House of Commons Treasury Committee
Independent Commission on Banking Final Report
Oral and Written Evidence
Ordered by the House of Commons to be printed 10, 18 and 26 October 2011, 2 and 23 November 2011, 14 December 2011, 11 January 2012, and 30 October 2012
HC 680 [Incorporating HC 1534, Session 2010–12] Published on 12 November 2012 by authority of the House of Commons London: The Stationery Office Limited £18.50
The Treasury Committee
The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies.
Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Rt Hon Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Mr Brooks Newmark (Conservative, Braintree) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)
Michael Fallon MP (Conservative, Sevenoaks) was also a member of the Committee during the inquiry.
Powers The committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via www.parliament.uk.
Publication The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/treascom.
The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in printed volume(s). Additional written evidence may be published on the internet only.
Committee staff The current staff of the Committee are Chris Stanton (Clerk), Lydia Menzies (Second Clerk), Jay Sheth, Adam Wales (Senior Economists) and Matthew Manning ((on secondment from the Financial Services Authority)(Committee Specialist)), Alison Game (Senior Committee Assistant), Steven Price and Lisa Stead (Committee Assistants) and James Abbott (Media Officer).
Contacts All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 5769; the Committee’s email address is [email protected]
List of witnesses
Monday 10 October 2011 Page
Sir John Vickers, Chair Martin Taylor, Bill Winters, and Martin Wolf, ICB Commissioners Ev 1
Tuesday 18 October 2011
Mr John Hitchins, Senior Banking Partner, PricewaterhouseCoopers LLP, Mr John Grout, Policy and Technical Director, Association of Corporate Treasurers, and Mr Matthew Fell, Director, Competitive Markets, CBI Ev 22
Mr John Kay, Cass Business School, and Dr Peter Hahn, Cass Business School Ev 30
Wednesday 26 October 2011
Andy Caton, Corporate Development Director, Yorkshire Building Society, Graham Beale, Chief Executive, Nationwide, and Chris Rhodes, Group Product & Marketing Director, Nationwide Ev 39
Wednesday 2 November 2011
Peter Vicary-Smith, Chief Executive, Dominic Lindley, Principal Policy Adviser, Which?, Christine Farnish, Chair, Consumer Focus, and Gillian Guy, Chief Executive, Citizens Advice Ev 49
Wednesday 23 November 2011
Stephen Hester, Chief Executive, Royal Bank of Scotland, and Douglas Flint CBE, Group Chairman, HSBC Ev 56
Ana Botín, Chief Executive, Santander UK, and Tim Tookey, then Interim Group Chief Executive, Lloyds TSB Ev 73
Wednesday 14 December 2011
Peter Sands, Group Chief Executive, Standard Chartered Bank Ev 82
Bob Diamond, Chief Executive, and Antony Jenkins, Chief Executive, Retail and Business Banking, Barclays plc Ev 89
Wednesday 11 January 2012
Rt Hon George Osborne MP, Chancellor of the Exchequer, and Tom Scholar Ev 100
List of written evidence
1 Lloyds Banking Group Ev 116, 137 2 Nationwide Building Society Ev 120 3 Consumer Focus Ev 122 4 Association of Corporate Treasurers Ev 127 5 Royal Bank of Scotland Ev 130, 134 6 Barclays plc Ev 130, 150 7 Letter from Tim Tookey, then interim Group Chief Executive, Lloyds Banking Group, to the Chairman of the Committee Ev 136 8 Standard Chartered Ev 138 9 Campaign for Community Banking Services Ev 153 10 The Finance and Leasing Association (FLA) Ev 155 11 Unite the Union Ev 156 12 Building Societies Association Ev 158 13 Financial Services Consumer Panel Ev 161 14 Institute of Chartered Accountants in England and Wales Ev 164 15 Confederation of British Industry Ev 168 16 British Bankers’ Association Ev 171 17 Payments Council Ev 176 18 C. Hoare and Co. Ev 177
List of Reports from the Committee during the current Parliament
Session 2010–12 First Report June 2010 Budget HC 350 Second Report Appointment of Dr Martin Weale to the Monetary Policy HC 475 Committee of the Bank of England Third Report Appointment of Robert Chote as Chair of the Office for HC 476 Budget Responsibility Fourth Report Office for Budget Responsibility HC 385 Fifth Report Appointments to the Budget Responsibility Committee HC 545 Sixth Report Spending Review 2010 HC 544 Seventh Report Financial Regulation: a preliminary consideration of the HC 430 Government’s proposals Eighth Report Principles of tax policy HC 753 Ninth Report Competition and Choice in Retail Banking HC 612 Tenth Report Budget 2011 HC 897 Eleventh Report Finance (No.3) Bill HC 497 Twelfth Report Appointment of Dr Ben Broadbent to the monetary Policy HC 1051 Committee of the Bank of England Thirteenth Report Appointment of Dr Donald Kohn to the interim Financial HC 1052 Policy Committee Fourteenth Report Appointments of Michael Cohrs and Alastair Clark to the HC 1125 interim Financial Policy Committee Fifteenth Report Retail Distribution Review HC 857 Sixteenth Report Administration and effectiveness of HM Revenue and Customs HC 731 Seventeenth Report Private Finance Initiative HC 1146
Eighteenth Report The future of cheques HC 1147 Nineteenth Report Independent Commission on Banking HC 1069 Twentieth Report Retail Distribution Review: Government and FSA Responses HC 1533 Twenty-first Report Accountability of the Bank of England HC 874 Twenty-second Report Appointment of Robert Jenkins to the interim Financial Policy HC 1575 Committee Twenty-third Report The future of cheques: Government and Payments Council HC 1645 Responses Twenty-fourth Report Appointments to the Office of Tax Simplification HC 1637 Twenty-fifth Report Private Finance Initiative: Government, OBR and NAO HC 1725 Responses Twenty-sixth Report Financial Conduct Authority HC 1574 Twenty-seventh Report Accountability of the Bank of England: Response from the HC 1769 Court of the Bank Twenty-eighth Report Financial Conduct Authority: Report on the Governments HC 1857 Response Twenty-ninth Report Closing the tax gap: HMRC’s record at ensuring tax HC 1371 compliance Thirtieth Report Budget 2012 HC 1901
Session 2012–13 First Report Financial Services Bill HC 161 Second Report Fixing LIBOR: some preliminary findings HC 481 Third Report Access to cash machines for basic bank account HC 544 holders Fourth Report Appointment of Mr Ian McCafferty to the Monetary HC 590 Policy Committee Fifth Report The FSA’s report into the failure of RBS HC 640
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Treasury Committee: Evidence Ev 1
Oral evidence
Taken before the Treasury Committee on Monday 10 October 2011
Members present: Mr Andrew Tyrie (Chair)
Tom Blenkinsop John Mann Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Stewart Hosie Mr David Ruffley Andrea Leadsom John Thurso ______
Examination of Witnesses
Witnesses: Sir John Vickers, Chair, ICB, Martin Taylor, ICB Commissioner, Bill Winters, ICB Commissioner, and Martin Wolf, ICB Commissioner, gave evidence.
