Banking Standards

Submission from the Association of British Insurers (S032)

The UK Insurance Industry

The UK insurance industry is the third largest in the world and the largest in Europe. It is a vital part of the UK economy, managing investments amounting to 26% of the UK’s total net worth and contributing £10.4 billion in taxes to the Government. Employing over 290,000 people in the UK alone, the insurance industry is also one of this country’s major exporters, with 28% of its net premium income coming from overseas business.

Insurance helps individuals and businesses protect themselves against the everyday risks they face, enabling people to own homes, travel overseas, provide for a financially secure future and run businesses. Insurance underpins a healthy and prosperous society, enabling businesses and individuals to thrive, safe in the knowledge that problems can be handled and risks carefully managed. Every day, our members pay out £147 million in benefits to pensioners and long-term savers as well as £60 million in general insurance claims.


The ABI is the voice of insurance, representing the general insurance, protection, investment and long-term savings industry. It was formed in 1985 to represent the whole of the industry and today has over 300 members, accounting for some 90% of premiums in the UK.

The ABI’s role is to:

- Be the voice of the UK insurance industry, leading debate and speaking up for insurers.

- Represent the UK insurance industry to government, regulators and policy makers in the UK, EU and internationally, driving effective public policy and regulation.

- Advocate high standards of customer service within the industry and provide useful information to the public about insurance.

- Promote the benefits of insurance to the government, regulators, policy makers and the public.

Executive Summary

Insurers have an important stake in the future of banking - as investors in banks, as users of the services provided by banks, and as investors and participants in the wider economy. The recommendations of th is Commission are important to us.

A productive banking sector is necessary to the market economy, and the prospects of sustainable economic recovery in the UK are to some extent dependent on banks being able to raise the funds necessary to f inance the growth of small and medium-sized companies. From the perspective of institutional investors, it is essential that banks should be an investable proposition.

We are concerned that banking regulators are currently focused on financial stability at the expense of economic growth . This has a negative impact on banks’ investability. A n extensive programme of regulation has already been undertaken to address the problems in banking exposed by the financial crisis. This should be given time to work.

We are particularly concerned by banking regulators’ reliance on raising the level of regulatory capital requirements. Some of the proposed levels of regulatory capital will make it difficult for banks to perform their social and economic function. They will also make it d ifficult for banks to earn a return on their capital , and therefore to raise funds in the market .

We believe that c ultural change is the key to further change in banks, and this can only be driven internally from within the institutions. The Commission will therefore be most effective if it focuses on changes of culture in banking that are already underway, and on encouraging those who are trying to lead this.

As insurers, we are concerned by regulators’ tendency to read banking solutions across to insurance. In view of the differences between insurance and banking, this will lead to regulation that is inappropriate to insurance, and will create obstacles to insurers performing their economic and social function.


Questions for Consultation

1 To what extent are professional standards in UK banking absent or defective? How does this compare to (a) other leading markets (b) other professions and (c) the historic experience of the UK and its place in global markets?


1.1 The Commission asks about comparison with other professions. Insurance is subject to many of the same fundamental changes and pressures examined in question 4a, as is demonstrated by mis-selling in the life industry, the collapse of Equitable Life, and the LMX spiral at Lloyds. It is nonetheless the case that insurers came through the crisis with much less damage than the banks. We have given some thought to why this might be, and have a number of possible answers:


(i) The structure of an insurer’s balance sheet is inherently more stable than a bank. Insurers are obliged to hold reserves against future claims, sometimes stretching decades into the future. Insurers are financed by premiums which cannot normally be repaid, and savings policies are subject to penalties for early surrender. Both factors provide defenses against a sudden exodus of capital, making an event such as a "bank run " unlikely ;

(ii) British insurers benefited from the FSA’s well-conceived Individual Capital Asse ssment (ICA) regulatory regime, which drew the right lessons from the collapse of Equitable Life. Capital requirements are based on an insurer’s assets and liabilities, are consistent with management practice and controls, take into account all material risks, and use a consistent valuation basis ;

(iii) Professional standards are taken seriously in insurance, as in banking. T his allows initiatives such as the Aldermanbury Declaration [1] to emerge. In particular, insurers draw strength from the strong professional backbone provided by the actuarial profession. The role of the actuarial profession goes beyond professional qualifications . It is regulated by the Financial Reporting Council, and disciplinary action is taken against bad practice. Their work is subject to external peer review. The actuary’ s role is recognised in the pr udential framework for insurers;

