008.

Q66 Adam Tolley: You have mentioned some of the obviously high priorities for banks at the time that you became chief executive of the BBA. Do you accept, as the BBA has put to the Commission, that the association and its members had to some extent lost sight of the interests of their customers?

Angela Knight: I recognise that that is absolutely the case with some of the members, but not all, because there was a very diverse membership, as you know. Therefore to say that all the membership had lost sight of its customers would be wrong. I would agree that in some instances there was certainly a detachment from customers. You cannot sit and listen to what the consumer groups have said and ignore their points. A lot of their points were absolutely correct. Therefore, it was vital to bring back the closer relationship between banks and their customers. One of the areas that I think we were successful in, during my time, was doing that with small businesses. As you probably are well aware, we first of all instigated a significant report into small business lending issues, which culminated in 17-plus proposals, which we then started to implement in 2009 to 20114. A round table with business groups was one step, how to handle loan applications from small businesses was another and putting in place independent appeals for SMEs that had been turned down for loans was a third. You are absolutely right to raise the question. As I look back at my five years, I can see quite a lot of things that we did that I think were right in that area. I can also see quite a lot of things that, if we had not had the crisis as well, we would have been able to get to. But you cannot do everything all the time, especially at a time of historic problems within the industry-that were not just here, but elsewhere.

Q67 Adam Tolley: It appears from what you are suggesting that there may have been higher priorities for the banks than dealing with the problem of PPI. Is that fair?

Angela Knight: You will have to ask the banks what their highest priority was. I suspect that for some, it was survival. But in no way should one take my remarks as downgrading the priority of PPI. PPI was and remains a high priority. There are a lot of customers, concerns, issues and complaints. There still needs to be final resolution. No way should one downgrade that.

As my first year with the BBA passed, the complaints relating to PPI started to rise significantly, at which we got much further engaged in trying to get to some resolutions. I think we had good discussions with the regulators, particularly in a number of areas. I would flag some of the earlier ones related to, for example, sorting out a proper way of redress when an individual had turned in their loan early-when they wanted to cash in their PPI and did not want to proceed with that any further-and how one calculated what the rebate was.

It is important. How one described the process was important. What should be the content of the information supplied to the customer and how that was supplied was all part of those discussions that started in the latter half of 2008. There are timelines; you will have got them from the BBA submission. I can go and look into the detail if you like, to ensure that I get the times and dates right-please don’t pick me up on the specifics-but the generality of the thrust was to take a situation, which was not a good situation, and try to improve it in a number of areas.

Q68 Adam Tolley: Just to assist you with the time-this is not a memory test-in the immediate period before you became the chief executive of the BBA, in September 2005 there was the CAB super-complaint. In November 2005 there was the FSA’s first thematic report and the Treasury Select Committee’s report. In October 2006 we have the OFT’s market study and the FSA’s second thematic report. In February 2007 we have the OFT’s reference to the Competition Commission. You take office in April 2007. I appreciate that you mentioned that when you took office, the most immediate problem was the question of bank charges and the issues in relation to them, but would it be fair to say that at the time you commenced work at the BBA, there was something of a gathering storm so far as PPI was concerned?

Angela Knight: Yes. There was indeed. The BBA was taking this seriously. It had staff fully engaged on PPI, working with both the industry and the authorities in trying to move some of the issues forward. As you say, you have the first set of proper, formalised rules coming in, with the FSA having taken over PPI and starting to implement new rules, via what was known then as ICOB. It was very extensive. There were a lot of rules and guidance. It wasn’t reflective, in the sense of the detail, of the regime that had operated previously to that; it was a very detailed regime.

The fact that the FSA was also doing thematic visits, was highlighting some issues that clearly needed to be resolved. The work on trying to come to those resolutions and implement the changes-not just in detail, but understanding what was behind the changes required-was taken forward. As I look through the sorts of things that we were engaged with, one of these was implementing the result of how we dealt with redemptions. The second that I think came to the fore was PPI as it related to mortgages-MPPI. Equally, while it is possible to say, "Here are specific areas," there is more to it than that because complaints were there and they were high. You could not work in this industry at that time-and probably not now-without being aware when problems arise and consumers were unhappy. That is because they do not go in just one direction, to a bank; they go to consumer organisations and they go on to the internet. So the build-up of concerns can happen very rapidly indeed, as it was doing with PPI by the end of 2007, and as we went into 2008. So, yes, what had been a reasonable number of complaints that had been going to the ombudsman-let’s put it like that-had become very significant in numbers.

Before I arrived, when I looked back, the percentage of complaints where FOS considered that the banks were in the right, and they found in favour of the banks rather than the complainant, was high. Then, it reversed itself almost completely. In 2008 it reversed from the banks winning-whatever-80% of cases that went to the ombudsman to them losing 80% of cases that went to the ombudsman, and the numbers of cases also rose dramatically. Part of that, I am sure, will have been the OFT case, which highlighted PPI as an issue; part of it is because information is shared very easily these days; part of it was that people were really concerned; part of it was that people had tried to claim and they had not claimed.5 So we went very quickly to a significant numbers issue-a numbers problem, if you like, as it is a problem when you have got that many complaints. Clearly, there were significant areas which then required to be addressed. We were all working, I think, pretty well together on this and we were listening closely to the consumer groups.

Q69 Adam Tolley: Following up on the point you made on the change in the way in which complaints were resulting in particular outcomes, the FOS made the point that the change was more in relation to the type of complaint, so whereas before the majority of complaints had been about claims on PPI policies being turned down, thereafter it became complaints about the mis-selling of the policy in the first place, and it was that type of complaints which resulted in much higher rates of success for consumers.

Angela Knight: That is how I understand it to be. It was the nature of the complaint as well as what the FOS was then looking at. That is how I understood it, unless you have further information to the contrary, but that is how we saw it.

Q70 Adam Tolley: Finishing off on the point about bringing issues to the attention of your membership, the BBA has told the Commission that it held what it has described as a "generic PPI seminar" in 2007. Are you able to shed any light on what that comprised?

Angela Knight: Yes, I think so. I have not brought the note with me, but I am sure that it can be provided to you. The seminars around PPI were very much like our other seminars: they brought in people from outside the banking industry, in the main, to mix with the banking industry, as far as the speakers were concerned, for the purposes of providing perspective on what the issues and concerns were that were being raised. I cannot tell you who the specific speakers were at either of them, but I would strongly expect that, at least at one, there would have been a regulator if not at both; there will have been somebody from one of the consumer groups at one of the seminars if not at both; there would have been somebody from completely outside, and I have it in my mind that someone from the Competition Commission came to one of them but not necessarily to both. That is my best recollection for you. As I said, I am sure that both the topics that were discussed and the speakers who gave their presentations can be provided to you.

Q71 Adam Tolley: I am sure that will be helpful, thank you. I have a quick question about the relationship between the BBA and the FSA during your tenure. How would you characterise the nature of that relationship?

Angela Knight: I think that we had a good relationship at all times. Although there will always be issues and you will inevitably have disagreements, there was never a time that we were doing anything other than talking to each other properly at all levels. There was never a time that we were not sharing at all levels. There were regular meetings on a whole variety of areas between representatives of the BBA and the FSA. There were individual meetings and group meetings. That is the sort of relationship that one needs. With the ombudsman it was not so frequent, but a similar type of relationship existed. That does not mean that you agree on every point, and it does not mean that you do not have arguments about some issues. However, the important thing, whether you have an agreement or not, is to keep talking, to know each other, to be able to ring each other up, to trust each other and to be able to try to do as much as you possibly can together.

Q72 Adam Tolley: I will come, in due course, to the major argument that you had with the FSA. Before I do that, I wanted to understand a bit more from you about the BBA’s approach to standards in relation to PPI. The BBA told the Commission that it had limited involvement with the question of PPI prior to 2005 because at that time PPI sales were either loosely regulated, to use one phrase, or wholly unregulated, to use another.

Angela Knight: And it was an insurance product so it was dealt with by the insurance side. I think the General Insurance Council was the primary entity involved. Yes, I agree.

Q73 Adam Tolley: Moving forward to June 2007-so after you became the chief executive-the FSA then started consultation on the new ICOBS rules. With some exceptions-obviously, PPI was a particular one-there was a general trend towards having fewer detailed rules and more principles-based regulation. To what extent did the BBA agree with that approach on the part of the FSA?

Angela Knight: You said ICOBS, but it was ICOB in 2005. Do you mean ICOB in 2005 or ICOBS in 2007?

Q74 Adam Tolley: I was asking about the commencement of the consultation in June 2007 in relation to the revised rules, which became ICOBS.

Angela Knight: That’s fine. I think it reflected very much what the FSA had been finding. It believed that ICOB, which was for all insurance products and was a document of some substance in terms of rules, guidance and so on, could be lightened for many insurance products. From their assessments of PPI, they wanted to see more detailed rules. They specified, for example, some areas of transparency and some areas in relation to sales. This had come up not only from the thematic reviews but they were regulating the member firms generally. That experience was that they wanted to see something more specific. That was not an unreasonable view at all.

Q75 Adam Tolley: I will deal separately with the question of the general approach and the specific approach in relation to PPI. What was the BBA’s overall view of the general approach of moving to more principles-based regulation?

Angela Knight: You mean more principles-based regulation for general insurance?

Q76 Adam Tolley: More principles based and less detailed. Yes.

Angela Knight: For general insurance? I think we were far more engaged in the PPI part of it. There is a role for looking at different aspects of the financial services industry in different ways. The move towards more rules for PPI was the area that we were concentrating on because that was the issue of the day as far as we were concerned. I do not recall whether we commented on the decision to go to fewer rules and more principles for general insurance. We may have done but I do not recall it. I recall that our attention was on the PPI aspect of it, looking at and seeing how those issues arose and how the new rules would be implemented.

Q77 Adam Tolley: So dealing with the specific approach in relation to PPI, in particular, was the BBA content that a more detailed rules-based approach was appropriate?

Angela Knight: Yes. It is often, if I may say, a debate that I find slightly strange when one talks about principles versus rules. I do not think that that is the right sort of discussion. You need principles and rules. In some areas, you will always need more rules than in others, particularly if things are, for example, complex. Another area would be that if, by putting in more rules, it gave a greater degree of confidence to parties. May be we would say in this instance, the consumers, but that would not necessarily be the only case.

As the new regime is going to be constructed on financial regulation in this country, there needs to be a real mature reflection on the role of more detailed rules in some areas, not to negate in any way that there is a need for principles as well- but may be to address what some have referred to as a potential regulatory gap, where evidencing the principles can be done in a number of different ways, and some of those ways may be better than others. There are some critical decisions in that area that need to be taken forward.

At this time though with PPI, certainly the concerns of the BBA were that PPI was an issue where complaints were high, there were widespread concerns and that reviewing the rules was a sensible thing to do. Trying to resolve issues was absolutely appropriate. It was at this time as well in 2008 that we started to discuss how we could get to much better standards of complaints handling.

Q78 Adam Tolley: Prior to the judicial review, it appears that the BBA took the approach in relation to PPI compliance that there was perfect compliance on the part of your member banks if they followed the detailed ICOBS rules, even if they had not in fact satisfied the FSA’s higher-level principles, such as treating customers fairly. Is that fair? That was the BBA’s approach.

Angela Knight: No, I do not think that it is fair as an approach. I can see why you asked the question though. The mis-selling of PPI covers a range. To give two examples, there is PPI where the product is sold to people whom it should not have been sold to and where the product was not going to pay out or did not pay out. Let us call that bucket 1.

In Bucket 2 were the issues where PPI had been sold according to what were understood as being the detailed requirements. Do not forget that both ICOB and ICOBS are very detailed about what you had to do and what you had to put in writing. There were extensive discussions and decisions on this and it was not just an industry issue, but an industry with regulators. Therefore, the concern was whether FSA decisions that had been taken and been conveyed to the banks, for example, that a bank had to ensure that some of the critical points of the policy were put in writing to the customer rather than just being given verbally still remained. These were very specific areas, so it was unlike a situation which had general rules as the industry had very specific rules. And so when you have very specific rules but there is a question as to whether those rules could be interpreted in one form or another, this presents a different type of mis-selling potential. You question how one should describe that. This is not about whether it is a wrong product. If it were a wrong product, that is mis-selling and we have no patience or time for that. It is not a question of it being sold to the wrong person and should not have been done. We have no time or patience for that at all. All those many areas that so many have discussed are clear mis-selling, We had no disagreement with them.

When there starts to be a different interpretation of an agreed set of practices and rules-some created directly as a result of discussions with regulators, such as the so-called rule of 78, the way that refunds were calculated, or what the statements had to be on the top of the policies, the second-signature requirements, the 30 days to change your mind and what had to be pointed out- the industry understood that it was doing it right because there had been discussions about these and there were still normal supervisory visits taking place. Here you have a question of interpretation of a rule.

That is the second group. This was not about, "Are we negating principles?" No, it was not. It was a straightforward understanding of what needed to be done that started to change over a period of time. You have got to be able to evolve any regulatory system, of course you have. You have got to evolve any rules as well. But if you start to evolve rules that then seem to come back to a part of life that was beforehand and where those rules did not seem to apply then, that is where the concerns about rules start to rise and that was the area with which we engaged.

Q79 Adam Tolley: As you raise that point, the BBA has said in its submission to the Commission that, prior to the outcome of the judicial review proceedings, the BBA and its members held what it described as the legitimate view that there had not been widespread mis-selling of PPI. The basis on which that view was expressed was that the detailed rules had, as they put it, "by and large been complied with". Do you agree that that was the BBA’s view, putting aside for the moment whether it was legitimate or not? Do you agree that was the BBA’s view?

Angela Knight: If I had been writing to you, that is not the phraseology that I would have used, no. I don’t want to go back again and say, "Look, there was not mis-selling in lots of areas." We accept that is entirely the case. Then there was the question of rules. That would have been the way that I would have expressed it.

I am afraid I would not have used phraseology to you to say that the BBA’s view was that there had not been widespread mis-selling. The BBA’s view was that there was mis-selling. The BBA’s view was that there was also a question of rules. The BBA’s view was that there needed to be some resolutions. That was one reason we set off on a route, again in conjunction with the FSA, the ombudsman, consumer groups and other trade associations, to try to effect what we have called a Statement of Principles for the purposes of dealing with the complaints. I hope you were at least provided with the draft of where we had got to on the Statement of Principles. Of course, the group was chaired independently, originally by Lord Hunt.

The way that we looked at that Statement of Principles for dealing with complaints was not just absolute rules, as you can see, it was broader than that. It was a genuine attempt to pick up in a broader way the complaints that were occurring, so that we could actually effect-not just across the banking industry, because don’t forget PPI was also sold by others-a broad-based way of handling and resolving the complaints that was not, as you say, just ruled-based, but took into account that there were some other significant issues. To this day, I am very sorry that we never did actually get to a conclusion. I have to say that it was not the BBA or the trade associations that stopped that work.

Q80 Adam Tolley: Can I ask you again about this point on what has been said? I know you say you would not have expressed it in that way.

Angela Knight: Perhaps you could show me where it is in the submission.

Q81 Adam Tolley: I can tell you it is at paragraph 62, if you want to find it.

Angela Knight: Yes, I would be interested in finding it, if that is okay. Fine.

Q82 Adam Tolley: Is it fair to say that you don’t agree that that was the BBA’s view, let alone that it was a legitimate view?

Angela Knight: As I said to you earlier, that is not how I would have expressed it myself. There were well-known and widespread concerns on PPI. There was a large number of complaints on PPI. They fell into two broad camps: one of which was easily related to PPI being sold to the wrong people, and PPI which was ultimately not going to pay out. Those are two examples, but there are others as well. Then there was another pot, if you like, relating to what were-or were not-the rules that the banks understood they were abiding by, following, as I say, discussions with regulators and others, also discussions with the BBA. So in a situation in which there were so many complaints, I would not have used phraseology like that. That is certainly not the phraseology that I felt was the case.

Q83 Adam Tolley: We are short of time, but I want to ask a few questions about the judicial review. Just to help you with the timing of it, the judicial review claim against the FSA and the FOS was brought in October 2010, with the hearing in January 2011 and the judgment in April 2011. The BBA has told the Commission that it believed that it had what it’s put as a "meritorious case", to the extent that you were able to assist. Can you say what the basis for that belief was?

Angela Knight: Yes, but if I may I am also going to take a little time in explaining the run-up to the case, because it is important. The first was that we wanted to get a result-and get it quickly-to the whole problem of complaints and the issues that people had. That was what trying to effect a Statement of Principles was all about. That Statement of Principles was getting pretty wide agreement across the committee, which as I say was independently chaired, and I think to this day that it was a great pity that it could not conclude. We had a second try at it at the start of 2009, because if we could have got that in place then, we could have got to a conclusion much earlier and saved all the delays and the rest of the time.

The next aspect is also important. In 2009, when we were responding to what was then the FSA’s consultation on changing some of the standards, we started to set out the 404 as a route of coming to a conclusion. The 404 is a section in the Financial Services and Markets Act. I accept it is complicated to use and it required Treasury involvement, but it would have been able to effect a solution to the issues across the market. We6 would have been able to say, "This is the way in which you deal with complaints and now get on with it". That was why we raised it as early as that, because if you couldn’t do it by the Statement of Principles, there needed to be another way. Did the authorities have another way? The answer was yes, 404, but I was sorry that this also was not picked up.

At that time, of course, we started to run into the consultations on the new Financial Services Act-I don’t know whether I should call it the new Financial Services Act, but certainly changes to financial services legislation. This was concluded just before the general election of 2010. In that wash-up process, what was agreed was a much simpler 404 process, one that was within the grasp of the regulators and they did not have to go back to the Treasury. So we went back and said, "Okay, use the section 404 powers, because if you use them, that effects a solution right across the market. You’ll have done it and won’t have to go any further with the tests". Again, it is a pity that this took place.

We also proposed having an independent reviewer-we suggested somebody high in the legal profession-to come in and do an independent arbitration on PPI. We tried a lot of options.

We came to a point at which the assessment of the costs of PPI by the industry was orders of magnitude greater than those of the FSA. I believe I am right in saying that the FSA started at something like £200 million; we started at several billion. They got to about £2.5 billion-maybe slightly more-but we were still orders of magnitude greater. We never made that public because it is a price-sensitive issue, but we did tell the FSA. You had a situation where there were huge sums of money involved; where the industry-proposed solutions-not just by us, but across the piece-had not been agreed; where the powers implicit in the Financial Services and Markets Act, in 404 as amended, had not been used; and where it was not possible to use an independent arbitrator because that option was also turned down. That was the reason why our members required the BBA to go to court.