Q1 Chair: Thank you very much for coming before Q4 Stewart Hosie: Sir John, you have said that the us and for the huge amount of work that all of you annual pre-tax cost to banks of the actual reforms have done, and one of you missing, on a very would be in the £4 billion to £7 billion range. Was that complicated subject of enormous importance to the an in-house analysis or was it an average of external country at the moment, and indeed well beyond these analyses? How did you come to that figure? shores. Before we get into some of the meat of the Sir John Vickers: Yes, what we have said is that our report itself—and you have had from us a list of best estimate would be within that range. There is a questions that we had for the interim report, which I lot of uncertainty around that however. The evidence think to some degree will serve as a basis for these that went into formulating that estimate is a mix of exchanges—could you say whether you are happy things. A number of City analysts, particularly in the with the fact that Moody’s downgraded our banks, summer, produced their own estimates, which we apparently in response to your report? were able to look at and study and assess their Sir John Vickers: Thank you very much, Chairman. methodologies and so on. We also had data provided May I just place on record, on behalf of the to us on a confidential basis by the banks so we could Commissioners, our thanks to the secretariat who compare and add that other evidence to the evidence worked with us, who were absolutely magnificent in pot that we had available. It was a combination of our all their work? We would never have been able to put survey of external work, together with our own this together without that. internal work and, as I have indicated, that internal On the Moody’s downgrade, insofar as that is a work had the benefit of confidential data from the reflection of a step of progress in getting the taxpayer banks. It was on that basis that we thought that some off the hook, I personally would see it as an entirely of the City estimates, which ranged up to £10 billion benign development. annually, were going too high and that the likely true number—no one knows exactly what it is—was distinctly lower than that, and hence we arrived at the Q2 Chair: So there is no downside to the range you described. That is the private cost to the downgrade? banks. Sir John Vickers: Insofar as it reflects that factor, and that is what was emphasised when they made the Q5 Stewart Hosie: Within that, £1 billion to £3 downgrade, I would see it as a natural reflection of billion is what you have called the social cost, which the taxpayer getting one step further off the hook, so leaves us between £3 billion to £4 billion on your I would not see a downside in that. estimate, possibly higher. Can you tell us how that £3 billion to £4 billion non-social cost is derived? How Q3 Chair: You are not concerned by reports that it do the banks come to that figure? What would that might trigger a further bailout in RBS? cost figure include? Sir John Vickers: There are many other things going Sir John Vickers: The difference between the £4 on in the world but the reason cited in the context of billion to £7 billion range and the £1 billion to £3 the downgrade was the implicit Government billion range is that the former are the private costs guarantee, and on that I have expressed the view. and latter the social costs, but it was not the banks Maybe others have— who were providing an estimate of that difference; Martin Taylor: I think if Moody’s had published a that was our own work. The two main factors are, report on the UK banks and had said, “We don’t take first, the point already discussed about the curtailment the ICB’s suggestion of removal of the implicit of the implicit Government guarantee and we believe guarantee seriously and we therefore see no need to that most of the private cost to the banks, which downgrade the UK banks”, we would have considered comes through funding costs principally, relates to the that a retrograde step. curtailment of that implicit guarantee, which is not a cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 2 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf cost to the economy as a whole although it is a cost Sir John Vickers: You are welcome to point to our to the banks. report on any matter. The second most significant factor in that difference is that the recommendation of higher equity Q10 Stewart Hosie: Just one final question. You said requirements, together with the recommendation that that, “Establishing the private costs of the the ring-fenced entity has its own self-standing capital recommendations, the proportion of these that are pot, creates a tax differential between equity and debt social costs and the benefits of reform all necessarily and that differential translates to a private cost, involve significant irreducible uncertainties”. Can you although it is not a social cost, because the Exchequer tell us what the most significant irreducible gains the revenue from that tax difference. So if you uncertainties are on the cost side of the equation? put those two ingredients into the pot they are more Sir John Vickers: There are quite a few of them. than half the £4 billion to £7 billion, hence the £1 There is, first of all, uncertainty about how large the billion to £3 billion. implicit Government guarantee is, and that might be a matter that comes back in a later question, so that Q6 Stewart Hosie: Equity costs, a self-standing would be one factor. That one itself evolves through capital pot, the tax difference between equity and debt time so even if one had a perfect snapshot of it now, and the curtailment of the implicit guarantee is that would not speak to the future in, say, 10 years’ effectively that difference. That £4 billion to £7 billion time necessarily. in total, is that all of the banks or is that just the big Another area where it is very hard empirically to four? quantify the matters at hand is to what extent there Sir John Vickers: I stress that these are all uncertain are cost synergies between retail banking on the one figures, but the intention is that it will be the cost to hand and wholesale investment banking on the other. the banks as a whole. By far the largest element of We have tried to propose a design for the ring-fence that relates to the largest banks, not only because they that maintains to a very considerable extent such are the largest banks but also because the value to synergy benefits as exist. Some may be forgone by the them of the implicit guarantee is proportionately restrictions on the transfer of capital within a group, greater than to smaller banks. if there were to be a ring-fence, but to quantify that is a difficult thing to do. We did not get a great deal of Q7 Stewart Hosie: Of course. In terms of those evidence from the banks that aided us in that costs, whatever they end up being, what do you think quantification, but that would be another example. the balance is between what will fall within the ring- fence and what will fall outwith the ring-fence? What Q11 Stewart Hosie: In terms of what you were able number falls on the narrow banking and what number to quantify, you did say that, “The recommendations falls on the investment side? would deliver net benefits, it would reduce the Sir John Vickers: Again, precision is impossible and probability or impact of crises by a range between would be spurious but there are strong reasons to think one-fortieth, 2.5% and one-thirteenth, 7.5%”. How on that most of the cost would be outside the fence earth did you get to that degree of certainty, to the because in terms of unstructured universal banking, 2.5% and 7.5%? the scope of Government support, should there be a Sir John Vickers: I hope we hedged the statement that calamity, applies not just, as it were, to High Street you have quoted with appropriate caveats, but the banking in the UK but much more generally. So we basic arithmetic was as follows. We have been talking think it is likely that the majority of the cost would be about the cost of the measures. Turning to the benefit outside the fence; probably a bit of both however. side of the equation, the cost of financial banking crises is absolutely huge. We took as what we consider Q8 Stewart Hosie: Has there been any comment in an entirely reasonable but working example the terms of the possible impact on investment or lending central estimate of a study of the Bank for decisions if the bulk of that cost was lying outside the International Settlements, which is that a financial ring-fence? crisis, if you like an average one while there is no Sir John Vickers: If it is outside the ring-fence and such thing as a typical one, might well entail a GDP if international wholesale and investment banking is loss that has a net present value of 60% of annual competitive, to the extent that it is, then the GDP, so the range is huge around that. competitive marketplace would discipline the pass Then you have to say, “How often do crises come through of that cost to the final consumer. But even along? What insurance premium would you pay if you on a ready reckoner basis if one assumed it was an could get rid of them altogether?” and do that thought even spread right across all the balance sheets of those experiment. On what we think is a reasonable worked costs, given an aggregate balance sheet of £6 trillion example, that insurance premium was 3% of GDP to or so, then the £4 billion to £7 billion would translate, eliminate crises altogether, and that equates to about say the number is £6 billion, to one-tenth of 1%, so £40 billion of GDP at the moment, a little bit more, that is the scale of things in proportion to the and it is by comparing that £40 billion with the £1 balance sheets. billion to £3 billion that you get the 1/40th or the 1/13th. Q9 Stewart Hosie: So if banks come and say, “We We were not claiming that that insurance premium is are terrified this is going to damage us” we can point an absolutely rock solid number. We were putting to you and say it is a few basis points and we together what we considered to be a number of shouldn’t really worry about it? reasonable assumptions, coming out with an estimate, cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 3
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf which others are perfectly free to disagree with on the Chair: That is why I have been asking the question, upside or the downside, but that mechanically is how not is there a subsidy but is there agreement of a we got to the figure that gave rise to the 1/40th or methodology by which it should be calculated. 1/13th. Q15 Mr Ruffley: Sir John, your report concludes Q12 Chair: Setting aside the numbers, do all the that, “Any economic impact resulting from the banks agree that methodology? proposals specifically on UK competitiveness, Martin Taylor: Well, they haven’t proposed a including that of the City, should be broadly neutral different one as far as— or positive, especially over the longer term”. I just Chair: That is not quite the question. Do the banks wondered, can we deduce from that that you think in now accept that they are a subsidised industry, like the short or medium term there might be damage to agriculture or any of the others that collect a cheque the City’s competitiveness? from time to time? Sir John Vickers: That is not the intended inference Sir John Vickers: They have not, in those terms or in at all. We saw our task as being for the medium and similar terms, said as such to us. I would, however, long run. In other words, our task was to propose a say that I think there is a shared view that there ought set of measures that would be a much better platform not to be an implicit Government guarantee, that there for stability and a more competitive platform in the ought not to be an implicit subsidy, but views differ marketplace for the future. There clearly are short- as between the banks and ourselves and others about term issues and if we had recommended a very tight quite how large that implicit guarantee might— timetable, such as get it all done by 2014, then I think there could have been a detrimental impact on the Q13 Chair: I said setting aside the numbers. My shorter term from the recommendations, but we went question is just on the methodology, which you do set for a longer timetable than that. Indeed, the end date out in your report and which is interesting. we recommend is the same as the Basel date of the Sir John Vickers: I do not recall anyone arguing that start of 2019. We believe that that, together with the there ought to be a subsidy. nature of the proposals, should remove any concerns that people might have had about a shorter term Q14 Chair: There has been no challenge to this adverse impact. methodology from the banks? They will be coming before us; I just want to be clear. Q16 Mr Ruffley: Just to be clear, you do not think, Sir John Vickers: Yes, others have produced different because of the timetable you have set out and the answers but along similar methodologies. For Chancellor has endorsed, there will be any short run example, internationally, the Institute for International negative impacts on the City’s competitiveness in the Finance have a method, with which we do not agree, world? which produces much, much higher cost figures. I Sir John Vickers: Correct, that is my view and if there forget what they do on the benefit side of the equation. is policy credibility, and this is a matter for Theirs is a global study not a UK study. Government and Parliament, behind measures that Martin Wolf: I just wanted to add on this particular would make for improved banking stability in the UK, point that, as I am sure you know, the rating agencies I think there might be, as it were, a dividend from that quite normally analyse the creditworthiness of banks credibility, even before the implementation date. both on the basis that they stand alone and separately with ‘support’ ratings, which is indeed what they have Q17 Mr Ruffley: Sure. Many commentators, just adjusted in the case of Moody’s for UK banks, particularly Charles Goodhart, have made the and bank analysts, so the employees of banks quite assessment that it will be harder for UK investment normally use those different ratings to assess the banks to compete with foreign competitor banks and impact of changes in support. So it would appear to a result could very well be the so-called me that the financial sector broadly and the banks’ Wimbledonisation of the City of London, that is to employees explicitly do recognise that there is a say the UK hosts the tournament but all the leading subsidy associated with Government support and that players are from overseas. In terms of the analogy, it has considerable value. That was the question you foreign banks might prosper to the relative disbenefit asked. of UK banks in the square mile. Do you agree with Chair: It is. I do not want to prolong this discussion. that assessment? Martin Taylor: I simply wanted to say some of the Sir John Vickers: The curtailment of the implicit banks have argued that in normal times the subsidy Government guarantee, which we were just talking was not a benefit to them because it was passed about, inevitably raises the funding costs of banks that through to customers. I don’t think we agree with that. have been benefiting from that guarantee. In line with As to the question of whether the subsidy exists, given the response to the earlier question, insofar