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13 Nov 2008 : Column 824

If it was thought to be so, I ask how—of course, in some sense, it still is. Bradford & Bingley’s £20 billion of retail deposits in the UK and the Isle of Man were held by 2.7 million retail depositors with an average deposit of £7,500. I repeat what the Chancellor said:

“The circumstances go way beyond simply a threat to depositors”.—[Official Report, Commons, 19/2/08; col. 175.]

Were the depositors threatened anyway? How many of them had deposits of more than £35,000? After a wait of only three or four days, the figure increased to £50,000. It does not seem that the depositors were threatened, and there were no queues as far as I know at the Bradford & Bingley offices.

What was actually happening to Bradford & Bingley? By then, the banking crisis was in full view, which was not the case when the legislation was passed last February. Bradford & Bingley relied to too great an extent—unwisely, as it turned out—on wholesale money. But surely it was more a victim of the circumstances than a threat. Its size was small, and the problems of the banking system were very large. The sums of money being quoted and the whole scheme at the beginning of October for the bailout of the banks was in figures that were way beyond anything that Bradford & Bingley could bring to bear on the financial stability of the United Kingdom. We need an explanation of the judgment that on 29 September Bradford & Bingley triggered the purpose of the Act, which is,

I beg to move.

Moved, That an humble Address be presented to Her Majesty praying that the order laid before the House on 29 September be annulled (SI 2008/2546).—(Viscount Eccles.)

Lord James of Blackheath: My Lords, I support the Prayer from my noble friend Lord Eccles. I declare that I sit on the same Merits of Statutory Instruments Committee with him that has given rise to the questions he raised. In this matter, he is absolutely right in his analysis that circumstances did not justify, under the criteria set by the original order, the draconian action being imposed on Bradford & Bingley in this case.

I shall go back a further stage to suggest, as I have believed for a very long time, that the Government have been fundamentally wrong, root and branch, in their perception of how to mount a rescue of these banks that have gone into trouble since the days when the Northern Rock issue first crossed the horizon. Although the Bradford & Bingley is significantly less of a danger than Northern Rock was at the time, I still thought that the better solution for Northern Rock, and the right course of action for the bank, would have been to proceed down the path of regarding it as a conventional business workout and place it in the hands of an expert bank that could undertake this work along the lines of the Lloyds Bank proposal at that time. Today, that looks as though it would have been infinitely the cheapest solution available to the taxpayers in resolving that problem. It would also not have created the atmosphere of banking panic and crisis which eventually swept up Bradford & Bingley in

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its wake. I feel very strongly that the Government developed an appetite which then grew on that it did feed upon; they decided that they liked getting control of banks and that Bradford & Bingley became another vulnerable one that they could sweep up on the way.

I shall not go down the same erudite and precise course of analysis that my noble friend did, because he has said it all and said it very well. However, I shall add two thoughts not so far aired in this House arising from this crisis and bring them to the attention of the Minister responsible for banking activities.

First, to go back to the real core origin of the crisis, I suggest that it lies in the Consumer Credit Act 1974, which came in after the second coming of the Wilson Government and was brought about by the fact that, in the first coming of that Government, they relied very heavily on hire-purchase controls as the means of taking the heat out of the economy. In doing so, they inadvertently wrecked the British motor industry, leading to the formation of British Leyland and, eventually, to the bankruptcy of that business. In the course of that, they moved the Japanese market share of British car sales from 3 per cent to 22 per cent in a year, which gave rise to a massive impact on the balance of payments adversely to this country, which has never been corrected or repaired.

The Government went to Professor Goode of London University and asked him to come up with a completely new credit package that could be translated into law, which came out eventually as the Consumer Credit Act. The banks did not like it very much because it did not give them any asset-backing security for the loans that they were making, which is what gave rise in turn to the creation of second mortgages, or sticking the additional finance for a car on the back of a house loan. That tended to give a huge emphasis to the importance of accruing values for houses as the only means of financing both the domestic economy and personal needs, and “taking the waiting out of wanting”, in the dreadful phrase of the time.

As time went on, the banks realised that by putting the credit for a motor car at a few thousand pounds into the back of a house loan, they were not doing as well as they had done in the old days of hire-purchase, because they could have charged higher and got a bigger profit out of it. So they decoupled the arrangement and started to work on the basis of a specific second mortgage, to which they could apply a different set of turns and rates. However, they went a stage further—and here is where I would like the Minister to give very careful thought. They separated the methodology by which they analysed the profitability of a loan, separating the interest from the capital repayment portion of each instalment.