I put it that way because we were the umbrella. We provided the conduit. One of the reasons that was the case was because any individual bank was concerned that if they went themselves they would be hugely picked off-you have the court of public opinion there and then. It was better to provide an umbrella.

Q84 Chair: Angela, I am sorry, I do not want to interrupt, but other people need to come in with their questions.

Angela Knight: Yes. I beg your pardon, but I can’t answer the question quickly. There is a story.

Chair: Could you get the main points across?

Angela Knight: I will try to be brief. I do apologise. The phraseology of the case, as set out by the lawyers, was that it was meritorious. That means there was merit to the case. The decisions were not made by ourselves; they were made, of course, by the individual banks, under the BBA umbrella. They used their in-house lawyers, and that took some considerable time. Recommendations were finally made by the retail committee to the board of the BBA after some iterative process. But meritorious is the phraseology, which I understand is well known within the legal profession.

Q85 Adam Tolley: You have given a very full answer, but the question is one that I am not sure you have yet answered: what was the basis for the BBA’s belief that it had a meritorious case?

Angela Knight: Sorry, what was the basis for the BBA believing that it had a meritorious case?

Adam Tolley: Yes.

Angela Knight: The basis was that for the lawyers considering that it was a meritorious case. That was the legal opinion.

Q86 Adam Tolley: We know that the BBA’s claim was dismissed. If things had turned out differently and the BBA had succeeded in the judicial review, what, in your view, would have been the benefit of a favourable outcome for the BBA?

Angela Knight: A favourable outcome would, first, have established the position of the rules in the hierarchy of principles, standards and rules; secondly, it would then have provided an effective template to be able to do the compensation. As to the decisions that were ultimately made on the case by the court, my recollection is that they do talk about the regulatory gap-I think that is where the phraseology comes from-between the principles and rules. The rulebooks say, "These are the rules to effect the principles."

Q87 Adam Tolley: If the BBA had succeeded in the judicial review, do you think that such an outcome would have assisted in restoring trust and confidence in the banking sector?

Angela Knight: I personally had very grave concerns about taking a case in the first instance. The reason is that given the nature of the situation at the time, given the very high attention on PPI and the fact that there were some really serious issues out there, I could not personally see that a case was necessarily going to do anything in that respect. I also worried about the political consequences. What would politicians feel they had to do should the case be won? It is for those reasons that I tried so hard to get resolutions in advance. In my view, going to court was the last resort. I was not personally in favour and I made that well known.

Adam Tolley: Thank you very much. Lord McFall may have some more questions.

Q88 Chair: In terms of your feeling uncomfortable, Angela, was it a unanimous decision of the BBA board at the end of the day, or did you record your unease?

Angela Knight: My unease was well known by the retail committee, which was the overarching committee.

Q89 Chair: Did they take a unanimous decision?

Angela Knight: Yes, and it was well known by the board as well. Sitting at the back of this room is one of the lawyers who was involved in the case, so if you want any confirmation about my unease, you can ask him directly after you have finished interviewing me.

Q90 Chair: The BBA website states that members "shall not follow a course of conduct likely to bring the financial services industry or the Association into disrepute. Failure to do so shall entitle the Council to deprive the Member of membership, or the Associate (Associateship)." Can you give an example of what a bank would need to have done to be deprived of membership?

Angela Knight: Yes. I suppose I can in some respects. The decision, of course, on whether you deprived membership would have been taken by the board/council of the BBA. We had to discuss this in some detail at the time, not in respect of the PPI question but in respect of bank failures and the involvement of the Government in bailing out the banks. The question that we discussed was how under those circumstances-because you could argue that was also a disrepute issue-we dealt with that and whether it was better to keep people inside the tent and so help them or not.

As I am sure you accept, when a bank got into those sorts of difficulties, there were many inside the bank-there were the few who steered it, but there were many other people inside. The decision that we came to was that they stayed involved, but what they were involved with was now only certain areas. So not a major committee was one of the questions that we discussed, and decisions were made there. Another was related to what they came to in the workshop/ seminar programme. At that time, with so many banks in difficulty-not just here, but with an international membership, as you will know, they were in trouble across the world-it was not an easy discussion to have, so we had to come to almost a sort of two-stage arrangement.

Q91 Mark Garnier: Clearly, this was a monumental crisis. Everyone was blaming the banks for doing this, and I completely appreciate your point about helping the banks out, but none the less it does say that members "shall not follow a course of conduct likely to bring the financial services industry or the Association into disrepute." My goodness-has there ever been anything that has brought an entire industry into disrepute more?

Angela Knight: Quite. Any rules or proposals such as that were never drawn up for a crisis in which so many banks got into difficulty. Our regulatory process was not drawn up like that. I don’t think politicians ever drew up the law for the sort of situation we had to deal with. The Bank of England did not expect it, and that was reflected in other countries.

You are right to highlight the fact that we had requirements as an association that worked on the basis that there may be from time to time an entity that did something really dire and therefore we had to deal with it, but not a situation in which a whole industry gets into difficulty. I suppose you could argue you then have one of two choices. One is to continue to do your best-in this instance, helping your members resolve their problems, working as closely as possible with other authorities and trying to get it better. Or you can walk away. I am not one who is inclined to walk away, so I did what I thought was in the best interests not just of them but of UK plc, which was being badly affected.

Q92 Mark Garnier: That is a reasonable response. What sanctions can you bring against individual bankers?

Angela Knight: Individuals within banks?

Mark Garnier: Yes.

Angela Knight: The BBA, as far as I am aware, to this day does not have any individual sanction requirements. I do not know whether any trade association does. You would have to ask.

Q93 Mark Garnier: Presumably, the Institute of Chartered Accountants in England and Wales, for example.

Angela Knight: It might, but isn’t that a regulatory body as well?

Q94 Mark Garnier: Yes, but it is also a trade association.

Angela Knight: Isn’t the Law Society a regulatory body as well?

Mark Garnier: Well, it has a subsidiary, which is the SRA.

Angela Knight: I am sure that the British Medical Association-

Mark Garnier: The GMC and the BMA.

Angela Knight: That is where you have the two things combined in one organisation in one form.

Mark Garnier: Sure, I appreciate that, but you are confusing two things-

Angela Knight: Sorry. I am not intending to.

Q95 Mark Garnier: No, I am sure you are not. These are regulatory organisations and we are talking about a trade association. For example, a bad director of a company who is also a member of the Institute of Directors could be thrown out of the Institute of Directors. That is a clear message by an organisation that they are pretty fed up with the behaviour of an individual. What I am curious about is whether the BBA has at any point drawn any censureship on to an individual to say-I am not going to name any names-"So-and-so has behaved disgracefully and we feel it should be highlighted."

Angela Knight: I do not know whether they have. On your Institute of Directors point, you are a member of the Institute of Directors as an individual, but in the BBA you are a member as a firm. It is a different concept. Your point is an interesting one, and I think it is something that has to be considered. What you cannot do, when you have had such a crisis as we have had, is to say, "Everything in the future will be the same." Lots of things have to be reconsidered, rethought through and changed. The point that you are making may well be a good one for the BBA to consider going forward. I do not know whether any individual was ever censured, as you put it, in the past. You will have to consult the records.

Q96 Mark Garnier: But not under your tenure.

Angela Knight: On my watch, a decision was taken to try to keep as much going as possible and try to get things as better as possible. That is the decision we took at the time. I do not know what you are like on hindsight, but when I look back in hindsight I always think, "Why didn’t I do this? Why didn’t I do that?" I am not entirely sure whether that is one that I would do, because so many people who had a culpability were leaving the industry anyway, but it is certainly something that needs to be thought through. I think you make a fair point.

Q97 Mark Garnier: We have had a colossal explosion of the banking system. There is a monumental amount of distrust in the whole banking system, particularly among bankers. So far, to date, the worst that has happened to anybody is that they have lost a knighthood. Among everybody, including the BBA, that is the best sanction that has happened-a knighthood.

Mr Love: And for the others, bringing them before the Treasury Committee and this Commission.

Angela Knight: I expect that you, like me, are pretty surprised at that.

Q98 Mark Garnier: But you were in charge of the BBA.

Angela Knight: Yes, but I cannot take sanctions against people.

Q99 Mark Garnier: You can’t, but it is an organisation that you run. I am curious as to what you did in order to try at least to use the BBA as an exemplar of good practice-to demonstrate that the organisation that you were leading was prepared to turn around and say, "No. This is the bar under which we will not tolerate. We are fed up with you"-whoever it is-"We think you have done wrong."

Angela Knight: I am not going to name names either. Did I have some pretty difficult conversations? The answer is yes. Did I make some very pointed points? Yes. Did I ask for some people to be changed? Yes. But I am not naming names, and I hope you will understand that.

There was also reform of our decision-making processes in the sense of such things as the composition of the board, and how the role and responsibilities of the board and the council were altered, which are important. In some way, if I add those together-I apologise for being elliptic-that did a lot of the things that you are saying, but I did not make it public.

Q100 Chair: In terms of judicial review, Angela, do you think the effect of proceeding with that brought the industry into further disrepute?

Angela Knight: It was in pretty high disrepute anyway.

Q101 Chair: But it added to it? It must have done.

Angela Knight: I don’t know.

Q102 Chair: If you were against it.

Angela Knight: I was against it for a number of reasons, Chairman, not least on some of the points that I have just been asked. What would the outcome have done that would have been beneficial?

Q103 Chair: Did you think of resigning?

Angela Knight: Yes. I thought of leaving the BBA on a number of occasions before I did. You can, and you do, have a particular point here with PPI. That was not the only area though.

Q104 Chair: Are you writing a book?

Angela Knight: Let me find my words. I appreciate you want to rush me, but I would be enormously grateful if you did not because I am trying to give you open and honest answers on what is a difficult point.

One of the aspects of PPI which I felt was extraordinary-I just repeat it once more-is (a) it had not been dealt with by another means and (b) the costs were so huge; the difference was so big. The question you then have to ask yourself is what serves a purpose best. You and other elected politicians around this table will know that as well as I do. Sometimes you will hold your nose and go through the Lobby on the basis that you can then sort it out better than to say, "No, I am going to go elsewhere." With this decision, I repeat again, I was enormously uncomfortable about seeking judicial review. I had considered on a number of occasions what I should do in respect of the BBA. Perhaps wrongly, I decided that what I would do was stay and try to move the industry into the best place I possibly could. That is why I stayed.

Q105 Chair: You and I were engaged in this intensely at the time, Angela. You were out all the time in the media, in the press, and the rest of them, those responsible, kept their heads down and were under the radar. You were the enemy as far as people were concerned. The others ducked away.

Angela Knight: I know.

Q106 Chair: Here at a time when you feel it is coming further into disrepute these people have been silent. It was the ultimate act of cowardice by these people to put you out all the time to do the dirty work for them.

Angela Knight: You will know that I was not out much on PPI, Chairman, and you will be able to draw your conclusions on that. I will leave your comments as they stand. What was I trying to do? I think there is a case, as I am sure you will agree, that one requires sometimes to bring balance if possible to a discussion. Not everybody is wrong. Half a million people operate in the industry. They are not all wrong. This is still one of the world’s financial centres. You have to stand up sometimes and say it. It also made it extremely difficult ever to go to a pub for a drink or to travel on the train because people recognised me. But that did not mean that I felt that I should duck away from trying to do something about that broader representation role.

Chair: I understand that.

Q107 Mr Love: I respect your decision not to name names but can I come back to that part of your testimony and ask you whether you had any success in having people moved?

Angela Knight: Yes, I did have some.

Q108 Mr Love: I know you are not going to name names-

Angela Knight: I think we are going to have to stop this one. Not because I in any way feel that what you are trying to ask is wrong. Please do not take it like that, but I am not going to start speaking in a way that could result in scapegoat hunting or any of those things. So if you are prepared to accept my word for it I would be grateful.

Q109 Mr Love: Thank you for your evidence. Let me come on to a different subject. On the basis of the discussion that you had with Mr Tolley, can I put to you that both the banks and the BBA have in effect gamed the FSA’s principles- based approach to regulation? Would you accept that?

Angela Knight: I would not accept that the BBA gamed it. That was not our intention. If it reads and looks like that, I can only apologise for what is on the paper, but that was never ever the intention. The whole thrust of where we were from late 2000 through to 2008 and on from there was nothing to do with gaming. There was a lot of establishing the facts and a lot of engagement, but not about gaming.

Q110 Mr Love: Let me put some other statements to you that hopefully you might find more agreement with. Would you accept that the banks prefer ticking boxes? Indeed, they have actively lobbied through the BBA for that, and then complained after they have been introduced that there are too many boxes to tick and "give us a response". This came out very clearly in Mr Tolley’s questions to you. Their response to claims of mis-selling was, "We’ve complied with the rules, the boxes were ticked". Do you accept that?

Angela Knight: I think that was what did happen, certainly at the early stages. As the issue moved through, though, please can I point again to you what we tried to do with the Statement of Principles for dealing with complaints, which albeit was in late 2008 and then revisited at the start of 2009. That was not a box-ticking exercise; that was shifting away from box-ticking.

I recognised a point that was made earlier by one of your previous guests-I think it was Peter Vicary-Smith; if it wasn’t, I apologise-when he said that there hadn’t been a recognition of what treating customers fairly quite meant. I think that was probably very much the case, as in some other parts of the financial services industry. Moving into recognising what was the right approach to rules, to treating customers fairly and so on took some time.

Q111 Mr Love: Let me press you a bit further. The industry, through the BBA, lobbied very hard when the ICOB rules came in and PPI was under discussion, that you actually lengthened the rules and increased the box-ticking. Do you accept that you lobbied to increase the number of rules covering PPI?

Angela Knight: ICOB came in in 2005, before I came to the BBA, so I would have to go back and ask them, because I wasn’t there.

Q112 Mr Love: But ICOBS came in under your watch.

Angela Knight: Yes, ICOBS was 2007.

Q113 Mr Love: Surely you must have asked the question, "Why, when we already have very extensive rules for insurance regulation, do we need to extend them even further for PPI?"

Angela Knight: There were some results that had come through from both the themed visits of the FSA and from other areas, where there were some view changes about what was and what was not required. A particular one is the writing versus the oral requirements. In 2005 with ICOB-as I understand it-there had been a long discussion about what should be in writing and what should be explained verbally to a customer. The reason why the decision was made in favour of writing was that if you say things to people verbally they can forget it, so write it down. There was quite a lot of prescription on the statements that had to be written down. As time passed, and the ICOBS process came into being, it picked up some of those things that had not necessarily worked well in practice. In this instance ICOBS said "Not only do you put something in writing, but orally you must then point the customer to any salient, relevant or particularly different bits".

I think rules should develop. It is absolutely right that if after you’ve tried something, you’ve done your visits and you don’t think it is working as well as it should do, you should revisit rules as a regulator. There is an evolving process, and that is just one example.

Q114 Mr Love: Do you not have any worries? The industry has just lobbied for more extensive rules on packaged bank accounts, where there is some concern that similar practices are endemic in the industry. Are you not concerned that those additional rules have made it easier for the industry to cover themselves when mis-selling is going on?

Angela Knight: There’s got to be a rethink in this area, and I entirely take your point. How would I see an appropriate way forward? Rules are important because they can give confidence to your customer that there is a set of rules that the firm has to abide by. There is also a role for standards and a role for ethics. If I had to say where I think the major focus that we now need to think about is, it would probably be in these other areas-the ethical standards and the cultural standards. In a litigious environment-we all live in a litigious world in all sorts of areas-clarity is necessary, and people take confidence from rules and like to know where they stand. However, the rules are not the only game in town, and you are right to say that. So how we move as a country into a new environment that provides the relevant mix of what are rules, what are standards, and gets the ethics and the culture right, is vital. I would also hope that the future is about not just finding out what the problems are when they arise-we have to accept that problems will always arise-but sorting them out.

Q115 Mr Love: But the net effect is that we would move entirely away from the principle-based way in which the FSA wishes to deal with these issues-you would accept that?

Angela Knight: It certainly looks to me like that is the way it is going, but I have to say that I am not following the subject now. You will be following it much more closely-I don’t know where it is going.

Q116 Lord Turnbull: Given that at the time the judicial review was launched, banks were losing 90% to 95% of the cases, and given that it looks as though about a third of the premium income is going to be retained, it looks like an absolutely calamitous error of judgment on their part to be seen to be defending the indefensible. By the time you left, do you think that the banking sector-the people who were then in the BBA-had come to recognise that, or did they still think that they were right after all?

Angela Knight: People in the BBA had recognised the concerns that I have raised here-

Q117 Lord Turnbull: Forgive me, not the BBA as an organisation, but basically the people, or the successors of the people, who forced you to take this action in the first place.

Angela Knight: I am quite keen to separate out the BBA and the members in some instances, and I am sure that you can understand why I do that. It is an easy shorthand, and I would ask you to be careful about it.

Q118 Lord Turnbull: I did actually say that the question was related to the board of the BBA-the people who voted for it, or their successors-and whether they now recognise that this was a terrible mistake.

Angela Knight: I sincerely hope that they do. Certainly when I was there, this was a wake-up call. Frankly, it should never, ever happen again, either the fundamental issue of PPI itself, or that a trade association acting on behalf of members has to take a judicial review in this way. However, I think that if I take your question right, you were very much asking whether the view of this has now registered in a different way within companies, or are they still saying, "We were right all along, but we have got to do it now"? I sincerely hope that it is not the latter. I suspect that there will always be residual concerns about how some of the issues developed and why they couldn’t have been addressed earlier. I am sure that that will remain, but I have absolutely no reason to believe that there is anything other than the intention to resolve and the intention not to let any lookalike happen again.

Q119 So there is no foot-dragging by people who think that they were hard done by in the verdict?

Angela Knight: I am no longer there, and those are the sorts of questions that you will have to ask the members who are directly involved with PPI. I say also that of course, while they were large banks, they were by no means the majority of the members of the BBA.

Q120 I know you would not name names, but are any of the people who were arguing for this still part of the BBA council or board?

Angela Knight: I didn’t look before I came here, sorry.

Q121 Mr McFadden: Angela, you left BBA last summer?

Angela Knight: Yes.

Q122 Mr McFadden: We have been talking all afternoon about PPI. I do not want to ask you about this in detail, but did you know that the LIBOR scandal was coming when you left?