as that is the Dexia story over the last two or three days you mostly felt in the international activities, then the simply have to look around you. Subsidies are very, funding costs of the affected banks in that area very clearly there and alive and well. increase as the entirely natural counterpart of the Martin Wolf: A great many institutions were saved by market perception that that guarantee has been taxpayers around the world and in this country, and if curtailed. So there is that effect and we have never they had not been saved by taxpayers they would have sought to say otherwise. collapsed and their creditors would have lost money, Beyond that, there seems every reason to think that that is a subsidy, period. London remains an incredibly attractive centre to base cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 4 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf banking operations, both for UK banks and other moving its company HQ outside of the UK as a result banks. I welcome the openness and internationalism of the ICB proposals? of the City as a host but I certainly would not expect Sir John Vickers: We have put a lot of work— Wimbledonisation in the terms that you describe. Mr Ruffley: It is a straightforward question. What is Maybe British tennis will improve, as it is at the the probability of one of the major banks relocating moment. its HQ? Sir John Vickers: Obviously those are questions for Q18 Mr Ruffley: Have you had any comments from the banks but my response to your question would be UK investment banks that their competitiveness will a low probability. We put a great deal of work into be hit? Have they quantified for you or have you tried this and we have calibrated our proposals on equity, to quantify what the impact will be on UK investment on other primary loss-absorbing capacity, the design banks in the square mile? of the ring-fence and so on. The intent, absolutely, is Sir John Vickers: Part of it comes out of the response to achieve the stability benefits at the lowest cost to to the questions earlier about the £4 billion to £7 the economy and indeed to the affected banks. If we billion and where that is felt and so on. I am conscious had disregarded those considerations, the ones behind that Bill and Martin are better placed to answer that your question, we would have come up with different than I am certainly. proposals. But we think we have calibrated it, and I draw attention to two things in particular. Firstly, the Q19 Mr Ruffley: Perhaps Mr Winters might want to ring-fence—one of the advantages of the ring-fence reply, specifically on the UK investment banks architecture is you can have higher domestic standards competitiveness vis-à-vis foreign investment banks. than apply internationally. So one of the merits, as we Bill Winters: A large portion of this cost that John see it, of the design is to enable international standards referred to earlier will relate to the international to apply to international business. As for retail investment banking operations for UK banks, for sure. banking itself, that is not the kind of activity where That is where we think the costs will be concentrated the difference of a few basis points on capital and obviously, as John said, the objective of our requirements or funding costs will cause a whoosh of Commission, and I think this Government and other business one way or the other, because the High Street Governments around the world, exclusively and is the High Street. entirely has been to eliminate the subsidy. If you speak We have looked very carefully at things like the to the American Government, the French European rules around passporting and branching and Government, the German Government, they all want all the rest, and there is quite a lot both in the interim the subsidy out. Each country has taken its own path report and the final report to back up our belief that to reducing or eliminating that subsidy. The UK has the probability of relocation is low. asked us to conduct this report, which we have done and which we are discussing. Q21 Mr Ruffley: So neither Standard Chartered nor The United States passed the Dodd-Frank Act, which HSBC nor Barclays intimated to you or any of your does not recommend ring-fencing, does not have an colleagues on the ICB that they would consider increased primary loss-absorbing capacity, but does moving out of the UK as a result of the proposals? introduce notions such as the Volcker rule, which Sir John Vickers: It may have been at a very early prevent banks from proprietary trading. Of course stage before we had got to the design. there is a ring-fence already in the United States Mr Ruffley: I am talking about your final proposals. between commercial banking and investment banking, Sir John Vickers: Our final report? I was at a which has been around in various forms for 70 years. conference in Washington a couple of weeks ago When we speak to American bankers they frequently where Bob Diamond said almost the opposite. Well, say that the American banks are being tremendously not the opposite of that, but he said that some discriminated against relative to British and other uncertainty has been taken away, London is a terrific European banks. The British banks of course say that place to do business and so on. Your question was as they are being discriminated against; the French and a result of our proposals if they were adopted— the German banks say the same about their own Mr Ruffley: Your final proposals, yes. Governments. Sir John Vickers:—and I think the short answer to The only thing I am certain about is that every your question is no. Government has the objective of eliminating the Martin Taylor: I think if a bank were to take that subsidy in its entirety. The second thing I am pretty decision it would not be just as a result of our sure about is that we have been more thoughtful about proposals. It would take into account other things that the process, perhaps in part because we are an the banks frequently complain about, as the independent Commission that had a year and a very Committee well knows, such as the bank levy, levels strong secretariat to work through this in a relatively of personal taxation and so on. But we have had neutral environment, but perhaps for other reasons. I nobody make that threat to us. think we have come up with a thoughtful approach to removing the subsidy that is particular to the nature Q22 John Mann: Mr Winters, you said it is the of banking in Britain, and I think that puts us in a policy objective of every Government to remove good place. subsidies. Does that include the Government of China? Q20 Mr Ruffley: Final question, Sir John. What are Bill Winters: No, it does not and I realised as soon as the chances, do you think, of a major UK bank I said that that there are exceptions. Thankfully the cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 5
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Chinese banks are not competing with British banks geographical scope. As to the nature of our for international investment banking business, so in recommendations, we are clear in the report, and we terms of the context in which British banks are were in the interim report, that on capital and loss operating, and therefore the competitiveness of the absorbency we think there is a case that goes well British banks, I think the countries that represent the beyond the UK for higher capital requirements and competition for British banks are uniformly in favour much greater loss absorbency, and we comment on of removing the subsidy. the international Basel initiative in that regard. But our work was very outward looking, it was very Q23 John Mann: Today’s competition? conscious of the international competitiveness issues Bill Winters: Today’s competition, that is right. I think that the UK banks face and the role of banks, UK and that begs the question if in the future countries choose other, in the success of the UK economy, so I do not to subsidise their banks, what should the proper policy think this was a parochial inquiry in any way. response be for Britain? That is not within the remit Martin Wolf: Let me just add something on that, of our Commission but it is a very vexing question because it is a context I have thought a lot about. I because it is hard for us to see that subsidising British think it is important to be perhaps a little bit more banks, because other countries have chosen to precise about why this was, in my view, a very subsidise their banks, creates value in the short, sensible terms of reference for us and where other medium or long term for the British taxpayer. countries may stand. We are all aware obviously that the US position is, in fundamental ways, different in Q24 John Mann: Sir John, why are no other that both investment and retail banking is dominated Governments adopting your proposals? Why is it that by a very large domestic market, so it is a very we have got it so right and have they got it so wrong? different context in the banking sector, and is much Sir John Vickers: I would say two things in response smaller—a fourth as large relative to GDP as ours. to that. First, we were asked to produce proposals for The relevant comparison would be other countries of UK banking against the background of the factual roughly our size, France, Germany, Italy. At the time situation here. The factual position for the UK is when this crisis occurred, we had clearly much the different from that of a lot of other countries, in terms most severe banking crisis of these countries with the of the ratio of banking assets to GDP, which is partly most expensive rescues. It naturally led the a reflection of the success of the City of London, so Government, in the light of our position and looking that by itself is not sinister although it is a potential at some other countries smaller than ours with very risk to the UK economy. Then with unstructured high bank balance sheets relative to GDP, to ask us to universal banking you have High Street banking and look very closely at the possibility of managing the international investment banking, as it were, on the risk for the British taxpayer in the light of the same book. exposure of this industry to the world economy. It is also the case that some other countries are taking As I am sure you are aware, since you have raised the steps, if not precisely the same steps. Bill has already issue of the ongoing crisis, it seems not implausible, referred to Dodd-Frank in the US. The Volcker rule is no one is using a crystal ball, that a number of part of that structurally, and it is in a context where countries similar to ours are going to register very even after the repeal of Glass-Steagall there are forms significant losses in their banking systems in the near of separation between banking and other kinds of future and they are already being called to mount very financial activity in the same groups with Rule 23 and expensive capitalisation exercises, recapitalisation Regulation W. The Swiss are a country with another exercises associated with that. It would not seem to very high ratio, unlike the US but like us, of bank me very surprising if, in the light of that experience, balance sheets to GDP. They had a commission whose and their view of what was appropriate for their main focus was on capital and loss absorbency more countries, the management of their banking system than on structural issues, and there are other countries might move more in our direction because their looking at the matter. Who knows where policies in experience will be closer to ours, which it was not up different countries might lead, but we are not to now. So I consider that what we have done was prescribing beyond the UK. That was the task we were utterly appropriate in the light of our experience and set and that is what we have sought to do. our situation. What we were asked to do was appropriate and this story and this crisis is very far Q25 John Mann: Which begs the question whether from over. that was the right brief. Sir John Vickers: In a sense, that is not a question for Q27 John Mann: On that point, and with what the us but since you have asked it— Governor is saying and what we can observe emerging in front of us, the world is going to move rapidly Q26 John Mann: I think it is a question for you in beyond the implementation of your recommendations, the sense that because the Governor is making dire it would appear, and therefore have not we been predictions since your report, not because of your asking the wrong questions? If there is a crisis greater report but since your report, are we looking—we, than 2008, which is what the Governor is seeming to Britain plc, Government, the rest of it—far too suggest is possible, then we do not have the ability to inwardly for solutions and missing the moving world? throw taxpayers’ money at it in the way that we did Sir John Vickers: No, I believe we are not. I did say before, therefore we are in an entirely different that we are not seeking to prescribe beyond the UK. I economic paradigm. So have we not been asking the think our remit was perfectly appropriate in its wrong questions at the right time and coming up with cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 6 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf things that are about to be bypassed by the inevitable the composition is different. The Swiss have turn of events from the ongoing crisis? recommended that all 19% be capital, as in equity or Martin Taylor: This is a very important point, I think contingent capital, which is structurally subordinated made very clear in our report. We were very aware and has equity-like characteristics, whereas we have that we were not trying to design a system that would recommended that a portion of that 17% to 20% could have prevented us from suffering the last crisis. We be senior debt as long as it is subject to bail-in at the are very well aware that banking crises are inherent point that the bank is deemed unviable by regulators. in the structure of the industry as subsidised, as While it is a relatively technical difference, it is quite promoted and as structured now, and our desire was substantial in terms of expected cost. to create a structure that would be resilient in the face Chair: That is an important point. of future crises, in particular to have a structure that Martin Taylor: I do not regard the Swiss approach as would allow losses to fall without generating huge being diametrically opposite to ours. As you know, I crises for those who fund the banks. That is essentially spend a lot of time in Switzerland. I think there there what we have been trying to do. Obviously if has been a lively interest in our deliberations and our something enormous happens in the next three months report has received a lot of publicity. The biggest our recommendations will not have been challenge for the authorities there is to keep their implemented, therefore they could not prevent it, but wealth management businesses safe from the it is obvious to me at least, and I think to the other investment banks and the rogue trader loss at UBS Commissioners, that provided these are put in place three weeks ago has brought this whole subject up they will provide a banking structure that would deal again. I do not believe that the Swiss have reached the exactly with the sort of eventuality you are describing end of the road in regulating of the banking industry because that is exactly what we were trying to do. yet.
