The commission’s recommendations provide an extensive agenda to rectify this, including a senior managers regime to replace the APR, which will define responsibilities and hence create a chain of accountability. That will make it easier to identify who is responsible and therefore to sanction or disqualify poorly performing executives. It seeks to eliminate the Macavity defence of “I didn’t know” or “I wasn’t there”. Below senior management, banks will be required to identify all staff whose actions are capable of damaging the bank, its shareholders or customers and to attest that they will operate to proper standards.

A new body has been created by the banks, led by Sir Richard Lambert, to promote codes of professional standards. A new criminal offence of reckless conduct is to be applied where a bank has failed and required state assistance. There would be a tougher remuneration code requiring a larger proportion of pay to be deferred and for longer, plus a power for the regulator to claw back remuneration that has already vested where a bank fails and requires state support.

I return to some of the questions I posed at the start. Is this unfair targeting of banks and bankers? I would argue that it is not. Even now, banks accept that their conduct was not acceptable and that they have forfeited the trust of their customers. Banks are also exceptional in a number of other ways. They provide a public service through the payments system, which cannot be allowed to be interrupted. They are highly interconnected: a failure of one bank can damage other banks either directly or by undermining the trust on which the whole system is based. They can fail with astonishing speed. Even after the structural changes have been made, they will still enjoy some degree of implicit guarantee. In addition, their funding structure is different. Compared with most industrial and commercial companies, equity forms a tiny part of their balance sheet. Almost of necessity, they are highly geared organisations.

Will banks, and hence London as a financial centre, be forced by tighter regulation and higher capital requirements to contract or divest themselves of certain

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lines of business? To a degree, yes they will, and we should accept that. Our largest banks became too big to manage. Cutting RBS down to size so that it concentrates on serving UK firms and households is to be welcomed. It is essential that leverage is brought down. The UK is a middle-sized economy with a global-sized banking sector. In 1990 the combined balance sheet of UK clearing banks was 75% of GDP. In 2010 that had risen to 450%. Even by 2012, it was still at 350%. That exposes us as a nation to certain risks that we have to be prepared to face.

A lot of proprietary trading is better conducted in the hedge fund sector where the proprietors have more at stake and the implicit guarantee does not operate. Will banks or bankers move out of London, as many around the dining tables of the City tell us? Where would they go—into the hands of the US Department of Justice, the land of the orange jumpsuit and the perp walk, or into the bureaucratic clutches of the European Commission and the European Parliament? We should have the confidence to see a better regulated London as a source of strength, not weakness.

Finally, we must ask whether it is all going to work. In our debates, some noble Lords have described the ring-fence structure, even as strengthened by the commission, as an experiment. To a degree, it is, but so, too, would be fuller structural separation. The option of staying with the status quo simply is not available. Will the report achieve the objective of its title, Changing Banking for Good? We need a regime that works not just now, when banks have been chastened, but when animal spirits have revived and memories of the crash have dimmed. If it is to succeed we need to address both parts of the agenda, structure and culture, as they are closely linked.

The Government said they strongly endorsed,

“the principal findings of the report”—

and intended—

“to implement its main recommendations”.

The initial proposals in the Financial Services (Banking Reform) Bill fell short of that claim. Some recommendations were accepted but only weakly implemented, while others were ignored altogether. However, I can report that through the process of Committee and Report, a number of important amendments have been agreed, and significant assurances have been secured on the nature of reviews and on how the regulators will operate the new regimes. I hope that by Third Reading next week we can resolve the remaining issues.

Ultimately, however, the question of behaviour is for the banks themselves. Will they get back to a greater emphasis on relationships rather than transactions, and to serving their customers rather than seeing customers as the people from whom they make money? Opinion is clearly shifting for the good, but will this be temporary or will it be a change that lasts? Only they can answer this.

7.31 pm

Lord Eatwell (Lab): My Lords, the Parliamentary Commission on Banking Standards’s reports form a landmark, dissecting the structure of banking in this country and hence exposing the serious systemic

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weaknesses both within the banking industry itself and in government policies toward banking. The reports display a constructive blend of financial and institutional analysis. They also display a healthy disdain for the common fallacies which have been propagated by the banking industry in an attempt to limit change, such as the fallacy that higher capital requirements will reduce lending, as if greater capital were simply hidden away in the cellar rather than lent out for profitable return. The Government’s response has been generally welcoming, though a little timid.