(iv) Insurance naturally has a longer time horizon than banking. Any life insurer dealing with pensions is obliged to think decades into the future. Long tail risk in general insurance has a similarly long timeframe. In all forms of insurance, the most important experience – the claim – will take place sometime after the sale , and it is claims experience that will in most cases determine the profitability of the firm. Therefore it takes time for insurers’ actions to be translated into profit. In contrast, a ctions taken by a n investment banker can deliver instant improvements to the balance sheet or profit and loss account .

1.2 Some of these factors are intrinsic to insurance, underlining the need for a regulatory regime tailored to the specifics of insurance. Others, we believe, offer helpful insights for the bankers leading the reform process within their institutions. In summary, our view would be that, while professional standards are important in banking and indeed in all financial services, there are other aspects of the banking model which have contributed to the experience of the last ten years.


2 What have been the consequences of the above for (a) consumers, both retail and wholesale, and (b) the economy as a whole?


2.1 The issues associated with the financial crisis, the reputational impact of the recent regulatory scandals and the impact on consumers of mis-selling have been reported at length over recent months, and we have nothing to add on the consequences for consumers. We have additional remarks about the impact on institutional investors and on the economy as a whole.

2.2 Investment banks have taken advantage of a privileged position as intermediaries in the wholesale financial markets, and this has been to the detriment of the markets overall. The ABI contributed to the Rights Issue Fees Inquiry under Douglas Ferrans, which explored the excessive fees charged by investment banks for underwriting rights issues. We believe that their pursuit of transaction-based income has also contributed to the poor quality of the pipeline of new public offerings (IPOs) in the London equity market. In addition, the well-intended liberalisation of the EU MiFID Directive has left the investment banks in a powerful competitive position that they have exploited, at the expense of market end-users such as issuers and investors. While the costs of individual trades on EU equity markets has gone down, the markets have fragmented, and the overall cost of trading has gone up.

2.3 The consequences for the economy as a whole are complex to assess. It is easy to extrapolate a line of GDP growth from before the financial crisis, and attribute the fall in output to failings in financial services. Easy, but inaccurate. The fact is that GDP would never have reached pre-crisis levels if not for an exuberant financial sector. Many states, businesses and households also took advantage of easy credit. Banks can reasonably be seen in this context as victims, along with many others, of central banks' focus on inflation, and excessive confidence in financial markets as a reflection of confidence and economic activity. Macro-economic policymakers on both sides of the Atlantic ignored the fundamental imbalances in the global economy, rapid growth in leverage, and the development of asset bubbles, particularly in real estate


3 What have been the consequences of any problems identified in question 1 for public trust in, and expectations of, the banking sector


3.1 Financial services are not just a commercial exchange. Sophisticated financial services are essential to life in modern society, and at their best provide a socially useful role in making capital available to business and households, and enabling them to manage risk. Lack of public trust affects the innocent as well as the guilty, making it even more urgent to deal with it.

3.2 Financial services are the natural intermediaries between savings and investment opportunities, and natural sharers of risk with the State. However, this requires both State and public to have confidence in an increasing range of interactions with the financial service sector. Fi nancial services providers whose actions undermine public trust are standing in the way of essential public policy developments.

4. What caused any problems in banking standards identified in question 1? The Commission requests that respondents consider (a) the following general themes:


· the culture of banking, including the incentivisation of risk-taking;


· the impact of globalisation on standards and culture;


· global regulatory arbitrage;


· the impact of financial innovation on standards and culture;


· the impact of technological developments on standards and culture;


· corporate structure, including the relationship between retail and investment banking;


· the level and effectiveness of competition in both retail and wholesale markets, domestically and internationally, and its effects;


· taxation, including the differences in treatment of debt and equity; and


· other themes not included above;


4.1 ABI members’ analysis of the changes in banking feed directly through to our remarks on corporate governance in answer to questions 4b.

4.2 The banking sector and its culture are not homogeneous. It is clear that banking has changed markedly over the past thirty years. The factors listed above have all been significant. It is less easy to draw safe connections between these change factors and any problems in banking standards. Changes in culture are probably a consequence rather than a cause, and should therefore come at the end of the list. The extent to which culture is still a negative factor varies from firm to firm.