Q28 John Mann: Did you consider at all looking at Q30 Chair: As a Commission, you couldn’t have what some would suggest is the unique British timed that one better yourself, could you, to have that situation of the opaqueness of finances in so many UK popping up? Crown Dependencies and the impact that has on the Martin Wolf: You are fingering us for doing it. financial crisis that we have had? Was that part of your consideration of whether to look at that? Q31 Michael Fallon: I want to come back to costs, Sir John Vickers: We did not look at that. Sir John, because in annex 3 you discuss how the costs might be attributed round various external Q29 Chair: Mr Wolf, you have shown a big groups and so on. What range of this, whether it is £4 difference between us and America, not least on the billion to £7 billion cost, would be passed on to GDP share in relation to the banking sector. consumers? Switzerland has a ratio banking sector to GDP share Sir John Vickers: I find it easiest to think in terms of roughly the same as ours, and they are taking a very what that might imply in terms of interest rate different route, aren’t they? Did you look at that? percentages, and earlier I said that if that were spread Martin Wolf: We looked at Switzerland very closely evenly across the £6 trillion of assets then it would be in our policy. The recommendations we made, as far of the order of a tenth of 1%. That is just the starting as I can see—Bill can comment on this perhaps— point of any calculation. If it is right, as we believe, follow very closely in respect of loss-absorbing that most of the cost proportionately would fall capacity; we have come out with a very similar sort of outside the fence rather than inside the fence and if framework for that. In Switzerland’s case—they might international competition disciplines that, then the have followed this, maybe they still will—the extent of the pass through to bank customers on both domestic retail banking industry is so small a part of sides of the fence would tend to be lower than that the overall balance sheets of their giant banks, because initial figure. obviously the economy is roughly an eighth of ours, that I think they felt that merely ring-fencing the retail Q32 Michael Fallon: Sorry, lower than a tenth of bank would not be enough to give reasonable stability 1%? to what would remain as enormous global banks, in Sir John Vickers: In terms of the pass through to the the case of UBS and Credit Suisse, and therefore I final customer. presume their view was, or has been so far, that this sort of ring-fence would not be appropriate. Again, Q33 Michael Fallon: Lower than a tenth of 1%? they may re-examine this but Switzerland is on the Sir John Vickers: Yes, because of absorption to some opposite end from us. That is why I tried to compare degree within banks by a combination of measures to us with a country like France, Germany or Italy, mitigate, lower remuneration, possibly including because Switzerland has a tiny domestic market lower bonuses and lower returns to investors, one relative to the size of these two extraordinarily large would not expect one-to-one pass through to the end banks. consumer. Bill Winters: One thing to add to Martin’s comments is that I think the big difference between the Swiss Q34 Michael Fallon: You suggest this amount of 10 approach and the approach that we have basis points as an average, I think. Will some SMEs recommended is that, while the aggregate loss- pay more than that? absorbing capital number is similar—it is 19% in Sir John Vickers: As a result of the implementation Switzerland, it is 17% to 25% for a large bank here— of proposals of this kind? cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 7
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Michael Fallon: Yes. Q38 Michael Fallon: So not only will it not be any Sir John Vickers: I do not see a reason why, as a more expensive but it will increase the supply of result of these proposals, one would expect a higher affordable credit to SMEs; is that the proposition? figure. Of course out in the marketplace different Sir John Vickers: I am not asserting that it would SMEs pay for different things, but I struggle on the increase. I am pointing out that it is a framework that spot to think of why certain SMEs would have a should have a positive in that regard. How to quantify higher impact as a result of the implementation of that is very difficult, and I would not seek to do that, proposals of this kind but others, former bankers, may but I am just pointing to the structural architecture we be able to do better. would see as being friendly to SME lending in that Martin Taylor: The credit spread paid by SMEs at the regard. Had we gone for a narrower fence, which had moment, I am afraid, as the Committee is probably kept retail deposits inside the fence and all corporate aware, is many hundreds of basis points. I do not wish lending outside the fence, I think that would have to say that 10 basis points here or there does not given rise to problems and a much greater impact on matter but I do not think it will be noticed. I think it conditions for lending to SMEs. We deliberately will get lost in the roundings. If you compare it with avoided those problems by the wider and indeed flexible ring-fence design. the average bank rate movement of 25 basis points when they happen, the 10 basis points plus was, as John says, supposing that all the costs were passed Q39 Michael Fallon: It ought to ensure more through to borrowers. We do not believe they will be. affordable credit to small businesses, but you cannot put a number on it? We believe that a lot of the costs will be absorbed by Sir John Vickers: I cannot put a number on it and of other actors, by investors, by staff. course there are many other factors in the macroeconomy that affect the nature of that lending, Q35 Michael Fallon: I just want to be clear about as we all know. this. You are saying that the total cost of all this, £4 Martin Wolf: If I remember correctly, total corporate billion to £7 billion, will not make any real different lending is 10% of the balance sheet; is that right? To at all to borrowers, whether they are small businesses non-financials, of which small and medium or personal account holders. Is that right? enterprises are themselves a sub-category, to try and Martin Wolf: It is important to understand how big predict what the cost would be on a very small bank balance sheets are. £4 billion to £7 billion component of a small component of these giant sounds like a great deal of money even in the context balance sheets is effectively impossible, but you can of our current deficit, although it is pretty small certainly ask the banks how they would intend to compared to that. But the bank balance sheets are so attribute any increased costs they see. enormous that related to that it is quite a modest sum and, on our assumptions that much of the costs will Q40 Michael Fallon: I hope you understand it is fall on the balance sheets outside the ring-fence, the important to us, even if it does not appear very conclusion that the possible proportional rise on the important to you. cost of borrowing is very low is completely plausible Martin Wolf: We have devoted a lot of thought to this simply because the balance sheets, the total loans question and we have come to the view you say. I outstanding at the banks are so gigantic. would also add the point, although I do not wish to stress this in any way because it is sort of more Q36 Michael Fallon: I am just looking for the speculative, that should it be the case in normal times answer. You are saying personal account customers, that the interest cost will be a little bit higher and that small businesses, won’t notice this? would have some effect on the economy then of Martin Taylor: They should not notice the difference. course that would inevitably naturally be part of the decision-making framework for the Bank of England. It has to be, within their terms of reference, since they Q37 Michael Fallon: Should not notice the have to hit an inflation target and monetary conditions difference. would be, if that were to be the case, a fraction tighter. Martin Taylor: The balance sheets of the bank are £6 Martin Taylor: If I can put it in a more positive way trillion. If the cost is, say, £6 billion, to take a number that I think you seek, I think there is absolutely no between £4 billion and £7 billion, it is a thousandth. reason why the banks should claim that anything in Sir John Vickers: In direct response to your earlier this report should reduce the supply or significantly question, I would not say no difference at all. I would increase the price of credit to small companies, say a relatively small difference in line with what nothing at all. If they claim that there is, you should others have said. I would like to add that we are question them very closely. talking about the higher funding costs and so on. The architecture of ring-fence design we believe should be Q41 Mark Garnier: Could I just pick up an answer friendly to SME lending because it is a framework to one of Mr Ruffley’s questions? It was about where, for one thing, the retail deposits in the UK can whether the ICB report is going to make the City of be channelled into UK SME lending to non-financial London less competitive. Sir John, you answered this corporates rather than some of that going off into by saying that in itself it would not and, Bill Winters, international wholesale and investment banking, so it you said that there are other things that are going to is a framework for channelling savings into lending. be contributing to people’s viewpoints on whether or So we think that that should be a good and stable one. not to stay in the UK, particularly obviously Barclays, cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 8 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
HSBC and Standard Chartered. Given the fact that we We think we have taken one clear step in the direction have this financial regulation coming through, the of getting that right by providing certainty around the ring-fencing of banks means you are going to have regulatory environment and hopefully dampening the obviously no cross-subsidisation of the investment impact of future externally generated credit crises on banks from the retail banks. You have Basel III the UK economy so that the reaction from that coming through; you have your proposal for Basel III Government in the future when there is a domestic Plus; you have higher tax rates; you have all the rest problem need not be so impactful on the international of it. While I completely agree that in itself this report participants. That is why we think, first of all, the will not have a direct effect on the competitiveness of overwhelming majority of the British financial sector the UK banks, what consideration have you given to is not British owned; something like 15% of the the whole package that is coming through? This is British financial services employment come from now getting a very complex place to do business and British-owned wholesale firms. The retail firms are it is a very important part of our economy. not going anywhere. The wholesale firms are mobile, Sir John Vickers: We certainly strove to analyse the the capital and labour is very mobile. cumulative impact of all these things and the So we think the proportion that is affected by our difference that our recommendations would make to recommendations is a relatively small proportion of them. That was very much part of the assessment. It the total, and the improved predictability and certainty may be that Bill is well placed, given his career and for the rest is quite helpful. so on, to comment on some of the wider implications As for the second part of your question about the of your question. competitiveness of UK banks, as we have said, we Bill Winters: Sir John is absolutely right that we would expect the investment banking arms, the non focused on the cumulative impact, and of course the ring-fenced arms, to incur a higher funding cost. We cumulation was changing along the way and will think there are many ways for those banks to mitigate continue to change for some time, as we see in terms those costs, starting with changes to business models, of rules that are being put in place. The first thing which most likely do not involve lending to British clearly important to distinguish is between the corporations or individuals, although they may in competitiveness of British banks and the some individual bank cases. You would have to look competitiveness of the UK as a financial centre. I bank by bank. But carrying on from that, the cost can think our statement about the competitiveness of