The commission was established following the revelations of LIBOR manipulation. Its primary goal was to examine the culture of the banking industry, but its work soon broadened to included systemic risk. This was not simply because banking culture is itself a source of systemic risk to the UK, but also because the work of the Independent Commission on Banking, bold when published, was revealed by longer-term examination to be less powerful than originally thought—hence the PCBS proposals to electrify the ring-fence, and the commission’s numerous dark hints that ring-fencing is not going to work at all.

This is not, however, the occasion to stage a re-run of banking Bill debates. Instead I hope the House will forgive me for recalling that at the time of the establishment of the Parliamentary Commission on Banking Standards, I argued that it would not have the time or the resources to do the job needed—namely, a wide-ranging inquiry into UK financial services and their role, or lack of it, in rebalancing the real economy. I was right. While the commission has exceeded expectations, there is an enormous amount still to do if we are to have a financial system that does not just provide stable finance, but provides the high-quality, long-term financial support that modern industry needs.

My agenda of future work for a reincarnated commission covers three areas: the size and composition of the financial services industry, the changing nature of systemic risk, and the development of high-quality finance to support innovative, competitive industry. I shall discuss size and composition first. In a speech in mid-October, the Governor of the Bank of England, Mark Carney, suggested that UK banking assets would rise from about four times UK GDP today to nine times UK GDP by 2050. In other words, he predicted Britain would become Iceland circa 2007. In defence of his relaxed anticipation of this ominous prospect he argued that,

“a vibrant financial sector brings substantial benefits”,

not only to the UK, but to the world, saying:

“The UK’s financial sector can be both a global good and a national asset—if it is resilient”.

The governor is calling for greater international financial integration, and it is easy to understand why. The City of London is absolutely brilliant at taking funds from around the world, repackaging them into new risk-return structures and selling them back to the rest of the world. It is the world’s finest offshore financial centre. But is a financial sector nine times bigger than GDP such a good idea, even with all the measures of the recent Financial Services Act and the new banking Bill in place? Is the ring-fence sufficient to limit national risk exposure to those inside the

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ring-fence, while all the risks outside fall on private sector shoulders? We should remember that Lehman Brothers would have been outside the ring-fence. Perhaps it is in the wrong place and should be between, on the one hand, domestic operations and, on the other hand, international operations, thus at least in part insulating the British economy from international financial instability. These issues should be the first items on the agenda of the new incarnation of the commission—whether the governor has got it right.

The second item on the agenda of the new commission should be the changing nature of systemic risk. The key warning of this came last May, when Ben Bernanke hinted at a tapering of US quantitative easing. The result was a massive slump—even chaos—in international bond markets around the world, particularly in emerging markets, and severe difficulties in some foreign exchange markets. In the press, this was attributed to the reversal of flows of what was called a “wall of money” that had originally migrated to emerging markets in the search for yield, given the near-zero interest rates in advanced countries. That portrayal of the problem was wrong, because flows of funds to emerging markets have fallen year on year since 2008—there is no wall of money. What is important is that their form has changed. The capital flow from global banks to emerging markets has slowed to a trickle. In its place, emerging market banks have increased their issuance of bonds. Even more dramatically, non-bank investment in emerging market bonds has soared. Today, in emerging market funding, the global banks have given way to asset managers and other buy-side investors who have global reach. Most of this new bond issuance has been in US dollars, so that emerging market corporates have become much more sensitive to US interest rates and to fluctuations in exchange rates vis-à-vis the US dollar. This increased sensitivity in the changed structure of the market is clear in emerging markets.

Exactly the same transformation of funding flows is taking place here at home. Industrial and commercial firms starved of funding by the banks are turning to the bond market. Asset management firms and insurance companies are responding by increasing their flow of funds into corporate bond markets—which are far more sensitive to prospective interest rate changes than traditional bank lending. A new vicious cycle is being created in which the prospect of interest rate rises leads to falling bond prices, which leads to a flow of managed funds out of the corporate bond market, which leads to declining investment and growth, which in turn undermines future bond yields so that asset managers cut back the flow of funds. That is the vicious cycle.