4.3 Banking regulation has also changed over the period, with increasing reliance on detailed rule books. There is a plausible argument that management focus on regulators’ detailed rules has loosened the hold of personal integrity and ethical standards in some parts of some banks.

4.4 Received wisdom today flags up the risks of financial innovation, but the benefits should not be forgotten. From a retail perspective, banking is unrecognisable from the days when mortgages were rationed, banks were closed on Saturday and there were no ATM machines. Nobody wishes to go back to those days.


4.5 Technological developments have been an important contributory factor to the changes. They enhance the service for retail and wholesale customers, but bring their own challenges as managers have struggled to retain proper oversight and control over diverse and complex businesses. Technology itself compounds that complexity. The speed with which decisions now have to be made is also a serious management challenge.


4.6 We have seen convergence between retail and investment banking. Core banking business has moved away from the traditional management of the two sides of the banking book towards proprietary trading, increased use of wholesale funding, securitisation, and use of derivatives. There is no obvious reason why investment and retail banking should not be able to co-exist in the same institution. However, evidence from the periods when this has been tried – in particular the US, in very different time periods – suggests that there are significant risks. We therefore believe that it is safer for these businesses to be housed in distinct legal entities, backed by separate capital, and we have expressed broad support for the proposals on ring-fencing made by the Independent Commission on Banking led by Sir John Vickers – though we recommend that the execution of the ring-fence proposals could be much simpler. We also believe that universal banks have proved unhealthy for the supply of finance to the real economy. The structure concentrates access to both debt and equity finance in the hands of one industry, which has led to high costs in British and US markets and inflexible financing in continental European markets.


4.7 An interesting insight to the convergence in the financial services sector can be illustrated from the Rights Issue Fees Inquiry. Listed companies took the view that the structural changes caused by Big Bang to create integrated investment banks had not led to an immediate loss of the quality of independent advice and support provided by corporate brokers and other advisers, so long as there remained a strong cadre of individuals who remained in influential positions, but that such a change was evident when those individuals retired from those roles.


4.8 Another consequence of convergence between retail and investment banking is that the investment bank bonus culture has migrated across into mainstream banking business. Historically, British merchant banks’ ownership structure was partnership-based. They paid substantial bonuses for value created during good times, but real downside risks were run and partners’ capital was on the line. Many investment banks are now publicly owned, and this changes the impact of bonuses completely. Risks are now run with shareholders’ capital, and bonuses have become a free option on the upside for banks’ employees, with no corresponding share in the downside. This has been the environment in which institutional culture has been built up, and personal expectations have become established

4.9 Each banking institution is of course different. However, as a generalisation these fundamental changes in the nature of banking in the period leading up to the crisis, including the behavioral influences on those who came into positions of power in that industry, go some way towards explaining why remuneration in banking rose to unsustainable levels, why some shareholders question whether the sector is investable, and why corporate governance checks and balances came to be overwhelmed in some institutions.

4.10 This is the subject of our remarks on question 4(b). 

and (b) weaknesses in the following somewhat more specific areas:




the role of shareholders, and particularly institutional shareholders;


creditor discipline and incentives;


corporate governance, including


the role of non-executive directors


the compliance function


internal audit and controls


remuneration incentives at all levels;


recruitment and retention;


arrangements for whistle-blowing;


external audit and accounting standards;


the regulatory and supervisory approach, culture and accountability;


the corporate legal framework and general criminal law; and


other areas not included above.


4.11 In answering this section, we have focused on the corporate governance issues, which are an important focus of interest to ABI members as major institutional shareholders.


Corporate governance


4.12 The Treasury Select Committee’s (TSC) report Fixing LIBOR: some preliminary findings states:


"The Parliamentary Commission on Banking Standards’ examination of the corporate governance of systemically important financial institutions should consider how to mitigate the risk that the leadership role of a chief executive may permit a lack of effective challenge or to the firm committing strategic mistakes."


4.13 A clear distinction needs to be drawn between the use of corporate governance for regulatory purposes, and the use of corporate governance to run the company and to manage relations between shareholders and company management. The two purposes are often met through the same mechanisms. The two purposes will often have objectives in common. For example, the issue set out above by the TSC is undesirable from both angles. However, the two purposes need to be considered separately, as they may conflict. As institutional shareholders, ABI members’ primary purpose is to defend corporate governance as a means of running the company.