At that time, the banks relied on a ludicrous method called the rule of 78th, which is what you get if you take the months of the year from one to 12 and add them together. If you then take the months of the year and write them down in reverse against the one to 12, you get 13 against one, and so on. They decided that if, for example, you had £200 a month to pay back to a bank under one of these arrangements and you paid back £600 after three months, you had not paid back a quarter of the interest in that time. They added the 12,

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11 and 10 together, which came to 33, and expressed that as a percentage of the total 78, which gave them something like 42 per cent—which meant that 42 per cent of the £600 that they had collected in three months gave them £240 of interest, which they claimed as their profit. That also had the disadvantage for the borrower that he still owed a higher proportion of capital, which was very unfair and has remained unfair ever since.

From that position to what we have now, we have reached a situation in which banks that were created as banks after the demutualisation of the building societies went down this path and were able to show a massive advance in profitability, arising in comparison with conventional clearing street banks, because they were using this old hire-purchase-type profit extraction formula. As a result, the stock market loved them, rights issues were snapped up, money flooded in and a disproportionate amount of money came in to the least responsible, newest and most inexperienced arm of the banking community and drove it up to the point where it unbalanced the national economy by creating purchasing power with what was really false money. It did not exist; it was being put up and subscribed on a myth.

I suggest to the Minister that one of his first priorities should be to discuss with the Accounting Standards Board the methodology by which a single formula could be established for the extraction of the profit content of all lendings and repayments, whether for clearing banks or building societies. In future, we could take the heat out of the overgrowth of the secondary banking market and never have this awful situation occur again. That would be the first and biggest thing to take us out of the boom and bust cycle that could be done by this Government, which they have not done so far.

Secondly, I suggest that one thing could have been done very simply a long time ago, which should now be done. We should ask the auditing profession to do a little more to earn its money. It gets very well paid and it could do one thing for us all that could very well save us from having this panic-stricken crisis situation occur again. That is, we should ask them in all audit certificates in future ever signed on behalf of a lending institution of any sort—and on behalf of anyone in, say, the Times top 1,000 as well—to have a certified working capital certificate for 12 months from the date of the signing of the audit certificate. That certificate should make it clear that it has been reviewed and assessed in the context of the known business plans of that company concerned. It would not have stopped Northern Rock going bust, but it would have given us a year in advance to decide what to do about that while we decided what the industry could do to save it.

I make those two recommendations. My noble friend has given a very reasonable argument why this provision was wrong on this occasion, but none of us would be here today if we had had those two changes in the law previously.

1.59 pm

Lord Howard of Rising: My Lords, we on this side of the House will not oppose the order, but I hope that the Minister will answer the questions and comments

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of my noble friends Lord Eccles and Lord James of Blackheath, which were a most erudite contribution to the debate. In particular—I am sure that other noble Lords will be interested in hearing the answer—who was the Minister responsible for the original action with regard to Bradford & Bingley, and who is the Minister now responsible? My noble friends, who are both members of the Merits Committee, asked a vast number of questions. I look forward to hearing them answered by the Minister.

I should also be grateful if the Minister could clarify who regulates this particular financial institution. On Tuesday, 11 November, in response to a question put by me, the Minister said:

“The responsibility for the regulation of institutions rests with the FSA, and the FSA alone”.

A few moments later he said:

“My Lords, noble Lords know that the initiative for regulation will remain in this country with the Financial Services Authority, the Bank of England and Her Majesty’s Treasury through the tripartite arrangements”.—[Official Report, 11/11/08; cols. 549-50.]

I wonder which statement is correct.

2.01 pm

The Financial Services Secretary to the Treasury (Lord Myners): My Lords, I am grateful to the noble Viscount, Lord Eccles, for initiating today’s debate—a debate which he described in his introductory comments as timely—on the Bradford & Bingley order. I am also grateful to the Merits of Statutory Instruments Committee for its important work on the instrument. The noble Viscount, Lord Eccles, brings to his observations a distinguished record of achievement in industry, investment and corporate regulation. I was also pleased that the noble Lord, Lord James, with his experience in this area, has been able to participate in the House’s discussion.

Before I respond to the points raised in the debate, it may be helpful if I set out the record of how we got to this point. Following extraordinary turbulence in global financial markets, Bradford & Bingley found itself under increasing pressure as investors and lenders lost confidence in its ability to carry on as an independent institution. The noble Viscount asked what we meant by “the business plan not working”. We simply mean that the business plan which hitherto had worked was no longer working because of a serious loss of confidence in the institution on the part of those placing deposits with it.