the be absorbed by changes in business model, changes in UK as a financial centre is unambiguous. This should structure, changes in cost base, of course lower be somewhere between neutral and very helpful to the remuneration for employees and lower ultimate position of the UK as a financial centre. payouts to shareholders to the extent that that is achievable and desirable. Q42 Mark Garnier: Discuss why helpful. Certainly my view is that British banks will come out Bill Winters: We look at the things that would cause of this at the end of the day, having gone through a bank like my former employer to decide whether to some difficult times, as in fact all banks are right now, invest in the UK or not. We look at availability of in much better and stronger shape by virtue of having resources, infrastructure, language skills, things where a policy platform implemented by their Government the UK is already a clear winner, geography, and so that is relatively clear. That unfortunately is not the on. We also look at the desirability of getting case in the eurozone. It is not the case in the United international employees to work here and the UK States right now where the rules are very unclear and historically has been a destination for the international as a result banks are having a tremendously difficult employee, both because of the quality of life and also time figuring out what to do. because of a relatively favourable tax regime. Regulation in the UK was somewhere between light Q43 Mark Garnier: Following on from one of Mr and neutral in terms of intrusiveness in international Fallon’s questions, which was about the availability of banks’ business models and corporate taxation was lending to SMEs, as the ring-fenced banks are neutral on a bigger scale. building up their balance sheet, do you not feel that The response to the crisis, quite understandably, has that will create a period of tightening credit to SMEs been to impose a cost on all members of the financial and, indeed, to retail borrowers? sector operating in the UK and it manifests itself in a Martin Taylor: As they are building up their capital number of ways, higher personal tax rates, balance base? sheet levies and much more intrusive regulation. Mark Garnier: Yes, in order to meet your Some of these things were entirely appropriate and expectations. probably inevitable in the context. Some of that might Martin Taylor: In a sense that has been happening have been avoided had the British taxpayer not needed over the last three or four years and it is always to shoulder the burden of the British banks. Of course difficult to disentangle at this phase of the cycle the the foreign banks were not bailed out during the crisis; extent to which demand for lending has fallen because they were bailed out by other countries. It was the people are not confident to invest and the extent to British banks that were bailed out here, and that cost which the banks are tightening up their terms; they on the British taxpayer had a very normal reaction, are certainly tightening up their terms from the pre- which was to impose a cost on the financial sector and crisis levels. The answer we came up with for this, introduce uncertainty to the financial sector as a because there is clearly a danger that if you move whole. That has clearly undermined the capital levels too fast, too abruptly it will have an competitiveness of the UK as a financial centre. impact, was to spread it over the longest possible cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 9
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf period of time. It is quite comforting to note, banks were safe. It turned out they were not, and then depending on what happens in the eurozone crisis, that the guarantee exploded. That is what Andy has the British banks have to quite some extent rebuilt pointed out. All I am trying to point out is it is their balance sheets since 2008, that as far as total unavoidably uncertain, inescapably uncertain. We loss-absorbing capital goes our 17% to 20% target is don’t know what the guarantee is worth because we by no means out of reach for most of them. don’t know what is going to happen to bank balance The ring-fenced bank is for all the big banks, except sheets, but it is important. Lloyds, a relatively small part of the total, so the extra Martin Taylor: Banking can be very volatile. 3% there is nothing like 3% on the whole lot. All of Martin Wolf: That is why the size of the guarantee is these factors, I think, should give some so volatile. encouragement that it will not be as bad as you might feel. Q45 Mark Garnier: My next question is who is benefiting from this? Is it the shareholders of the big Q44 Mark Garnier: Can I turn to the implicit banks, which is us I suppose, or is it the customers of guarantee, which we have sort of talked about in the the banks? To what extent do people like Metro Bank context of some of the costs as well. We still keep benefit from it? It would have been said if they had coming back to the fact that Oxera came up with an failed, but nobody would really notice in the grand implicit guarantee value of £6 billion, while Haldane scheme of things. Who is benefiting from it? came up with £57 billion dropping to £40 billion. You, Sir John Vickers: The benefits are proportionately I think, are saying £10 billion in your interim report. larger for the larger banks. There is clear evidence of Have you nailed it down any tighter? that. I believe that a bank such as Metro Bank is Sir John Vickers: We have made some progress getting very little benefit indeed. between the interim report and the final report but less than the Committee may have hoped for. At the time Q46 Mark Garnier: If any at all? of the interim report, we expressed our own view as Sir John Vickers: If any at all, yes. To the first being considerably in excess of £10 billion, and that approximation I would say zero. In terms of who is a position we held also at the time of the final benefits, it is a bit like the earlier discussion about report. You have mentioned the two studies that were costs and where they are borne. I think it is a mixture; at different ends of the spectrum and they differed by it is a combination of customers, shareholders and a factor of 10. The £57 billion is nearly 10 times £6 employees, depending on the extent to which they billion. We did further work and in the final report, would be passed through. using a Haldane-type methodology on the facts as Martin Wolf: It depends on how competitive you they had moved on—and there is a complicated point think the industry is. about the length of the debt, you use in the analysis— Sir John Vickers: It does. that figure had come down to £40 billion, as you Martin Wolf: It turns out to be a very complicated mentioned in your question. The Oxera number work question, but it depends essentially on how was commissioned by RBS, and if one varied the competitive the industry is, whether it is held by assumption about the risk-free interest rate in a way shareholders or distributed to customers. that we thought was more realistic, then their number of £6 billion got up into the teens. It is still a Q47 Mark Garnier: Well, the important point I think difference of a factor of three, which is not great but on this is that if you have an implicit guarantee— it is better than a difference of a factor of 10 and all Martin Wolf: Or by employees who are part is consistent with our statement, our carefully crafted shareholders in this regard. Sorry. statement, considerably in excess of £10 billion. Mark Garnier: Sure, but if you have an implicit Of course, the facts move on and the session began guarantee, which is effectively to the benefit with questions about the recent Moody’s downgrade. ultimately, I suppose, of customers, then does it matter Both the number of notches that we are talking about if you have one? Since the vast majority of people in and risk appetites in the marketplace and, as it were, this country are banking with the big four or five, then the price per notch, are fluid things, they move if you have the implicit guarantee by the taxpayer, the around. taxpayer is putting it up but if you take it away then Martin Wolf: Could I add one tiny thing? Assume that it is the same people who are paying for it in a there is some Government support that is expected in different way because they are going to have to pay the market, which seems to me pretty plausible, then extra costs on their bank. Is the only reason why the the value of the guarantee depends on how bad implicit guarantee is such a bad thing because it is lending decisions turn out to be ex post. We do not holding back people like Metro Bank and other small know how bad they are. We might hope that they will people coming into the market? be so wonderful that there are no losses at all, in Sir John Vickers: No, I think there are many other which case ex post the guarantee will turn out to have reasons why. no value. If it turns out that they succeed in losing sufficiently large fortunes, the guarantee will be ex Q48 Mark Garnier: Explain? post of enormous value. That is part of what Andy Sir John Vickers: I hope it is not an injustice to your Haldane’s work is about. It is clear that it turns out question to put it in these terms. It is almost as though that the market assumed, before the crisis, that the there is a merry-go-round that is robbing Peter to pay value of the implicit guarantee was nothing and the Peter. I think part of the problem is that quite a bit gets reason the market assumed it is that it assumed the lost in the process. Even on that basis, the ordinary cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 10 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf individual who may be getting a tiny sliver of benefit nobody will fund them to do it if there is a credible from the guarantee in terms of the rate at which they loss of the insurance, and if they do get into trouble can borrow, as discussed earlier possibly too small to the costs to the taxpayer should be either zero or very be noticeable, is at risk, is on the hook as a taxpayer much lower. They seem to me to be two enormous to a considerably greater extent. To iron that out also benefits. has the very important benefit of getting incentives straighter for the future, because if the banks make Q50 Mark Garnier: Can I just ask one last question? decisions in a world where there is a big guarantee On many occasions you are referring to bad lending and where the markets are giving them funding costs and the risk of bad lending and the fact that that risk as well on the basis that there is a large guarantee, can go up with an implicit guarantee. This is maybe then the brake on their risk taking is nothing like what coming from slightly out of left field a bit, but it should be in a properly market-oriented system obviously to have bad lending you need to have bad where those who supply the funds are themselves on borrowing, effectively. What assessment have you the hook for the risks. made of the financial literacy of the customers of the A lot of what we are trying to do, not just in terms of banks? I think it is quite an important point because equity capital, loss absorbency, but depositor you can’t sell something to somebody unless they are preference and all the other measures to try and get prepared to have it. If people were more financially the taxpayer off the hook, is to get the risk borne by literate they wouldn’t necessarily borrow. Have you those who provide the risk capital. We saw very made any assessment on the financial literacy of the dramatically three years ago how you had a UK consumer? dysfunctional system where those who supplied the Sir John Vickers: On your prefatory remark, I think supposedly risk capital, the equity holders, certainly one needs to look at the lender, the borrower and the took a big hit, but a lot of those who had lent regulator as well in terms of some of the practices that unsecured to banks ended up not being hit because the were going on mid-decade in the marketplace. We taxpayer was marched almost to the front of the queue have not looked specifically at financial literacy. I after equity holders in terms of loss absorbency. That believe there are studies that the regulatory bodies and incentive gain I think is terrifically important too. others have done on that subject in the past. However, part of our report when we turn to competition issues Q49 Mark Garnier: You refer to the costs as a very, and consumer choice has very much concerned the very small percentage of the £6 trillion balance sheet. information that is available to consumers. That is not Surely the whole point about banks is that it is not the quite the same as