4.14 Good governance practices should not be seen in the financial services sector as a substitute for proper supervision and regulation, and neither directors nor shareholders should be expected to perform this role. Good corporate governance should supplement the regulation of financial services firms. Corporate Governance exists to help ensure that the company is run in the interests of its shareholders and that it is successful in the long-term. Regulation and supervision exist to ensure market confidence and stability, and to protect the interests of consumers and the wider public. Any reforms that are enacted should be proportionate and effective in delivering both these aims. There are risks that any remedies proposed might not contribute effectively to these aims, and indeed might lead to the unintended consequences of damage to the banks, their ability to create value and employment, and the prospects of economic recovery in the UK.


4.15 ABI members have participated in the debate about the extent to which weaknesses in corporate governance contributed to the weakness of professional standards in banking. At the level of some individual banks, this is undeniably true. But other banks have high standards of corporate governance, and problems in corporate governance are by no means confined to the banking sector. We have not concluded that the general regime of corporate governance in the UK requires radical change. Nor do we believe that banking requires a special corporate governance regime. We have encouraged incremental improvements in the regime, and where individual Boards have failed to meet shareholders’ expectations, we have engaged with them. In general, standards of corporate governance in the UK are some of the highest in the world, and this has served the British capital markets well. The goal should be to make the existing regime work effectively.


4.16 Good governance is about behaviours, not about adherence to rigid rules. In our experience it is not something that can be enshrined or enforced by legislation – indeed the results are often counter-productive. We therefore continue to believe that the most effective corporate governance regime is based on the comply-or-explain principle. ABI members are strong believers in the ‘comply or explain’ framework, and feel that it remains appropriate in the financial services sector. If a company believes that a principle of good governance is not appropriate in their individual circumstances, it can provide an explanation of why this is the case. It is then up to shareholders to take account of the individual firm’s circumstances, and judge the quality of the explanation. If shareholders have concerns with the reasons for deviating from the Code, or if the explanation is inappropriate or insufficient in detail, shareholders can then engage with the company. Shareholders are in the best place to make these judgements on what is appropriate for the company in its individual circumstances.

4.17 We see no evidence to suggest that any other approach to corporate governance would have been more effective in the crisis. The greatest challenge in designing effective oversight of listed companies in general, but in particular for banks and other complex businesses, is to ensure sufficient knowledge of the business and expertise among the independent non-executives, so that they are able to hold management to account. A unitary board structure will have advantages compared to other structures, since the independent non-executives will be closer to the active decision-making organs of the business. We see no evidence that other structures, such as supervisory boards, would have worked better in the financial crisis. European countries with a supervisory board structure also had to support financial institutions, such as Aegon and ING in the Netherlands and Fortis in Belgium.


Role of shareholders

4.1 8 There have been numerous analyses of the role of shareholders in the financial crisis, most notably the Walker Review. The ABI Investment Committee acknowledged that the financial crisis demonstrated that shareholders could have played a more active and responsible role as owners.

4.1 9 As part of the drive for reform, the Institutional Shareholder Committee produced a Stewardship Code, to enhance standards of engagement between companies and their shareholders; ownership of this Code was then passed to the Financial Reporting Council. Evidence has shown that shareholder engagement is improving following its implementation . The I nvestment M anagement A ssociation ’s recently published survey of adherence to the Stewardship Code found that there has been a rise in dedicated stewardship resources , prioritis ation of engagement on key issues, more integration of stewardship into the wider investment process and an increase in voting levels. [1]

4.20 However, there is a limit to how involved shareholders can become . Shareholders do not have access to the same confidential information that is available to company management, and do not wish to become insiders , as this would constrain their ability to operate in the market . In addition, the resource implications of intensive engagement are significant, and would add disproportionately to the cost of asset management if this became the norm. A s set managers already carry significant fiduciary responsibilities to their clients, without also stepping into territory better occupied by Boards, Executive and regulators.

4. 2 1 Our assessment is that shareholders in banks, both individually and collectively, already devote more time and resources to their responsibilities in such companies than they might otherwise be expected to do by reference to criteria such as current value of the shareholdings. To expect too much may deter investment.

