Evidence heard in Public

Questions 4409 - 4504



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Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

on Wednesday 27 February 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

Examination of Witnesses

Witnesses: Adair Turner, Baron Turner of Ecchinswell, Executive Chairman, Financial Services Authority, and Martin Wheatley, Managing Director, Financial Services Authority and CEO Designate of Financial Conduct Authority, examined.

Q4409 Chair: Thank you for coming to give evidence. We have, of course, already heard from you once. Lord Turner, I have here an extract from your written submission to the Commission that cites three reasons why trust in UK banking has declined. They are, in summary: the recession, doubts about bankers’ values, reinforced by LIBOR, and exploitative retail product sales. What about regulatory failure?

Lord Turner: That is one of the things that lies behind that. It is clear-and the FSA has been more honest and open about that than any organisation across the world, just about-that a lot of the things we were doing before the crisis were not the right things to guard against these problems. I would still see regulatory failure as a supporting mechanism that allowed those other three aspects.

Q4410 Chair: But the public know there is a regulator, so they are likely to be more trusting of a bank if they think the regulators are doing a good job.

Lord Turner: That is a fair point. I believe that the FSA over the past four years-and I think it had begun before I arrived at the FSA-has taken the steps that are putting that right, in terms of our prudential regulatory regime and supervision, and our conduct regime. I think the new successor organisations-the PRA and FCA-will build on some quite transformational change over the past four years and, in the case of enforcement, going back about six years.

It is of the nature of things that the benefit of that will, I hope, accrue to the brand names of the PRA and the FCA. I have thought over the last four years that things had simply gone so wrong with the regulatory structure that there was almost nothing we could do at the FSA that would make people trust the brand name of the FSA. I think it is one of the reasons-not the most important reason-why there is a value in the change we are now making. I think in substantive terms we have changed almost entirely over the past four and half years.

Q4411 Chair: But it is not the change of the regulatory structure I was referring to, but the regulation itself and the regulatory culture.

Lord Turner: That is what I am referring to. I think it has fundamentally changed.

Q4412 Chair: We have been given the task of looking at the culture of banking. It is clear from the evidence we have collected that there is something quite seriously wrong with aspects of the culture of banking. I am asking you, one, whether you think there has been something quite seriously wrong with the culture of regulation and, two: has it been fixed?

Lord Turner: Yes, I think it was wrong, and I think it has been fixed. There has been a continual process of fixing it, which had begun in about the year before I arrived at the FSA, and we have been in a continual process of changing it since then.

Q4413 Chair: Those are clear answers. Is there anything you want to add to that, Mr Wheatley, before I pass the questioning on?

Martin Wheatley: Yes, I think so. I agree that the regulatory failure, in a sense, was a failure of philosophy. It was a belief, for a period, that banks would self-correct, would know best and would put their customers first, because that was what was good for banks and good for shareholders-and a belief, therefore, that regulators did not need to intervene so strongly. It was also, in a sense, a backward-looking view, at whether firms were complying with a set of rules, not a forward-looking view, at whether firms were getting the right outcomes for consumers. Those are the sets of changes which, as Adair said, have been in process for some time now. The next change embeds them very fully in the new structure.

Q4414 Chair: You will be forgiven for a hint of scepticism, because what we get from the banks whenever they come to see us is, "Well, yes, there was something wrong with us. We did have a cultural problem, but we’ve fixed it." Then something else goes wrong and they say, "Well, yeah, there was just this extra little bit of the cultural machinery that needed attention and we’ve now fixed that, so you can rest easy." You gave us a clear answer: you think that you have fixed it.

Lord Turner: Well, I think one would be wary of saying that the fixing is complete, and I think the successor organisations will take it forward, but I think in many ways the way that we do regulation and supervision now is transformationally different from that before the crisis.

Q4415 Chair: You mean culturally better?

Lord Turner: Culturally and, as Martin made a key point, philosophically. If you look at the story of PPI-

Chair: We are going to come on to that.

Lord Turner: We can expand on it there, in terms of the steps in which that occurred.

Q4416 Lord Lawson of Blaby: Lord Turner, as you are well aware, the banking crisis which we have all just lived through-and is still to some extent ongoing-is not a one-off event. Over the past 100 years there have been a series of banking crises. If you study these, you see that there are a number of common elements, yet somehow or other the lessons of history never seem to be learnt. To what extent are FSA staff taught about the history of previous crises? To what extent are they aware of it? To what extent are they looking out for the things that history might suggest they should be?

Lord Turner: That is a very good point. I have not looked at our training programmes; I will now encourage the PRA in particular to do that and to say, "Is there a history element of it?" You are quite right that there are a series of banking crises which have extraordinarily common features. Too much lending to commercial real estate-which goes up in value, which then encourages more lending and, for a period of time, makes people feel that the risks have disappeared-is one of the most common features of everything from the Scandinavian crisis of the early 1990s to the Japanese, etc. There is a huge problem within banks about having institutional memory-you know, credit officers who were around last time.

At the moment, for the last three or four years since the crisis, we are so aware of those issues on the prudential side that we are not going to lose sight of them, but I think it would be a good piece of advice-it is not something I picked up before-to the PRA in particular in future, to embed a bit of history of what happened before. This will matter, in particular, in 10 or 15 years’ time when there will be another "This time it’s different" myth-another belief that some house price or commercial real estate credit boom is not to be worried about. I think that is a good point.

Q4417 Lord Lawson of Blaby: I am glad to hear you say that. I think it would be helpful if they had this training. It is perhaps concerning that they have not in the past, but if they do that in the future, that would be excellent. It is not just the particular forms of bad lending that you mentioned. Particular forms of misconduct are also interesting because there are very great similarities. To that extent do you think it might be useful if not merely the PRA, but the people in the FCA also had some knowledge of the history of past banking crises and banking meltdowns?

Martin Wheatley: We have built into our training certainly the lessons from the recent crisis-the past five years. It is an interesting point as to whether we should take a more expansive view and look at the repeated crises over a longer time period, but certainly the past five years have been very much built been into our approach.

Q4418 Lord Lawson of Blaby: It could not do any harm, could it, if you were to do that with your staff in both the PRA and the FCA?

Martin Wheatley: I agree.

Q4419 Mr Love: One of the issues they would learn if they looked at recent history is that when the FSA was launched, Howard Davies said that they would take a risk-based, not a tick-box, approach. What went wrong then, Lord Turner?

Lord Turner: As I have thought carefully about what went wrong, I am not totally convinced that this use of the word "box-ticking" is the best characterisation of what went wrong. When I look at what went wrong on the prudential side before the crisis and try to understand what we were doing in prudential back in 2004 and 2005, I could argue that one or two ticks or crosses against some very important boxes-such as sensible liquidity and capital rules-might have been better than what we were doing. I think also it is important to realise that some of the flavour that was put forward-in terms of, maybe not the risk-based approach, but the principles-based approach, which was launched a year or so before the crisis-may have led us astray. Certainly on the conduct side, it tended to suggest that we should stick to encouragement and general principles-you’ve got to treat your customer fairly-rather than being willing to dive into the details of how you were actually doing it and what the sales processes were.

I would accept that on the prudential side we clearly diverted from a true interpretation of a risk-based approach. On the prudential side, three things ultimately matter: capital, liquidity and asset quality. That is the absolute core of what prudential supervision is about. If you look at what we were doing on RBS and HBOS at that time, there was not enough focus on those. It’s a subtle thing; the only thing I would be a little bit careful of is the characterisation of what went on as "box-ticking". The more I thought about it, the less sure I became that it is a good characterisation of what went wrong.

Q4420 Mr Love: But it is a shorthand.

Lord Turner: It is a shorthand, but I sometimes wonder whether it is a shorthand that slightly misleads us, because it does not help us to think through what the real essence of the problem was.

Q4421 Mr Love: There are particular dangers for conduct regulation in terms of box-ticking. How are you going to ensure that the judgment-based way in which you want to carry out your regulatory function will be sustained and that you will not fall back into-if I can characterise it as such-a box-ticking culture?

Martin Wheatley: It is a good question. Obviously we will have a large number of people who go out and visit firms. They will have to have a manual-a process that they assess firms against. It is quite a difficult job to get below what firms are telling you-what is really going on in firms and whether you feel comfortable with them or not. A lot of judgment goes into that. I do not want it to become something where, as you say, we say, "We’ve ticked off-we spoke to the chief executive; they do send ‘treating customers fairly’ reports to the board; they’ve got a committee that looks at customers; they do monitor complaints." We could tick all of those boxes, but that still would not tell you whether people were getting good outcomes.

The way we are addressing that is to say that we will not just rely on supervisory visits that go into firms. We have built in the organisation a counterbalance to that-what is called our policy risk and research function, which will be talking to consumer groups, talking to the media, tracking the internet and getting a completely different take. If we have got, on the one hand, a firm telling us, "Yes, we’re compliant: we’ve got good governance and we’ve got all these rules in place," and if the supervisor comes back and says, "We can tick that; that firm appears to be well behaved", we can have another body of evidence that says, "Hang on a minute, we’ve got a lot of consumers complaining and we’ve got a lot of bad outcomes." What we are building into the organisation is, if you like, a cross-check against people falling into a simple acceptance of what a firm is telling them. For me, that structural change is one of the important ones, which will give me more confidence that we have not slipped into a box-ticking approach.

Q4422 Mr Love: And you will maintain the priority for that centralised function to ensure that its proposals are sustained?

Martin Wheatley: Yes. For me it is very, very important that you give equal weight and that there is the ability for those two sorts of disciplines to challenge and cross-reference each other.

Q4423 Chair: I have in front of me what I consider to be a somewhat extraordinary questionnaire, which has 17 pages of boxes to tick on financial sector diversity. It asks firms a series of questions: how many staff they have, what gender they are, and what is their race or ethnicity, their faith, belief, age and sexual orientation-incidentally, that is divided up into gender identity, transgender and intersex-and then it goes on to disability, pregnancy, maternity, marital status, carer and so on. There are pages and pages of this, in great detail. It is voluntary, and I think it was put round about 18 months ago.

I saw a firm on the day this arrived, and of course it arrived with the compliance officer. He considered it sufficiently important that he had better interrupt the chief executive, who was in a meeting discussing a major transaction, because he did not want to be on the wrong side of the regulator, filling in loads of boxes wrongly because they did not have all the information available or, worse, sending a message, "Frankly, we are too busy trying to deal with the consequences of the crisis". So the chief executive came off what he was doing and considered it, along with his chairman. I am talking about a pretty large finance house, very anxious that they should remain anonymous, because they are concerned about the regulator. I am not passing judgment on the importance of ensuring that regulators get hold of information that relates to diversity, or the importance of the diversity agenda. I give you that as an example of what actually goes on, or has been going on over the last couple of years. I wondered if you would like to comment.