These distress dynamics have some unfamiliar elements. We normally invoke either leverage or maturity mismatch when explaining crises, and the usual protagonists in the crisis narrative are banks or other financial intermediaries. By contrast, in the newly emerging scenario, asset managers are at the heart. Those are usually the people we characterise as benign, long-term investors, routinely excluded from the list of “systemic” market participants. However, the distinction between leveraged institutions and long-only investors matters less if they share the same tendency to procyclicality.

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Today, asset managers increasingly base their trading on the same measures of risk used by the banks, so the behaviour of asset management firms will tend to exhibit the same type of procyclical risk-taking that the banks are known for. None of those issues is dealt with in current legislation; they must be dealt with by the new commission.

The third item on my extensive agenda for the reincarnated commission is how the financial services industry serves the need to rebalance the real economy. For the harsh truth is that despite the fact that banking balance sheets around the world are today 15 times greater, relative to GDP, than they were 30 years ago, trend world growth in the real economy is certainly no faster than it was then; and in the West it is significantly slower. No wonder the noble Lord, Lord Turner, labelled much of financial services as “socially useless”.

Most notably, private sector investment in research and development is slowing down. Indeed, if there were not substantial public sector R&D spending, investment in crucial drivers of future growth would be falling. Here, the public sector is really sustaining the R&D agenda. In 2012 alone, state development banks financed $109 billion-worth of investment in renewable energy, energy efficiency, and electrical transmission and distribution, while private sector investment was less than a third of that. In the US, it is government funding in high-growth areas such as the life sciences that is absolutely essential. Where would British life sciences be without the long-term funding provided by the Wellcome Trust?

The private sector problem is lack of the right sort of funding. Even venture capital, designed in theory to provide high-risk finance for innovative companies, snubbed by risk-averse banks, has become itself increasingly risk-averse. The sector is focused on early exit, usually through IPOs in three to five years—while innovation takes 15 to 20 years.

If we are to steer the economy from the consumer-driven mini-recovery that we have at the moment to a productive investment-driven economy, where is the long-term finance to come from? We need the reincarnated commission to refocus reform of the financial sector on quality of financing, not solely on stability or quantity. Reform of the financial sector should be joined up with innovation policy so that productive, not speculative, investment is nurtured in companies of all sizes.

My report card for the commission therefore reads as follows: “Has done an unexpectedly good job; indeed, a brilliant job, and should be congratulated; but has the potential to contribute even more, if only there were a Government that would give it the mandate to fulfil its potential”.

7.43 pm

The Commercial Secretary to the Treasury (Lord Deighton): My Lords, this has been a very constructive and timely debate. I felt that I was getting one of my exams marked there, for a minute; that was the feedback I used to get 38 years ago. It is the right time to be talking about this, given where we are with the Financial Services (Banking Reform) Bill, which has been extensively amended in response to the recommendations of the

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Parliamentary Commission on Banking Standards. Of course, as a number of noble Lords pointed out, we are moving toward the end of that Bill’s progress through the House. That marks the final stage of the Government’s programme of legislative action to reform banking.

We are all aware of the serious problems that have come to light in recent years. I thought that the noble Lord, Lord Turnbull, gave us the best exposition of all the individual incidents and the questions that we should be asking. We are absolutely right this evening to be focusing on the culture within banking.

Step 1, from the Government’s point of view, was to fix the regulatory system. As well as giving the Bank of England responsibility for financial stability, therefore, the Financial Services Act established the Financial Conduct Authority as a tough new conduct regulator, focused on making sure that conduct issues get the serious attention they need and deserve.

I welcome the insightful comments in the maiden speech of my noble friend Lord Carrington. He enumerated far more concisely than I could the merits of the new judgment-led approach that the regulators will apply to supervision, and the disappointing failure of what we describe as the tick-box approach. I am in tune with that analysis. I was also quite taken by my noble friend’s discussion of Islamic banking, which is values-based. There are probably some lessons for the rest of the banking sector there.