4. 22 Although the implementation of the Stewardship Code has resulted in progress , our experience has been that , even since the financial crisis , some bank Boards have still not always been willing to listen to shareholders’ views . We should be clear that this is not a universal experience, and other bank Boards have devoted considerable thought to sustainable remuneration structures . This has required shareholders to find alternative methods of carrying out their stewardship responsibilities. One example is the letter which the ABI wrote to the five UK listed banks in December 2011 on the structure of bank remuneration . This unprecedented step of writing publicly to the banks was a result of the contin ued frustration of our members at the low level of engagement by some banks on remuneration matters. The resultant engagement was constructive, but showed how the different banks take differing approaches to engaging with sharehol ders. Some Boards engaged seriously with the issues raised in the letter, and are making strides towards a sustainable remuneration structure. Others w ere still only paying lip service to shareholder views. C ontinued shareholder frustration was seen in the voting outcomes at the AGMs of the b anks in question.

4. 23 It is not the role of shareholders to micromanage any company , including banks. Ultimately, it is the responsibility of Boards to ensure that they have appropriate corporate governance systems in place , to listen to feedback from shareholders, customers, regulators and market commentators, and to identify issues with individuals and culture. Shareholders will continue to challenge Boards to ensure that they have the appropriate systems in place, but if the Board and non-executive directors do not identify issues with individuals and culture, it is hard for the outside shareholders to be aware of these issues. A shareholder’s ultimate r e sort is to sell the stock.

Non-Executive Directors (NEDs)

4.2 4 The role of the Non-Executive director is key to good governance. There have been several examples in banking where the wrong culture has been set by the Executive Directors , and this has not been challeng ed by the NEDs .

4.2 5 We recognise the significant challenges faced by NEDs in taking effective oversight of very complex organisations such as banks . S ince the financial crisis there has been s ignificant focus on ensuring that they have the appropriate skills and can make the necessary time commitments. The structure of the Board committees, the quality of the management information made available to the NEDs , t he transparency of the Executive Directors, and the effectiveness of the Chairman in ensuring full engagement of the Board team is key.

4.2 6 T he role of a b ank’ s nomination c ommittee is critical to ensure the right balance and diversity of skills and experiences around the board table. Boards and nomination committees should be sensitive to, and where appropriate be proactive in soliciting, the views of shareholders. The FSA’s approval process for Significant Influence Functions (SIF) plays an important role in the recruitment of non-executives. We believe that the interview and approval process should be simplified and expedited. We also believe there should be greater emphasis on personal integrity, and less on professional expertise. Ultimately there is a risk that many suitable candidates will not accept appointment at financial services firms.

4.2 7 The introduction (on a comply or explain basis) of the annual re-election of directors, although a relatively new provision of the Code, is an important development. We have seen this year that shareholders are willing to vote against Non-Executive Directors that they do not believe are representing the best interests of shareholders.

Board effectiveness

4.2 8 Both the Walker R eview and the UK Corporate Governance Code focus on Board effectiveness and evaluation. Institutional shareholders pay particular attention to the quality of disclosures that are provided in this area. The ABI published a report in September 2011 entitled Board Effectiveness – Highlighting best practice: encouraging progress . Our report highlighted the variety of ways in which leading companies currently implement diversity, succession planning strategies and board evaluations. We believe that highlighting best practice will encourage progress , improve B oard effectiveness , and provide an important input into a firm’ s corporate governance. This will contribute to the development and execution of strategy , and ultimately contribute to the continued long term success of the company.

4.29 There are significant variations in standards of Board effectiveness and evaluation. The Financial Skills Partnership (FSP) has received funding from the UK Commission for Employment and Skills for a programme called Leadership 21C. This programme aims to enhance Board effectiveness in the financial services sector through the development and adoption of standards and guidance for board competence, culture and diversity - including good practice guides and tools to support in their application. This will take forward recent corporate governance activity and review findings to determine standards of competence and behaviours specific to the sector, including regulatory competence requirements. It will include a cultural framework with guidance and examples of best practice which will help employers adopt and achieve these standards and competence requirements.