Martin Wheatley: There may be 17 pages of boxes, but we have to collect data. One of the things-particularly to deliver a diversity agenda-we have to be able to do is collect data from the industry. I would be very surprised if we had sent it with the urgency that suggested it needed the CEO to be interrupted in a major transaction. I would be very much surprised if that was the implication of us sending it out. It is just data collection.

Q4424 Chair: I am just asking you to consider what effect sending questionnaires of this type might have on a reasonably large firm, extremely concerned to stay on the right side of the regulator and to do everything properly.

Martin Wheatley: We will try to be proportionate. We do not send out information requests lightly. We know that there is a cost to the industry, and we try to be proportionate about doing that. I cannot comment on the specific case, but I am sure that going forward we will have data requests where we will ask information of firms.

Q4425 Lord Turnbull: If you have been following the evidence we have received, a number of people have complained about data, and that the deadlines are also getting shorter. Data is being asked for in a very specific form that does not relate to how the company collects it, and sometimes the purpose for which data is being sought is not clear. Are you specifically looking at this question of how best you collect it? Is there some check, which asks, "Do we really need this? Do we need it in this detail and in precisely this form?"

Martin Wheatley: We collect data for quite a lot of different purposes. There is the set of standard regulatory reporting data, which is the core set of data that we need to do our job, on both the prudential side and the conduct side. You asked whether we do any checks. If we were to add to that standard regulatory reporting, then typically we would consult; we would go to the market and say that we intend to add these sets of issues. We would consult and say that we would like to look at the cost-effectiveness, and whether it is economic to provide the data.

Any changes in terms of core reporting of data going forward are quite likely to be driven by European legislation, rather than necessarily by us. That is one set of data. Then we have ad hoc requests, some of which are enforcement driven. Very often we will have an inquiry when we make an ad hoc request because we want to know about a particular aspect of business. We will have requests as part of our supervisory programme, where as part of the preparation for going to talk to firms we will ask for a whole set of data, and we will do what we call thematic requests. We try to be proportionate, but we cannot regulate the industry without having information about the industry’s activities.

Lord Turner: Could I add one point on that? I have not followed whether those comments about ad hoc data requests were coming on the conduct or the prudential side, but I think we were well aware from autumn 2008 onwards that we were on many occasions-originally just co-ordinated between the FSA and the Bank of England, and since summer 2011 often at the request of the FPC-asking for extra prudential information that we had not previously had.

If you take, for instance, the exercise that came out of the FPC recommendations in the autumn about the valuation of assets and risk-weighted assets, that has generated very significant extra requests to firms on the prudential side. I think that reflects the fact that in order to do good macro-prudential regulation of what the FPC is meant to do, we had not previously designed, on a bottom-up systematic basis, what information flows would be required to do that.

Hopefully, that will be part of a settling-down process. The FPC at some stage ought to be able to say, "We know what information we want in advance, and there will be less ad hoc stuff." I would imagine that our major firms do feel that they have been asked for quite a lot of information on a somewhat ad hoc basis, but I find it difficult to know how we would not have done that. For instance, in autumn 2011 we were very worried about the eurozone and we were asking for degrees of detail on exposures to peripheral eurozone countries that we had not previously asked for. Were we meant not to? I think we had to do that.

Q4426 Lord Turnbull: All we are asking is that as the urgency and sense of crisis abates, you have a conscious policy of looking at data requests and saying, "Is this really necessary? Does it have to be in this form? Can we make more use of the data that are already there, rather than requiring firms to adjust exactly to the template?"

Lord Turner: I agree that is exactly what we need to do.

Q4427 Lord Turnbull: Can I come to the question of twin peaks? The case for it is that the prudential side gets closer to the bank and its financial stability work. The danger is that, as you move B closer to A, B moves further from C. You then open up a new gap between prudential and conduct. We have a quote here from your beloved colleague Michael Foot about the way in which the FSA was originally created. It was thought to be a good thing that business and prudential people came together. He said: "We had conduct of business and prudential people in the same building arguing like cat and dog because they had never been together before."

All issues have two sides to them. Take Equitable Life: it had a conduct side and a prudential side. What mechanisms are you setting up to ensure that the gap that has opened up has some kind of co-ordination, so that the two of you work together and decide how to find a solution, and what is the trade-off between them?

Lord Turner: It is a very important issue and one that we have discussed within the FSA executive, at the FSA board and also at the Prudential Regulatory Authority proto-board, as it is called. You are absolutely right that almost by definition any organisational change will fix one set of problems and create a new set of problems. That is the nature of organisational change. I believe that the new structure will be better than the old structure. I believe that the focus is important. It will be very important to have people whose institutional objective is to think about prudential issues even when the rest of the world has decided there are no big prudential issues and all that matters is conduct, and vice versa. I think that is the big benefit we will get, and there are many signs, both from the way we dealt with LIBOR and prudential issues, that that was a disadvantage of being together in the pre-crisis period.

I am a supporter, and I have been from a very early stage, of the twin peaks approach, but it will create problems that need to be co-ordinated. We have discovered-we always knew-that some of them are most severe on the insurance side. For instance, what is a conduct issue within a with-profits policy-fair treatment of policyholders-and what is a prudential issue-appropriate levels of capital-are deeply mixed up together, given the nature of with-profits.

One of the things we have consciously done over the last year is to say that once we divided internally between the prudential business unit and the conduct business unit, we would very carefully spot issues that spanned across them. They come to a thing called ChairCo, which I chair, and we have used them as a learning process to say, "Well, if they had to come to ChairCo in the last year, how will that work in future? What mechanisms of co-ordination?" We have had debates about with-profits, and we have had debates about standard variable rates within mortgages. We are trying as best as possible to put mechanisms in place that, in future, will enable us to spot and debate those issues.

Q4428 Lord Turnbull: But when the great chairman, Lord Turner, has left the scene and we have Bailey and Wheatley, what mechanism will the two of you use to co-ordinate?

Martin Wheatley: A lot of very concrete things are in place. It starts with an MOU that governs how the two organisations are supposed to communicate, and places obligations on us to consult or inform at different points. There are obligations when we are thinking of acting in a particular way. We will have a regular, quarterly review of co-ordination. Andrew and I will sit down with all the data from our respective organisations and look at the extent to which we are actually co-ordinating properly.

Going back to your earlier point about how the market sees us, we will constantly be going back to the market and asking, "How does it feel for you? What is the co-ordination like?", and that will be the input into the process. We will have respective seats on each other’s boards where we will be kept abreast of the key policy issues that each organisation is pursuing.

Q4429 Lord Turnbull: You need to be doing that week by week, don’t you?

Martin Wheatley: Sorry, I was talking about the most senior level. At the level of firms-an individual bank-we will have a college where the two sets of supervisors have to get together formally at least twice a year to review the process, and would be sharing and passing information backwards and forwards on a weekly basis.

I am not saying that there will not be faultlines. Clearly, with two regulators, we have to manage that, but we have put quite a lot of thought into how we would manage it and what mechanisms we will need to prevent the sort of problems you suggest.

Q4430 Lord Turnbull: No doubt, successors to this Committee will be looking at precisely that issue.

Let me give an example. Let us take PPI, seen principally as a conduct issue. I assume that you are accepting what a number of people have told us-that there was a regulatory failure. To take the date of the super-complaint in 2005, for example, for the five years to 2010, the problem was rumbling on; the policies were still being sold. You really should have got to grips with it faster-what the nature of the problem was, and come up with a solution for dealing with it.

Lord Turner: I think that the FSA should have been faster after 2005. I want to say one thing in defence, not of myself, but of the pre-2008 FSA. It was taking some action. It is important to realise that by 2009, sales of PPI were less than a quarter of what they had been in 2004. That is not no action. It is quite big action, and is in the figures that were provided in the account of what had happened on PPI that we provided to this Commission. It should have been faster. We have looked very carefully at what was going on, and there was, as Martin mentioned earlier, a philosophical tendency to say, "It is not for us immediately to enforce completely new rules."

Remember that PPI had been going on under the previous regulatory regime for several decades. The FSA was given responsibility on 1 January 2001. In a perfect world, it would have very rapidly, within the first year, said that there was a major problem, which the previous regulatory regime has not dealt with, and we are going to deal with it in a very tough fashion. I think they were a year or two behind the perfect curve, but the previous regulatory regime had failed completely with PPI; it had not done anything about it, and this had been going on for decades.

Q4431 Lord Turnbull: But can we be assured that in the new way of operating, these kinds of issues-where there is a huge clamour and a growing chorus of complaints-are not going to take five years?

Lord Turner: When we produced things back in 2010 saying that we were going to intervene earlier, that was the board and executive reflecting on the fact that we should have been faster on PPI. It was one of the biggest things that pushed us into saying that we had to have an earlier intervention strategy.

Q4432 Lord Turnbull: Okay, finally you got round to dealing with it. Let us look at the solution. What we have at the moment is mayhem. We have millions of claims. You are fining people who are not dealing with the torrent of claims fast enough. It looks to us as though the cost of redress is probably greater than the benefit that the companies got from this. I can explain why if you want. The reason that there is a prudential and a conduct issue is that the state has put large amounts of capital into banks, and banks have been encouraged to increase their capital, and there is this mechanism sucking a lot of that out; the sums of redress for PPI are now material in relation to the capital issue. Doesn’t that indicate that you have to get a grip of this thing and bring some order to it and get some closure, rather than allowing this kind of free-for-all of claims, a lot of them bogus? Where we are at the moment is not a satisfactory response.

Martin Wheatley: I absolutely agree. We are not where we want to be. We are not in a satisfactory position. You have not mentioned the claims management companies, but they are also part of the problem; they have been generating lots and lots of claims. In terms of the total cost, just to put things in perspective, the banks sold about £50 billion worth of PPI. The current redress cost to the industry is approaching £10 billion, so it is approaching 20% of the total original sales of PPI. You could argue as to how many were mis-sales, but it is not at the stage where it is out of proportion to say, "Well, actually, this has clearly gone too far and all these consumers are wrong." If you look at the detail of what goes to the FOS, you will see that when the FOS investigates cases, it is still upholding around 90% of the cases that get referred to it. Whatever you may say about bogus claims and fictitious claims, when they are properly looked at by an adjudicator, an ombudsman, the FOS is actually saying that about 90% of the claims are valid and should be paid out on. It is chaos in the sense that the volumes are huge, but it is a process that we are working through, and we want to get to the end of that process. We have had some discussions. The BBA has come forward with some ideas about how we might accelerate the end of that process while still looking after the needs of consumers.