Angela Knight: I would presage my answer with two points. The first is that I cannot talk about LIBOR publicly. I have been requested not to do so, other than about what is in the public domain. The second point, if I may say so, is that I was still there when the first of the LIBOR cases became public. You can ask your questions and I will tell you whether or not I can answer them, if that is alright.

Q123 Mr McFadden: As Mark Garnier said, the PPI mis-selling is probably the biggest retail scandal in recent banking history. We have had the banking collapse of 2007-08, and now we have this unfolding scandal of rottenness and corruption in the setting of interest rates. The LIBOR issue puts the BBA as an organisation in the frame in a way that PPI does not. You took legal action as the umbrella group. You did not have the role of setting it. Do you think that the BBA can continue as a credible representative institution for the banks, or do they need to just start again?

Angela Knight: Yes, I do. From the way in which you raised the question there are some points that I can make to you in reply on the LIBOR issue, which I think might be quite pertinent to what sits behind your question, which is a very valid one that I absolutely accept. First, as I am sure you are aware, while the BBA owned the trademark for LIBOR and published the website for LIBOR, the LIBOR contributions made by the contributing banks were sent directly to Reuters, and the teams that set other rates. The point at which the BBA was aware of what the LIBOR setting was-and it is in many currencies and in many tenors every day-was the same time as everybody else, and that is the time that they were made public.

Secondly, the processes and procedures that a contributing bank has to follow are within the regulated environment, and therefore the processes and procedures of a regulated entity are for the regulator. When you actually look at the only statements from the regulators that I have seen so far, you will see that there are two aspects to them. One is the competition issues - was A talking to B in a way that was wholly unacceptable? The second was that the regulator said that the bank had not put in place the right practices for the purposes of their LIBOR contribution. The regulation of those processes and practices was not one of the BBA’s duties, it was one of the FSA’s. Clearly, that is the way that the inquiries are continuing to go.

It is also well known that in 2008 we launched a consultation, which is well known because there has been some information published by the Bank of England that the BBA and myself were very keen for the authorities to be very closely engaged with the development from 2008 onwards. I can say that in public, but I cannot say any more.

I think, therefore, that perhaps sets out a further point. A trade association can be responsible for a lot of things, but there are some things that have happened around this crisis where it has been nice just to land it on the BBA, and I think that that is not necessarily appropriate. That does not mean that the BBA should not change, alter, and refocus. That was well under way and I look forward to it continuing because an industry of the importance that banking has to the UK requires a representative voice, and I am very saddened that so many problems arose in such a short period of time. I have to say that, from a personal basis, it was an extraordinarily uncomfortable five years.

Q124 Mr McFadden: We are about to vote so this will be my final question. You have opened up an interesting area in terms of where you clearly feel blame may lie between the BBA and the FSA about-

Angela Knight: I am not blaming, I am just setting out what the regulatory situation is and the legal position. It has long been on the websites.

Q125 Mr McFadden: You said that you were still at the BBA when the first FSA report on Barclays came out last July. You said earlier in your evidence that there were several times during your five-year tenure when you thought that you might walk away. Was the fact that this LIBOR thing was coming part of your decision last year, after five years-

Angela Knight: I did not know that it was coming then, I only knew when it arrived. The investigation had been going on for a long period of time and I had no idea that that was going to land then-none at all. The first I knew that that was going to happen was after the announcement had been made, and I then got a call.

Q126 Chair: Angela, Pat mentioned the issue of LIBOR. I mention this just in light of what you said about things being landed on the trade body. In 2005 you said to me that LIBOR had stood the test of time. You have issued a press release on the net-I have got it here-where you said, "BBA LIBOR has stood the test of time: it has been published on every business day since 1985 and is among the most transparent indices in the world. These changes will further strengthen BBA LIBOR and the confidence of its many users." Is that an example of things being landed on you as a trade body? In light of what you said to Pat, you can answer or not, but I think that it is important to put that on the record.

Angela Knight: Sorry-that is not 2005. I was not there in 2005.

Q127 Chair: It was whenever you came to me, perhaps 2007. I can get you the extract-

Angela Knight: You mean when you and I discussed it at the Treasury Select Committee?

Chair: Yes.

Angela Knight: I think that that has got to be 2008.

Q128 Chair: Yes, whatever. But you have also got a press release out-I got it off the net just now.

Angela Knight: No, that is fine.

Q129 Chair: So on two occasions-in 2008 and in this press release-you said the same things.

Angela Knight: That is fine. We had taken the steps that we could as an organisation. We could not take the regulatory steps but we had published a consultation; got some responses; done the rounds of authorities; engaged lawyers to put in new governance and taken that back to authorities.

We were completely unaware, though, Chairman, of the nature of what has now come forward from the investigation that is now public, and, indeed, there have been some other things coming up in the public domain.

We had no inkling whatsoever of what appears to be an absence of proper Chinese walls. We had no knowledge that A could be contacting B in another bank or C could be asking D to make changes-none whatsoever. I am absolutely appalled that that was the case. If I had known that, there was no way that I would have given you the assurance-

Q130 Chair: Not you.

Angela Knight: We did. We had notified the authorities. There is only so much that is within our responsibilities, remit or control.

Q131 Chair: It feeds into the notion that there was a lot hidden behind the surface.

Angela Knight: Yes it does.

Q132 Chair: Exactly. We respect that you were going to go no further, but there is a scandal here that has contributed to the corrosive lack of trust and confidence in the industry, which prevails today.

Angela Knight: I agree with you.

Chair: If you change your mind in terms of what you have said to us before and wish to write to us, we will be happy to receive that; otherwise, thank you very much for the 90 minutes that you have been here and your readiness to come and answer questions.

Angela Knight: Chairman, if I can provide some further information, I will. I will have to take some legal advice on legal issues. If I can, as I say, I certainly will undertake to do so. If I can’t, for legal issues, I will also let you know, so you know exactly the situation.

Examination of Witness

Witness: Clive Briault, former Managing Director of Retail Markets, Financial Services Authority, examined.

Q133 Chair: Clive, welcome to the afternoon session. I know you have been here listening to the others. You will have heard the CAB person say that she thought the regulator was too close to the industry and nobody knew precisely what principles-based regulation was. Were you, at the FSA, thrashing around and was there a lack of clarity and commitment from the FSA, which helped generate this long time scale of getting the problem fixed? We’re still in the process of that.

Clive Briault: No, absolutely not. I think there are probably three separate questions there. One is the point about the relationship between the FSA and the industry on one hand and consumers on the other. I did indeed hear the earlier comment from the CAB to the effect that the FSA was too close to the industry.

In practice at the time, the situation that the FSA was in was that, as a matter of statute under the Financial Services and Markets Act, there was a practitioner panel and a consumer panel. In addition to that, there was a wide range of communication and contact with both consumer bodies and industry bodies more generally. That was deliberately set up in order to create a sense of balance and ability particularly for the consumer voice to be heard much more powerfully than might otherwise be the effect.

Q134 Chair: Are you telling me that the consumer voice was heard powerfully by the FSA?

Clive Briault: Well it was certainly very powerful within the FSA as provided, first, by the statutory-based consumer panel, which commented at length on consultation papers, policy approaches and so on from the FSA. As far as I remember at the time the consumer panel used to meet for approximately one and a half days a month to formulate their inputs, many of which were sent to the people working on particular subjects. Where the consumer panel felt that they had issues that had not been properly taken on board by the FSA staff that went to the FSA board.

Q135 Chair: I think we are going along a different avenue here. As Chairman of the Treasury Committee, I had the consumer panel before us and they had a litany of issues that they felt the FSA was not taking up. This idea that you are putting across as if it was a best buddy arrangement and you would be hamstrung by them does not ring true.

Clive Briault: The consumer panel certainly had a large range of issues. In fact, on most of the policy issues taken forward by the FSA, in effect both the consumer panel and the practitioner panel were left unsatisfied at the end of the day, because the FSA on each of those cases had to take a decision on what to do, what policies to put in place and what approach to take.

I am not saying that the perfect approach was always to have the consumer panel and practitioner panel equally unhappy, but what I am saying is that I am not surprised that they still had a number of issues that they would have wanted the FSA to take differently, just as the industry practitioner panel felt exactly the same on many occasions.

Q136 Mark Garnier: Good afternoon. Can I talk about your principles-based regulation? You were a champion of the treating customers fairly regime. How did that fit in with principle 6? Obviously it is added into principle 6. Why was there a specific need to treat customers fairly when you already had principle 6?

Clive Briault: Because I think that was an area where it was arguably least developed through detailed rules. Let me step back a bit and explain one thing. The principles are themselves rules. It is not that the principles are somehow not rules. They have the status of rules within the FSA handbook. They can be enforced against and have been enforced against on many occasions by the FSA as rules on their own account. They are rules. They are not something separate from the rest of the rules.

Q137 Mark Garnier: As we have seen with UBS in the past few days.

Clive Briault: That is a very important point to make, I think. When the principles were first consulted upon back in about 1999 if I remember correctly, what the FSA said was that there will clearly be many occasions where those principles are amplified through a mixture of more detailed rules and guidance and other forms of communication from the FSA about what it is that those principles mean in practice. How is the FSA going to interpret those principles? In some cases, such as the principle about holding adequate capital and other resources, that is amplified at great length through some very detailed rules about minimum capital ratios and the like.

In cases such as one of the other principles you mentioned earlier this afternoon, about the information provided to consumers, that is amplified in many respects through very precise rules about the information that should be provided to consumers, who should provide it, when it should be provided and so on. Treating customers fairly is in a way an overarching principle above all of the conduct of business sourcebooks, including the insurance conduct of business sourcebook we have been discussing today. Nevertheless, there was a sense in which people were still saying, "Hang on a minute, if we meet all the detailed rules, does that mean that we meet the high-level rule? Is there something more to it than that?" This was a question which the FSA was asking as well as the industry and consumer groups. The answer that the FSA reached very clearly was that, yes, there is much more to it than that. There are things which we expect a firm to do under principle 6 - the treating customers fairly rule - which may not be contained in any of the detailed rules.

So the way that the FSA tried to help firms to think about that was by setting out what were called the six consumer outcomes, which I think were first set out in 2004-05. This basically said to firms, "What we want you to do under treating customers fairly is to think about the entire life cycle of a product; the life journey of a consumer through that product". So how is a product designed, how does a firm think about which consumers that product will be suitable for, how does a firm ensure that either its distribution channels, or others that it uses, makes a product that ends up in the hands of the consumers for whom it is designed? What is the information provided to consumers at the point of sale? What is the continuing information provided to consumers during the life of a product, how is a complaint handled and how is a claim handled?

All those issues, which we set out in the six consumer outcomes, were intended to help firms to think through for themselves the answer to the question: are we treating customers fairly and therefore meeting that high-level rule?

Q138 Mark Garnier: Clearly, with things like a firm maintaining financial prudence on principle 4, you can be very specific. You have to have your 90-day regulation capital and all this kind of stuff. That is a very easy thing to do. But when you come back to principle 1, "a firm must conduct its business with integrity", that is a very abstract type of thing. Clearly your treating customers fairly is somewhere in the middle, but you will be aware of Andy Haldane’s argument with the dog and the frisbee that if you are too prescriptive, what you then do is devolve intelligence, thought and wisdom to a set of rules. This is an abstract question, but do you feel that perhaps with treating customers fairly we are going too far or we haven’t gone far enough, or do you feel we should be leaving it up to the management of banks in order to work out the standards behind treating customers fairly?

Clive Briault: As I said, one of the sources of information about what those standards should be, one of the expressions of that set of standards, is that where there are detailed rules and guidance offered by the FSA, that is helping to flesh out what this means and what it should mean for particular firms and particular circumstances. The reason why we pushed treating customers fairly in particular as an initiative in its own right was partly that we could see that writing ever more detailed rules was not a sensible way to go forward. That is not the same as saying that we should dispense with all the detailed rules. It is clear that they were not sufficient in and of themselves. It is also partly because we wanted firms themselves to take much more of an initiative at a senior management and board level and ask themselves the question: "What is it that satisfies us as senior management and the board of the firm, that we are indeed meeting this principle?" Not: "We have asked our compliance officer if we are meeting the detailed rules in ICOB", but "What is it that we are doing as a firm and then what is the management information that we are collecting as a firm that provides evidence of the fact that we are meeting the principles and not just the detailed rules?"

Q139 Mark Garnier: Were you here for Peter Vicary-Smith’s evidence session?

Clive Briault: I was.

Q140 Mark Garnier: Then you will heard his quite remarkable revelation that the senior executive of one of the state-owned banks-which was kind of deduced-was rather contemptuous of these principles. What do you make of that?

Clive Briault: First of all, it is very disappointing.

Mark Garnier: We would all agree with that.

Clive Briault: Secondly, am I surprised to hear it? No. I said in my written evidence, just by way of the extent of the industry push-back from some quarters, that we intended to issue a paper-we did issue it in the end-with the title Treating Customers Fairly, setting out the initiative and what we meant by it and what we wanted senior management and boards of firms to do. That would have been in about 2004 or 2005, if I recall correctly.

The then chair of the practitioner panel asked to see myself and John Tiner, the then chief executive of the FSA, to express the practitioner panel’s extreme displeasure that we could possibly be thinking of issuing such a paper. He said that the very title of the paper suggested that firms may not be treating customers fairly. As I said, we pushed back on that and said, "This is the principle; this is what it says." Actually, all the evidence we had at that time from a series of previous mis-selling scandals of one sort or another suggested that there were indeed many cases where firms were not treating their customers fairly. That is why we thought it was important to push ahead with the initiative, so we did.

But that was the industry view at the time. There was a state of denial that there was even a problem around treating customers fairly. I think that is consistent with the individual mentioned by Peter Vicary-Smith either being contemptuous or being contemptuous because he or she believed that they were already doing it, and therefore there was not a problem.

Q141 Mark Garnier: The impression we got was that they were contemptuous of the rules, of the principle, as opposed to contemptuous because they thought they were already doing it. In December 2007, you issued ICOBS, which is an update of ICOB. However, the PPI section of the rules was beefed up. Why?

Clive Briault: At the time that the original ICOB was issued-it was finalised in 2004 and came into effect in January 2005-there was very little differentiation between different types of general insurance product. To a large extent, the sale of PPI was treated much the same as the sale of home or motor insurance. As a result of the series of thematic reviews, particularly the first two thematic reviews in 2005 and 2006, it became clear that one of the problems around the selling of PPI was that the rules in ICOB not only were not being followed by many firms, but firms were taking advantage of a lack of detail in the ICOB rules to justify practices that the FSA regarded under the high-level principle approach as being inadequate as a sales practice.

Q142 Mark Garnier: You are suggesting that they were in breach of principle 6.

Clive Briault: Yes, some firms were in breach of principle 6. Indeed, for some of the firms against which enforcement action was taken as a result of indicators of bad sales practice that came out of the various thematic reviews, the enforcement notices relied either in part or wholly on breaches of the principles as a basis of the enforcement action taken by the FSA.

Q143 Mark Garnier: So this reinforces that banks are incapable of instilling good culture.

Clive Briault: It is certainly indicative of that, yes. To completely answer your question about ICOB, one of the things that the review found was that, if anything, the rules were probably a bit on the heavy side with respect to the sale of things such as motor and home insurance. There was a lot of push-back in dealing, in some cases, with consumers who say that they do not want to listen to a two-minute talk about being regulated by the FSA before they renew their home or motor insurance. On the other hand, we were finding in the thematic reviews that there were some elements of sales practices where we needed to be more detailed, precise and explicit in the rules. Therefore, for protection products generally-PPI, medical protection, etc.-the rules in ICOBS were reinforced and strengthened, whereas for household and motor insurance some of the detailed rules were removed because they were felt not to be meeting a cost-benefit analysis test.

Q144 Mark Garnier: Reinforcing and strengthening the rules presumably makes it easier to bring a case against a firm.

Clive Briault: Yes. It certainly makes it clearer as a result of the detailed rules, but some of the poor practices we were finding as a result of the thematic reviews were unacceptable.

Q145 Mark Garnier: I take your point about car insurance and all the rest of it, but it seems that what we are learning from this is that banks, or people selling PPI, will game the system as best they possibly can.

Clive Briault: I don’t think it necessarily demonstrates that banks will game the system. I think it shows that the banks or other financial services firms that choose just to focus on the detailed rules and not to go through the senior management and board thinking that I was explaining in the context of treating customers fairly might feel that they have done enough simply by meeting the detailed rules, when actually they hadn’t. The way to make clear that there is still a gap in meeting the high-level rule of treating customers fairly is to amplify what treating customers fairly means. In some cases, that may be through more detailed rules; in some cases, it may be through guidance; and in some cases it may be through bringing enforcement actions and explaining very clearly in the enforcement notices the FSA’s interpretation of the high-level rule. There are various different ways of amplifying it. What was done in the Insurance: Conduct of Business sourcebook was one way of doing that. It was not the only way of doing it.

Q146 Mark Garnier: What is your advice to Martin Wheatley with your experience of treating customers fairly?

Clive Briault: The advice would be that it would be wrong to assume that the financial services sector will willingly embrace the spirit of treating customers fairly.

Q147 Mark Garnier: I think that that writes off the financial services industry nicely, doesn’t it? Thank you very much.

Q148 Mr McFadden: I want to ask you a few questions about discovering the extent of PPI mis-selling by banks. Your period of tenure was 2004 to 2008.

Clive Briault: Yes, to April 2008.

Q149 Mr McFadden: So you were there when the FSA became responsible for the regulation of PPI and other general insurance products at the start of 2005.

Clive Briault: Yes.

Q150 Mr McFadden: At that time, a thematic review was conducted quite quickly. How did you go about selecting the 45 firms for this thematic review? Bank, non-bank-how did you decide the split?

Clive Briault: That thematic review was undertaken within a matter of months of the FSA taking over responsibility for the selling of general insurance. At that time we were aware, for some of the reasons explained earlier this afternoon, that there were particular potential issues around the selling of PPI, which was why one of the reviews was focused on PPI as a general insurance product. Within that, we sought to pick up on a range of different types of PPI business and a range of different types of firm undertaking that business.

Q151 Mr McFadden: How many banks were in the 45? Do you know?

Clive Briault: I cannot recall exactly how many banks were in the 45.

Q152 Mr McFadden: Is there a way for us to find out?

Clive Briault: I am sure that the FSA has those details, yes. You would have to ask the FSA to write to you with the details.