On Saturday, 27 September, the Financial Services Authority determined that Bradford & Bingley no longer met its threshold conditions for operating as a deposit taker under the Financial Services and Markets Act 2000 and the FSA’s own rules. At that point, the Government, on the advice of the FSA and the Bank of England, in accordance with established tripartite practice, acted immediately to maintain financial stability and protect depositors while minimising the exposure of taxpayers. Officials worked over that weekend to bring about a part-public, part-private solution which best met those objectives.

The tripartite authorities had explored a range of private-sector solutions before taking action. I hope that the noble Viscount will realise that it is extraordinarily

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difficult to put into the public domain issues of high confidence in discussion with other banking institutions. Quite frankly, to have detailed with any precision those discussions, while it may have satisfied our curiosity and wish to better understand the circumstances here, would, in the judgment of the Government, have severely impeded the opportunity to have similar discussions should they be required at some further time in the future.

The Government concluded that a transfer order under the Banking (Special Provisions) Act 2008 best delivered the Government’s objectives of maintaining financial stability, protecting consumers and protecting the taxpayer. This action taken in relation to Bradford & Bingley demonstrated that the Government stood by, and continue to stand by, ready, to do whatever is necessary to maintain the stability of the UK financial system, and confidence in that system.

The noble Viscount quoted my right honourable friend the Chancellor of the Exchequer as setting a high test for the exercise of such orders. I assure him and other noble Lords that in our judgment the circumstances here were such that a failure to take action to protect the interests of the depositors of Bradford & Bingley and to reassure people that they could have confidence in the British banking system would have had adverse consequences had we not taken that action. The fact that there were no queues outside Bradford & Bingley does not mean that this was not a serious situation. The fact that there were no queues is largely a consequence of the decisive action taken by the tripartite authorities.

That is how Bradford & Bingley got to this point. I thank the noble Viscount for his erudite summary of the finances of that institution, in particular his important observation that this organisation had, with the benefit of hindsight, become overly dependent on wholesale deposits. Since 1851, Bradford & Bingley had largely funded itself from its own retail deposits, but it changed its whole culture and business ethos as a consequence of or immediately after demutualisation. In so doing, it significantly increased its riskiness.

As noble Lords are aware, the flexibility in the Banking (Special Provisions) Act allowed for an immediate transfer of Bradford & Bingley into public ownership and for the onward transfer of the retail deposit business to Abbey National. That was crucial for maintaining financial stability and ensuring that customers retained access to their accounts. The noble Viscount described that as “draconian”. I would beg to suggest that most of Bradford & Bingley's depositors were delighted that that action was taken in order to ensure that their interests were well protected and, in so doing, others could see that the interests of depositors with British institutions would be similarly protected in similar circumstances should that be required.

This is the second order under the Banking (Special Provisions) Act since it was passed by Parliament in February this year. As noble Lords will remember, the Government used an order under the Act in February to transfer Northern Rock into temporary public ownership. Unlike that order, the Bradford & Bingley transfer order which we are debating today exercises

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the power to make a further transfer following a transfer of a bank to the public sector. Let me summarise for noble Lords some of the key components of the transfer order.

First, the order transferred Bradford & Bingley into public ownership through the transfer to HM Treasury of the company’s shares. Secondly, the order was used to transfer Bradford & Bingley’s UK and retail deposit business, its branch network and its shares in its Isle of Man subsidiary to Abbey National plc. The liabilities were backed by a contribution from the Financial Services Compensation Scheme and the Treasury. The balance of Bradford & Bingley’s business remains in public ownership. That includes its mortgage book, personal loan book and headquarters.

The decision to make the second transfer of the retail deposit business was based on the need to protect depositors in the then prevailing market conditions of a wholly private sector solution. As I explained to noble Lords, the authorities explored possibilities for a private sector solution. The Government concluded that Bradford & Bingley was not sustainable to be run on a stand-alone basis in a circumstance where it had lost the confidence of depositors.

Through the two transfers under this order, a stable resolution for the whole of the bank was achieved. It has been effective in enabling the Government to protect depositors and maintain financial stability. The transfer of the retail deposit business to Abbey National, a stable institution, was achieved without any disruption to customer service and maintained financial stability.

The Banking (Special Provisions) Act 2008 also provides for a compensation order to be made. The Treasury will define a scheme for determining the amount of any compensation payable to the former shareholders and others who may have been affected by the transfer of shares into public ownership. To this end, the Treasury will lay a compensation order within three months of the transfer order, as defined in the Banking (Special Provisions) Act.