Q4433 Lord Turnbull: Are you working actively on the idea of a deadline? In some ways, you could present this as being good for consumers.

Martin Wheatley: Again, just to be absolutely clear, there is a deadline already. One of the banks, which wrote to its customers three years ago, is now telling any new complainants, "I’m sorry but you’ve passed your deadline." If a bank wrote to a customer, and some banks did right after the judicial review, then those customers at this point have no further claim. One or two banks are in that position today. Frankly, the problem is with banks that have not approached their customers.

Q4434 Lord Turnbull: You mentioned the claims management companies. The particular form of redress basically gave those people an opening.

Martin Wheatley: There is a cash payment coming back, and they are taking 30% of that cash payment.

Q4435 Lord McFall of Alcluith: Is it not the case that the three-year rule applies? The companies that have written to their customers apply the three years as they did with endowment mortgages. If people had been responsible and written to their customers, then there would have been an end point. It is those who have not written to their customers. From the FCA’s point of view, it would be wrong if you did not adhere to the three-year rule, because it would be seen that your first act was against consumer interest.

Martin Wheatley: There is a balance to be struck. The truth is that there has been very high publicity around this. I do not think that any one of us has not had a phone call or a text about PPI. But the problem we face is that a lot of people who found themselves buying PPI did not know they were buying it. It was automatically added. That is why we think a redress campaign has actively to approach customers, and that is why the banks that did approach customers are not in a mess. They are able to say to consumers, "I’m sorry. I wrote to you three years ago and your time is up." Some people are in that position.

Q4436 John Thurso: Can I move from that specific point to a more general one about the supervisory approach to products? Mr Wheatley, you made a couple of speeches recently in which you acknowledged that the FSA’s simply sending information out to customers was not effective in the past at enabling people to look after themselves, and that the regulators, therefore, need to have a much better understanding of products and their nature, profitability and the benefits or disbenefits to customers. How are you going to do that?

Martin Wheatley: We have a number of very specialist experts within our organisation who have come from the banks that design, create and sell these products. One of the aspects of the FSA and FCA is that it is actually very interesting work for people who are the quants who design and structure these products, so we have the experts in-house.

Q4437 John Thurso: Talk me through the change between the past, when you quite rightly said that this was not going on, and today. What is the difference in the assessment of products between today and three, four or five years ago, when it clearly was not happening?

Martin Wheatley: The key difference is that we will not only look at the product features as they are described to us and deal with complaints as they arise, but we will do two different things. One is that we are taking a much more engaged approach to working with consumer groups and different groups that raise issues. Rather than us being a closed door, we are very much trying to open that dialogue so that we get early intelligence where-frankly-there are things going wrong.

The second thing we are doing is building into our supervisory approach what we call our business model and strategy analysis. PPI is a good example, because in the period between 2005 and 2008 we were taking actions on PPI; we were aware that it was a problem, but we never realised that for some of the major banks this was the vast majority of their retail profits. One of the things that we are building into our methods now is that, effectively, we will follow the money. For an organisation, we will look at what its growth area is, where its significant margins are growing and where it sees its future profits. I am not saying that there is anything wrong with making profits; we will use that as an indicator of where we should address our time and attention. We did not realise with PPI until after the OFT report just how much money was being taken out of customers’ pockets with that one product.

Q4438 John Thurso: It would be fair to say, just so I have got this absolutely straight, that you will in fact be doing two complementary but different things in regard to products. You will be looking at where the money goes, as you have just described; you will be looking at where profits are being made and therefore you will have an idea of the scale of risk there. On the other hand, you will also be looking at products on their own in order to assess how good or bad they are. How much does caveat emptor for the consumer still play a role, and to what extent will what you are doing be effectively giving approval to a product?

Martin Wheatley: We are very careful to say that we do not see ourselves approving products. That is a difficult position for us to be in. Resourcing-wise, it would be impossible, but it would also become a block to the industry being able to innovate and compete with new products. I do not think we should be in a pre-approval mode. Clearly, when we look at products, we will be looking at them in terms of the effect of how they are sold to individuals. Caveat emptor still has a role, and it is still a valid concept, but I think what is difficult is that the consumers we will be concerned about range from the very sophisticated, for whom most of the time they are acting in a caveat emptor capacity, to the very much less literate, who most of the time are reliant on the bank or the intermediary, to a slightly complex group in between-the mass affluent group, as the banks would call them-who may or may not be sophisticated. We are absolutely not saying that caveat emptor has no place in the future; there is a consumer responsibility.

Q4439 John Thurso: If we accept that particularly with regard to the informed purchaser or investor, given the processes you have, there is a clear role for caveat emptor, can we park that group and go to the group that is the high street consumer? What we have learned from much of the crises over the years is that any reliance on caveat emptor is misplaced in regard to the people who think that automatically a bank or financial institution is a trustworthy institution and, therefore, if a product is for sale it is a trustworthy product-it may or may not be the right product for what they want to do, but the product is inherently trustworthy. What we know is that actually there have been quite a lot of products that are not inherently trustworthy.

You have an assessment procedure and you will be making an assessment. Is it realistic to say "We have assessed a product. We think it is inherently risky and we don’t think the man on the street can work that out for themselves, but we will sit back and wait to see what happens?"

Martin Wheatley: You have calibrated it as the man on the street through high street channels, I think, because that is quite different from the informed investor who is making a selection.

Q4440 John Thurso: Exactly. I am not at this point concerned with the informed investor who can look at it and make a judgment. I am concerned with my many constituents who take it on trust that if they go into a high street bank and they say, "This will protect you from X", or "This will insure you against Y", or "This will allow you to pay off loan Z", it will do what it says on the tin.

Martin Wheatley: One of the things that we are changing, or have changed, as you know, is that through the retail distribution review we have removed one of the in-built conflicts, so when an intermediary is selling a product they are acting without the conflict-they know that the product they sell is who they get paid by. So we have taken that conflict out. We have increased the qualification standards that are necessary for people in customer-facing roles, so hopefully we will see better staff; and we are working, as you know, with the industry to try to take out some of the incentive skews that are built in.

Q4441 John Thurso: The core point I am really asking you about is that you have told me about the assessments you are now doing, and you are telling me you have the competence and the capability to assess products, look at them and make sure you understand them, so if you have a product that you feel is perhaps not doing what it says on the tin, are you saying that you will not be taking any action?

Martin Wheatley: No, sorry-if that is the specific question, under the new Act we are being given a specific power to take action, and the power works in a way that effectively reverses our normal process. Our normal process-PPI is a good example-is that we have to do a lot of data analysis. We have to consult, we have to go through the courts, and all the time we are doing that the product is being sold. Under the new power, we would have the ability to intervene first, and say, "Actually, this product is inappropriate" and then do the analysis, and we would have a year period in which to prove that we were right, effectively.

Lord Turner: And we can ban it to a particular group of customers.

Q4442 John Thurso: So you effectively have the equivalent, more or less, of the US cease and desist.

Martin Wheatley: Effectively, but it is a time-limited power; we still have to make the rules permanent at the end of a year. But yes, it allows us to step in early-I think that is what you are asking.

Q4443 John Thurso: Can I just put this to you? I know we have had this discussion before in the Treasury Committee about the possibility of kitemarking a small range of simple, it-does-what-it-says-on-the-tin products, which a number of the banks who have appeared before us have given evidence saying that they would welcome. Where you have what should be simple products going to unsophisticated consumers, where you are already making the assessment anyway and if it is not up to scratch you will stop it, where is the great difficulty in simply turning that over and saying, for those simple products, "We will be capable of giving them a kitemark"?

Martin Wheatley: To be specific, the concern is what the kitemark represents. If it represents "Here is a product that is safe and does what it says on the tin", that is one thing, and I don’t think we would particularly worry too much about that, but if the kitemark is saying, "Actually this product is safe, and can be sold in all circumstances, and the bank basically has a safe harbour from any action from us," I would worry, because even products that pay 0.5% commission and are very simple products can be churned. That is one of the problems we see very often-a churning of products where customers are being taken repeatedly into different products. It would be very hard for me to stand back and say, "For simple products we never have to worry."

Q4444 John Thurso: Just let me get that straight, because I think it is a very helpful observation you have just made, which is that your concern is not actually with saying a product is good or bad, but actually with saying "We think it is a good product and we will put a kitemark on it", which gives anybody the right to sell it to anybody in all circumstances, which clearly could be wrong.

Martin Wheatley: Yes.

Q4445 John Thurso: So if we, or Parliament generally, were to say to you, "We like the idea of a simple kitemarking system", rather like with car insurance but for a mortgage, life insurance or whatever, provided it just did what it says on the tin, as long as that was not taken as saying, "You can sell it to everybody in all circumstances where it would be inappropriate", would you be happy with that kitemark?

Martin Wheatley: Yes, and it is that second part, the process-

Q4446 John Thurso: It is very helpful to have got that clear. A final question, if I may. Unlike the PRA, the new FCA is not moving building nor coming under the oversight of a different organisation. It is pretty much just changing the flag over the door, as it were. To what extent does that make it more difficult for you to ensure that the FCA’s culture is not simply the old FCA continued?

Martin Wheatley: There are some symbolic things. Clearly changing a building and a new start is symbolic, and the staff will feel a level of excitement from that. But I can absolutely guarantee you that every single person who works in Canary Wharf for the FSA is hugely excited about the change that we are going through and sees no less a change that we are going through than the PRA. Culture change is difficult. I am not saying it is easy. It is never easy, but we are working very hard. I am working very hard at it, communicating what is expected of people and getting people engaged in the process. I don’t feel that the lack of a move in that sense and a rebranding of the building makes it any harder to create that culture change. I think people are very excited about it.

Q4447 John Thurso: Can I ask you, Lord Turner, as you are going to be a free agent very shortly, if in a year and a bit I asked you to advise me what question I should ask Mr Wheatley to ensure that he had done his job, what would that question be?

Martin Wheatley: Careful.