literacy, but one needs to have entire size of the balance sheet, but it is the interest conditions for informed choice for the market to work rate spread that is the profit that it is making. well and, in particular, for improved switching to have Therefore, if the costs go up you should be looking at the effect it should have in the marketplace. We have it as a proportion of the interest rate spread and not touched on the issue there, but we certainly have not the entire balance sheet, because an extra cost is a P& addressed the literacy issue head on. L thing not a balance sheet thing. Sir John Vickers: I think in a sense we are doing Q51 Chair: You wanted to come in a moment ago, both. Doing it in terms of the balance sheet sort of Mr Winters? scales it and if it were that uniform thing it would be Bill Winters: Yes, I was going to answer the question around a tenth of 1% on these estimates. But as Martin on percentage of profits. The estimate seemed to range indicated, the spreads have been much fatter than that, from something well less than 10% impact on profits certainly relative to official rates, and indeed relative to as much as 30% all in the case where the bank to official rates on other kinds of lending too in this does nothing in response to the changes. As we have current very strange macroeconomic environment. discussed a few times, there is every possibility for Martin Taylor: If you look at the implicit guarantee banks to mitigate the cost at many levels so that the as a form of free insurance provided by the taxpayer, impact on bottom line profitability should be very effectively what the taxpayer has done is to say to the small. banks, although not explicitly because it was an implicit guarantee, “You can do what you like and you Q52 Chair: You were quoted, Mr Winters, in the FT will be bailed out”. The whole market believed that as saying, I am paraphrasing, if we have succeeded in would happen, so obviously, as John said, that has a putting in place a structure to remove the subsidy then very negative incentive effect because you increase the case for the bank levy does not look very strong the likelihood that the banks do crazy things. That is any more. Could you just elaborate on that? exactly what happened in the run-up to the last crisis Bill Winters: Yes. I think the comment was certainly and it has been happening on the continent since. I broader in the sense that—and I think I commented think the problem about the guarantee in this highly on this briefly earlier—there were a number of steps globalised, very liquid banking market—very liquid that were taken in the aftermath of the crisis intended when it is going well—has been that the free to deal in short order with the effects of the crisis, insurance has constantly increased the risk that the both regulatory and fiscal. With the passage of time taxpayer was insuring and then when it all went bad and hopefully the received thoughtfulness of our the bill has been huge. If through reports like this we report, the conclusion could be we have addressed can get the incentives in the right place, we can make some of those issues in a different way through the that sort of crisis less likely, because the banks will implementation of the recommendations that we have not be able to run such high leverage again because made. To the extent that we have been successful, then cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 11
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf let’s go back and look at everything else that we have and the least cost for getting the desired effect. That done from the onset of the crisis to today and ask has been a guiding principle of what we have done. whether it is really accomplishing what it was intended to accomplish. If the balance sheet levy was Q57 Chair: By which one must presumably, listening intended to raise money, then it raises money from a to that, want to conclude that the bank levy is not the particular constituency and so be it. If it was intended least cost method? to remove the subsidy from the banking industry to Sir John Vickers: You might want to conclude that. I incent proper behaviour going forward by taxing am agnostic on the question— wholesale funding or something like that, then we are dealing with that elsewhere and the levy should be Q58 Chair: I am just trying to work out what the removed. implications are of saying, “We have done our best to get rid of the subsidy”. I am not going to prolong this Q53 Chair: Well, we do not need to do any mind but, “We think we have put in place the measures that reading because the Government themselves at the are required going forward to get rid of the subsidy”, time of the introduction of the levy made clear the so the other measures that were in places rough and levy means, “The banks will now make a full and fair ready tools—and that is a pretty clear description of a contribution in respect of the potential risks they pose rough and ready tool that I just read out—is less to the wider economy”, which must be an strong. unmistakeable reference to the subsidy. Sir John Vickers: I think Martin wants to come in; if Bill Winters: That is certainly how I took it. I could just say one brief thing on the way to that. My recollection is that the levy was not just about that Q54 Chair: Therefore, you are arguing as a and there are some issues about the nature of funding, committee, I take it, for the removal of the bank levy liquidity issues and all the rest. I think there might be if— a bit more to it. Sir John Vickers: No, I— Chair: I am just following the logic inexorably to its Q59 Chair: I have the explanation for this measure conclusion if the proposals are implemented in full, in front of me and I am not going to prolong it, but I and since we are agreed you have made as good an think it is difficult to argue that it was put in with effort as it is possible to make to eliminate the subsidy, other purposes in mind. there can’t be a case for the bank levy. Martin Wolf: This is purely personal, because we have no collective position, but to the extent that we Sir John Vickers: If I may say so, I think there might do eliminate the subsidy then that reason for the levy have been a little leap in logic there. I am no longer is certainly weakened. However, there are, in fact, chairman of the Commission because there is no arguments that financial activity and financial services longer a Commission to be chair of, but if I could just to customers more generally are under-taxed within say on behalf of the— the context of our overall tax system, particularly in Chair: I am sorry about that leap. relationship to value added tax, and there may be Sir John Vickers: As a Commission, we did not arguments, therefore, for having the levy for other address that point, and I think it would have been reasons. Economists can always find good reasons for wrong for us to start issuing fiscal advice of that kind. a tax, as I am sure you know. In our— Chair: They are such a bunch of politicians, don’t you think, colleagues? Q55 Chair: That is a quite separate question, which is do you need the money, but the case for this is no Q60 Jesse Norman: No more than you, Chairman. I longer there on the basis of the subsidy. It may be thought it was a highly mischievous line of there because the Government needs some cash; questioning. If it could be shown that the subsidy was correct? going to be eliminated, and if it could be shown that Sir John Vickers: If our measures were completely the subsidy was eliminated now as opposed to when successful in eliminating the subsidy, 100% you are predicting it in 2018–2019, and if it could be successful, then that may well be a legitimate shown that the case for taxation was not as indicated inference. We did not get that far in our deliberations. by Martin Wolf, then the Chairman’s line of thought However, we did in discussion of competitive— might have some validity. I have a question for you, Sir John. You have put in Q56 Chair: Have a go at getting a bit further now, place a relatively high backstop leverage ratio. Is there because I think this is a very important question. a danger that is discriminating against mutuals who Sir John Vickers: In consideration of competitiveness have a quite different business model to most banks? more generally, I believe both in the interim report Sir John Vickers: Yes, I understand the question. The and the final report we noted that there are various Basel III leverage backstop is a factor of 33, 3%. What instruments at the disposal of Government and that we recommend with the higher equity ratios for the our measures should be seen in that context. Certainly, ring-fenced entities, which applies to the larger ones— we did not collectively take a view, and I for my part this would not touch many mutuals at all, but it could have not personally taken a view, on what other well affect some and one in particular—is a pro rata measures could be offset in response to measures of adjustment to that leverage cap, which would take you this kind. We have tried to craft this package of from a large ring-fenced entity to a ratio of 25, measures in a way that has the least regulatory burden roughly. On our judgment, that is a backstop in the cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 12 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf sense that normally the binding constraint would not for example, most famously brought down Northern be the leverage ratio but rather the ratios as Rock. It does seem to us, and it is certainly my conventionally expressed in relation to risk-weighted position, that within the context of the global assets. Indeed, if the backstop ratio became the regulatory environment and the British banking binding constraint that might pose some sharp system those issues are quite adequately handled in questions about whether the risk weights were really other ways. I do not know whether Bill wants to add doing their job, which manifestly they did not do in to that. the run-up to the crisis. The recent eurozone debt Bill Winters: I completely agree. There are a number crisis also poses questions about the risk weights. Our of things that we did not go into great detail in in feeling, certainly my feeling, is that even in areas such our report, including, for example, reviews of liquidity as mortgage lending, which of course a number of the rules, for a very simple reason. We think they are mutuals do a very important amount of, a leverage absolutely central to the regulatory architecture and ratio of 25 does not strike me as unduly prudent and well handled by the Basel Committee already. unduly cautious. I feel very comfortable with that Likewise, we think the infrastructure supporting the recommendation as we made it. derivative business is well handled by the Basel Committee and the FSA. We refer to those things in Q61 Jesse Norman: It is certainly not a part of your our report but without going into detail because we remit, though, to do something that might have the did not have any value to add materially. In other effect of discriminating against mutuals and in favour areas where we thought that the global regulatory of banks, I take it? initiatives needed to go further or were not adequate Sir John Vickers: No, we certainly do not wish to for Britain, such as the level of capital adequacy and discriminate in that way, but we ended up with that loss absorbency, we said we like what they have done factor of 25 to 33, and let’s face it, mortgage lending so far and we need to go further in Britain. Obviously, is not risk free, certainly not. we spent much more time on those things than where we were effectively giving a tick to the efforts that Q62 Jesse Norman: No, that is true. Martin Wolf, others had taken already. the report, which I think is an excellent piece of work, does not, it seems to me, address one of the crucial Q63 Jesse Norman: Thank you both for that. In our issues behind the problems that we have encountered, commentary on your interim report, we asked if you which is the origination of transactions that were not could look at whether or not corporate governance understood at the time when they were created and might be improved in a way that assisted the stability were subsequently sold on the basis of a similar lack of the banking system. Do you feel that your final of understanding. It may be that no one understands report moved the debate on in that area particularly? them even now. Is it your view that this is a defect or Martin Taylor: We have concentrated on the were you leaving that to other legislation or regulation governance of the ring-fenced entity in the sense of to address? insisting, should Parliament approve, that it has Martin Wolf: I am not really the expert on this; I think separate independent governance from the rest of the Bill is more expert. Our sense was that within the organisation. I don’t think we felt—my colleagues terms of reference, which focused very much on may, of course, disagree—that we had anything much banking, in particular British banking, we have to add to the reviews that had already taken place on addressed the principal issues that arise in that regard. this subject. As you of course know, the question of what to do about derivatives, which many of these were, how to Q64 Jesse Norman: David Walker has done some introduce greater transparency, how to introduce work on this, but the RBS report has not been greater stability into the dealing in them, the use of published and there is no doubt that there was a clearing houses and exchanges and everything colossal failure of corporate governance in several associated with that is an important part of the global key institutions. regulatory framework as it is evolving. I think there Martin Wolf: We could not comment on a report that is a lot of debate about whether this is going to be did not appear, obviously. adequate, but it is important to remember that inasmuch as it affected British banks as purchasers of this stuff, this was the investment banking arms Q65 Jesse Norman: No. We could not also rely on purchasing in particular assets being created in the the work having been made public if it was not United States. This is part of the international made public. business, so the ring-fenced banks would be protected Martin Wolf: Precisely. from this and that would be subject to the sort of international regulation that I have mentioned. Q66 Jesse Norman: Thank you. On the ring-fence, Meanwhile, for our ring-fenced banks, obviously there do you think there is a danger that that will have the is an issue because that was a very big question in effect of increasing reliance on wholesale markets for the pre-crisis situation. Retail banks would continue either the ring-fenced or the non-ring-fenced entity? to have such access to wholesale funding, but it is Perhaps the ring-fenced entity first for a shortage of clear to us that the evolving rules of the FSA, deposits. presumably in future the Bank of England, will have Martin Taylor: I do not see why the introduction of and should have a considerable role in managing the the ring-fence should change the quantum of deposits extent of the exposure to wholesale markets, which, in the system. They may be distributed differently and cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 13
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf clearly some kind of deposits will be mandated to be opportunities for making mistakes. I think there is a within the ring-fence. widely shared view that somehow we think that retail Sir John Vickers: Without quantification, we talk ring-fenced banks are inherently safer than investment about the desirability of regulatory constraints on banks or inherently more guaranteed. We think wholesale funding of the ring-fenced entity. I just neither. It is quite clear to anybody that the retail think in the nature of things, because of the fact that ring-fenced banks can clearly make very bad loans retailer deposits and SME deposits have to be within and, indeed, I think that is one of the reasons for those ring-fenced entities, that has some implications having higher capital in them. The reason for making for wholesale funding but that should be a solid the split was not that one is safer and the other is platform, a combination of measures. less safe or one more guaranteed and the other is less Martin Taylor: When talking to the banks about this, guaranteed. We genuinely think the banks will be one of the difficulties we sometimes had was that we better structured, better run, more resolvable if the were trying to design a structure of a system, if you split occurs. Clearly, it is possible in this model for like an architecture, that would come in over a period retail ring-fenced banks to acquire one way or another, of years and that we would hope would be reasonably as we know from the past, very, very bad assets. We durable. The banks are understandably most hope they will not but history suggests that can concerned about the shape of their balance sheets over happen. the very short-term foreseeable future. The fact that most of the British banks, with one single exception, Q70 Jesse Norman: The final question if I may, Mr are quite short of deposits at the moment and so on, Chairman. I take it it is not the view of the committee, these are the things that are shaping their fears. It was or the Commission as it was, that, for example, a very much our desire in designing the ring-fence not serious problem in BarCap would not have a knock-on to disadvantage deliberately any particular business effect on the ring-fenced entity in the event that they model over any other, and that was why the flexibility were separate, the non-ring-fenced part? on assets was built into it. Martin Taylor: That is what Harold Wilson, after whom this room is named, used to call a hypothetical Q67 Jesse Norman: Why did you carve out question and he always refused to answer. securitisations, own loan securitisations, as being permissible within the ring-fenced entity? Q71 Jesse Norman: I can put the question a different Bill Winters: We want the ring-fenced bank to have way, which is what have you done to look at what access to the securitisation market should they choose happens when one of these joint institutions gets in to finance themselves partially through, for example, distress and, therefore, people want to start pillaging the securitisation of home mortgages. As is often the the ring-fenced— case with the securitisation of a home mortgage, some Martin Wolf: That is why they have independent portion of that securitisation remains on the balance corporate governance. You have defined precisely the sheet of the originator. In fact, under EU directives condition that we looked at very closely. Do we refer and global Basel directives, known as the skin-in-the- to the Enron example? I don’t remember. game rules, it may be required for a bank to hold 5% Sir John Vickers: Yes, we do. or 10% of the risk in the securitisation on their own Martin Wolf: In a situation in which, God forbid, balance sheet. The advisability of that set of rules is a BarCap as an independent entity were in serious whole other question that we did not opine on, but to difficulty and some CEO—obviously, I don’t wish to the extent that that is law and to the extent that the imply in any way this has anything to do with present UK bank wants to or needs to finance itself using the management—were in this situation to want to take securitisation market, which we think is a good thing advantage of the resources available in the ring-fenced properly structured, the skin-in-the-game rules, we bank, the corporate governance arrangements are would be obliged or— designed to prevent it. Furthermore, should it be necessary to resolve BarCap in that situation, or a Q68 Jesse Norman: You do not want to, as it were, hypothetical investment bank in that situation, we do own an entirely dead animal. At the moment you have believe the structure we have designed would allow not ruled out the possibility of someone securitising that to happen without bringing down the retail an awful lot of very bad quality debt and keeping it ring-fenced bank. Yes, we do think it would make a within a ring-fenced institution. very big difference to the continuity of retail banking Bill Winters: If a bank is in the business of originating in the UK and it would, therefore, give the UK bad debt and finding a way to hold on to 5% or 10% Government—I have been looking very closely at but sell off the other 90% to 95% they will not be in what Alistair Darling has said about the pressure they business for very long. were under—in such a crisis options that simply were not available at the time of the previous crisis. To my Q69 Jesse Norman: Or they don’t know. We have mind, and I think others on the Commission, this is had that experience in the last few years. perhaps the strongest single set of arguments for our Martin Taylor: They would be better selling off 90% proposals. of it than keeping 100%. Jesse Norman: Well, we hope. Q72 Chair: Just on BarCap, and this is a completely Martin Wolf: The ring-fenced banks would continue hypothetical question, do you think there will be brand to do banking business and in the banking business— contagion or contamination and how is that dealt and this is a very important point—there are plenty of with? cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 14 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Martin Taylor: It is possible to conceive of number of things. Everybody has Lehman Brothers in circumstances under which that might be, but the their memory. It was quite a recent event. I think that supervisors ought to have the comfort of knowing that the synapses tend to connect up. Lehmans was an if the problem is in BarCap, the ring-fenced bank is investment bank; BarCap is an investment bank; sound and so to the extent that there is a public Lehmans got in trouble; BarCap could easily get into concern about the ring-fenced bank, they can safely trouble. Lehmans did not have 17% to 20% of support it with unlimited liquidity. Clearly, that would loss-absorbing capital. It was not following the new not be a problem for the central bank. liquidity rules. There are all sorts of things that make it more difficult for BarCap to get into the sort of Q73 Chair: The ring-fenced retail bank has retail trouble in future that people have done recently. You customers who are hearing the news that the bank of cannot rule out some colossal fraud or something like the same name is going south. that, but the scale of things that would have to go Martin Wolf: I think this Governor can get up wrong to put the retail bank in jeopardy in the minds completely confidently in the situation—he would of sensible people I think are so huge that we should also be the regulator—and say, “Your accounts are not frighten ourselves. safe. We stand behind it as lender of last resort”. It did not happen in Northern Rock, as you remember. Q76 Jesse Norman: Mr Chairman, may I just ask It would seem to me plausible, though one can never one very quick question on corporate governance? be sure so this is desperately hypothetical, that under You talked about the ring-fenced entity, but you have those circumstances sensible members of the British not made any recommendation about the public will take the view that the retail bank is safe. compensation arrangements for the head of the Of course, one cannot deny the possibility that they ring-fenced entity though, have you? That person will would disbelieve the officials, but I think that it is a continue to have their comp set by the chief executive compelling situation for him. He can be absolutely and the chairman of the board presumably of the— confident of saying this. Martin Taylor: No, by the board of the ring-fenced Sir John Vickers: That retail depositor is in a very bank. different situation in this hypothetical world from last Jesse Norman: The board of the ring-fenced bank, time around because you have self-standing capital in okay. the retail entity. You have primary loss-absorbing debt Martin Wolf: Sorry, this point is so important. I think on top of that. You have primary loss-absorbing debt and the higher international standards in the BarCap we accept that there is the logical possibility, but it is part of the entity. You have much greater ease of very important also to stress that not even the most resolution. The official toolkit is much richer than it important form of contagion is brand contagion. In a was before, and you have insured depositor crisis there is extremely powerful cross-brand preference. So the retail depositor in your question has contagion. Put bluntly, if any of the major masses of protection. British-based investment banks were to get into very serious trouble, this would make people nervous. Q74 Chair: We have read your report and grasped Having a system that indicates that you can manage all those points. My concern is that however well you such crises, that you have a system for managing such designed it, I am just trying to clarify whether you crises that is reasonably well prepared, reduces the think there is a risk of brand contagion. If it is a non- likelihood of mismanagement, is far and away the negligible risk then we are still left with the problem most likely way of minimising the danger of that ring-fencing carries that separation does not. contagion, broadly defined. Sir