Q153 Mr McFadden: Within the types of PPI, there are single-premium or a regular premium that you pay over years. Can you remember how you decided which types to look at?

Clive Briault: In the first thematic review, the decision was to try to look at all types. For example, one of the findings of the first thematic review was that with regular premium PPI sold to protect mortgage payments-from approximately 15 of the 45 firms that undertook primarily that type of business - we found relatively few problems with the sale of regular premium PPI on mortgages. That was a sub-sample of the sample, looking at that particular type.

The other firms were a sample designed to pick up on a combination of regular-premium and single-premium PPI against a whole different range of types of lending: unsecured lending, secured lending, car loans, credit cards, etc. Again, the intention was to pick up on the full range of PPI products, albeit within a relatively small sample.

Q154 Mr McFadden: But this is simpler than it looks. The FSA has told us that, of the 53 million PPI policies sold in total, 45 million of those-the vast majority-were sold by banks and that the big high street banks were responsible for the majority of the sales. Could you have not got to that conclusion pretty quickly?

Clive Briault: I am not disputing the facts about the majority of sales being by banks and, in that sense, also by large banks. It is just that the FSA review was intended to look at the effectiveness and the early implementation of the new regime for general insurance. In selecting PPI, we wanted to look at a wide sample of different types of firms and different types of product. We were not aware at that point, and had no evidence to suggest that, if there were mis-selling, it was confined either to the banks or to the large banks.

Q155 Mr McFadden: At the same time, you started to do mystery shopping.

Clive Briault: Yes. That was part of the first thematic review.

Q156 Mr McFadden: Given that the problem with PPI, as the evidence we heard earlier showed, was that it was often bundled with other products, was mystery shopping an effective way to get to it? You would not often be told that you had to take the product, or almost had to take it, until you had agreed to another product. For example, your mystery shopper is unlikely to get far enough to receive a mortgage offer, are they?

Clive Briault: Not a mortgage offer; but for some of the other types of lending the mystery shopping was undertaken in such a way that the mystery shopper did indeed get to pretty much the conclusion of the transaction. The mystery shopping was done by an independent body, but I assume that at that point the mystery shopper would then leave and, if necessary, cancel both the loan and the PPI. That was taken into account.

Q157 Mr McFadden: What did the mystery shopping exercise tell you, then?

Clive Briault: The mystery shopping exercise demonstrated a number of the failings that were highlighted in the first thematic review. The mystery shopping was particularly important in demonstrating what information was provided to customers about the PPI. It was particularly important in demonstrating whether or not firms were assessing whether or not an individual would be eligible to claim under the PPI, because firms selling it were obliged to undertake that suitability check. It was particularly important for assessing whether or not firms were making clear that the taking out of PPI was optional. In all those cases, the mystery shopping found some problems.

Q158 Mr McFadden: What we are concerned with is the enormous length of time that elapsed between discovering that this was a market consumer problem and ending up with this huge bill on resolution. I am trying to follow the timeline. You as the FSA take over responsibility for the regulation of the sale of this kind of product at the beginning of 2005; you do this review; you do an exercise in mystery shopping. When these exercises are over, at that point, what have you discovered? What are your conclusions about how big a problem this is?

Clive Briault: At that point, as published as the findings in the first thematic review, we found that there were, as I say, first of all relatively good practices in the selling of regular-premium mortgage PPI, but elsewhere, a whole series of poor sales practices. Those poor practices were very widely communicated, through publishing the thematic review and through what were called by the FSA "Dear Chief Executive" letters to all of the major providers of PPI products, highlighting all of the negative findings in the thematic review and asking those chief executives to write back to the FSA saying that they had looked at the situation in their own firms and were satisfied that those problems should not arise. Also, as a result of that initial thematic review, five firms were referred to the FSA’s enforcement division for further investigation and, if I recall correctly, enforcement action was indeed brought against four of those five firms approximately a year later, towards the end of 2006. Again, having the enforcement action and publicising the reasons for the enforcement action-the breach of both the ICOB rules and the principles-were all part of a very important communication exercise to the industry.

Mr McFadden: I think the Chairman is going to take up the issue of the firms you selected for enforcement action, so I will leave it there.

Q159 Chair: On that particular point, in your evidence to us you say that you referred five firms to the FSA enforcement division for further detailed investigation, and that resulted in four actions towards the end of 2006. You then go on to say that in addition, a major high street bank was referred to the enforcement division for further investigation in late 2005 when a sample of PPI sales for that bank indicated issues that would have been problematic if repeated more widely across PPI sales. Could you tell us what the firm was?

Clive Briault: I would prefer not to, on the basis that the result of the enforcement investigation was that enforcement action should not be taken against that firm.

Q160 Chair: Yes, but you say that after a lengthy investigation, it was because they felt there was insufficient evidence, but it would seem from reading between the lines in your report that this was contested by that firm. Given that as a Commission we have the power to send for papers and to send people to the FSA, it is something we will get anyway. In the spirit of communication and transparency within industry, as you say, it would be good if we saved ourselves that hassle and you could tell us today.

Clive Briault: All right. The firm was Lloyds TSB. As I stated in my evidence, what happened was that the FSA’s enforcement division then spent the best part of two years in a much more extensive investigation of the sales practices of Lloyds TSB in the area of PPI. The reason why it was referred was failings in a relatively small number of cases, because a very small sample was used for the thematic review. As I said, at the end of that, although the enforcement division found that there were a number of sales practices which were not necessarily of the highest standard, nevertheless, overall, there was not a case to bring enforcement action against that particular firm.

Q161 Chair: I have had the opportunity and the privilege of speaking with senior people in the FSA over the years. I quote directly, on an anonymous basis, what they said. I want to preserve their anonymity, but they said to me, "Even after we took the tough line, banks fought us all the way. It took us tremendous time, and the odds were stacked in favour of the industry. In a sense, we lost our nerve on that. They were always pushing back. They saw the fines as the cost of business. They knew the fines the FSA imposed would not be huge. They had every opportunity to stop this over four years, but they didn’t, because it was a highly lucrative profit centre." To sum up, they said: "The FSA’s heart was in the right place, but they were scared of the immensity of the challenge." Do you recognise some of those sentiments?

Clive Briault: I certainly recognise some of them, yes.

Q162 Chair: The thing about Lloyds is that that was just an example of banks pushing back.

Clive Briault: Well, the fact that a bank is investigated for two years, and the conclusion of the enforcement division at the end of that is that an enforcement action should not be taken, is not necessarily evidence of a bank pushing back. It is a question of what evidence the enforcement division found and whether they have assessed the seriousness of any breaches in their sales practices.

Q163 Chair: Yes, but you had four other banks where you had enforcement action, and this fifth bank, Lloyds, precipitated your two-year investigation. It seems that the other banks were co-operating at the time, hence the enforcement, but you had to undergo this two-year investigation.

Clive Briault: To be fair, the other four cases were much, much smaller institutions, where it would have been much easier for the enforcement division to review the relevant files and take a view whether the deficiencies in sales practices were such as to merit enforcement action.

Chair: Okay, but I think we will try to find out what information is in those files with the FSA, so that we can get an idea of the scale of the enforcement.

Q164 Lord Turnbull: I am still puzzled by paragraph 10 of the FSA’s submission: "In 2005 and 2007, the FSA did not appreciate the full extent of the profit made by a few high-street retail banks. The FSA lacks the capability to do market-wide analysis which would inform mathematic work." There is a later paragraph which says: "The FSA estimated that claims are about 16% of gross written premiums", but I think that was a figure that did not really become apparent to you-I am looking at a footnote in very small type-until January 2009.

I think you said that around 2006, you were getting into mystery shopping, and you were identifying some sales practices. In other words, products were being sold to people for whom they were not suitable and who would not be able to make a claim. I am surprised that people did not put two and two together and say, "If you sell someone something and you are only going to deliver it to a small percentage of the people who have bought it, that is basically a fraud, and they must be making a very big profit." You were not quicker off the mark to spot that mis-selling to people who could not really claim, such as pensioners, was part of the basis for the excess profits. It was almost three years later that you realised that claims were only 16% of premiums and hence this was an exceptionally profitable product.

Clive Briault: Yes. Let me try to answer that. First, the mystery shopping began in 2005. It was part of the first thematic review. That is a side issue here. The FSA was aware from the outset that this was a market which did not work at all effectively. The FSA was aware that because of the combination of consumer ignorance and a lack of consumer engagement when buying this product-after all, what the consumer is really interested in doing is buying a house or taking out a loan to buy a car or whatever it might be. That is what they are most interested in: the house or the car. They then probably have a secondary interest in the loan to pay for that purchase. By the time they get to the question, "Do I want to take out payment protection insurance against that loan?", the consumer engagement is probably extremely low. So a combination of the lack of knowledge of the complexity of the product and where it appeared in the chain of that three-part transaction meant that there was a very sharp imbalance.

We certainly knew about these issues at the time. I certainly knew at the time because a number of insurance brokers had told us very early on when we took over the regulation of the sale of general insurance that this was a very uncompetitive market. If somebody taking out PPI from a lender had actually taken the trouble to go to an insurance broker and said, "Can you please provide me with an independent quotation from a third party of PPI to cover this loan?" the very strong probability is that they could have received that at a much, much lower price. We were aware of that. That is not quite the same as saying that we had calculated exactly the value chain and where all the profitability arose, but we were certainly aware of that pricing issue arising from the deep-seated lack of competitiveness in the market.

Q165 Lord Turnbull: You are absolutely convinced that the two warning signals are information asymmetry-even you did not know just how bad a deal they were so how could the customer know-and bundling. Those two things were absolute warning signals. You could see the dangers; some insurance brokers were telling you about the dangers. With the flood of complaints to the CAB and the Consumers Association this was looking like a really bad product. Then somehow it takes until 2007 before you really get to grips with it and think you have to do something about it.

Clive Briault: Two things there, if I may. First, the FSA in the preceding years, not specifically about PPI, but the FSA board, and as communicated originally if I recall correctly even from Howard Davies as joint chair and chief executive of the FSA, took an approach based on the mantra of "We are not a price regulator". So the fact that the market was uncompetitive and as a result some consumers were paying much higher prices than they needed to pay was not necessarily something which the FSA would have picked up as being in itself mis-selling. There was nothing in the ICOB rule book which said you may not charge more than £X,000.

Q166 Lord Turnbull: When it comes to the with-profits sector, the FSA was very hot on what was the appropriate share of the pool that goes to the policy holder. Effectively in some parts of your business you were interested in a fair distribution of the outcome. Here there is something manifestly unfair, not just in the sense that people were being charged too much for something-you could say that is caveat emptor; they were being charged for something and almost, as I understand it, fraudulently being offered something and then being told later, "Yes, but it didn’t cover this and it didn’t cover that."

Clive Briault: Absolutely. Where we found that people were being sold products for which they would not be eligible to claim-for example, because they were over 60, self-employed or had a pre-existing medical condition-those were all areas where we came down extremely hard, including through the enforcement actions.

Q167 Lord Turnbull: That was still going on into ’06-’07.

Clive Briault: Some of that was still going on, yes. But you asked about the economics of a pricing point. I think the other important aspect here is that, as we heard earlier, the OFT did receive a super-complaint from the National Association of Citizens Advice Bureaux in September 2005 and embarked upon their own market study. It is certainly the case, as I look back on this, that one of the things the FSA did-rightly or wrongly, with the benefit of hindsight-was to take the view that the OFT was the expert in market economics and the Competition Commission was the expert in remedies designed to make markets work more effectively and more competitively. Coming back to the question about why this took so long, one of the reasons-

Q168 Lord Turnbull: When did they finally-

Clive Briault: The OFT market study was published in October 2006. That made clear a number of findings about the low claims ratios compared with other insurance products, the high commission rates and the wide differentials in price for similar cover across identical products. In my written statement-I think you were referring to a different piece of written evidence, which was not from me.

Lord Turnbull: I was referring to one written by the FSA.

Clive Briault: I am sorry, but I can only refer to the one written by me. As far as I am concerned, the FSA was fully aware of those market economics-type points as a result of the OFT market study, which was published in October 2006. I do not recognise the proposition that somehow the FSA was not aware until 2009. In fact, as I said, I think the FSA was aware of the broad nature of the market and the broadly non-competitive nature of the market from the outset.

Q169 Lord Turnbull: What was it, then? There was some action that you specifically decided to take in 2009, which eventually led on to the judicial review.

Clive Briault: That is because there was a decision taken earlier by the FSA, as I mentioned in my written evidence, that in the revision to the insurance conduct of business rules in 2007 should not introduce rules designed to change the market structure. Nevertheless, such changes to the rules were considered actively within the FSA. They were considered, and I actually made a speech in 2005 where I set out some of these possibilities, so they were clearly being actively considered by the FSA even at that stage.

It was suggested that you could try to change the market structure, for example by introducing a rule which was very similar to the Competition Commission remedy that was suggested in 2009 of having a one-week separation period between taking out a loan and taking out PPI against that loan. That would give you a week to consider, to think about shopping around and to ring up your insurance broker and say, "My bank"-or whoever it is-"is suggesting I take out this PPI product from them. Can you do it any cheaper for me?" just as you might naturally do with home insurance, travel insurance or motor insurance. The FSA was considering whether it should take that kind of action from quite early on, which I think demonstrates that we did understand quite a lot about the way in which this market did not work effectively, and were thinking about remedies.

As I explained, the reason why we did not introduce that as a rule when we revised the insurance conduct of business sourcebook in 2007 was, first, because we the FSA were unable to construct a convincing cost-benefit analysis case to justify such a rule and, secondly, because by then the OFT had already referred the market of PPI to the Competition Commission. That referral was made in February 2007, and we the FSA felt that it was best to wait for the Competition Commission to produce its remedies for market imperfections, rather than us introducing a set of rules in late 2007 which might prove to be inconsistent with whatever the Competition Commission came up with.

Q170 Lord Turnbull: Looking at it now, do you think it might have been better if you had acted at that point to at least do something and then brought it into line with whatever the OFT and the CC came up with?

Clive Briault: As I say in my written evidence, that is one of the things which, looking back, I think we could certainly have done differently. I also say something in the written evidence that, in a way, is justified by what was seen after my time at the FSA, when the banks collectively took the FSA to judicial review and when, if I understand it correctly, two banks challenged the Competition Commission’s findings in 2009; there was a separate legal case about the Competition Commission inquiry findings. I think that that demonstrates the extent of push-back that the FSA would have faced had it tried to introduce quite radical solutions earlier in the process. I am not saying that that is a reason for not trying to introduce them, but I think that had we consulted on that, say with a one-week separation gap, explicitly as part of the review of ICOB-

Q171 Lord Turnbull: Do you think that the man in the street is thinking, "There are three players in this-the FSA, the OFT and the Competition Commission-they could have taken two or three years out of this timetable and brought this whole abuse to an end earlier"?

Clive Briault: You will have to ask somebody else whether or not a combination of the Office of Fair Trading and the Competition Commission could have reached their conclusions more rapidly. I really cannot comment on that.

Q172 Lord Turnbull: We will have an opportunity.

Clive Briault: As I say, the FSA took the view that it was right to wait for the Competition Commission, as the expert in market economics, to take a view on what the appropriate remedies would be. As soon as those remedies were announced, the FSA intervened and encouraged the banks as quickly as possible to introduce those remedies. Again, that was after my time at the FSA, but that was the broad timetable, coming back to the earlier question about why this all took so long.

Q173 Chair: If you had known a consumer who had a complaint against PPI in the late ’90s, and found that it took them till April 2012 and maybe even April 2013 to get the whole thing worked out, would you have said-standing in the consumer’s shoes-"Look, there’s something wrong with this process"?

Clive Briault: A consumer who made a complaint in the late 1990s would have had that complaint dealt with reasonably promptly. If whoever made a complaint did not agree with the findings of a firm, that would have gone to the Financial Ombudsman Service and so on. We heard earlier that most of the complaints were about what happened when somebody made a claim and then suddenly found that some of the exclusions were brought to bear. Most of the complaints in the early years were not about some of these other aspects of mis-selling-in terms of how the PPI product was sold, as opposed to how a PPI operated when somebody made a claim against it as a result of unfortunate circumstances in being unable to repay the loan.

Q174 Mr Love: To pick up your final comments, in relation to finding a market solution you indicated that the Competition Commission had started its inquiry and that you wanted to wait for it to reach its conclusions, but you also mentioned push-back from the banks. Could you explain to us the balance of those two things? Was there a great deal of push-back from the banks towards a market solution and you therefore decided to wait for the Competition Commission, which has far greater powers in this area, or was it just that everybody was relaxed about it and felt that they ought to leave it to it?

Clive Briault: There were two different types of push-back. First, the specific push-back that I mentioned was the push-back that actually arose in 2009 and 2010, after I had left the FSA, against the Competition Commission and the FSA respectively. What I was saying was that, given the push-back seen later, I would have expected that had we attempted more radical solutions in 2007, when we revised the Insurance: Conduct of Business Sourcebook, the chances are that the banks would have pushed back very hard at that point.

In terms of the actual push-back, having identified, as a result of the first thematic review, that there were these failings in terms of how the market worked-the structure of the market, the imbalance of power between consumers and providers-one of the things that we did, and indeed I chaired the meetings, was to call in all the relevant trade bodies and discuss with them what they could do by way of industry-led initiatives to try to change the way in which the market operated. What we concluded from that series of meetings was that they offered some initiatives around better information to consumers, how you deal with the PPI premium when a loan is repaid and you therefore want to cancel the PPI, and those sort of issues, but there was absolutely nothing being put on the table by the industry around how you would change the overall nature of the market in terms of the fact that PPI was sold after the primary purchase of a product, after the loan and at a point at which consumers were uninformed and, generally speaking, unengaged.

Q175 Mr Love: Can I interpret that as meaning that the banks were prepared to move superficially, but anything that would have interrupted the significant profits they were making from PPI were resisted?

Clive Briault: That is a very reasonable conclusion, yes.

Q176 Mr Love: Can I come back to the point made by Mr Garnier about the decision to change the ICOB rules and the ICOBS’ extended rules? You have given a clear explanation for the reason why the FSA was minded to move in that direction. I am interested in the motivation of the banks to move in that direction. I assume that there was a lot of pressure from the banks-perhaps you could confirm that-to move to a more elaborate set of rules. Based on your experience at that time, would you care to reflect on what the banks thought they were getting out of the extension of the rules?