Lord Turner: I can tell you what it would be, because I think there is a new area of responsibility, and we have not yet focused on how important it will be. It is, "What are you doing with your new responsibility for consumer credit?" From March next year, the FSA gets responsibility for consumer credit. Interestingly enough, I suspect that if you did a random survey of most people, they would probably think we are in charge of it already. They probably think it is one of the most important things. It makes the FCA much more involved in the mass market ordinary people than it has been in the past. Let us be clear: a lot of investment products, and what IFAs do, is skewed towards upper-income, moderate wealth type people. Consumer credit will get us involved in very complicated issues, particularly on the caveat emptor approach. What is the responsibility of somebody providing consumer credit to make sure that that is a good deal for the individual? We have been thinking about this in the FSA. It is a crucial thing for the FCA, so come summer next year I would ask some searching questions on what you are doing on consumer credit.

John Thurso: I have got six months to turn that into a short question, but you are well prepared, Mr Wheatley.

Q4448Baroness Kramer: Mr Wheatley, if we could turn to competition, of course the FCA will now have an operational objective, if you like, to promote objective competition. It is not the overarching objective. In the conversations that we have had with many people there is a great deal of scepticism that, although it is now, as it were, a "can", the FCA will have the will to make use of that power. When I put this question to Clare Spottiswoode she said: "I do not see much sign that it"-the FCA-"is going to employ these powers at all… I do not see many signs that the FCA is taking this seriously". Is she correct?

Martin Wheatley: No. Well, she is correct in terms of signs. There may not be visible signs, because we are in the process of building a capability. Until we have built some capability we are not doing a lot of things very actively in the market to use that competition power. We will have that power in four weeks’ time. We are in the process of recruiting a competition director and we have a number of very good candidates. We have a shortlist for that. So she will see a sign when we announce a competition director, which I hope will be in the next month or so.

We are building up a unit internally. We have worked very closely with the OFT on the areas that they are dealing with in competition over the next 18 months and the areas where we could therefore be complementary with them. We have started a process of work doing a market study on the general insurance market. So in fairness, there are not so many visible signs, because we are in the process of preparation and we are building that, but we are taking it very seriously.

Q4449 Baroness Kramer: Obviously, we are a Commission that’s looking specifically at the banking sector, and you don’t need to look at the endless testimony we have received to see how heavily concentrated that sector is in key services. According to much of the testimony we have had, competition essentially doesn’t play a terribly powerful role within the banking sector. Any enlightenment you can give us on where you are taking that would be extremely helpful.

Let me put it to you this way. According to much of the conversation we have heard from the FCA, where there are problems, the response is very much around rules and regulations as a method to deal with problems. Would you not agree that the market-used effectively, which it hasn’t been in the past-is almost the best disinfectant to deal with issues, including conduct, that start to distort and corrupt that industry? Are you concerned about the current level of concentration?

Martin Wheatley: On the question of whether the market is the best cleanser, in pure economic theory a set of well informed consumers with choice and freedom of movement, and a set of low barriers to entry to an industry, obviate the need for heavy-handed regulation. That is what theory would tell you. Our experience is that that is not the case. There do not appear to be many significant new entrants in the banking market, and there haven’t been for the past 30 years. There have been around the fringes, but not in terms of the major players.

One of things we have been looking at is the extent to which we and our processes are part of a barrier to entry. We will be publishing a paper on barriers to entry into the banking market in the next month or so. We will watch with interest the moves that the banks are making to introduce current account transferability, and we have been asked by the OFT to revisit that question after people have some time and experience with it. Will people actually use that opportunity effectively to punish poor performance?

We will use other competition levers, because as you say, this is the new thing for us. We have always had enforcement powers, we have had supervisory powers and we have got rule-writing powers. Competition powers are a new part to that. We will use those in a complementary basis along with those other powers, where we see that as the most effective route.

Q4450 Baroness Kramer: Help me with some of those competition levers. I say this to you in the sense that you have mentioned reduction of barriers to entry, and I know that you’ve got a paper coming out. I think that the FCA portion of that is the application process, isn’t it?

Martin Wheatley: Yes.

Baroness Kramer: But that doesn’t deal with the issue of the difference in capital weightings, which falls under the PRA part.

Martin Wheatley: Adair may comment on that part, but do you want to finish your question?

Baroness Kramer: I think it is an important change, but it is a modest one, if you like, in terms of the application process. You’ve talked about account switching, and there has been a lot of discussion around the payment system. Do you really see that those kind of changes, in and of themselves, would be sufficient to really create a competitive market any time in this current economic cycle?

Martin Wheatley: In truth, no, I don’t. I think that the real change that will disrupt the market is going to be disruptive technology. I think that mobile banking will be the big change so that, if there a new entrants, they will come in with a different model. Frankly, as long as competition is based on bricks and mortar, an embedded customer base and a back book that can be charged, it is very difficult. If the things we are talking about are barriers, we should take them away, but they are not in and of themselves sufficient to create a competitive market.

Q4451 Baroness Kramer: Tell me more about the levers you’ve mentioned that you think you can use. Does that includes breaking up the banks?

Martin Wheatley: Possibly, as we go forward. As I say, there is a set of modest things that we can do today. There is a set of things that are already happening in the banking industry, and current account transferability is one of those. If, when we come back to this, we see that those have not had effect, then we have a broader range of competition powers, which will include references to the Competition and Markets Authority or could include structural changes to the market. Those sorts of things are not taken lightly, and it wouldn’t be something we would come to without quite a lot of study, but structural change to the market could be one of the sets of power that we could use.

Q4452 Baroness Kramer: Can you do it without effective co-operation from the PRA, which has this very pale, "may have regard"-nothing more than that-role in competition? Perhaps an illustration is the barriers to entry. From the conversations we have seen, we get a sense that there will be significant change in terms of the application process, but relatively little shift in problems of capital-risk-weighted capital versus standard models and so on. I would like your answer, Lord Turner, but I would also like to know from Mr Wheatley what kind of powers he thinks he has to put a gun to the head of the PRA to respond properly to the competition requirement.

Lord Turner: The barriers to entry document will be about the last single document that is an integrated FSA document. It includes, as you say, something on important changes to our authorisations process. Within that, I think that the biggest change we are making is on the prudential side, not on the authorisation side. Broadly speaking, it is as follows: in the past, we have had pretty much the same capital and liquidity rules for new entrant banks as for existing player banks-indeed, we have tended to have capital or liquidity add-ons for new entrant banks, so they have been disadvantaged-but we are shifting to a process in which a new entrant bank will be able to run on the minimum legal requirement under CRD IV, which is a 4.5% capital ratio, whereas RBS, Lloyds bank and HSBC will effectively have to be up at about 9.5% or 10%, once you allow for the 4.5% plus the 2.5% conservation buffer and the global SIFI surcharge or equivalent under the Vickers rule.

That is a significant difference, and it reflects a PRA philosophy that is saying that we are going to accept in future-this will be very important for Parliament to accept-that the actual failure of a bank, provided it happens in a smooth fashion, with smooth resolvability and rapid pay-out to insured depositors, is not necessarily a regulatory failure. That is clearly in the PRA philosophy, and that is going to be very important for Parliament to accept when this happens in 10 years’ time. It should not be saying to the PRA, "You let this person in." If you want to remove barriers to entry, you have got to have entry and exit, as they do in the US.

We are introducing a significant change to the relative capital regime for new entrant banks versus existing banks. I think that people have failed to realise so far what a significant shift that is. It reflects the fact that we will allow time for new entrant banks to get up to the 7% that will be required before they can pay out dividends and that new entrant banks, by definition, will not be subject to the globally systemically important surcharge that will apply on top of that, because they are not globally systemically important. There has been a failure to understand how significant the changes are on the prudential side.

Q4453 Baroness Kramer: I look forward very much to seeing that report, but does that not all still end up in the wash, as it were, when you actually look at the use of the models? New banks, even though they will now have the same standard model as existing small banks, will still fail to have the benefits that apply to the large institutions that can use their own models to produce risk-weighted asset calculations, which create an enormous differential in the amount of capital that has to stand behind every activity.

Lord Turner: Again, because it is one thing that I have done quite a drains-up on over the past two months to make sure I fully understand it, I am not convinced that that difference is as big as people suggest, except in one area, which is prime mortgages. Broadly speaking, if you take commercial real estate now, we have introduced even in the modelled area what we call slotting-a way of charging capital against levels of loan to value-which has brought the modelled approach pretty much equivalent to the standardised approach in the severity of the capital charge. I think that that is absolutely right, because we were allowing people to do commercial real estate lending on the existing models on too low a base.

When you look at SMEs, where the standardised is either 75% or 100%, it is possible that some models will produce slightly lower, but not dramatically lower. The big difference is in prime mortgages, where the standardised is 35%, and you can run a prime mortgage book and produce a model that says you only need a 5% or 10% capital ratio. That is a big difference, but we offset that very significantly already by a capital planning buffer and, bluntly, we are interested in the idea of whether we should be putting an underpin under those very low weightings in the modelled area, as Sweden has just done. Sweden has said: "You can run your models how you like, but we are going to have an absolute 15% minimum."

It is important in this debate to realise that we have concerns about how models run. If Andrew Bailey was here, he would say that in so far as there still is a distinction between modelled and standardised, that may raise more questions about whether we should be underpinning the models and the too low rates they produce, rather than accepting too weak capital requirements for new entrants. I am not convinced that this is as big as people suggest. In fact, we went through it with one of the new entrants in a meeting two weeks ago, and when we went through the details, they said, "Well, we can see that this is not as big an issue as we thought."

Q4454 Baroness Kramer: That is very helpful. Lastly, Mr Wheatley, for competition to be effective as a tool there has to be a strong commitment from the FCA and the PRA. Given that you are the lead as the legislation is currently structured, are you going to be able to lever the PRA into providing its role? Or does there need to be additional legislative underpinning to ensure the PRA commitment to competition so that it can function across both regulators?

Martin Wheatley: Clearly, there is an imbalance in what our competition objective looks like compared with the PRA’s competition objective. If we wanted to intervene on the basis of a competition intervention and needed to consult the PRA, it would not necessarily meet the threshold for the PRA’s competition objective. I think that is a potential crack in the system, but we have the alternative route of a competition reference to the Competition and Markets Authority. I do not know whether the PRA’s objectives need to change. I think you are right to identify that there may be circumstances where we might want to act on the basis of competition but, on consulting the PRA, they might have a different view because it is not consistent with their objectives.

Q4455 Chair: Perhaps I could follow up by asking specifically about the FSA’s objectives under the new legislation. You have an overarching strategic objective to ensure that the relevant markets "function well". What does that add that is not covered by these three operational objectives?

Martin Wheatley: I am not sure that it does that much to the three operational objectives. You could argue that promoting effective competition in the interest of consumers and the market, enhancing the integrity of the system and ensuring an appropriate degree of protection encompass everything that is in the phrase "ensuring markets work well".