The Government supported the establishment of the PCBS under the chairmanship of the honourable Member for Chichester, Andrew Tyrie, and the work of that commission has played an absolutely vital role in shaping the future approach to conduct and standards in the UK’s financial services sector. Of course, its pre-legislative scrutiny of the draft banking reform Bill, which has been referred to, also led to a strengthening of the ring-fence, with its electrification.

The commission’s impressive final report, Changing Banking for Good, which was published in June, made some key recommendations, ranging across individual accountability, corporate governance, competition and long-term financial stability. In July the Government published our response to those recommendations. We endorsed the main findings of the commission’s report and committed to implementing its principal recommendations, using the Bill where legislation was the right way forward. I would like to think that the Government have delivered on that commitment. The debates we had in this House were extremely helpful to the Government—and, I hope, refined some of the commissioners’ thinking—and we have ended up in what I think is a very good place. I hope that next week, at the next stage, it will all come to fruition.

We tabled amendments to establish the new senior managers regime, which is the critical control system to ensure that the culture is right, and are going to implement the commission’s recommendation to introduce what is in effect a licensing regime to cover more junior banking staff. For the first time, regulators will be able to make conduct rules applying to all employees of a bank, and these changes form the basis of a much more robust focus on conduct and standards within these banks, both by giving the regulators new and

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important powers with regard to senior managers, such as time-limited and conditional approvals, and by placing firm obligations on banks themselves to take responsibility for the conduct of more junior staff. The Government have put in place a new offence of criminal recklessness in the management of a bank so that in future those who bring down their bank by making thoroughly unreasonable decisions can go to jail for their actions.

All these changes have improved the Bill significantly, and I thank all noble Lords who have contributed to the debates so far. I particularly express my gratitude to the former members of the commission for their continued constructive engagement throughout, which has enabled the Government to realise their vision comprehensively.

Of course, to a man with a hammer everything looks like a nail, and there is sometimes a risk that to a parliamentarian every problem looks like it needs legislation, but this debate is a timely reminder that legislation is just one weapon in our armoury towards building the highest standards within the industry. As the most reverend Primate said, you cannot solve problems by changing law, and you cannot make people good through law. I absolutely agree with that.

The commission’s recommendations about the regulation of individuals in banks rely heavily on rules that the regulators will make underneath the legislative provisions, and the way in which those rules are applied. We have to work all this through to see how it works in practice.

The Bank of England and the FCA published their responses to the commission’s report in October, and set out their positions on each of the recommendations. They continue to make progress. I hope that the regulators will take note of the points that have been raised this evening—I know many of them are here witnessing this—as they go ahead to implement the commission’s recommendations through their rules. They will be launching public consultations on these rules next year. I urge all those who have spoken this evening to reiterate their views to the regulators through this process.

I return to the issue of creating culture change. One of the most reverend Primate’s questions was, “What will drive this cultural change?”. Regulatory rules are a necessary but not a sufficient condition for creating a profound change in the culture of banking. It is clearly an area where banks themselves must take significant responsibility. They have committed to the establishment of a professional standards body, which represents some progress; but I also hope that the industry’s leaders will take notice of this debate and continue to work to rebuild the fundamental trust which the public need to have in them if this is going to improve over time. That trust will only grow through a relatively long healing process.

Perhaps I may take a couple of minutes to refer to my own experience and what I learnt in the business. I was in the banking business for 27 years. What attracted me to it in the first place resonates with the comments of the noble Lord, Lord Eatwell, about the quality of finance and those of the most reverend Primate about what banks are for and what contribution they make

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to local and national economies. The thing that made me want to go into banking was the opportunity to work with so many different businesses; to work with so many other different kind of financial institutions; to work with different countries around the world; and to use finance to make things happen, to build things and to see development. For me, it was the best possible opportunity to make an enormous difference to so many businesses around the world.

I never lost the sense of magic that the position you get at the centre of things gives you. My career divided into two halves. In the first half, my responsibility was to manage and build a group of clients and, frankly, to maximise the market share for my firm from those clients by winning as much business from them as we possibly could. I learnt one very simple thing: the most important rule for success was to put the customer’s interests first. There was nothing worse than an unhappy client. My most profitable long-term client relationships were with those people whom I had initially advised not to do transactions. We have heard a lot of discussion about taking care of the customer and putting the customer first. My own experience tells me not only is this the right thing to do, it is also in the bank’s long-term financial interest to behave in precisely that way too. The essence of effective leadership of a bank is to bring those things together.