Clive Briault: In fact, I do not recall the banks being in a position where they were pressing for an extension of the rules. Given the findings of the first two thematic reviews, nobody was very surprised about the extension of the rules on those types of protection products which the FSA proposed and indeed then implemented at the end of 2007. I do not recognise the proposition that the banks were pressing for a lot more details. So, there was not a lot of push-back to the extension of the rules, but I would not see it as the banks pressing the FSA to do that extension. The extension of the rules was very much at the FSA’s initiative. The FSA consulted on it, as it always did with any changes to its rules. There was not much push-back to the proposed extension of the detailed rules for a particular class of general insurance products.

Q177 Mr Love: Let me put the question in a slightly different way. I asked Angela Knight earlier on whether she would accept the use of the word "gamed" the system in the sense that the FSA had a series of principles and rules and the way in which that was interpreted by the banks-I assume the vast majority of banks; you can correct me if I am wrong-was that as long as they followed the rules and ticked the boxes they had complied with the principles. I will come on to the issues that you have raised about that, but would you accept that that was gaming the system?

Clive Briault: I would not describe it as gaming the system. I would go back to the point that Mr Garnier made which is that if you do not treat seriously the rules that are high level principles, and if you do not go through the sorts of processes that the FSA was demanding that firms did go through as part of a TCF initiative to ensure that they were indeed treating customers fairly and had the management information to demonstrate it, then the firms were potentially in breach of the high level rules themselves. Simply meeting the detailed rules is, as I said earlier, not in itself a defence against a breach of a high-level rule. The detailed rules are not designed to be exhaustive.

Q178 Mr Love: Correct me if I am wrong, was not that the very defence? Mr Tolley laid it out in some detail in earlier comments with Angela Knight. Was not that indeed the very defence that the banks gave-that they had followed the extensive rules, ticked the boxes if I can use that term, and that that therefore meant that they were treating customers fairly? That is despite the fact that there was emerging evidence that they were doing anything but treating customers fairly.

Clive Briault: I think that there was a lot of evidence that they were not even meeting the detailed rules. That is what all the thematic reviews and mystery shopping found. So first, they were not meeting the detailed rules. Secondly, even if banks were meeting the detailed rules, it did not necessarily follow that as a result of that they were meeting the high-level rules set out in the FSA’s principles.

Q179 Mr Love: The reality is that for whatever reason, ICOB and ICOBS failed to get the banks to engage with this whole issue of culture. They did tick the boxes and they did not look at the high levels that you have talked about. How do we address that failure now because there are other products coming on to the market? The defence may be that we follow the rules while the evidence is emerging that they are not treating customers fairly. How do we deal with that?

Clive Briault: The point I made in my written evidence and was making earlier was that the FSA was operating in three different areas during the period 2005 to 2007 and early 2008. One was whether firms were meeting the detailed ICOB and then the ICOBS rules, and how those detailed rules should be amended to try to make that better. The second was whether firms were meeting the high-level rule of treating customers fairly, and the other FSA high-level principles. The third was how someone can make the market as a whole work much more competitively and effectively in the interests of consumers. To some extent, there is some overlap between the three, but it is useful to separate them out.

On the question of whether banks were meeting the detailed ICOB rules, and whether the changes to the ICOB rules were likely to be sufficient, they were never designed to change bank culture. They were about procedure and practices at the point of sale of PPI, and about the information you gave, the suitability checks, making it clear that PPI was optional, and those sorts of things. They were not designed to change culture.

The element of those three that was designed to change culture was absolutely the treating customers fairly initiative. I said earlier that the emphasis on that was not simply to say that if you meet the high-level principle, you do not need to worry about the detailed rules. That was not the point of it as such. Its real essence was to get the senior management and boards of banks to focus on what they were doing that demonstrated to themselves that they were meeting all those principles-not just the TCF initiative, but all of them-and what management information they were discussing at board meetings each month or each quarter that enabled them to take a view on whether they were indeed meeting those principles.

One thing I used to say in speeches was that I expected firms that were major players in the market to be doing their own mystery shopping on themselves, and reporting the results to their board monthly or quarterly, saying what they were finding and whether they still had issues, and asking what that told them about incentives, sales practices, sales scripts, and whatever it might be about the root cause. The view was that if you could get firms to focus on how they design products, how they ensure that those products are suitable for some consumers, how they ensure that the products end up in the hands of consumers for whom they are suitable rather than not, how they treat complaints, and how they handle claims, and if you could get senior management and boards to focus on such issues and to think hard about whether they are delivering that, that might then feed into culture and behaviour. That was the underlying purpose of the TCF initiative. Regrettably, it proved to be insufficient.

Q180 Mr Love: That is probably the main reason for having this inquiry: to get to the point that you have just outlined. But let me put it to you that on the evidence that we have received and indeed on the evidence of the failure of PPI, the reality is that treating customers fairly has failed. We have been shown so many professional organisations’ codes of conduct, and you could present books full of evidence saying that the culture was right, yet we know that it was wrong. Even the detailed rules, as I think you have admitted, have not worked. Where do we go, recognising those three salient facts, to get to the position you are outlining? Let me add to that because there has been a discussion around this table and in other parts of the inquiry about a duty of care. Is that just another Aunt Sally, or will there be positive benefits from moving in that direction?

Clive Briault: There are two different questions there. One is about what might be sufficient to change culture and behaviour, given that all that has gone before does not seem to have done so. As I think a previous witness said, it seems that that is equally true in the wholesale market as in the retail market. Again, if I look back, one of the questions I was asked was what would I do differently. I think that, arguably, the FSA underestimated the extent of industry push-back on the treating customers fairly initiative, and on the opportunities that the FSA thought that it was giving firms as part of its more principles-based approach: to think through for themselves how they can best meet the principles rather than simply following the letter of the detailed rules. One of the reasons for that is certainly the one you suggest: the amount of profit to be gained from not doing that proved to be a very powerful incentive for the firm as a whole, and all sorts of things followed as a result of that. So, my biggest disappointment from this period is that firms did not embrace, and therefore embed, the treating customers fairly initiative.

How do you move to a better place? Well, with great difficulty. It is not clear to me that writing more detailed rules is the answer. Most possible formulations of the duty of care that I have seen come up with wording that is very similar to the FSA’s principles’ current wording. Then you reach the point about duty of care; if you express it at that very high level, you then have exactly the same question asked: what does this actually mean for particular firms in particular circumstances?

Either the regulator has to produce rules and guidance to amplify its interpretation of that or, if a duty of care is used by consumers to take legal cases, the courts begin to identify what it is that constitutes an interpretation of that duty of care. But it does not get around the very fundamental question that people will still come and ask: whether this practice, in this market, for this product is acceptable because there are lots of different interpretations of what treating customers fairly and acting in the best interests of customers-or whatever the formulation might be-means.

Q181 Adam Tolley: Mr Briault, you said in your presentation to the Commission that some firms took the treating customers fairly initiative seriously while others only paid lip service to it, and you have put that in strong terms, saying that they hid behind elaborate projects that did not deliver much by way of concrete outcomes.

Clive Briault: Yes.

Q182 Adam Tolley: Are you able to say which firms, in your view, fell into the latter, lip service category?

Clive Briault: No, because firms were given deadlines to embed and demonstrate that they were indeed treating customers fairly. The ultimate deadline that they were given was December 2008, but I had left the FSA nine months before that. I really cannot comment on which firms were able to meet, or were judged by the FSA as having met, that target by the end of 2008 or not.

Q183 Adam Tolley: But you must have had a basis for your view that some firms only paid lip service to the initiative?

Clive Briault: Part of the basis for the view is that many of those firms, which did indeed have projects, nevertheless seem to have been caught up in all the various scandals that either have come to light or, indeed, have occurred since my time at the FSA. You might assume that, had they paid more than lip service to it and genuinely changed the culture and behaviours of the institution, they would not have been caught up in some of the problems that have subsequently arisen. In fact, it is difficult on that revealed evidence basis to give a very long list of major firms who appear to have both embraced and embedded the treating customers fairly initiative in the way that was intended.

Q184 Adam Tolley: You say, perhaps with some generosity, that many banks placed profitability ahead of compliance with FSA rules. Were there any banks that, in your view, did not do that?

Clive Briault: I am a fair person; I would prefer not to damn every single individual firm. Therefore, I resorted to a word that comes back to my memory from my FSA days, which is to say "many" when you mean "most" but you are not actually clear about the precise percentage that lies on either side of the equation.

Q185 Adam Tolley: Are you able to give any examples from your knowledge of banks that would be shining beacons of good practice in this field?

Clive Briault: That would be difficult.

Q186 Adam Tolley: One more thing about the enforcement question that you were asked by Lord McFall. You mentioned that the bank in question had escaped enforcement action at the end of 2007 due to a lack of evidence, and the view of the FSA was that Lloyds TSB-obviously, with the considerable benefit of hindsight, we know that Lloyds TSB is the bank that has made the largest provision for mis-selling refunds in relation to PPI. Can you say what the FSA might have missed at the time, in 2007, given what we now know about the actual position?

Clive Briault: I was not closely involved in the enforcement investigations, so I cannot really comment on that.

Q187 It is perhaps a fair inference that something important would have been missed, given what we now know about mis-selling in the context of that and other similar bank.

Clive Briault: As I say, it is very difficult for me to comment on that. I was not closely involved in the Enforcement Division investigation, so I cannot really comment on the details of what they either found or did not find.

Q188 Mr Briault, you said in your presentation that the FSA might have focused earlier in its work on the largest players in the PPI market, but it was only after the FSA’s third thematic review, and the mystery shopping that was associated with that, that the full extent of consumer detriment arising from the mis-selling of PPI was apparent. Just before I ask you the question I want to tell you that the FSA’s own presentation to the Commission expressed the view that it was only once the Competition Commission had produced its "Market investigation into payment protection insurance" report in early 2009 that the full extent of consumer detriment arising from PPI mis-selling became clear. Are you able to assist the Commission as to why it was that the FSA did not perceive the extent of the problem earlier?

Clive Briault: It is very difficult to comment, because I am not in a position at the moment to know the full extent of the problem, because I have not been closely involved with PPI since I left the FSA. It was stated, absolutely clearly and unambiguously after each thematic review, that the poor practices found-to the extent to which poor practices were found in each thematic review, which they certainly were in some areas-were practices which could easily lead to consumer detriment. They did not necessarily of themselves automatically constitute consumer detriment, but obviously if you put all of those practices together it is very difficult to see how consumer detriment would not arise, as for example in the case of people taking out insurance for which they were not eligible. That has to be up-front consumer detriment, because they paid money for something which is useless to them. So the fact that there was consumer detriment was evident to the FSA from 2005 onwards.

I think there is a much more difficult question about how you would quantify the extent of that consumer detriment, because that rests very much on what you think the FSA should be including in that equation. So coming back to a discussion about the economics, if you take the view that paying more than a perfectly competitive price for a product is in itself consumer detriment, you would potentially in this case have a very high figure. If you took the view that the FSA is in essence not a price regulator and therefore that particular aspect is not a central concern of the FSA, you would reach a different conclusion about the extent of consumer detriment, because you would focus much more on specific mis-selling, rather than the lack of competition in the market.

I am sorry, that is a rather long way of answering. But I think there are lots of different ways of calculating the extent of consumer detriment. I don’t even think, for example, that the amount which banks eventually pay out as a result of the current remediation and complaints handling programmes is in itself necessarily a good measure of the extent of consumer detriment.

Q189 One last thing in relation to the timing, the chronology and the dealings between the FSA on the hand and the Competition Commission on the other. You have expressed the clear view to the Commission that at the time you took the view at the FSA-we are now talking about 2007-that it was best to wait for the Competition Commission to produce its remedies, rather than the FSA going ahead with any independent reform or new regulation of its own. You indicated to Lord McFall that you acknowledged that things could have been done differently. With the benefit of hindsight would you accept that things should have been done differently, and that the FSA ought to have pressed ahead with attempting reform of this particular market without necessarily waiting for the Competition Commission?

Clive Briault: With the benefit of hindsight, possibly so. At the time that was far less clear. As I say, the view was that the Competition Commission were the experts in this field of market economics and market remedies. One of the problems-not the only problem, one of the three main problems in the PPI market-was about the way in which the market operated, and the view was taken that it was best left to the experts in that field to look very closely at the way that the market operated, and to come up with remedies that would make it operate more effectively.

Q190 It is just that the Competition Commission has been very clear that their remit was limited to those aspects of the market that were having an anti-competitive effect. They had nothing necessarily to do with mis-selling.

Clive Briault: Absolutely. That’s why I say there are three different things going on here. One is the nature and competitiveness of the market; that is what the FSA decided, in effect, in terms of remedies to leave to the Competition Commission. In terms of the mis-selling through very poor sales practice, that was taken forward through publicising thematic reviews, taking something like 25 enforcement cases just in the time that I was at the FSA, which is probably more than for any other single issue dealt with by the FSA. The largest mystery shopping exercise ever conducted by the FSA in 2008, shows that it wasn’t that the FSA was doing nothing.

The FSA was doing a lot to publicise and make clear to firms the importance that it placed on both compliance with the detailed ICOB and ICOBS rules, and with the treating customers fairly initiative. Those two aspects of it were vigorously taken forward by the FSA. The question about how to make the market operate more competitively and redress the imbalance between consumers and producers was left to the Competition Commission as the experts in that particular field.

Q191 Chair: It has been put to us that the fines imposed on the banks were just seen by them as a cost of doing business. The £7 million fine levied on Alliance & Leicester was the biggest fine levied. Given that any potential fines are tiny fractions of the PPI profits, would you go along with the view that it was just a cost of doing business to them?

Clive Briault: I would certainly go along with a view that, purely as a matter of economics, if you compare the level of the fine against the big profitability of the business, you could chose to regard it as a cost of doing business, yes. That is why one of the results of, I think, the third thematic review was that the FSA issued a statement that, given first of all that point, and second that after the first two thematic reviews sellers of PPI were very much on notice of the extent to which the FSA regarded this as a problem, the FSA pre-announced that from then on the level of fines would be substantially higher. That is one of the things that the FSA recognised during this process and made a very clear pronouncement about and indeed then carried through on.

Q192 Chair: Carried through on?

Clive Briault: In terms of then increasing the level of fines imposed for breaches here.

Q193 Chair: It is a tiny fraction of the profits that have been made; that is the point. Martin Wheatley has made the point in a speech that I was at a few months ago that the FSA didn’t look at the business model-in other words, didn’t look at the profit and loss. Therefore you were missing something in that equation.

Clive Briault: It is certainly true that at the time, fines were not based explicitly on profits made, although it was one of the factors taken into account and set out in the handbook as to how fines were imposed. Nevertheless, it was not linked very closely to the amount of profit made through the particular activity. That was just as true in all other activities as for PPI. That was by no means unique to PPI.

Chair: Thank you for your evidence.

Examination of Witness

Witness: Jon Pain, former Managing Director of Supervision, Financial Services Authority, examined.

Q194 Chair: Thank you very much, Jon. You have been very much involved in the industry over the years, and you were managing director of general insurance at Lloyds TSB. At that time and in your subsequent role with Cheltenham & Gloucester, did you have any concerns about PPI and did it influence the actions that the company undertook at the time that you were in charge?

Jon Pain: The short answer to that is yes, Mr Chairman. As Clive already illustrated, particularly in the mortgage market. There are distinctions between the mortgage market and the loan protection market in that some of the issues in the loan protection market were not as prevalent or as detrimental in the mortgage market in that respect. By its nature, the mortgage market was more competitive. There were more choices and more players in that context, so that did drive some different characteristics in the mortgage market. Throughout that period, there was a constant issue of trying to address some of the issues in the mortgage market to make sure that the mortgage market worked effectively.

Q195 Lord Turnbull: You have been poacher/gamekeeper/poacher, so your evidence is quite valuable to us. I am trying to establish how far the designers of the products, not the people in the branch offices who were selling the products, knew that they were consciously-you could say cynically-exploiting the asymmetry of information between them and the customer, knew that they were selling something with a lot of small print, often over 100 pages we have heard, which would disqualify quite a lot of people from claiming, and knew the margin that they were making on it, yet nevertheless, no one said, "We can’t put our names to a product with those characteristics."

Jon Pain: That is quite a wide-ranging question, Lord Turnbull. Complexity of products is definitely a feature of some of the issues that you have been talking about today. The more complex a product, the more the issues are likely to be challenging for any distributor, whether it be a bank or anybody else, to then make sure across multiple distribution channels that that is done effectively. One of the features that is very apparent, if there is a lesson to be learnt out of the whole PPI question, is the complexity of products. That is different from saying there was an overt intent right from the word go to design a product that could be mis-sold. I would not say that, if that was the view you were trying to put with your question, but there was the intention-

Q196 Lord Turnbull: But the designers of the product must have known that they were designing it with very large categories of people-eg pensioners-not being able to take advantage of it, knowing that it would actually be sold to those kinds of people.

Jon Pain: The nub of the issue is your last sentence. The issue was that the product, the product features and the eligibility of the product were very clear. From a design perspective, it was very clear which categories of insurance cover were applicable to which group of customers. The issue about then making sure that information is given to the consumers, given to the people who are selling that product in a way that makes it very clear, and then make sure as far as possible that the right customers buy that product is a feature. But the more complex you make that, the more complex those issues of exclusion add to that issue. But I do not think that the product was intently designed to be mis-sold to groups of pensioners.

Q197 Lord Turnbull: I am not convinced of that at all. I think that some people design things-"Let’s exclude them, let’s exclude them"-and then make no effort to tell the front-line people that they should not sell those to people with pre-existing conditions etc.

Jon Pain: That certainly would not be my experience. I don’t think there is a cynical intent right from the word go to sell. You can argue that the sales process proves to be ineffective. You can argue that the disclosure process does not work effectively. But I do not think that there was a cynical intent to design a product that could be inherently mis-sold to people in the way you suggest.

Q198 Lord Turnbull: If you buy a car, you get all sorts of people following up, "Are you satisfied with it? Were there any faults with it?" If the people who designed these products had done any mystery shopping of their own, they must surely have picked up on the fact that a number of people had bought the products who were facing exclusions and probably had not spotted that on page 89.

Jon Pain: I cannot help but agree that that is one of the deficiencies of what PPI shows us, that that type of follow-up and the rigour of that follow-up process were not as good as they could have been.

Q199 Lord Turnbull: The reason why I persist with a cynical view is because of the rigour with which the banks sought to defend their interests. When challenged, instead of saying, "Maybe you are right. We had better soft pedal on this," they fought to the last to protect it and looked like someone who had created a bit of a gold mine and was very reluctant to give it up.