Q4456 Chair: We have received legal advice that it might add things to the detriment of the operational objectives, so the fact that you are not sure that it adds much is extremely helpful. I am sure you do not want to draft anything on the hoof, but if you look at your integrity objective, it is to secure, among other things, "the orderly operation of financial markets." If that was very slightly altered to read "the orderly operation and good function of financial markets," off the top of your head and without committing yourself, do you think that, prima facie, it might fully do the work of your strategic objective, which is to ensure that the relevant markets function well?

Martin Wheatley: In fairness, rather than comment on the hoof, because these things have been so carefully crafted and the lawyers have been through them, I would want to spend a bit of time with the lawyers on what that change might mean.

Q4457 Chair: Your open-mindedness is extremely welcome. What we are really talking about here is, for the first time in many cases, giving bank customers a seriously better deal and a meaningful choice in retail banking. We have had advice from lawyers and others-Clare Spottiswoode was quoted earlier-saying that, even after the Herculean efforts that the Treasury Committee has put into trying to secure the competition objective, we might not get what we intend from the legislation.

Martin Wheatley: I would be open to a redrafting that keeps us to our core purpose, which is to get proper conduct standards in markets so that consumers get a better deal. Rather than comment on the specifics, I would be happy to go away and consider it.

Chair: That comment is very helpful.

Q4458 Lord Lawson of Blaby: May I move to another dimension of all this? Do either of you think that whistleblowing has a useful and possibly important role to play in effective financial supervision?

Martin Wheatley: Absolutely. It is a core part of our function today. We have a whistleblowing structure in place. We get 3,000 to 4,000 whistleblowing alerts a year. For us, they are a very valuable source of intelligence. Let’s be clear, there is mixed quality in terms of what comes in, but we take it very seriously. About 12% of what comes in as whistleblowing alerts is what we would call actionable intelligence that we then pursue and may lead to cases. It is a core part of our business and we think it is very important.

Lord Turner: The answer is basically yes. I think the issue is whether we could have more of it. We are producing our report on LIBOR next week. One of the points it will make, which is pertinent to this, is if you look at the element of what was going on in LIBOR that was not the low-balling for reputational reasons but the manipulation for trader profit, none of the authorities round the world independently knew that that was going on.

Both we and the CFTC began by looking at the rumours about low-balling and, as a by-product of that, because we asked the firms to tell us everything about what had been going in LIBOR and submission, we discovered trader manipulation. The question I then asked was, "Could we have ever known about trader manipulation?" I can’t see that we could have through supervision, unless we were to have an army of 10,000 supervisors real-time in every trading room. It is like how big a police force you would need to spot every crime that ever occurs.

In trying to think about what would have been required to tell us that that was going on, one of the few mechanisms that you can think about is whistleblowing. I think it is one where we probably need to think more deeply than in the past. It is a reflection that I will comment on next week when we bring out our report, on what we knew and didn’t know and what we probably could not have known in relation to LIBOR.

Q4459 Lord Lawson of Blaby: I think your general point is very well taken and your example is well chosen. One would have thought that there might have been, among all those dishonest traders, perhaps one honest one who might have been a whistleblower, if you were going to encourage that. In that context, have you been studying the American system? It is by no means infallible or flawless but in that system much more importance is attached to the encouragement of whistleblowing. Have you looked at that and formed any conclusions?

Martin Wheatley: Yes. Under the Dodd-Frank Act they have introduced a provision whereby a whistleblower-

Q4460 Lord Lawson of Blaby: But it’s not just under the Dodd-Frank Act. That has been going for some time.

Martin Wheatley: The new changes, the payment part of it, allow a whistleblower to retain somewhere between 10% and 30% of what the proceeds of the crime would have been. Are we interested in it? Absolutely. We have spoken to the US authorities and we are looking carefully. To ask whether we have studied it, I would say it is probably too early. So far, I don’t think they have brought a successful prosecution on a case of whistleblowing. I think there is one in quite an advanced stage. More time is needed to see whether that system works well.

Q4461 Lord Lawson of Blaby: You say more time needed, but you need to get a system in place. You have the experience of whistleblowing in the United States previously. It is not something entirely new brought in by the Dodd-Frank Act, although that has enhanced it. I am not suggesting that you would want to emulate every detail of the American system but, if you are not going to, you need to know why you are not. If you are going to improve on it, you need to know how you are going to improve on it. You certainly need to look at the experience of whistleblowing in the United States, not just wait and see what happens after Dodd-Frank, surely.

Martin Wheatley: We will study it-absolutely. The elements that are quite common are that we have quite a rigorous process around the structure and we do have a number of whistleblowers today. The difference is the key thing, which is the incentive to whistleblowers. Under our structure, the incentive is effectively doing the right thing. It is a personal moral incentive. Under our rules, you are required to tell us if there is anything suspicious, but it is still down to a moral incentive. The US system introduces a financial incentive, and there are some pros and cons with that.

Q4462 Lord Lawson of Blaby: Where do you stand, both of you, on the idea of a financial reward for seriously important whistleblowing?

Martin Wheatley: Personally, I am unconvinced that that will yield a better structure than we have.

Q4463 Lord Lawson of Blaby: What structure do you have?

Martin Wheatley: We have a structure in which people whistleblow. We get up to 4,000 whistleblowers a year. Probably one in eight of those are valuable intelligence, which we pursue, and then we act on the basis of that. It is not that we do not have any whistleblowing-we have a structure-we just do not pay people.

Q4464 Lord Lawson of Blaby: Can you give us an example of whistleblowing that has made a significant difference to the way in which the FSA has operated?

Martin Wheatley: The law around whistleblowing is very strict in terms of protecting the identity of whistleblowers.

Q4465 Lord Lawson of Blaby: I’m not asking for names.

Martin Wheatley: I can’t give you specifics. I am sure we could provide some examples, if it would help, of the types of things where whistleblowing has been helpful. We have whistleblowing in relation to benchmarks now. As Adair said earlier, we didn’t in 2008. There have subsequently been different types of benchmarks-some of them very publicly-where people have come forward and said that there is abuse in this space, which has led to investigations. We have had whistleblowers on individual products that they consider to be fraudulent products. Where we have whistleblowing on fraudulent products, again we have then pursued that and acted. Some of those have resulted in quite significant outcomes, but I cannot talk about the specific details.

Q4466 Lord Lawson of Blaby: Did you say that you are about to produce something that is going to bring us up to date with your present thinking on how the whistleblowing process can be improved?

Lord Turner: No, not on whistleblowing. What we are producing next week is the drains-up. Members of the TSC may remember this. In July last year, when the Barclays LIBOR case came out, Barclays produced a thing that said, "Here are 13 occasions when we said something to the FSA or the Bank of England, where we thought they might have known about what was going on." When I saw that, I said that we had better do a complete drains-up and find out whether there were any other occasions. One of the things that it reveals is that there were some other occasions, although none as important as the Barclays ones, but there was no information in relation to the trader manipulation. Neither us nor the CFTC, or any other authority, had any way to spot the trader manipulation. There is nothing that you can look at and say, "You should have responded to that." There simply was no information on the trader manipulation.

I am simply saying that, having seen that evidence, it has made me think, "How would you do that?" if something is going on that is incredibly difficult to spot from market manipulation algorithms. On the equity markets we have clever software that says, "There is something funny going on in this equity price movement; better look at it." That really did not apply on the LIBOR side. We could not have got at it by intensive supervision, so, in a sense-I have to say again I am responding to something you’ve said and trying to crystallise in my own brain what we think about it-is whistleblowing one of the very few mechanisms that would have worked in that area?

We are not commenting on whistleblowing next week, but we are producing the risk report on the actual facts of what we knew about LIBOR. That then poses some interesting issues for you and others about what are the mechanisms for addressing that sort of issue. There are some issues for which you just cannot have a police force big enough ever to spot all these problems.

Q4467 Lord Lawson of Blaby: Time is running short, so I do not want to pursue it further here, but it might be useful to the Commission if you could let us have a short note on your thoughts, because you have obviously been thinking about it. You obviously think it is important. If you could let us a have a note on your thoughts on the way forward on whistleblowing, that would be helpful.

Chair: If you want to wait until 2 April in order to write a personal note, that would also be helpful.

Lord Turner: I would be happy to do that. When you get to the end of a job like this, you reflect on certain things and some ideas that might slightly diverge from the official position. Not that one is disagreeing with what I or others have done, but there is a process of reflection that sometimes pushes you into a different space. So I would be happy to do that.

Q4468 Chair: Later on this morning, we may try and get a preview.

Why could you not have got to the LIBOR issue with intensive supervision? Why could intensive supervision and an ARROW visit not have got as far as asking LIBOR traders, for example, what their relationship was with their own derivatives desks? I would just like Lord Turner to answer this, because Lord Turner made this assertion.

Lord Turner: The difficulty is just the sheer number of people that you would need for that. We have radically increased the number of people involved, say, in the supervision of a bank like RBS. As the RBS report set out, it was five pre-crisis and is now between 20 and 25. Even with that, if you think of a large-multinational in some cases-business involved in retail banking, investment banking and wholesale banking, there is simply a limit to the number of different areas of the business that you can get into.

Q4469 Chair: Just going to sit on a trading floor for a couple of afternoons or going to chat with a few people and getting to know 10 or 15 people on the floor, is that going on?

Lord Turner: They would not necessarily tell you. The official visit is sometimes met by statements that are not the full-I think it would be difficult.

Q4470 Chair: But you are saying that it is not worth trying.

Lord Turner: No. I think what we really have to do is to reflect-

Q4471 Chair: You said that you cannot get to this with intensive supervision.

Lord Turner: I am not convinced that we can, but what we have to think about are the different tools through which we get to things. Let us take equity market trading, insider dealing and market abuse. We do not typically get to that by intensive supervision in terms of people on the trading room floor itself. We get to that, in part, because we have very sophisticated software that enables you to look at the trading patterns of equity price movements and then say, "That is a bit odd," and then you dive in and look at it. One really has think through the different techniques here.

Q4472 Chair: I just want to pick up on this point. We have discussed a number of aspects of whistleblowing, but what do you think we are not doing now that we could do to support whistleblowers who fear that they will come under the pressure of losing their job or persecution at work? What more can you do in that area? Have you given thought to that, Lord Turner? If you have, would you be prepared to put this in your valedictory whistleblowing note where you are going blow the whistle on the FSA?