In the second half of my career, when I was in much more of a leadership role, I spent an enormous amount of time building and managing the systems of controls and compensation to try to align that kind of long-term profit maximisation with taking care of clients and doing the right thing in a regulatory environment. I understand the enormous challenges of sitting near the top of these big organisations; wanting to do the right thing, yet never quite being sure whether there was a so-called rogue trader out there and whether you had the capacity to spot them and deal with them early enough.

A number of noble Lords have pointed to the importance of competition as a way of keeping everybody honest on a number of respects. I absolutely support competition as a healthy and stimulating part of this dialogue.

My final comment about the culture of banks is that it comes from the top—the tone is set at the top. You absolutely need systems, controls and management structures to ensure that it is effectively deployed throughout the organisation, but, for me, culture is ultimately about leadership. It is about leadership of the financial institutions, in the regulators and in government. That triumvirate needs to continue to display the right kind of leadership if we are effectively to change backing for good, as the commission has recommended.

Finally, I thank noble Lords who have spoken this evening, and thank the most reverend Primate for presenting us with this important opportunity to discuss these matters.

7.54 pm

The Archbishop of Canterbury: My Lords, I add my thanks to all noble Lords who have contributed this evening. A number of striking comments and speeches

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have been made, notable among them that of the noble Lord, Lord Carrington, with his description of a Sharia-compliant bank and the impact that that can have and his deployment of his experience both in the other place and in the banking industry over many years.

The debate has ranged far and wide. I want to draw on two characters. One is Dracula. We have the threat of reincarnation—or, if one is into “Doctor Who”, regeneration—of the Parliamentary Banking Standards Commission. I saw the blood drain from the face of the noble Lord, Lord Turnbull, as I sat from this distance. I hope that we can find some stake and clove of garlic that can put it into its grave and that someone else will have the pleasure of reincarnating it at some point.

The speech of the noble Lord, Lord Eatwell, clearly reminded us that financial services are immensely connected and that what you squash down in one place pops up in another—to put it less elegantly than he did—often with great force, little regulation and usually much danger. His exceptional speech should be noted and thought about. I fear that there will be need for continual monitoring of what happens over the next few years.

I have a couple of comments. I shall be brief, because we are at the end of our time and it has been a long day. The comments made by the noble Lord, Lord Sharkey, about size were also strong reminders of the difficulties that we face. One of the most memorable comments in evidence for me was from a former head of UBS, clearly deeply affected personally by the pain of what he had gone through. He was one of those bankers who came who had borne the whole weight of it on his shoulders and suffered greatly as a result. There was no lack of responsibility from him. When asked if, in the depths of the night, he looked back and thought that he might have done differently, he said that you can have a big simple bank or a small complicated bank; you cannot have a big complicated bank. He said that if he had his time again, he would have kept it simple.

When I listened to the noble Lords, Lord Sharkey and Lord Eatwell, I was reminded of the extraordinary statistic anticipating the banking industry at nine times GDP. I was reminded of the need for banks to be kept to a size where they do not threaten everything else. They are not the only goose laying golden eggs in our economy. We cannot be a “monocrop economy”, as Martin Wolf described us in a notable article in the Financial Times in January 2009.

I cannot go through all the other points raised, but I heard with gratitude the comments about education. Competition is obviously essential, but, as the Minister said a few moments ago, competition must be to be the best supplier of the customer, not the most profitable bank going. You may get the second through the first, but if you aim solely for the second, you will never get the first.

Finally, the quality of finance—to which the noble Lord, Lord Eatwell, referred directly and indirectly—is that which sustains our communities and enables the talent of our nation to flourish, grow and develop jobs. He used a phrase, “financial services”, that has

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been used many times in the debate. All these industries, banking and the others, are there to serve, not to rule. They are, as I was taught as a child by my grandmother, when talking about fire, good servants and very bad masters.

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Motion agreed.

House adjourned at 8 pm.