Jon Pain: I certainly see why you make that assertion. I can only just repeat what I said. I do not think that there was a cynical intent from the word go to design a product to be mis-sold.

Q200 Lord Turnbull: An alternative explanation-I suppose this is what the FSA has found and why enforcement action and restitution is going on-is that it was massively incompetent to design something and sell it to thousands, or even millions, of people for whom it was unsuitable.

Jon Pain: Certainly the evidence of the mystery shopping that Clive has referred to points to the fact that a good number of the sales processes that should have followed to make sure that it was sold appropriately to the right people were not. The evidence speaks for itself.

Q201 Lord Turnbull: The FSA is not a price regulator, but did it have any requirement that they should do these mystery shopping exercises themselves?

Jon Pain: It is not a requirement. As Clive referred to, it is part of the FSA’s policy to develop its own TCF regime. It was one of the best practices that was promulgated through that process, but it was not a requirement. You would argue that it is good practice for any business to survey and interview its customers to make sure that they are satisfied with what they are buying by way of a product from a supplier. But it was not a requirement in respect of regulation.

Q202 Mark Garnier: On the question of sanctions against firms and individuals, do you think that the FSA’s sanction powers against firms are sufficient to cope with something like the PPI mis-selling scandal?

Jon Pain: Over this period of time and now, with the FCA, the powers of the conduct regulator are changing. They are fairly wide-ranging and quite significant. You would argue in one dimension that the FSA has the power to ban or vary the terms of permissions or effectively ban a firm from undertaking activities they are not doing in an appropriate way. Enforcement fines have been radically overhauled by the FSA over the last few years. The recent fines in respect of LIBOR and other aspects significantly point to a much higher level of deterrent from the sanctions of fining. Of course, the new powers of the FSA under the FCA will be more wide-ranging still, so the combination of all those things are a fairly powerful series of tools to deploy.

Q203 Mark Garnier: Prior to 2010, Alliance and Leicester had the biggest fine of £7 million. The total fines were £12.6 million and, in 2010, a new regime was designed to increase the penalties. But, at the end of the day, surely these are looked at by firms as merely a cost of doing business.

Jon Pain: That was the conversation you have just had with Clive. Some of the period that you are referring to was obviously before my time at the FSA, but there is no doubt that there was a substantive change in the whole thinking about financial penalties, which is what led to the changes in respect of the whole financial penalty regime in 2010. You can look back with hindsight and say that the level of penalties in the past looked much smaller than the current penalties, and that is an obvious statement of fact.

The question is to what degree would financial penalties have to rise to change behaviours of firms in the financial services marketplace.

Q204 Mark Garnier: The problem is, of course, that if you fine firms, you are actually fining the shareholders and the customers, aren’t you?

Jon Pain: In effect, because, ultimately, it is the shareholders who pay for that fine, yes.

Q205 Mark Garnier: So is the FSA trying to send a message that it is up to the shareholders to do the regulating, by, effectively, fining them?

Jon Pain: In terms of the regulation of the financial services marketplace, if you are going to rely on fines and financial penalties as the only toolkit that a regulator is going to deploy, that would be a very ineffective approach. Fines in themselves have got to be a deterrent in large measure, but it would be a very short outcome if that was the only way we tried to regulate a marketplace.

Q206 Mark Garnier: So in terms of sanctions against individuals-regulated, approved persons-how many people were prevented on your watch from remaining an FSA approved person as a result of PPI mis-selling?

Jon Pain: I honestly could not say.

Q207 Mark Garnier: Could you hazard a guess of the order of magnitude?

Jon Pain: I think you can see over the last five years that there has been increasing action against individuals in that respect. Individuals have been either barred from the industry or censured on an individual basis, but that is a more recent phenomenon. That sanction and that personal accountability are definitely a focus at the FSA currently.

Q208 Mark Garnier: Paragraph 45 of the FSA submission says there was enforcement against 23 firms and four individuals. I am not too sure which firms those individuals were at, but it seems that, if you are an individual, you get away with it. To return to my earlier point, it is the shareholders who get penalised.

Jon Pain: I take your point, but there is an increasing recognition now that personal accountability is becoming an increasing feature in the sanctions of the FSA.

Q209 Mark Garnier: Have you got any evidence that that is actually happening?

Jon Pain: Certainly, in my contact with the industry, they are very clear now that people will be held personally accountable in that regard. I do not dispute the numbers you are referring to, but those relate only to PPI. Across all aspects of FSA activities, I think the number of individuals who have been sanctioned, either publicly or privately, or barred from the industry is substantially higher than the four.

Q210 Mark Garnier: But, again, when you say "substantially higher", how many people are approved persons and how many will get sanctioned in a year, roughly?

Jon Pain: It is a large industry, so the numbers will be a very small percentage in respect of the overall population.

Q211 Mark Garnier: Is it not the case, though, that banks, and indeed many financial institutions, are just so complex, with so many different people carrying out so many different functions, that even if they are all approved persons, it is difficult to nail down an individual for doing something wrong? If you take PPI mis-selling, we have heard in evidence this afternoon that the incentive for sales staff at the front line in a bank on the high street in Kidderminster, for example, to sell a loan with PPI is six times greater than it would be to sell a clean loan. So who is the person responsible? Is it the individual doing the selling, is it the manager of the branch, is it the person who created the product in the first place, is it the person at the regional or board level who decided that this was a good way of doing things, is it the compliance officer or is it the risk officer? Who is it? Does that not make a nonsense of having an approved persons sanction?

Jon Pain: No, I do not believe so. There is a degree of different levels of responsibility throughout financial institutions. There will be people who are in charge of the sales process, people who are in charge of the oversight of that process and people who are in charge of the management and stewardship of the institution as a whole. All those levels of individuals have different levels of responsibility and culpability in respect of mistakes. You have to hold them to account for their levels and spheres of responsibility. I do not think it would be right to say nobody but the CEO is responsible in respect of a firm. Clearly, you run a large, complex institution by giving clear accountability and responsibility to individuals and then making sure they do their job properly. At different levels, those people have to be responsible for their sphere of responsibility.

Q212 Mark Garnier: Beyond clawing back bonuses, what financial sanctions are there against individuals?

Jon Pain: The ultimate sanction, of course, is that you bar them from the industry if their behaviour warrants that. That, obviously, can be a permanent sanction or it can be a sanction for three or five years. That is a severe sanction in respect of their livelihood.

Q213 Mark Garnier: But beyond clawing back a bonus, there is no financial sanction, is there?

Jon Pain: If they are found culpable of failing to adhere to FSA rules, regulations or principles, as Clive has just mentioned, they can be held accountable for that and dealt with accordingly. Enforcement action can be taken against individuals, and they can have sanctions, either through fines-

Q214 Mark Garnier: So they can be fined.

Jon Pain: Yes, individuals can be fined.

Q215 Mark Garnier: And they can be banned from the business.

Jon Pain: That is ultimate. Obviously, banning is-

Q216 Mark Garnier: I appreciate that. The problem is that we are looking at the culture and standards in the whole industry. There seems to be an almost heroic disregard for the rules, or at the least the principles, underlying the regulatory regime. A question we are trying to get to the bottom of is just what we need to do to make sure that the practitioners in this industry uphold standards. Is increasing sanctions against them one of the ways we can do that?

Jon Pain: I think that is one of the ways, but unless you change the culture of the industry, merely putting more rules in place and having greater and stiffer-

Q217 Mark Garnier: When you say more rules, do you mean more sanctions?

Jon Pain: Having greater and stiffer sanctions is not the be-all and end-all. You have to get the industry to change culturally, and this industry has evolved its culture over at least a decade and a half, so it will not change its culture overnight, although there are signs that it is beginning to change. You have to tackle this from both ends of the spectrum. I do not think merely applying higher individual, personal sanctions against individuals would be the way to go in its own right.

Q218 Mark Garnier: So you do not think the approved persons regime needs an overhaul?

Jon Pain: When you say it needs an overhaul, it is very clear to individuals at the moment that they are, and they are capable of being, held personally accountable through the sanctions we have just referred to, so I am not sure you could write even more stringent rules that would make that any clearer than it is now. People are capable of being prosecuted on an individual basis and, as I say, banned from the industry, so I do not think you need any more rules and actions to take against individuals-those are pretty severe.

Q219 Mark Garnier: A number of people have told us that one of the root causes of PPI mis-selling was the ineffective operation of the three lines of defence. Ultimately, of course, the first line of defence is the most important. What work did you do during your time at the FSA to look at the effectiveness of the three lines of defence model with respect to PPI mis-selling?

Jon Pain: Throughout my time at the FSA-I joined in autumn ’08-there was an increasing focus on a more intensive supervision regime, and part of that more intensive regime was looking at a range of issues. One of those was obviously a greater focus on the outcomes consumers were receiving. An aspect of those outcomes is how effective the control regime is in an institution. Part of that, in essence, is the three lines of defence-whether the front line take their responsibilities seriously and appropriately, whether the compliance function works effectively and whether the third line of defence is effective in making sure, on an independent basis, that those first two lines of defence are effective. That has formed an integral part of our supervision regime, but we have pushed that level of intensity a lot further over the last few years.

Q220 Mark Garnier: But your work was based on the integrity of firms and how the three lines of defence worked as part of that, as opposed to looking at the three lines of defence as a model that may or may not have had its time.

Jon Pain: The model per se-the control environment in terms of the three lines of defence you are describing-is an integral part of the control environment in a financial institution. Part of the supervision regime is to test the effectiveness of that.

Q221 Mark Garnier: So as a model it is fine; you just need to make sure that is being operated properly.

Jon Pain: You can have a range of different models. The issue is not necessarily the design of the model; it is its effectiveness. What was clear in terms of the strategy of supervision and increasing the intensity of the supervision was that we needed not merely to look at the presence of a process, or the design of the three lines, but to test its effectiveness. So there has been much more focus on testing the effectiveness and whether it actually works.

Q222 Mr McFadden: Why did it take so long for the customer to get redress? The regulatory authorities as a whole took years to reach a conclusion-in fact, they have still not reached a conclusion. Consumers have not been well served by this, have they?

Jon Pain: No, as the previous debate showed, it obviously has in practice proved to be a very long process. If I refer to the time I was at the FSA, which was at the end of 2008, some of the things that Clive referred to had obviously been put into place. One of the things that I strived to do was to try to bring to a conclusion the PPI process. Part of that then was leveraging off the final 2008 mystery shopping exercise, taking that to firms and getting them to do a past business review, based on a complaint-led process, to bring the whole PPI process to a conclusion. Despite the crisis, we invested an extensive amount of effort and time to make that happen. As part of that, the judicial review of that action elongated the process.

Q223 Mr McFadden: There are a number of reasons for it, but there is no doubt that taking years to reach a conclusion was far too long.

I want to try to draw some lessons out of this. You said in your evidence that the root causes of PPI lie in competition concerns, but the Competition Commission told us in its written evidence that it is not responsible for mis-selling. You could call it a disagreement, if you want us to be kind; you could call it buck passing, if you wanted to be unkind. That is part of the reason why this took so long. What is your conclusion as to what lesson might be learned from that in terms of future consumer issues that could arise? We already have the interest rate swaps and we have talked about packaged accounts, and there may be others. I do not know what they will be, but we cannot again have a situation in which the financial regulators and the competition authorities are saying, "After you, Claude."

Jon Pain: It is clear that the mis-selling issues are the responsibility of the regulators. I do not think there is any buck passing in respect of that. The action that I took in my time at the FSA was to bring that to a head. As Clive referred to, there are, fundamentally, overlapping, separate issues in respect of how the market functions. Some of the powers of the FSA in terms of its mandate to look at the effectiveness of markets will in part address that, but I think the principal responsibility of the regulator has got to be to make sure that the outcomes that are delivered to the consumer are appropriate.

When you think about interventions in the marketplace, you have to be prepared to make them faster, but there are some very real issues about how you make those interventions and how effective they can be. I have two examples that I would cite. When I came to the FSA, the RDR process had been long running and we accelerated that timetable. Lots of people in the industry are still not convinced that some aspects of the RDR are a great market intervention, but some of the issues that that market intervention was designed to achieve are a whole-market change.

As a regulator, you can intervene at a policy level and change the nature of the marketplace, like the RDR intervention. The mortgage market review is another one that I would cite-I instigated that in 2009. At that stage, there were issues about how the mortgage market had operated in the past. The mortgage market had effectively collapsed, but we were interested in ensuring that, as it emerged, it did so in a more effective way, so that is another policy intervention. Then there are the interventions to make sure that players in the marketplace, on an individual basis or collectively across the industry, fulfil their obligations to consumers in the marketplace. An aspect of that is that you have to do it faster. Again, I think the FSA’s appetite has changed quite dramatically. I would cite the interventions we made in the MPPI marketplace in 2009 and in the unfair contract terms of mortgage markets and SVRs as indications that we are making rapid interventions and getting the industry to respond, and if they respond in a positive way, getting them to put right what they need to put right and then move on. You have to assess whether you need a macro policy intervention, as I have just described, an individual firm intervention or a thematic intervention across the marketplace, or whether there is a more substantive competition question in the marketplace. I am very clear that the regulator has responsibility for the first two of those issues.

Q224 Mr McFadden: What I am trying to get clear is your view of whether this is an attitude problem or a powers problem. You seem to be saying that attitudes have changed and intervention would not take so long now. We have heard that an awful lot in response to questions at Select Committees, but you are not saying that there is a clear hole in the powers of the FCA or anything like that.

Jon Pain: That is a very good question. My view is that the scope of the FCA powers, as I have just tried to describe, is very wide ranging. I think that can be an effective way of doing the marketplace. You can put more policemen on the ground, you can write more prescriptive rules and you can make more policy interventions to try to shape the marketplace, but if the market itself does not have the right focus and culture of how it wants the market to operate, you are always pushing water uphill. So it has to work from both directions. I think, sadly, that the last 10 years have shown us that the marketplace needs to operate in a more effective way for itself.

Q225 Mr Love: During your time at the FSA, you extended transparency by publishing complaints data. Is there any further we can go along that road to greater transparency-I am not asking for things at the margin-that would help the consumer and make a meaningful difference to their ability to make a judgment about some of these policies?

Jon Pain: There are a number of factors that are a strong counterbalance to giving more information to consumers that would call into question whether that is the most effective way. The past 10 years of regulation have shown that making things more transparent and giving more information to consumers is not enough in itself. Those lessons show that the financial capabilities of consumers in general are very mixed, if not poor. The capabilities of consumers to absorb vast amounts of information about complex products never really address that asymmetry of understanding. You can give more information about complaints and so on-that has been the philosophy of the past 18 months or so-but it takes a long time to permeate and change consumers’ behaviour. Ultimately, there is a question about making the marketplace more competitive, having more choice in the marketplace and making it easier for consumers to make informed choices about switching providers and so on. If those dynamics do not exist, I do not think that merely giving the consumer more information would be an end in itself.

Q226 Mr Love: You mentioned the changes that have been made to strengthen the role of the FCA, as opposed to the previous role of the FSA. We all hope that that will make a greater contribution. However, we are not confident enough to put our hands up and say that that would stop this sort of mis-selling. I am really looking for areas where we might need to go further. The FCA has been given a competition remit. Should it be doing some of the things that the Competition Commission does to speed up the process in major cases such as PPI?

Jon Pain: Possibly, is the answer to that. I suppose, by its very nature, as experience has shown from the Competition Commission’s interventions in the marketplace over the last 10 years, no intervention from the competition authorities has been done in a short time frame. If you are going to carry out a substantive review of a big marketplace, that is not done in three months. Again, relying on that as being the be all and end all will not be sufficient in itself. I think it is absolutely appropriate that that should be part of the remit of the FCA, with the appropriate checks and balances, but I do not think that, if you are going to do that in an informed and balanced way, you are going to do it in a short term of a matter of months. It has those limitations by the very nature of what it is, so you need a wide range of issues.

I come back to the fact that the industry has got to respond and change for itself, because it recognises that there is now a fundamental breakdown of trust between large swathes of consumers. I see signs that the industry is responding to that, but I do not think we should underplay the fact that if the industry responded as positively as it needs to, that would make the job of the regulator and the whole reform far more effective.

Q227 Mr Love: It has been expressed in this room that the reason why the Competition Commission took two years to carry out the study was because the legislation says two years. It may well be that if the legislation said that it should be done quicker, it might be, although I fully understand that there would be arguments against that.

During my questioning of Clive, for which you were probably in the room, I raised the whole issue of a duty of care as an alternative to treating customers fairly. How would you look on that, based on your experience?

Jon Pain: I listened with interest to the debate about that question. Echoing a little what Clive has already said, I suppose in some cases it might seem to put a bit more clarity into the process between providers and consumers, but if you look across the principles and the detailed rules, the essence of what a duty of care would impose already exists to a large extent. They would have to give some thought to where it would add to and strengthen the existing regime and not merely add another layer of complexity or dispute about what a duty of care actually imposes on firms. With some of the principles and detailed rules, large swathes of that duty of care are already in the existing framework. I would not dismiss it, but I am just saying that you would have to be really open-minded about what added value it brought.

Q228 Mr Love: That is the very issue we are looking at: whether or not it is, in essence, an Aunt Sally-words sound good and the legal principle sounds good, but in practice if you end up with the same problems that you had over treating customers fairly, you have not really moved forward much.

You mentioned earlier the need to change culture and, of course, that is an issue we are looking at in quite a lot of our work. I wondered whether you had any specific ideas-we all recognise that this is a long-term process-about how the regulator could assist that process of improving the culture.

Jon Pain: It is one of the subjects that we looked at fairly extensively in my latter time at the FSA. It is a very challenging issue to get hold of, because how do you measure the culture of an institution? We talked then about the effectiveness of measuring three lines of defence, but to go in and have a prescribed mechanism and a methodology of actually measuring cultures is not easy. But there are tell-tale signs, and leading indicators and aspects of that-the tone from the top of the organisation, the clear accountability, the culture of escalation of issues, the distortion of behaviours and so on. All those are indicators of culture, so I believe that the regulator can focus more on the essence of the culture of an institution, and that clearly has to be part of its armoury.

I fundamentally believe that the primary responsibility for the culture of an organisation has to be set by the management and the board of the institution. Merely saying that that should be something that is then regulated by the regulator misses the essence of what the culture is designed to deliver. There needs to be more focus by the management and the board on the prevailing culture of the organisation. I do not mean just a couple of glossy slides of their high-level principles; I mean how they test whether that is actually the prevailing culture on the floor.