Lord Turner: I think Martin is closer to the details of our current approach to whistleblowing and how we have changed it, so I would prefer him to answer that question.

Martin Wheatley: The truth is, absent the question about incentives, that I am not sure that there is anything that we would need to add to the current structure. There is a high degree of protection for whistleblowers. They will sometimes need counselling if they are facing particular problems in a firm, and we would suggest areas that they can go to. We cannot provide that level of counselling. Our primary responsibility is to protect the identity of a whistleblower and to protect the source of information that comes to us.

Q4473 Mark Garnier: I want to talk about corporate governance, but before I do, may I turn to you, Martin Wheatley, with a specific question about proprietary trading and how it relates to market making? There is a big debate going on about proprietary trading, which is pure, non customer-focused trading with a balance sheet where the only interested parties are the shareholders of the firm and the dealers doing the prop trading and that element of the business that is market making, which is clearly where you are providing liquidity to market and providing services. Is it possible in any practical regulatory or supervisory way to disaggregate those two types of business and to be able to identify that which is non customer-facing prop trading and that which is customer-facing?

Martin Wheatley: I do not think it is possible to do it in a way that would not be gamed by the banks.

Lord Turner: It is very difficult. At the aggregate level, you can get some indicators as to whether a bank is clearly doing prop trading or not. At the individual deal-"We took this position"-you will find it very difficult to say whether that position was in order that you had market-making inventory that you could then sell. What you can do is look at the frequency distribution of daily profits. If you have a bank that says, "This is a market-making operation. It is customer facilitation; it is what they call flow trade," you are highly likely to see that the distribution of daily profits is somewhat like a normal distribution; they make a relatively small or moderate profit every day. Occasionally, that produces a bit of a loss, and occasionally it produces a larger gain.

If you look at the frequency distribution of daily profits and you find that every now and then there are some whacking great losses and whacking great profits and there is not much of this regular flow in the middle, it is highly likely that as a post facto indicator, that tells you that they are more of a proprietary trader. Indeed, I will not name names, but we did that exercise four years ago, and you could compare different banks, and it clearly lined up with what we knew about their philosophy as to whether or not they were trying to make money out of prop trading. That is the nearest that I can come up with.

It is an issue that I discussed with Paul Volcker when he was coming up with his rule. In fact, in front of the TSC he mentioned this idea, but it is difficult to turn into something operational as to how you would limit it. Personally, I am not totally against adding to Vickers a declaratory rhetorical statement that you cannot do prop trading, and I think that it might have some impact, but it is not transformational. I do not think that it is necessary, given that we have the Vickers ring fencing. That achieves most of what we want in terms of prudential clarity. It is an inherently difficult dividing line to draw between prop trading and market making.

Q4474 Mark Garnier: That was a much more in-depth answer. Martin Wheatley, do you agree broadly with that?

Martin Wheatley: Yes, at the margin, the banks gained that sort of thing. I think it would be a signal to say that prop trading should not exist within the ring-fenced bank, but enforcing that would be operationally a very difficult thing to achieve.

Q4475 Mark Garnier: But there are signals that you can use, as you discussed, which can flag up where something a bit strange is going on.

Martin Wheatley: Oh yes.

Q4476 Mark Garnier: I will leave it at that if I may. I want to get back to this LIBOR thing. Lord Turner, you were discussing the fact that there were no whistleblowers highlighting what was going on with the traders in New York. Surely part of the problem with that is that nobody seemed to know there was anything wrong to blow a whistle on. Is it not the case that it is the tone from the top that is the key to this? It is whether people really understand what is ethical behaviour at the front line, as opposed to what is normal behaviour. If you are working in an environment where you see this going on the whole time, how can you possibly know that that is something that you should blow whistles on?

Lord Turner: That is a very good point. I suspect my press office is having a fit at the moment that we have got on to LIBOR five days before we are producing a Report. You have raised something that is not specifically about our Report on LIBOR; it is a general point, and a very good one. It is about both the tone from the top and the nature of trading rooms. Some very thoughtful economists, such as Raghuram Rajan in his book "Fault Lines", have written well on this.

There is something about the trading room environment, which is sufficiently detached from what the economic function of this is in terms of its impact on real consumers and real businesses, that produces a moral universe. It is if they are saying, "This is just a computer game, and in a computer game, I can do anything to try and win. This is just a screen, why should I not cheat?" There is an economic function from trading and market-making activity. It does have a real economic benefit, but it is at the end of several layers of indirect effect that it is easy for the people involved simply to say, "Anything that I do that makes a profit is valuable." What that indicates is that those who are in charge at a senior level need to know that that is the case and that there is a tendency for that to occur, and they need to lean very deliberately against that.

Q4477 Mark Garnier: Do you think they know it?

Lord Turner: I do not think that they were leaning against that before the crisis.

Q4478 Mark Garnier: Do you think they are doing it now?

Lord Turner: I think they probably are, yes. I think there has been, within the leadership of our major banks, a really quite significant shift in culture towards these sorts of activities.

Q4479 Mark Garnier: I will tell you where I am going with this. I have been given an indication to move it along a bit, which I will do. I have no doubt about the sincerity of the people who are managing these banks. Certainly enough of them have come in and said that they really want to get this right. I believe them, and believe that they want to get it right. The problem is that at the other end of this scale, it does not actually matter whether you are LIBOR trading or whether you are PPI mis-selling or whatever, because you are a great distance away from the top, where that tone is being set. What has been really interesting-this is where we must turn to the regulators, in particular the FSA-is the accountability given to people at the top to make sure that tone is coming down. When the UBS chief executives came here it was truly remarkable that those people who were running UBS at the time of their LIBOR scandal knew nothing about the investigation until such time as they read it in the Financial Times, along with everybody else.

I asked Tracey McDermott about this issue-why was it that they had never been interviewed? Her answer was quite interesting. She said that when the FSA do an investigation they look to where the crime was committed, and follow the trail. When the trail goes dead they will stop investigating, which is fair enough. Of course, what happens is that the trail goes dead well before it gets to the senior managers. This problem creates a behavioural change. If you are a manager of a firm, no matter how good your intention is to set the tone from the top, you now know that as long as you create an accountability firewall between yourself-the management-and the front line, you have no personal accountability for the tone that reaches the bottom. That seems to me to be a very serious problem.

Why is the FSA in its normal course of events not coming down incredibly hard on the very senior people at these organisations when something goes so badly wrong at the other end? I am sure you are about to say that everybody resigned at Barclays, but the reason they resigned was that they came here and had an absolute mauling in front of the Treasury Select Committee. It is not up to Parliament-I suppose ultimately it is-to do the work of directly holding to account those people who got things wrong.

Lord Turner: There is a distinction regarding enforcement interviews, which legally and correctly have to be driven by whether someone has created an enforceable offence. When you are running a legal process you do not have the right to say, "I am pretty confident that there is nothing which is an enforceable offence three levels up, but I am going to do some interviews as-in the legal term-a roughing up process, to make them worried about this". That is not what the police are allowed to do and that is not what prosecuting authorities are allowed to do. Prosecuting authorities have to focus on the legal process. If you then switch over, enforcement has to operate within those precise legal rules. Should supervision in those environments say, "Something has gone wrong. We have to talk to people about what went wrong, and make sure that in future they are focused on it"? Yes.

In the case of RBS, one of the reasons why we fined RBS more than Barclays concerned the process we demanded of management, that they attest to us that they had fixed the problems. That was not dealing with the layer of management which actually caused the problems. We were concerned a year later that the fixing of the problems had not fully taken place. The answer is partly that we do follow up at the more senior level, and that is definitely true in relation to UBS. I can tell you that there were direct conversations with the most senior level-including between me and the chairman of UBS, Axel Weber-about the need to take seriously the fix that is required to make right the problems of the past. That does go on, so that is part of the answer.

Chair: One last brief question, and a brief answer please.

Q4480 Mark Garnier: This is very important, because what you are talking about is the accountability of an office or a role within an organisation, and not the accountability of the individual concerned. So you are absolutely right. The person holding the senior office, Axel Weber, was interviewed and held to account, but only because he held that post. The individuals had no individual accountability, and that is where this seems to be failing.

Chair: Do you agree?

Lord Turner: Not entirely. Like a lot of these things, there are issues, and we have been thinking about whether we should be clearer in future about defining responsibilities and accountabilities, which would give us a greater audit trail to go further up.

Chair: We cannot go into it now, but I think we would like that it in writing.

Q4481 Lord Lawson of Blaby: In the old days-in the pre-FSA days, which I remember very well and I am sure you do too-when it seemed that there was something amiss in a bank, the Governor of the Bank of England would not have hesitated to call the chairman in and tell him about his concerns, and say, "You look into this and do something about it." This is not a legal matter; it is common sense.

Lord Turner: We do do that, and we have done that more and more. I think that shift has occurred.

Chair: You are going to put something on paper for us on this subject, and we will take a look at that.

Q4482 Mr Love: Turning to other issues, what impact did financial incentives have on the behaviour of banks, and what more can the FSA do to align remuneration to the long-term interests of the banks and society?

Lord Turner: There are at least two issues on that, and I will ask Martin to comment on one of them. There is one about prudential risk and making sure that people are not rewarded with large cash rewards for things that create future prudential risk. That is the whole issue of the change in the remuneration of senior management and traders, and making sure that a significant element is deferred and is subject to clawback. I think we have made considerable progress on that, and the UK authorities have been the most forceful across the world. Bluntly, we have had a problem in that some other jurisdictions, particularly outside Europe, have not addressed that issue nearly as forcefully as we have in the application of what started as the FSB code in autumn 2009 and subsequently became European regulation.

Equally important are incentives in the retail sales area. We became increasingly aware about three or four years ago that that was a major area of concern. Martin, do you want to comment on that? I think retail incentives are hugely important.

Martin Wheatley: We published a paper last summer which was the result of some work we had done looking at retail sales incentives, and we found some quite shocking behaviour. Some cases have been passed to enforcement, we have pushed out some guidance and we have told banks that we will revisit this and review how they design structures and how they manage the conflict in those structures.

Q4483 Mr Love: At the European level, they are talking about imposing a cap on bonuses. How does the regulator respond to that?