4. 30 One particular area of Board effectiveness is the role of the Chairman. This role is critical in ensuring that the Board is working effectively, and is setting the right direction and cu lture for the organisation. It is particularly important that the Chairman is able to challenge and manage the Executive Directors, including the CEO. Clearly in some financial institutions this has not been the case.

4.31 We consider that the central role and legal duty of the Board is to help ensure the long-term success of the company. It achieves this by determining the strategy of the company and overseeing its implementation. This oversight should include ensuring that risks are properly managed. However, the Board should not become involved in operational or day-to-day activity. Nor should it become a regulatory tool or be seen as a substitute for proper supervision. If Boards become overburdened with information and responsibilities there is a significant danger that they will not be able to perform the central role of strategic direction, and this will harm the business, its employees and shareholders.


4. 3 2 As mentioned above, i n December 2011, the ABI wrote to the five UK listed banks to highlight our members concern with remuneration across the banking sector. Our members were particularly concerned about the level of returns that shareholders receive compared to the returns given to employees. Members believe that in recent years this balance has been inequitable, with too much value being delivered to employees in contrast to the dividends paid to shareholders.

4. 33 We conducted analysis to show how total employee costs and dividend payments have changed over the last 10 years, at the five UK listed banks ; all this data was collected from the Annual Reports of the Banks. At Barclays, for example , total staff costs have risen from £3.755 billion in 2002 to £11.407 billion in 2011. Over the same time period , total dividends fell from £1.206 billion in 2002 (dividend per share of 18.35p) to total dividends of £653 million in 2011 (dividend per share of 5.5p). Likewise at HSBC, total staff costs have increased from US$ 8.609 billion in 2002 to US$ 21.166 billion in 2011. Over this time period, dividend payments have increased from US$ 5.001 billion (dividend per share of 53 cents) in 2002 to US$7.324 billion in 2011 (dividend per share of 39 cents). In neither case has the payout to shareholders kept pace with the payouts to employees. ABI members continue to engage with all UK banks to improve the investment case for the banks by improving the remuneration structure.

4.34 ABI members are supportive of the principle of pay for performance; members are supportive of individuals being rewarded for exceptional performance, but importantly only if it is in the context of an appropriate capital allocation balance. It is our members’ belief that the aggregate level of remuneration for individuals across the banks has been too high.


5. What can and should be done to address any weaknesses identified? To what extent are such weaknesses subject to remedial corporate, regulatory or legislative action, domestically or internationally?


5.1 The Commission should bear in mind that multiple regulatory initiatives are already in hand to address the banking industry, at national, EU and international level. These initiatives should be given the time they need to deliver results. We believe that the most productive approach would be for the Commission to act as catalyst for the raising of professional and ethical standards in British banks. It is well worth encouraging the initiatives under way in some institutions to deliver this.


5.2 Expectations of higher standards must be driven from the top – therefore the critical issue is the appointment of the Board and senior executives. We believe that it would be a mistake to develop a dedicated corporate governance regime for banks, as this would further their isolation from the real economy and the business mainstream. The incremental improvements in corporate governance since the crisis should continue. We recommend that the FSA’s Approved Persons Regime should focus more on personal impact and integrity, and less on technical expertise.


5.3 Banks need to attract capital to perform their social and economic function. From insurers’ perspective as investors, banks need to be investable. At present, bank debt and equity is not an attractive proposition from the perspective of insurers as a class of investors. In the financial markets, very few banks have felt strong enough to turn to the equity markets to raise their capital levels. Banks’ issuance of senior unsecured debt has also fallen greatly, balanced to some extent by issuance of covered bonds. Banks need to earn a return on capital that makes them attractive to investors - or alternatively the current mix of deleveraging and exceptional funding from central banks will have to continue indefinitely. We are concerned that the regulatory pendulum may have swung too far. In particular, high levels of regulatory capital will make it difficult for banks to earn a satisfactory return, and will add directly to the cost of extending loans to the real economy.


5.4 We now have several decades of experience of a culture of banking regulation, set by the Basel Committee, based primarily on the tool of capital requirements. We recommend that banking regulators should reduce their reliance on capital requirements, which has too high a cost to society at these levels, and devote greater attention to risk management.


6 Are the changes already proposed by (a) the Government, (b) regulators and (c) the industry sufficient?


6.1 As we have said, there are already a large number of regulatory initiatives. We can have no idea what the cumulative impact will be. If anything, the regulatory reaction may already have gone too far. Any further initiatives need to meet a high burden of proof.