Q229 Mr Love: We talk a lot in politics about nudging in certain directions. Is there a role for the regulator to nudge organisations in a certain direction when they perceive that there is a weakness in the culture or something very obvious that an outsider can perhaps see more clearly?

Jon Pain: Certainly, both in terms of my latter experience at the FSA and currently, it is becoming an increasing feature of the FSA’s interventions with firms that culture is one dimension that it looks at in respect of that. Increasingly, it is looking not only at the particular issue and the failure of the process or systems, but the cultural dimension and whether the culture was such that it allowed that failure to manifest itself more easily-because there was a loose culture or focus on delivering the right outcomes or the right risk appetite, and so on.

Q230 Mr Love: I have one final question in relation to packaged accounts. PPI, of course, was and is a packaged product, but there are lots of others coming along. How can we best ensure that the regulator does the job that we perhaps failed to do on PPI with packaged accounts and other new products-ones that have similar weaknesses in their structure, and so could lead to mis-selling?

Jon Pain: I go back to the point I made earlier to Lord Turnbull: there is an issue about complexity. By its very nature, complexity of a product-either in its distribution or in its design features-always brings the risk that it will end up causing some form of customer detriment because of those factors. We are now beginning to see firms recognising that, and firms are now actually beginning to move towards a simpler product as a consequence. Packaged accounts are a good example: some banks are now changing the nature of how they bundle products into a packaged account, placing the emphasis much more on customers selecting products as opposed to pre-imposing what a bundle of products or features looks like. That is clearly going to be an increasing feature, because firms recognise that if they embed that level of complexity, they run the risk to which you just referred: there will be a repeat of some of those failings.

Q231 Adam Tolley: At the end of your presentation to the Commission, you indicate that the effectiveness of regulatory principles, whatever they might be-whether it is treating customers fairly or otherwise-is totally dependent on the way in which firms respond to them; it is a matter of compliance not only with the letter of the rules, but with their spirit. You then go on to say: "This was difficult to deliver, and the root causes of why that was so are wide ranging and complex". What you do not go on to do is to give us any assistance as to what you regard those wide-ranging and complex root causes to be. Are you able to expand on that, please?

Jon Pain: I will attempt to. By their very nature they are complex, Mr Tolley. They are some of the issues that we have just talked about. The culture plays a big part in some of those issues, as does product complexity. How markets work and operate plays a part, too-competition is a very effective mechanism for driving greater efficiency and simplicity of products for consumers. So it is all those aspects together. You can have a range of issues that distort the outcomes in a negative way, whether that be incentives, ineffective systems and controls or governance-and so on. You have to address a multitude of issues.

The point I was making earlier to Mr Love is that merely having more prescriptive rules, or higher sanctions and fines against firms, is not the end in itself. You have to try to drive a substantive change in the industry across all those dimensions, with culture being a key one of those issues.

Q232 Adam Tolley: Obviously that is right as a matter of principle; the question is how one might achieve it. You heard the question that I asked Mr Briault about examples and whether it would be possible to identify any examples of good practice in the banking industry in relation to PPI. From your experience, are you able to identify any examples of good practice that might assist with a view to spreading such practice across the industry as a whole?

Jon Pain: If I looked at the marketplace as a whole, as opposed to just narrowly PPI, I can see examples where the industry itself is changing and addressing some of those issues. It is simplifying some of its product set. If they believe that the inherent complexities in a particular marketplace can never be made to work effectively and they cannot put the appropriate controls on it, some institutions just do not participate in the marketplace any longer and withdraw from the marketplace in that context.

You now see far more focus over the end-to-end delivery of products. It is not just over the design and the governance of the design of the product, but all the way through the lifecycle of a product more focus has been played in that respect. That is a feature of where financial institutions, not just banks, tend to focus. Increasingly, they now effectively stress-test products not only at the initial stages of when the product is designed and launched, but throughout its lifecycle. It is very clear that changes in economic circumstances and other external factors can change the risk of a product to a consumer over the lifecycle of that product. I see evidence of some firms-I am not over-elaborating-having solved those issues, but across the range of the issues I have just talked about, they are trying to move forward, but there is a long way to go.

Q233 Chair: Thank you very much for your time, Jon. I apologise for things running late. It was good of you to come along and give us the benefit of your experience.

Examination of Witness

Witness: Peter Davis, former Deputy Chairman, Competition Commission, examined.

Q234 Chair: Welcome to the Commission, Mr Davis. I apologise for the length of time this has taken, but we were very ambitious in trying to have five sessions today. I am handing you over to counsel to open the questions.

Q235 Adam Tolley: The Competition Commission has clearly stated in its presentation to the Commission that its role or relevant time was focused on and limited to matters that concerned competition, whereas questions of insurance sales regulation were a matter for the FSA. Did you consider that that separation of roles between competition on the one hand and sales regulation on the other inhibited the effective conduct of the investigation into the PPI market?

Peter Davis: No, is the short answer. I did not think that it inhibited the investigation. I thought that there was a reasonably clear separation from the outset of the questions in front of the regulators and the Competition Commission. In some regards it has helped because, of course, it narrowed the scope of the issues that we were seeking to understand and then go on, if appropriate, to remedy.

Q236 Adam Tolley: Do you think that it would have made any useful difference to have had one steering hand in relation to both aspects of competition and sales regulation or would it have made no difference?

Peter Davis: It is an interesting question. This is a question that comes up in general around the competition regime and the extent to which there should be the scope for dealing with other issues as well as competition. To think of a banking example, I suppose that, in a merger context, Lloyds-HBOS would be an example where there is a competition question, but also a public interest that goes alongside it.

In this case there is another issue, which is the mis-selling, and of course there are pros and cons to dealing with that all in one go or to separating it out.

Q237 Adam Tolley: I will come to the question of timing in a moment. We are anticipating that the Competition and Markets Authority is to be set up to replace the OFT and the Competition Commission. The OFT, in its presentation to the Commission, said that the changes are considered to mark a significant step forward in the development of the UK’s competition regime. The Competition Commission, in its presentation, said that the CMA will not change the duties of the competition authority in relation to the market investigation regime. It may be that both of those things are equally consistent and correct, but is there a more lukewarm attitude on the part of the Competition Commission to the merger under the CMA-and perhaps the OFT?

Peter Davis: You will have to ask them what their view is at the moment. I think the essence of the concern that the Competition Commission rightly had around the merger is to do with the fresh-pair-of-eyes structure of the Commission, whereby an independent group of decision makers with a range of backgrounds and skills lead an inquiry under the Enterprise Act. The important concern is that if the phase 1 authority is making a decision during an in-depth investigation, the natural instinct may be to defend an earlier decision rather than to look afresh. The Competition Commission in that discussion around the CMA has been very public and very clear about its desire to maintain that advantage of the system as it currently stands. If the outcome is that the structure is maintained and the advantages of integration, such as reducing duplication, are captured as well through bringing together the authorities then that is obviously welcome.

Q238 Adam Tolley: I want to ask some questions now about the Competition Commission’s understanding of what is mis-selling, and how the work of the OFT and the CC on the one hand differs from that of the FSA. In particular, the Competition Commission has said that mis-selling and competition issues were not necessarily related and one understands that, but would you accept that there was in fact a relationship between mis-selling and anti-competitive behaviour in the context of PPI?

Peter Davis: That is an interesting question. The way I would put it is that the statutory question in front of us is whether or not there are features of the market that would prevent, restrict or distort competition. There is a very clear focus on competition. The link then has to be made between what is going on in the structure of the market and competition, competitive dynamics.

If you think, for example, about straight fraud, there is no immediate connection between straight fraud-that could happen in a concentrated market and in a very unconcentrated market-and competitive outcomes and the process of competition. In that sense, the issues can clearly be separated. On the other hand, where I would see a connection-we found in the report that the margins on some of the PPI products were very significant. I am an economist and think that incentives lead people into places, and at least, in the first order, they are a good place to look for motivations for behaviour.

The way I was thinking about the mis-selling issue was very much that if there was a competition problem-and we found there was-that may well lead to incentives that were for some individuals and/or some companies too difficult to not respond to. The interesting thing is, in fact, what the incentives were, given the ultimate outcome. The basic situation is that if there is a competition problem and you are getting very high margins, then perhaps the temptation to take some cookies out of the cookie jar when really you should not, clearly could occur. As we were going through the process of the competition investigation, I was reasonably comfortable that if we could get competition going in the market, that would lead to a reduction in the incentives, and may have ultimately had an impact on the degree of mis-selling, but that was not an issue that we specifically addressed. What we were thinking about was the incentives that were generated by the economics of this particular market.

Q239 Adam Tolley: Would it be fair to say that in this particular context, the anti-competitive aspect of the market may have led to or possibly even encouraged the mis-selling?

Peter Davis: I would stop at the point where there were clearly high margins. We saw some evidence of some degree of mis-selling. We never got to the point where we were quantifying that or deciding how significant that problem was, but there were clearly incentives generated by high margins, and that is indeed the kind of situation when one might generally-generally, you would expect people to respond to incentives, but I cannot say, on the basis of our investigation, that we drew the connection between those incentives and the mis-selling, because we did not. We didn’t take evidence on that point-or we received some evidence on that point, but we did not go at it specifically as a question, precisely for the reason that one can distinguish between questions of fraud and questions of competition.

Q240 Adam Tolley: If one makes the assumption-it may not be a fair one-that not everybody was guilty of mis-selling, it would be fair to say, would it not, that the mis-seller obtains a competitive advantage over those who are not mis-sellers?

Peter Davis: That is an interesting question. If you are asking me whether we could have written up, or could we have gone through the process of saying, "Well, how do we fit mis-selling into the investigation?" and could we have drawn connections between the degree of mis-selling and competitive outcomes, I think that is a line of argument, and it would have required a line of investigation. My general stance was that this was a competition problem that, at some level, did not require us to go to the mis-selling aspect of it. There was a clear incentive, given the characteristics of the market, to charge relatively high prices for the PPI and also give some of those margins earned on the PPI to customers in the form of lower credit prices. The analysis that we performed was a very conventional economic analysis to think about the effects of that on consumer detriment ultimately.

Q241 Adam Tolley: One last question on the distinction between mis-selling and competition concerns. I have noted in the Competition Commission’s submissions that a is reference made to what is called an unwanted sale, as distinct from a mis-sale. As I understand it, what the Competition Commission means by an unwanted sale is a case where a consumer may not have bought PPI if they had had the time and space to think about their purchase. Is that correct?

Peter Davis: I am sure it is. The issue of mis-selling was certainly around and we dealt with it to some degree-a little bit more in the remittal than we did in the original publication.

Q242 Adam Tolley: That line comes from the remittal report. I wanted to explore with you, Mr Davis, how, in your view on behalf of the Commission, an unwanted PPI policy differs from one that has been mis-sold. If the person has not been allowed the time and space to think about their purchase, is that not necessarily a policy that has been in one form or another mis-sold?

Peter Davis: That seems to me to be a question around the legal position on mis-selling, whereas what we were trying to get at was whether it was really the case that consumers were given the information they required in order for them to look across the market, find the product best for them in their circumstances and then make that best choice on the basis of the information and options available to them.

In principle, as a consumer, I could not make the best choice from all of the products that are available on the market, given my individual circumstances, and still not have been mis-sold that product. It could just be that I don’t have the information about the other products in the market, for example. You can draw a distinction. I am happy to receive feedback on whether we drew that distinction in as perfect a way as one would like. In principle, there is a distinction between not having the information you want to have to get the products that are best for you-and whether there are incentives and an ability for the firms to provide you with information-and, more generally, whether there is sufficient competitive pressure to mean that you are getting good quality and value products from those on offer on the market.

Q243 Adam Tolley: Can we move on to the different point of product bundling? One of the Competition Commission’s primary concerns, arising from its market investigation report, was the bundling of PPI as a secondary product, with the primary product being the credit sale, and the sale of the PPI at the point of sale of the primary credit product. Do you consider that this concern about bundling is likely to arise with any bundled financial product, or was there something specific about PPI that gave rise to this concern?

Peter Davis: Let me be clear. The economics of bundling is basically going to say that on lots of occasions putting products together is a good idea and serves customers well. There are, of course, circumstances where bundling leads to poor outcomes in markets and competition problems. At a principle level, I would answer that one should not take a one-size-fits-all approach to that question, but rather should look at the specifics of a given market situation to decide whether bundling is generating good or bad outcomes for consumers.

Q244 Adam Tolley: Are you able to provide any assistance as to the likely specific aspects of bundling in relation to financial products that are going to be of concern?

Peter Davis: Let me be as helpful as I can, while at the same time being a bit generic. The basic incentive to lower the price of the primary product in order to get you in the door, in the interests of receiving perhaps a higher-margin secondary product, can potentially have a very positive outcome for consumers. There are people who are benefiting from lower prices for those primary products. At the same time-sorry, there is a bell going off.

Q245 Chair: Please keep going. Try to keep your answers short; that might help us.

Peter Davis: I will do my best, Mr Chairman. At the same time, with an incentive to make those higher-margin sales on the secondary product-of course, you are then getting some customers who have been charged higher prices, and that is a downside-you may end up with lots more sales of secondary products at perhaps even lower prices than you would have had in the absence of the primary market sale, potentially because you are getting more people through the door for the sale of the primary product. Alternatively, there can in some circumstances be an incentive to raise the price of the secondary product and benefit from higher margins from the sale, in this case, of PPI.

Inherently, the logic of primary and secondary products leads you to outcomes for consumer welfare that are ambiguous in their nature. Sometimes they are going to be good for consumers, and sometimes they are going to be bad. It turns on the facts of the specific case whether or not you are in the good outcome situation or the bad outcome situation.

Q246 Adam Tolley: Your view would be that it is a case-by-case analysis rather than there being any general principle that one could apply to the likelihood of the conclusion in any particular situation.

Peter Davis: Absolutely, yes.

Q247 Adam Tolley: I want to ask you about store cards. I appreciate that this was before you became a member of the commission, although you were an academic specialist before this.

The OFT referred store cards to the Competition Commission in 2004, and there was a market investigation between 2004 and 2006. One of the aspects of that investigation concerned the sale of PPI as part of the store card transaction. I want to ask whether the Competition Commission took that work in relation to store cards into account when it dealt with its PPI investigation between 2007 and 2009.

Peter Davis: As I recall, in the terms of reference, store cards were explicitly excluded. We certainly did not have jurisdiction to look at the store card market. Obviously, there were staff who had been through the store card inquiry, and the report on store cards laid out the position with regard to store cards. In that sense, we looked at that.

In the report, I think we looked more at the extended warranties analogy, which was another investigation that the commission had undertaken, looking at the extended warranty sold on things like white goods. Again, the issue being considered was the extent of warranty being sold at the point of sale-in a shop in that case. Again, we thought about the economics of that situation and how it related to what we were seeing in PPI.

Q248 Adam Tolley: One of the Competition Commission’s remedies in relation to store cards was that the sale of PPI as part of a package with a store card should be banned. Would it have been possible for the Competition Commission to take any initiative at that point, having produced its store cards report, in relation to the more general prevalence of bundling PPI sales with other forms of credit? So we have store cards being put together with PPI and a remedy that says that that should not happen. Could the Competition Commission have done anything to suggest that more work ought to be done across the wider picture of bundling credit with PPI?

Peter Davis: There is a jurisdictional answer to that question in terms of the statute that we are operating under, and the answer is no.

In terms of wider activities-perhaps talking to our colleagues at the OFT and suggesting that this was an area that they should think about, whether it would be appropriate to think about it in other market contexts-a little bit of that could be and perhaps was done. But a market reference looking at the issue of cross-selling, for example, would not, with my understanding of the legal position, be possible under the current Enterprise Act. But it is a suggestion for the way forward.

Q249 Adam Tolley: To move on to the 2007 to 2009 market investigation and its timing, we know that Citizens Advice made a super-complaint in September 2005 and the OFT concluded its market study in October 2006 and referred the matter to the Competition Commission in February 2007. I appreciate that passage of time between September 2005 and February 2007 has nothing to do with the Competition Commission, but, in your experience, were such time scales of a year and a half between a matter being brought to the OFT by an external organisation, whether it is a designated consumer body or otherwise, and the matter arriving at the Competition Commission typical?

Peter Davis: My recollection is that the PPI market study at the OFT took longer and was more substantive than perhaps the average market study, but, obviously, more information and statistics on that are perhaps available from the OFT. I believe I have seen such statistics, and you could perhaps ask them for the factual position.

Q250 Adam Tolley: Once the matter got to the Competition Commission, the referral was in February 2007 and the report was in January 2009. Mr Love suggested earlier that the statutory time limit of two years might have had something to do with that. Was it really necessary, given that you were the chair of that particular investigation panel, to take that entire period to conduct the market investigation? Was there an element of working to the deadline, taking into account other commitments of the commission and its members?

Peter Davis: With the benefit of hindsight, there are, of course, some things that, personally, I would have done slightly differently. The leading point would be that, at some point during the investigation, I championed the idea of what I called "comfort 109s," which were the pieces of paper that provided clear deadlines on the delivery of information, for example. With the benefit of hindsight, I would have moved a little earlier to use those. Indeed, the Competition Commission’s practice has moved on on that front.

The other point I might look at is the reality that the CC was very busy in early 2007. There had been three large market investigations, as I recall: groceries was being looked at; BAA, the airports investigation, had arrived; and PPI. So there was something of a resourcing issue in the early months. Again, that sort of lumpiness in the arrival of market investigations might be one of the issues that will be sorted out with a single authority.

I would point to those two as being aspects of it. Is the tendency to take two years PPI specific? No, it is not. I do not think, as a general rule, that any market investigations have been completed in what is now the new delivery target of 18 months, which is a real challenge. The target is a challenge because you are looking at two very important questions, often in a very important context, in this and other cases-

Q251 Lord Turnbull: You have made much of the separation between the role of the Competition Commission and that of the other authorities; it is not really the Competition Commission’s role to investigate mis-selling. I wonder whether you really can make that separation quite so clearly. You point out that the banks and the PPI industry made £1.4 billion in excess of their cost of capital, so you could simply say that it is a kind of economic rent coming from bundling. The reason I think there is a connection with mis-selling is because mis-selling was one of the ways in which they made the profit. They made the profit by selling a product to large numbers of people and then, in the small print, writing various exclusions that they hoped the people did not spot. That was an integral part of the generation of profit.