Lord Turner: The danger of the cap on bonuses, as Andrew Bailey commented yesterday, is that if salaries simply increase as a result, we will have less that we can force to be deferred and therefore force to be clawed back. It is quite right that we have made bonuses deferred, paid in either equity or bail-inable debt, and subject to clawback. If you go too far in the direction of saying that there should not be bonuses at all, we lose an element of flexibility. First of all, we lose prudential flexibility; if the performance does not turn out to be good, the bonus does not get paid and therefore it is not coming out of capital. Although I am sympathetic to the objectives of many people who are in favour of that, my own feeling is that if we were to make the existing codes stronger, we would do better to lengthen deferral periods and demand that more of the bonus be paid in bail-inable debt or other instruments that disappear in failure, rather than insisting on a cap on bonus. I think those would be more intelligent strengthenings of the current regime.

Q4484 Mr Love: We are looking at some of those. May I turn to the entirely different subject of financial inclusion? In the Financial Services Act, you have been given a "may have regard to" power concerning the ease with which consumers who may wish to use those services, including consumers in areas affected by social or economic deprivation, can access them. That is a bit of a mouthful. Have you had a chance to look at that, and how it will affect the way you will work as an organisation?

Martin Wheatley: Yes, we have looked at it. Clearly, it is something we must take into account in any action we take so it becomes, in a sense, part of the process we would go through when looking at a policy change or intervention. We will have to add to the set of things that we do in a cost-benefit analysis and we will add a financial inclusion test. It is not a knock-out test. It is about weighing up the financial inclusion impact against the impact of other things that we would be doing.

Q4485 Mr Love: Perhaps you could give us note about your feelings so far. I want to ask you finally about basic bank accounts, which the Commission has looked at. We have noticed a race to the bottom, as services are taken away from people with basic bank accounts. Is that somewhere where you can intervene to prevent such a race to the bottom?

Martin Wheatley: It is a difficult one, because some banks are adding services, and some are charging for those services and providing other benefits. In a competitive industry, if we put a floor under the minimum level of service a bank can provide we are distorting the competition in this space. Frankly, it is one thing if it becomes a barrier to new entrants coming into the system, but if people start to charge for ATM access, for example, because it is not part of the core package, we would be concerned if it meant that a new bank coming in did not have access to the ATM infrastructure, which is clearly an important component of being able to service a new bank.

Q4486 Lord McFall of Alcuith: You said you were looking at business models, and that, particularly in relation to PPI, you found atrocious levels of control and conduct. We had Eric Daniels here. He is the former chief executive of Lloyds, which has put aside £6 billion for PPI mis-selling. That is the latest figure. He said that Lloyds was "on the side of the angels" on PPI. You may gasp, but what does that say for corporate governance and individual accountability? We have found that, whether we are talking about rogue traders, PPI mis-selling or even incentive schemes at counter level, senior management knew nothing about it. Is there not a need for radical accountability on individuals from the top down?

Martin Wheatley: I found the statement extraordinary. Like you, I was aghast that anyone could make such a statement. He seemed to think that running his bank was akin to operating a supermarket, which does not take into account the seriousness and important social impact that banks have in society. They are not supermarkets selling broccoli that goes off after five days. They sell something that takes 25 years to know whether it will pay off your house. It is extraordinary, and I do not accept the statements that senior management were not aware of the situation. They were aware of it, because it was generating most of the profit. I would be amazed if they were not aware of where their profits were coming from.

Lord Turner: May I make one point that I meant to mention to Mr Love? One source of information that we should perhaps tap into is the attitude of front-line staff. There is a major difference between retail sales staff and the trader environment. In the trader environment there was a cultural problem. One of the first times I really thought about front-line sales force incentives-I spent autumn 2008 and early 2009 100% focused on the prudential issues, because the financial system was collapsing-was in the middle of 2009. I used to have an annual meeting with the Alliance for Finance, which is a trade union group representing all the trade unions that have trade union or staff representatives in different banks. It said that one of the biggest things for its members was that they felt that they were under pressure to do things they did not like doing. I remember coming out and saying, "Are we looking enough at front-line sales force incentives?"

Martin has already said it: there are major questions for the top management and the boards of the retail banks before the crisis. They must have been looking-we should have been looking more, but we weren’t-at management accounts showing that a very large percentage of their total profit was coming from PPI, and that PPI was an enormously high-gross-margin product. I fear that almost nobody around those boards said, "Hang on, shouldn’t that be a signal for us to do a drains-up and make sure that this is really of interest to the customer?" I fear that the reaction was probably, "Well done-give a bonus to the person who is driving that."

Q4487 Lord McFall of Alcuith: The public would find it remarkable if we, as a Committee, did not say anything on remuneration. There still seems to be a disparity between what ordinary well-educated individuals get in their salaries and what people in the banking sector get in their salaries. In terms of transparency, is there not a case for all banks-if they want to regain trust and confidence-to publish the salary levels in the banks? There are a number of people who are on over £1 million. Given the concern about inequality, is there not a case for looking at the totality in banks-the lowest pay rates, and the average of the top execs, against the median income? We need banks to come into the real world and start paying the living wage if we are to address seriously the issue of inequality.

Lord Turner: Well, there are a number of issues. Banking-and finance in general-has stood out to an extraordinary extent over the past 25 years. It has diverged from the rest of society in terms of the rates paid not just to top managers but to many others. As part of the old debate about why inequality has increased-an important thing for us to reflect on-my belief is that it partly reflected the fact that, because of woefully inadequate capital rules and other things, we were allowing the banks to proliferate their trading activities, for instance, which appeared to make high profits, but which we knew left a toxic liability behind.

If your organisation makes high profits, some of that will end up sticking to the employees, rather than the shareholders. It is a major, important issue. On the whole, I am in favour of transparency. I think that Barclays has made a commitment to greater transparency, but I would be very wary of assuming in general, across the whole inequality debate, that transparency in itself changes behaviour.

If you go back to the mid-1990s and the debates that broke out extensively about top-level remuneration at that stage, particularly in relation to utilities-we had the Greenbury report and so on-it is a reasonable interpretation, in retrospect, that transparency of executive directors’ pay probably drove a further increase in top executive remuneration. It made it easier for remuneration consultants to say, "Look, your chief executive is not being paid in the top quartile. Surely you want a top-quartile chief executive."

Q4488 Lord McFall of Alcuith: You mentioned trading activities. One of our Sub-Committees has been looking at structured capital management with Barclays. You had a heap of criticism on your head in August 2009 when you mentioned a lot of "socially useless activity" in the City. Roger Jenkins, who was in charge of structured capital management, was getting £40 million a year in cash. Bob Diamond, over a 10-year period, got over £100 million. Tell me, as a regulator, what socially useful activities were they performing in that entity to get that reward of £40 million?

Lord Turner: I have major doubts about whether much of it was socially useful. It is almost by definition the case that tax structuring is almost a zero sum activity for society. It is not creating new value. It is not creating new products that consumers want. It is not improving efficiency of operation. It is shifting money from the generality of taxpayers to the individual. It is very welcome that Barclays has decided to close down, or very much reduce, that level of activity. I thought that it was socially useless.

Q4489 Lord McFall of Alcluith: In terms of the staff of the FSA, we have seen quite a lot of staff over the past few years leave for the industry; for example, your last chief executive. In his case, he left for a salary-if we can believe the FT-of about 10 times what he was getting in the FSA, with a package of over £3 million. I am not encouraging you to go elsewhere. Does that situation indicate any regulatory capture by the industry? Does it give any concerns regarding the ethos of public service, when the industry can capture people, take them out of the door and give them enhanced salaries after being in the regulator for a few years?

Lord Turner: With Hector and other senior managers, we have a six-month gardening leave period. Many of our best people will come from the financial services industry. Their skills sets are in the financial services industry. It is very difficult in almost human rights terms: you cannot limit somebody’s ability-

Q4490 Lord McFall of Alcluith: I am focusing on the public service ethos.

Lord Turner: What I would say on the public service ethos-this relates to the debates that we have had about the FSA, the Bank of England and appropriate remuneration-is that it is very important, when you are paying people who you want to do a public service job, to note this: although you cannot pay them a really small fraction of what they will get in the industry they will regulate, you do not need to pay them what they would get in the industry they will regulate. There is a balance to be struck there. That balance is partly determined by whether you have also managed to create an institutional ethos that people feel proud of, and where they are willing to be motivated by the job that they are doing.

I would say this about the salaries we now have in the FSA: you can employ, for a period of time, somebody who could walk out of the door for three or four times the salary they were getting, and the institutional ethos and the fascination with the job will keep them there for a significant period of time; if you end up trying to get them there for a 10th of what is outside, it just gets more difficult, so there is a balance. I think the salary levels at the FSA now roughly have that balance right. We do not pay fully competitively with the external industry; most of our best people could walk out for more. On the other hand, we now do not have a major problem of turnover. Our turnover rates are roughly where we want them to be, in terms of refreshing-

Chair: I am going to move on now, because we have to get into sanctions.

Lord McFall of Alcluith: May I have a very quick question?

Chair: Well, it had better be very brief, and a very brief reply.

Q4491 Lord McFall of Alcluith: On the Co-op and Verde, the FT this morning is saying that the Co-op deal could be in doubt-there is a £1 billion black hole there. António Horta-Osório said that Lloyds have already spent £1 billion on the Verde package, and that they will get back only-hopefully-£400 million to £500 million. What does that say about competition and the ability of new entrants to come into the banking sector?

Lord Turner: I think that you would accept that I cannot comment on something that gets close to the specific position of a specific deal in the institutions, I am afraid.

Chair: We are moving on, because we have a very important area to cover, which is sanctions.

Q4492 Mr McFadden: Lord Turner, you talked about the culture of the trading room floor and the culture of front-line staff. We actually made sure that we got the banking unions on to the PPI sub-panel precisely to tell us this story about charts on the wall, sales targets, and remedial help for people if they did not meet them and all of that, so we have had that story here. I may be in a slightly different position from our Chairman on the diversity point. Do you not think that one of the important cultural changes on the trading room floor would be to have far more women?

Lord Turner: I do not know. It is certainly possible that that is the case. Trading room floors are described as macho environments, and to a degree that is the case. If you read Michael Lewis’s book, "Liar’s Poker", going back to the mid-1980s, you get a whole series of macho, classic, testosterone-driven behaviours, including going off to lap dancing for post-work entertainment and so on. Perhaps you are right. I think it is a very difficult thing for the regulator to get into, but presumably, people’s behaviours are driven by certain gender biases, and they are probably also somewhat driven by whether they are in a predominantly male environment or not. The answer is that I do not have a firm point of view on that. It is not something I have looked at, but it is at least a possible hypothesis.

Q4493 Mr McFadden: The culture has been described to us as the culture of the gang. If, as a country, we can take a view on having a lot more women on FTSE 100 boards as a desirable goal, why can we not take a view that it is a desirable goal for important financial services, whatever the mechanism to achieve it is?