I draw noble Lords’ attention to issues surrounding the Financial Services Compensation Scheme and the triggering of payments. Following the FSA’s determination that Bradford & Bingley was unable, or likely to be unable, to satisfy claims against it, the Financial Services Compensation Scheme was triggered. Therefore, under the transfer order, the FSCS paid out approximately £14 billion to enable retail deposits held in Bradford & Bingley and covered by the FSCS to be transferred to Abbey. The Treasury made a payment to Abbey for those retail deposit amounts not covered by the FSCS, amounting to approximately £4 billion. That was the top-up over and above the maximum amount guaranteed by the FSCS. These amounts should be repaid by Bradford & Bingley from the realisation of the assets of the remaining business. The company will pay down its liabilities to FSCS and HMT as it is wound down over time; that is to say, as assets are sold and mortgages are repaid by Bradford & Bingley’s customers.

I draw noble Lords’ attention to the new Banking Bill and how it will affect similar situations, should they ever arise in the future.

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Viscount Eccles: My Lords, before the Minister moves on, I hope that I may ask one quick question. He just mentioned a liability to HMT. What is that?

Lord Myners: I thank the noble Viscount, Lord Eccles, for that question. As I explained, that is the amount paid over and above the amount covered by the FSCS—the guarantee of all retail deposits. In preparing the permanent replacement to the Banking (Special Provisions) Act, the Government have sought to refine and develop the powers in that Act. This has included extensive consultation with interested stakeholders. The new Banking Bill provides a package of permanent measures which we believe will be a significant improvement on those previously available to handle such a situation.

In taking Bradford & Bingley into public ownership, we put in place a number of additional controls to ensure that taxpayers’ interests were protected. The Treasury has published on its website a shareholder framework document with Bradford & Bingley and I have laid a copy in the Library today. This framework document sets out an appropriate corporate governance structure for the day-to-day interactions between HM Treasury and the company and the people who will be managing the company. It sets out HM Treasury’s delegations to the company and where the Treasury’s approval is necessary to protect its interests in Bradford & Bingley.

As announced by the Chancellor, there will be no compulsory redundancies, other than the job cuts previously announced, for the six months following 29 September. However, we are working closely with Yorkshire Forward and other agencies to handle that situation as effectively as possible. Bradford & Bingley is currently developing a business plan. I am in awe of the ability of the noble Viscount, Lord Eccles, to produce a business plan in seven days. I have some modest experience in business. However, the circumstances facing Bradford & Bingley are such that a few more days than seven are probably required to produce a viable business plan for the business going forward. Particular care will be required because the business plan will need to satisfy European Commission state aid requirements. A state aid restructuring notification will be submitted to the Commission for approval within six months of the grant of emergency state aid; that is, by March 2009.

The noble Viscount, Lord Eccles, also referred to the establishment of UK Financial Investments under the chairmanship of Sir Philip Hampton, and the role that institution will play in overseeing the Government’s investment in Bradford & Bingley. I assure the noble Viscount that, from my perspective, the Government have no wish to manage banks or to have any more banks in their portfolio. However, the risks that we faced as a result of a collapse in confidence as a consequence of the global financial crisis were such that we clearly had to act in order to forestall further problems. Confidence is a fragile flower and if people believe that they cannot be confident in a UK deposit-taking institution, they will begin to query any other institution which they fear is at risk of not being able fully to honour its obligations.

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The noble Viscount, Lord Eccles, asked what we meant by temporary public ownership. The best answer I can give is, not in permanent public ownership; that is, we will, as our response to Bradford & Bingley’s business plan, and within the framework agreement that we are establishing between HMT and Bradford & Bingley, fully explore all opportunities to realise value from ownership.

The noble Lord, Lord James of Blackheath, provided the House with a most informed explanation with smatterings of Shakespearean quotations and historic perspective. I am indebted, as, I am sure, are many others, to the noble Lord for his explanation of the background to consumer credit legislation. I was pleased to be reminded about the rule of 78s, which I had forgotten. He made important points and invited me to consider accounting and auditing issues. I assure him that I will do so. I may well invite him to join me for further discussion on those matters. I respect his considerable knowledge on such matters.

I should like to clarify for the noble Lord, Lord Howard, that the existing structures for regulation, supervision and the operation of the tripartite arrangements remain intact. From my perspective, the tripartite structure is architecturally sound and robust. In the case of Bradford & Bingley, the opportunity for Government to be advised by both the Bank of England and the Financial Services Authority certainly proved effective.

The noble Viscount, Lord Eccles, asked why the instrument was not signed. I hope that I may reply to him in writing on that as I am not fully advised on it. However, if this was an oversight, I apologise for those who failed to comply with the appropriate process.

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