Secondly, one of the remedies that I hope is included in paragraph 20 is something that says that, if you are a retired pensioner, there is no point in buying insurance for loss of earnings. To get the remedies right, you must bring in the mis-selling point, which is why you cannot make the clear separation you are trying to make.

Peter Davis: At some level, you must draw a line around the investigations because you are on tight statutory timetables. There is no way of extending the two-year time horizon, and it is a quasi-judicial process so you are exercising those functions transparently and fairly. It is right as a matter of procedure to try to draw boundaries round the scope of an investigation. If you are asking whether it would be possible to fit mis-selling into the test under the Enterprise Act, I would say in response, "potentially". Ultimately, it is a judicial decision about whether you interpreted that statute appropriately to bring in the mis-selling.7

Q252 Lord Turnbull: I am suggesting a different way, which is to look at the huge return-490% equity gain, which I do not suppose you see often in your line of business-but then to ask what are the causes, what is generating this, is there something special in the product they are selling, is there something special about their market position or, and I would have thought this was a natural question, are they mis-selling it to people? It would naturally follow as a matter of curiosity to ask how on earth such an excess over the cost of capital could be earned.

Peter Davis: Let me be clear about the £1.4 billion. It was the estimate of the margin on the PPI that was earned across the different types of products, but before we thought about the amount of that margin that was then given back to consumers in the form of lower credit prices. In fact, the detriment figure was net-£1.4 billion minus the amount that was then given back in the relevant customer benefits of lower credit prices.

Q253 Lord Turnbull: How big was the offset?

Peter Davis: That offset was very significant. The detriment figure, which I believe you will find in the Competition Commission’s response, was £200 million. The difference between the two figures largely takes into account the reduced credit prices. We saw examples of significant reductions in credit prices. The reductions varied across individual banks, some of which were-

Q254 Lord Turnbull: Then a different problem arises: the problem of equity. All the customers get the consumer benefit of lower credit prices, but some find themselves disqualified from claiming on the insurance. Would you say that is part of your remit: equity in the treatment of different classes of customer?

Peter Davis: One of the challenges in exercising judgment in these inquiries is making the judgment about whether there are offsetting benefits that should moderate or change the remedies that you subsequently put in place. The statute does not spell out clearly the way we should add up across people.

Q255 Lord Turnbull: I would just add a note of congratulation. Basically, you have killed an abusive product stone dead. It cannot exist now, can it?

Peter Davis: I have not been involved in the follow-up, but the OFT, as part of the package of remedies, is getting regular information. Clearly, what happened, and was already evident during the remittal process, was that a lot of the providers moved their product from being PPI to short-term income protection, which is a different design. The basic idea of having insurance against accident, sickness and unemployment on a short-term basis as an insurance product I do not think has gone away, and it certainly was not the objective of the competition investigation to make the product go away. That was not one of our objectives or, indeed, one of our expectations about the future of the industry.

Q256 Lord Turnbull: Why is that not regarded as PPI-this alternative product?

Peter Davis: It is regarded as PPI, and we made a very deliberate inclusion in the report to make sure that the remedies would apply to short-term income protection.

Q257 Lord Turnbull: How far have people taken up the option, which is now created by the time delay, of shopping around and unbundling-buying the product from someone other than the credit provider?

Peter Davis: You will have to ask the OFT, because I am not in a position to answer that in an informed way. The remedies included very extensive information provision requirements so that the OFT could track the evolution of the industry and keep its eye firmly on what was going on and whether these competition problems were persisting.

Q258 Chair: Do you have a value-for-money mandate as part of your competition remit? I will tell you what I am thinking of. Organisations running abnormal profits on products such as PPI for prolonged periods would surely indicate that the markets are not working properly.

Peter Davis: The interpretation of profitability evidence in competition investigations is an important aspect of the investigation, potentially, but I would not say it was right to say that, just because you have got evidence of high profits in an industry, you would immediately jump to the idea that there was a competition problem.

Q259 Chair: Let me give you an anecdotal example. A chairman of one of the big banks told me that he came along to the bank that was selling PPI and said, "With any product that has got a profit return of over 80%, people would have to be silly not to think there was something wrong with the market there." That was the type of return that it was getting, and that is what I am getting at. Has the Competition Commission looked at that element? You give an impression that this is all academic; that it is a common room debate that we have got here, when in fact we have had problems with PPI since the ’90s. Consumers were telling us we had problems, the BBA recognised that there were problems, the Treasury Committee referred PPI with credit cards to the OFT and the Competition Commission, and then we take a leisurely academic stroll down memory lane and we get the most exquisite thesis on it, but damn all happens.

Peter Davis: With great respect, that is certainly not what I am describing.

Q260 Chair: The fact is that we have had PPI since the 1990s, and we have got until April 2013 to get it sorted out. As somebody said, it has taken longer than the second world war.

Peter Davis: Is there an issue about the overall structure and the length, stepping back from the function at the Competition Commission? I think that is a really interesting question and a good question for this Committee to grapple with, but that is not the question that I and the group had in front of us. We had a clear question, under the Enterprise Act, a clear function to exercise, and a clear expectation of judicial scrutiny of that decision-and properly so. It is not the wrong outcome for there to be judicial scrutiny, but at the CC, my staff team and members on that inquiry worked incredibly hard. It certainly isn’t the case that we took a leisurely approach; we took the issue seriously.

I think I have already explained that the economics of selling primary and secondary products is not simple. It will be the case that sometimes consumers are better served by selling products in a primary and secondary manner, rather than selling them separately. It is therefore an important question and an important market worthy of detailed and careful scrutiny. That is what the market received at the Competition Commission.

Q261 Mr Love: May I in a sense follow on from the Chairman’s question? I have been struck by the fact that, during this whole saga, there appears to have been no discussions, meetings or dialogue between the OFT and the Competition Commission on the one hand, and the FSA on the other. Can you confirm whether any meetings took place with those organisations in relation to PPI?

Peter Davis: They certainly did take place. There were staff meetings between the FSA and the CC, and also between the OFT and the CC.

Q262 Mr Love: I am not so much talking about the OFT and the CC, because I assume that, for all sorts of reasons due the legal situation, they undoubtedly would meet. What I am trying to get at is that, as you were carrying out your inquiry, there was this hubbub rising in the background, which was the significant concern about the mis-selling of PPI. Although normally I would have said that you would have picked up from newspapers and other sources that it was becoming an increasing scandal, there is a formal process whereby the FSA could come along and say that there was a big, big, big benefit to you concluding your inquiry much quicker than you would normally, because you will save a lot of consumers from being mis-sold a product. Did any of those discussions ever take place?

Peter Davis: I think we were all fully aware of the importance of the investigation and acted as fast as we could.

Q263 Mr Love: But as I understand it-correct me if I am wrong-you took almost exactly two years; in other words, the statutory time. That leads me to believe that there was no rush. I understand what you are saying about the complexity of the issue and the need to get your facts right. I understand the pressures on you, but was it really necessary to take the full two years, recognising the impact that PPI was having on the marketplace and the significant mis-selling that was going on over the period the inquiry was taking place?

Peter Davis: The statutory time period is two years. I think that there is a clearly shared ambition among all the leadership of the CC-I do not speak for them any more, but certainly during my time-to reduce the timetables to the extent possible. In fact, a lot of work was going on during this time to re-engineer the market investigation process to try to reduce the number of steps and cut out stages in order to get these processes moving more quickly. However, I have to say that there is a limit, and there is a consequence of moving too fast, which is that the decision, as written, is subject to judicial scrutiny, and quite properly so. If you are appealed, you will spend six months in the appeal, and we spent a year in the remittal.8

One of the good outcomes of having been through that process was that we had established the "is there a problem?" part of the report to a level that the Competition Appeal Tribunal was satisfied that that part of the decision was, in their word, ultimately "unassailable"9. That put us in good stead for needing to revisit only an aspect of the remedies question during the remittal. In reality, we will be held to a high standard in these processes-quite properly so, because these are important questions from the Competition Appeal Tribunal and potentially from higher courts subsequently. The work therefore needs to get done.

Q264 Mr Love: I take all of that on board, but the discussion that we are having reminds me of the discussions that we had over the tripartite arrangements for the Treasury, the Bank of England and the FSA. The reality was that everyone stuck to their remit and nobody ever spoke to each other. One of the consequences of that was the disaster that we went through in 2007. I am trying to get to whether any thought is being given to having proper arrangements whereby those regulators with an interest in an inquiry that you might be holding can draw your attention to significant deleterious impacts that the current situation is creating, so that you can at least be aware of them.

I understand all the pressures that you are under. I understand that you cannot conclude a report and take the risk, but on the other side of that equation, for every month that it takes you longer than may have been necessary, significant numbers of consumers will have suffered considerable detriment as a consequence. A balance has to be met and I assume that there are no new rules on it under the new arrangement. I wonder whether people at the Competition Commission and the OFT, in their discussions over the new body that will start up this year, had any thoughts on consultation arrangements with other regulators like the FCA and the PRA, as it is now coming into being.

Peter Davis: Let me answer about the process of the inquiry: there is absolutely no limitation on the evidence and submissions that can be received from other authorities, but they have to be received formally, in a manner that is consistent with the statutory function being undertaken. It certainly would not have been a problem and I think we took the message from submissions early on in the inquiry that this market was of significant concern to the FSA and Citizens Advice. You would have to be blind not to see that, to internalise it and to galvanise behaviour. I do not think we need to worry in that sense that the mechanisms for receiving those messages are in place; they are certainly in place as part of the procedure.

The challenge in running a competition investigation is to go through the process of understanding the nature of the problem in sufficient detail, so that you can craft the appropriate remedies that will ultimately deal with the problems that you identify. There has understandably been a focus during this discussion on whether we could have moved the inquiry from two years to 18 months. The challenge for the system as a whole, across the regulators and the competition authorities, is one that was brought to bear for me at a presentation I saw Which? give about the issues that it identified in the late ’90s. I heard reference to that earlier, and it is genuinely a challenge to the system to get markets that are of concern into the process and out at the other end in a timely manner.

If you ask me, does it look great that you have got problems being identified in the late ’90s and it is 2012 or 2013 by the time you are seeing remedies take hold, the answer is clearly no. That really does raise the challenge, and do I think there are easy answers to that challenge, no. Fortunately, however, that is not the question in front of me but the question in front of you.

Q265 Mr Love: We are discovering that there are no easy answers to any of the questions we are asking at the present time. This Commission respects both the independence and the expertise of the Competition Commission, and we would not wish to challenge any of that, but it just seems to us that you are taxed with bringing the benefits of competition to the marketplace, to the benefit of consumers, but at the same time we have seen enormous detriment to consumers going on. It seems to me that a little judicious discussion might well have precluded that happening.

Q266 Chair: There is a feeling of silos-everyone is working in silos, and that is what happens.

I have a couple of questions before I pass over to Adam for his final couple of questions. One of your remedies, according to written evidence, was "an obligation to provide information about claims ratios to any person on request". Why not just require the banks to publish information, as they publish complaints data today?

Peter Davis: As I recall-I will have to revisit the report-the question around the provision of the claims ratio was around the degree to which that particular piece of information would be used and by whom. What we wanted to make sure could happen was that that information could be accessed by, perhaps, websites or people who were going to turn that information into something that was usable by consumers. Potentially, it would have been available to purchase as a product. The question around where it should be published and by whom, and available to whom, is really one of how that particular piece of information would be used in the context of making decisions, how that would impact and then whether that would add to the effectiveness of the remedies in generating competition.

Q267 Chair: You have heard our frustrations about reducing the time scale of future similar investigations. What is your view of giving the FSA powers to undertake market investigations in its own right, given the fact that it will have a competition remit of its own?

Peter Davis: I am conscious that you may be reading from the Competition Commission submission, which is of course not mine, because you are reading out those things.

Chair: I was.

Peter Davis: But on your question around concurrency, I think the question there is really whether or not that is helpful, but the evidence is mixed. On the one hand, giving regulators competition powers gives them a wider tool set which they can take to a given problem. On the other hand, at least in some regulated sectors, there seems to be a preference for using perhaps other mechanisms, such as licence conditions, rather than going with the competition tools. It may also have an impact on the decision to refer markets to the Competition Commission if you have your own toolkit.

Q268 Chair: What is your answer on that? It is mixed.

Peter Davis: Yes, it is mixed; I think there are pros and cons.

Q269 Adam Tolley: Just a few final things. I appreciate that it is the Competition Commission submission-a point you just made, Mr Davis-and not yours, but that submission must have been based on the reality of what happened while you were the chair of the relevant inquiry. The Competition Commission worked very closely with the FSA, and stayed in close contact with the FSA, throughout the market investigation, and this was by way of assistance in ensuring that the Competition Commission’s remedies did not detrimentally affect the FSA’s actions on mis-selling. First, presumably you agree with that proposition as to what the Competition Commission did and why.

Peter Davis: There was clear staff-level contact, particularly geared towards making sure, to the degree possible, that there was not a conflict between the functions exercised by the FSA and our investigation.

Q270 Adam Tolley: Was there any reason, in your view, for the FSA to defer action on mis-selling while the Competition Commission carried out its work in relation to the market investigation?

Peter Davis: That is a difficult one for me to answer in a manner that is informed. I was not aware of what was going on inside the FSA around the topic of mis-selling, because it was not the focus of the inquiry.

Q271 Adam Tolley: Is there any reason to think that the FSA could have misunderstood what the scope of the Competition Commission’s report was going to be?

Peter Davis: Certainly I do not have any reasons to believe that, but you really are better off asking them. But stepping back, there are reasons, as we talked about earlier, to believe that the mis-selling may be connected to the competition problem. That reason is around the incentive to earn those very high margins that we found on PPI, so to the extent that you think that dealing with the competition problem will deal with the mis-selling issue, then as a regulator it is not obviously unreasonable to take the view that you would be better off delaying, but obviously that is a judgment that the FSA made and which you have asked, and no doubt will continue to ask them about.

Q272 Adam Tolley: The last question on this particular point is whether the Competition Commission gave the FSA any reason to believe that the Competition Commission’s report was going to be produced any earlier than it in fact was.

Peter Davis: I do believe we had an ambition to deliver the report initially on a slightly faster time scale and we did adjust the administrative timetable that we had published, so I think all parties to the investigation would have been updated, as the investigation proceeded, on the timing of it, but beyond that we certainly did not-as far as I am aware, we did not give them any particular reasons to think that we would be delivering within six months or a year. I think we are talking about a matter of months, rather than something more substantive.

Q273 Adam Tolley: Lastly, I have a few questions in relation to the appeal that was brought by Barclays and Lloyds against the Competition Commission’s original remedies. The appeal was brought in March 2009, and we know that it was determined by the Competition Appeal Tribunal in October 2009. The only point in the appeal that the Competition Appeal Tribunal upheld was that the Competition Commission had not taken sufficient or any account of the question of the possible loss of convenience to customers from the point of sale prohibition on the sale of PPI. The question really is about timing, Mr Davis. It then took from October 2009 until October 2010 for the Competition Commission to produce its more detailed analysis of the point of sale prohibition, dealing with in particular the issue about potential loss of convenience to customers, and the commission came to the view that the package of remedies that it had promulgated at the beginning of 2009 was still appropriate at the end of that exercise. So the first question is this: was it really necessary for this additional work, arising out of the Competition Appeal Tribunal’s judgment, to take another year?

Peter Davis: It did not feel like a short period at the time; it felt like we were pushing the speed of the inquiry. Inherently, there are steps to go through, including consultation periods, and the reality is they add up. There are surveys to undertake. We undertook a significant piece of survey work that took a chunk of time during that process. Of course, there was a need to come to a provisional decision, consult on that and then come to a final view. Is there an obvious place to cut up that timetable? I think the answer remains no. It was an issue that we thought very hard about at the beginning of the remittal process-the appropriate timetable that would get us to the place as fast as we could go while of course doing an appropriately high-quality job on the question that had been returned to us.

Q274 Adam Tolley: The Competition Appeal Tribunal concluded that the possible loss of convenience to customers had not been properly or sufficiently considered the first time round. The question is why that was. Why did the Competition Commission miss that point, or miss it to a sufficient degree that the Competition Appeal Tribunal ruled against the commission?

Peter Davis: That goes again to the issue of the scope of such inquiries. The PPI inquiry was very large. It had 20 plus main parties and, depending on how many we include, potentially thousands of third parties, and it looked at an important question across a range of markets. In the appeal, we were picked up on one substantive point. The appeal dealt with a significantly larger number of points, and the decision was sustained on all of the substantive points apart from that one.

With the benefit of hindsight, would we have written more in the original report on that question? The answer is that yes, we would have. Did we write a lot already on many points? Absolutely. You are pointing exactly to the challenge, which is whether, when running such an investigation, you go for the faster option, in which the degree of investigation and analysis that is possible on every point within a shorter time horizon is inevitably more limited, or do you bring in as much analysis and evidence on each of the points that you have to address as you can, in order to do as thorough a job as you can in the time available? That is the challenge and the trade-off, and the risks and advantages of going faster or not are clear, but the consequences of saving a month in the original investigation, but perhaps losing on two or three points in the appeals process if that were a consequence of not doing some pieces of work, would obviously be much worse for the overall timetable of the investigation.

Q275 Adam Tolley: Looking back, do you think that there was any real failing by the Competition Commission in relation to this partially successful appeal to the CAT or was this tactical litigation on the part of the banks to produce a delay in the Competition Commission’s remedies taking effect?

Peter Davis: I have no particular information as to their motivation, but I again go back to my economic instincts and say that there are potential incentives for a delay, and those may well play a role in the decision making about whether to take appeals across the piece. That would not necessarily apply just to the banks by any stretch of the imagination. If you think about the BAA investigation and the comments made by the chair of that investigation, there have been multiple appeals to bring it to a close and, in the most recent case, to get BAA to sell off Stansted. There is an understanding that that incentive is there. These are important questions, with lots of money involved.

At the same time, however, it is difficult to think that it would be a proper system if the decisions written by the Competition Commission did not receive the appropriate degree of judicial scrutiny. Is there an easy solution to that conundrum? Not really, because you do want to defend the right to hold the decision makers’ decision up to the light of judicial scrutiny and see where we have fallen down in order to get, in this case, the Competition Commission to revisit the question. That seems to be perfectly right.10

Chair: Mr Davis, thank you very much. Thanks for staying the course with us until most of us either get a Horlicks or a little malt whisky before retiring. It has been five and a half hours, which is a long time, and I thank you for coming along and giving your time and experience to us.