Lord Turner: We are not the regulator of diversity. We are interested in the issues.

Q4494 Mr McFadden: I am only asking your opinion.

Lord Turner: You are asking my opinion, but honestly, I do not have really firm opinions on it. I think it is an interesting issue that I have not done enough research on, or had a point of view on. It is quite difficult to work out what you would do about it. Are you suggesting that on every trading room we deliberately try to make sure there is a gender balance? The difficulty is also that there are significant numbers of women on trading rooms, but they may be a self-selecting group of people who are more relaxed and happier with that predominantly male, macho environment. Let’s remember that, with gender stereotypes, we must not assume; there are tendencies in behavioural characteristics between men and women, but they are not absolute, and there are spectrums of behaviour within both genders. You cannot assume that if you had a whole load of women traders, you would not have ended up selecting the women traders who are most likely to have the same behavioural traits as the male traders.

Q4495 Mr McFadden: Some of this reminds me of the discussion that was taking place in politics 20 years ago. Let me ask you about sanctions. It is an obvious feature that hardly any enforcement action has been taken against individuals over either the banking collapses or the mis-selling scandals such as PPI. Without going over all the whys and wherefores of that, do you accept that the lack of individual enforcement sanctions has been a failure of the regulatory regime up until now?

Lord Turner: No, I do not. Again, it is one of these things that I have reflected very deeply on. Let me talk about the prudential issue-the side on why there was a banking collapse. I am personally wary of believing that we will ever be in a position to say, "Okay, this bank failed. We are going to charge the CEO or the members of the board, and run that through the court processes and be successful." The burden of proof that is required by due legal process will almost make that personal accountability difficult to stick, because at the most senior levels, people are responsible for many, many things, many of which went right, though some went wrong. It is going to be difficult to say to a court of law, "Okay, well that went wrong, so you are responsible for that."

I am much more attracted-I set this out in my foreword to the RBS report-to sanctions that have a degree of automaticity, and which affect a large number of people, rather than trying to pin it on one person. What I mean by that is that I am attracted by the idea that we should say that banks are different, that the failure of banks is more important than the failure of a supermarket, and that if you go on a bank board, you have to accept that if that bank fails, you will be automatically out of the financial industry in future, unless you can prove-shifting the burden of proof-that you were one of the people trying to alert the regulator and alert the board to the problems.

This is the idea that was in my own report-my foreword to the RBS report-and it was in the Treasury consultation paper last July, on the directors of failed banks. I think we are more likely to make progress by those automatic things, or by changing the remuneration. It is not clear to me why we could not, with non-executive directors of banks, say, "All of your fees are also paid in deferred bail-inable debt", so that at least when a major bank goes down everyone would say, "Well, the non-exec directors were not taken through a court of law but they all ended up losing £400,000 which was in the bank." I think that is a better way to go, because I honestly feel, having looked very carefully at how these processes of legal proof work, that it will always be difficult in courts of law to have people proved directly responsible for prudential problems going wrong.

Q4496 Mr McFadden: What about the conduct side, the product sales? We have all these billions being paid out in compensation to people over PPI but again, nobody really-in terms of senior figures in the banks-having enforcement action taken against them. I talk to this guy in Land of Leather a lot.

Martin Wheatley: It is again this evidential problem; you have to be able to show the clear evidential trail from a senior figure, a particular abusive decision, to what actually happened. There may be some-I am not saying that will not be any-but in many large organisations it is very hard to provide that evidential trail. As you said, the unions came in. The staff actually selling the product felt that they were bullied to sell it, and their bank managers were being bullied to sell it. Somewhere down the chain this had got translated. I am sure that at the top of the chain you would have had a bank saying, "Actually sell this product but do it ethically," and somehow that got lost. But you have got to show an evidential trail.

Q4497 Mr McFadden: It does sound like a counsel of powerlessness, if such a widespread mis-selling practice can go on, resulting in such widespread compensation to customers, but you as the regulator cannot find anyone responsible. What you seem to be saying, in fact-both of you, in different ways and on different sides of this-is that this looks like something that will not really change much in the new regime. Lord Turner may be making a difference on this bail-inable debt and so on, but on the conduct side is it going to be the future of the FCA regime that we should be able to expect more individual enforcement, more individual fines and potentially people going to jail?

Martin Wheatley: People do go to jail today. In terms of insider trading, we have a track record where we have brought a number of successful cases and people are going to jail for insider trading-market manipulation. We have made it a policy that we want more individual accountability, so we are pursuing more cases. We have made some quite specific technical recommendations to you about changes that could be made to the approved persons regime that would give us greater powers. One is in terms of the limitation period-the time we have got to put a case forward; in many of these very complex cases, the current constraint of three years is too tight. We have suggested that we would like to have the ability to put in place interim bans on people, when we feel that the behaviour was particularly egregious. So there are some changes; I am not saying that there are no changes, and you will see a change of philosophy and approach, but what I am saying, and being very realistic, is that it is difficult. We have to put a lot of resource into it and it is difficult.

Q4498 Mr McFadden: I am conscious of the clock, so I will finish with this. We had the American regulators in last month, and they said that their institution-affiliated party regime went from the top of the bank right through all the hierarchies. Should the approved persons regime be expanded so that it goes further down the chain?

Martin Wheatley: Yes, it should, I definitely think it should. One of our problems-LIBOR was a good example-was that for the set of people we wanted to take action against we did not have an approved persons regime, which meant that it became more complicated for us to take action. That is a specific proposal that we would like to see.

Q4499 Lord Lawson of Blaby: May I just follow up briefly on one point about the approved persons regime? You made it clear that you do agree with the proposition that there has not been sufficient focus on the individuals as against the bank in this whole disciplinary process, and that you would like to see a more vigorous use of the approved persons regime, possibly, Lord Turner said, reversing the burden of proof. I was slightly surprised, however, that Lord Turner talked about this exclusively in members of the board. Surely it is equally important if not possibly more important to have this apply to the senior, full-time managers?

Lord Turner: I agree with that. I did not intend it that was limited to the board. It includes, but is not limited to.

Q4500 Mr Love: Some years ago on the Treasury Committee you used to say that criminal action for insider trading can’t be done. You found a way to do it. You gave it the political priority, if I can put it that way, the administrative priority. Don’t you think we need to give a similar priority to finding a way to bring criminal charges against senior bank officials where it has been clear that this sort of activity has been going on? Don’t we need to give it more priority?

Martin Wheatley: You said clear criminal activity. Where there is clear malfeasance, yes. Yes, we have made insider trading a priority so we had 10 convictions in the previous year. There are prison sentences. They are still light compared with other jurisdictions.

Q4501 Mr Love: There is a consultation document out, and the FSA seems to be taking a relatively negative attitude towards bringing criminal charges. I understand there are real difficulties here, but there were real difficulties with insider trading. What we would like to see is more positive action to address the issues that we are trying to reach.

Lord Turner: It would be very difficult on the prudential side. Criminal sanctions across our legal system tend to be focused where people were deliberately doing things and they intended to produce the result which resulted. There are some things that are slightly different. There are elements of reckless driving etc. that go on the margins. But most criminal law resides around a concept of intent. It is tricky to extend it to where there wasn’t intent. On the prudential side in particular, the crucial thing is to shift people’s attitude to risk and return and to make them care more about the fact that something could go wrong. We are more likely to do that by the sort of automatic mechanisms. On conduct, it is closer to a possibility but I still think it is very difficult.

Chair: I am sorry to press you. It may be that we will come back to you in writing. I think Andy’s point is extremely important.

Q4502 Lord Turnbull: The extension of the approved persons regime is probably one of the things you will want to do. That implies that you are authorising people in advance. Can you construct a second tier where people employed in certain posts are automatically expected to have certain obligations and the employer has certain obligations, but it does not actually require sending an application to you in advance?

Martin Wheatley: Yes, I think we can. I think an application in advance to us for the number of people involved would be logistically difficult. So I think there is a way that people are deemed to be authorised by virtue of their employment.

Q4503 Chair: We may come back to you on that. I have a question for Lord Turner. You referred to this obliquely when you were talking about box-ticking and how it would be handy to have a box to tick on adequacy of capital. You also referred to it when you were talking about your concern with risk-weighting models. Do you think it is prudent to keep the leverage ratio unchanged while increasing the risk-weighted ratios?

Lord Turner: Broadly speaking if one were the benevolent dictator of a greenfield economy-

Chair: You’ve been one of those for some years. Not greenfield, but certainly a benevolent dictator.

Lord Turner: I would go for significantly higher leverage and capital ratios. I think if we had them we would not have to do so much supervision and getting involved in the details. We have achieved as much as we can globally in terms of agreement and as much as is sensible in terms of the present macro-economic situation. If you drive up capital ratios too quickly you can slow the economy. Therefore I am a strong supporter, and I am very proud of the role that I played in getting the Basel III agreements and driving it through. But the fact is that if I was completely in charge and one did not have to deal with transitional problems, I think we are still running the banking system on too high levels of leverage. I think we are the inheritors of a sort of 50-year giant mistake. Ideally, we would have much higher ratios.

On the leverage ratio itself, it is important to know that the leverage ratio binds on two categories of banks. It binds on trading banks, because they tend to have low risk rates relative to gross value asset, and it binds on mortgage banks with prime mortgages-the lowest risk mortgages.

Q4504 Chair: You will have seen that we said in our report that we need some kind of transitional arrangements for building societies.

Lord Turner: I would ideally like us to go to a higher leverage ratio, but I think we have to think about the transition. We should be completely honest and clear. That is one of the reasons why the Government have been worried about going to a higher level, because they are worried about the supply of mortgage finance right now, in the present economic conjuncture and macro-economic situation, and the need to get the macro-economy going. I think that is a legitimate argument, but it may be an argument for a transition approach. Ideally, we would have a higher leverage ratio.

Chair: Lord Turner, this is your last appearance-forgive me, Martin Wheatley, if I address this to Lord Turner-before this Commission and before the Treasury Select Committee. On behalf of both Committees, we would very much like to thank you for the lucid and forthright evidence and advice you have provided us with; it has been of extremely high quality. I have a suspicion that this will not be your last appearance before a Commons Select Committee, and that we will be finding out more of your exploits before long. We are very grateful for everything that you have done in your four and a half years in that job. We will also, I think, need to call on your expertise further, possibly in correspondence, between now and the completion of our work. Thank you very much, Lord Turner, and thank you, Martin Wheatley.

Prepared 1st March 2013