6.2 Regulators’ priorities need to reflect economic reality. Measures now being taken are intended to prevent a repetition of failings that occurred in a period of easy money and loose credit. A narrow focus on financial stability is over-cautious, and inappropriate in a world of tight credit and rapid deleveraging. If financial services cannot perform their social function, there is a real risk of economic stagnation and social detriment.


6.3 We remain concerned how the changes to the regulatory framework in the UK will pan out. The Bank of England lies at the centre of the new structure, and it is crucial that the Bank succeeds in the task it has been given. We are concerned that the recent history of the Bank of England may be an inadequate preparation for the huge responsibility the Bank now takes for the regulation and supervision of financial services. Prior to the crisis, the Bank had narrowed its focus to monetary policy, and wound down its work on financial stability. The greatest risk in the new framework is that it may over-stretch the resources and culture of the Bank, on which the whole structure relies. Has the Bank had the time to develop the framework of judgement required for its new role at the apex of the new regulatory framework? Judgement-based regulation is a praiseworthy ambition, but how will this mesh with the very granular regulatory regime now in force? Above all, is the framework of accountability in the Financial Services Bill strong enough to provide political cover for the far-reaching decisions the Bank will have to make? From an insurance perspective, is there adequate insurance expertise at senior level in the PRA, and in the Financial Policy Committee.


6.4 Flaws also beset the framework of accountability for the Financial Conduct Authority (FCA), which is being set up with inadequate regard to access to financial services and to the social consequences of regulators’ actions, at a time when we need private individuals to take more responsibility for their financial futures (eg through reform of the pensions system).


6.5 There is still time to make amendments to the Financial Services Bill to provide more explicit political direction for all the new regulatory bodies, for example by obliging the Government to set out its policy objectives, and obliging the regulatory bodies to report annually on their progress against those objectives and to ensure adequate insurance expertise in PRA and FCA.


6.6 On the other hand, we welcome the stronger emphasis on competition, both in the new regulatory framework and in the Government’s response to the Vickers report. We support the Vickers recommendations for greater separation between retail and investment banking – though further work is required on the way this is done. For example, we are concerned that the ring fence, as currently designed, includes features that might deter insurers as institutional investors. In particular we have specific concerns relating to the nature of creditors’ claims in the event of resolution or insolvency, even if the actual probability of failure within the ring-fenced institution might be lower. If this option is pursued, ring-fenced banks will have the unattractive characteristics of generating low average returns but imposing high risks in the event of insolvency. This is in turn likely to accentuate volatility in cost of funding, a greater reliance on funding from speculative investors and, generally, reduced financial stability.


6.7 As insurers, we are above all keen to underline that insurance requires regulation tailored to the needs of insurance. The temptation to apply to insurance the lessons learnt from banking should be avoided. Insurers’ balance sheets are more stable than bankers’ balance sheets: premiums are paid in advance, and reserves held to pay the best estimate of future claims. Events such as bank runs or other systemic risks are much less likely. Many of the safeguards now applied to banks – counter-cyclical buffers, resolution plans, liquidity floors – would add to costs for policyholders for little benefit.


7 What other matters should the Government take into account?


7.1 The Government and British regulators should make more of an effort to work with the grain of EU level initiatives.


7.2 The City of London is international. This is not understood properly by British officials and regulators, who believe the City is British, and wish to contain it within a narrow national framework. The UK as an international financial centre needs to attract international capital, or it will flow elsewhere. Nor is the City properly understood by the EU institutions, who believe that it is ‘Anglo-Saxon,’ and try to develop regulation to control it. Neither approach is suited to the continuing health of the UK as an international financial centre, which is very much in the interest of British citizens.


7.3 As regulated bodies, ABI members know that they have to follow EU regulation. Our Government and regulators often behave as if this does not apply to them, launching regulatory initiatives with no reference to the need to reconcile these with thinking at EU level. This reduces British influence over EU initiatives when they emerge, and adds significantly to the compliance cost for British providers of financial services.

6 September 2012

[1] The Aldermanbury Declaration was published in 2010 by a Task Force of the Chartered Insurance Institute. Further details can be found at



Prepared 22nd September 2012