John Vickers: Yes, and we do address that point. Chair: I am trying to identify the scale of that. Q77 John Thurso: Martin Wolf, what assessment Sir John Vickers: We do address that point and we have you made of the impact of ring-fencing on note the possibility of the risk in that direction. On the growth in the economy, if any? other hand, there may be times when it is UK retail Martin Wolf: Well, this follows from the discussion that is in trouble. One could have a hypothetical world we have had on the effect on the cost of funds and, in which there is some slump in house prices and therefore, on the interest rate that might be paid. Our mortgage books are under water, where the world view, I think, is we do not have our own growth generally is doing fine and BarCap is doing fine and model. Growth models have been developed by others can bring resources to bear to augment the resources. who have analysed this question, the Bank for Chair: Yes, I have understood that. International Settlements most notably. The Institute Sir John Vickers: The reputational point does cut for International Finance has done this, too, but I find two ways. it basically a piece of lobbying. We can argue about that, but if you look at the BIS type of work, which is Q75 Chair: It cuts two ways, but in the painful very extensive, and you put in the sort of cost of funds direction, I am just trying to clarify your view is that effects that we have looked at, which we have there is a negligible or non-negligible risk of brand discussed already, the effect on the growth of the contagion? economy is essentially so small that you could not Martin Taylor: The difficulty with the hypothetical possibly notice it. There is so much else going on. question and the reason I was so reluctant to answer Certainly, my view would be if you analyse it at the beginning is that when you talk about BarCap moderately sensible models, the effect on borrowing getting into trouble that could mean any one of a cost is so small, I do not think you could measure it. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 15
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Q78 John Thurso: On a scale of positive, negative Sir John Vickers: Not just the capital, but the retail or neutral, the answer is neutral? deposit base is very important. Martin Wolf: No, no, no. I have assumed we were talking about the growth in the short to medium term. Q86 John Thurso: By simplifying the operation to a In the long term, I go back to what John was saying, High Street commercial retail operation, you are which is—God knows we have experienced this in concentrating the mind of the banker on lending to spades—the impact of our measures in our view will those customers with the capital and resources be to reduce very significantly not only the likelihood available, assets available, and he or she is no longer of but above all the cost or impact of a crisis and it is tempted to go flirting off on an investment market. Is absolutely clear. But that is part of the growth and we that broadly it? have lost so far about at least five years of growth. Martin Taylor: That is certainly the intention. If I may add one more thing to your question about growth, the Q79 John Thurso: I am sorry, I don’t actually financial industry has been a big source of the understand any of your answer. In the medium term, volatility of the growth numbers in Britain and the say in the next five years, will what you have instability of our economy. If we can make the suggested have a negative, a positive or a neutral financial industry less unstable, there is a chance—I impact on growth and the economy? look to Martin Wolf for support—that we may make Martin Wolf: It won’t be implemented in this period future growth rather less volatile and that would be an so I would suggest it would have zero impact. extremely good thing for investment and for the SME market and for the people operating SMEs. Q80 John Thurso: Anybody like to venture an answer to the simple question? Q87 John Thurso: Broadly, what we are saying is as Sir John Vickers: I would vote for neutral for the these kick in, funds that at present are probably reason just given, in the next five years. seeking a higher return at the investment end would be more available within the ring-fence to the SME? Q81 John Thurso: Broadly neutral. In your answer Martin Taylor: Yes, but it is important to stress, as I to Michael Fallon, you said that you would expect it think Martin Wolf said earlier, what a tiny proportion to enhance lending to small and medium enterprises, of the bank’s balance sheets SME lending represents. which I would expect to be positive for growth. Are It really is a low single figure per cent, I mean 1% you discounting that in your answer? or 2%. Sir John Vickers: No, when I said I would vote for neutral that was because of the timeframe for your Q88 John Thurso: Which might be why it gets question, which was the next five years. As you know, ignored. our recommendations carry with them a timeline of Martin Taylor: SME, it is a very small amount, 3%. full implementation within seven and a bit years from It is hard to be sure that any impact on the total now. In response to Mr Fallon, I was thinking of that balance sheet of any kind at all will automatically further future not the next five years. have a similar impact on that number because it is such a small part of the whole. Martin Wolf: Like lending to house mortgages. It is Q82 John Thurso: Let me rephrase. You expect difficult to predict. nothing to happen until implementation. Once you Sir John Vickers: The same logic would apply to have implementation, it will be broadly neutral but households as to SMEs. you would expect it to help lending to SMEs? Martin Taylor: I think what we said was that we Q89 John Thurso: I am sorry to pick the nits on this, expected the supply of credit to SMEs to be affected, but I need to understand it because my start point in if anything, in a positive direction and the price might all of this was full separation. The ring-fence looks to be very slightly higher. me like a relatively elegant compromise that may do the job I am after but I want to make sure of that. Q83 John Thurso: Why would you expect that? What we are saying is that traditional business that is How will that happen? done by the High Street bank, commercial, retail, Martin Taylor: Because of the way the ring-fenced lending to individuals, mortgages, the whole range, bank is set up, which will have— will have available to it specific capital that currently might be being made available to other parts of the Q84 John Thurso: More money will be available? business that will be outside the ring-fence, which are Martin Taylor: The SME business will be a more profitable but more risky? considerable part of the ring-fenced bank’s activities. Martin Taylor: Correct. Sir John Vickers: More profitable in the good times. Q85 John Thurso: If I may, just pushing this a little Martin Wolf: Whether they are more risky, that further, what we are saying is that compared to today, depends, of course, but we are preventing— where some of the potential available credit is capital that is being used in, say, investment operations, that Q90 John Thurso: As an aside, if the Government capital cannot be used for those other things and, wanted to do something today on that, it could therefore, is available to the SMEs. That is the nationalise the rest of RBS, split off all the investment simple point? stuff and get shot of it and immediately put a new Martin Taylor: Correct. retail ring-fenced bank into play today. We could do cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 16 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf that in two months or whatever. Is that a correct have had to run smaller balance sheets of higher risks. assumption? The total quanta of risk run by both institutions has Martin Wolf: Definitely not in our terms of reference. actually been much the same, hasn’t it, if you compare the good ones and the bad ones? We certainly do not Q91 John Thurso: Can I move on to another subject, feel that the number that we have put in comes then, Sir John— anywhere near to making that dangerous. Martin Wolf: The UK Government is not the sole owner of RBS, so there are issues there. Q95 Tom Blenkinsop: The reason I ask is I do not think building societies, for example, got us into the Q92 John Thurso: Again, I think it has over 75%. situation that we are in at present. Do you think there It could, therefore, do a takeover on whatever terms are any lessons the banking sector could learn from it likes. building societies? Sir John, in answer to the point raised by David Sir John Vickers: We certainly think there are some Ruffley earlier, which related to what Lord Myners important lessons from building societies for the said about why doesn’t HSBC up sticks and go to banking sector and have drawn attention to them. In Paris, is it not the case that the French could not afford particular, there is the question of what risk taking or them, given that banks go home to die and if it had a hedging can the treasury function of the ring-fenced problem it would go home to die in Paris? bank do. We think it is very educative how it has Sir John Vickers: That begs a number of questions worked in the building society sector and the mutual about the French fiscal position, which are not just sector where that hedging activity does happen. To beyond the terms of reference but beyond me in other say you are not even allowed to do hedging ways too. I think looking at it from HSBC’s derivatives would be to rule out a risk mitigation perspective, because we did look carefully at the strategy, and then there is a big question mark: how passporting issue, we see a rather small incentive to do you draw the line between risk mitigation and do that, particularly given how we have pitched our speculative activity? I think the building society recommended levels of capital and loss-absorbing model has some very important lessons for the sector debt. Moreover, there are some pretty formidable generally, and we have referred to that in the report. practical, legal and reputational obstacles to an Martin Wolf: In fact, we consider we have learnt from organisation— it in this regard. The other aspect of it is by and large the building societies, as opposed to the converted Q93 John Thurso: The short of it is it was not a building societies, continue to rely very heavily for sensible suggestion, was it? their funding overwhelmingly on deposits. The Martin Wolf: It is not an easy thing to do. You could evidence has supported one’s prior assumption that ask them. We have looked at it carefully. It is not an that is a more stable basis for funding of lending and easy thing to do. that, it seems to me, is a strong argument for the John Thurso: Thank you very much. I had better stop ring-fence. while I am down. Q96 Tom Blenkinsop: Just one more question. Did Q94 Tom Blenkinsop: Following on from Jesse you consider lower cost methods of improving current Norman’s earlier question, would you agree that there account switching such as compelling direct debit may be unintended consequences for applying a originators to complete a switch within three days? blanket leverage ratio across all financial institutions, Sir John Vickers: In the report on that front we such as encouraging higher risk lending behaviour that focused in particular on this idea of a redirection generates sufficient returns on capital? service to improve switching so that both in fact and Sir John Vickers: I would give the same general response as before. If we had recommended a leverage very importantly in terms of customer-consumer ratio with a factor of 10, then the answer might be perception the risks of a payment getting lost or not yes, that is a risk. Instead, we have gone from the going through when the consumer has switched will Basel factor of 33 and ranged from that to the biggest just be taken care of by a redirect service, taking cost UK ring-fenced entities with a factor of 25, and at that and risk away from the consumer. We think that is a level I do not see that as an undue risk. I have very practical step that could be made within a couple responded before; I do not know if others have— of years from now. We did not look at other particular Bill Winters: I completely agree. I think we tried to things such as shortening those payment periods calibrate the leverage ratio so that it was really a directly. However, we said a number of things about backstop in sync with the core capital ratio but not what we think should be the role of the future overriding, and I think that is where we came out with Financial Conduct Authority. That seems to me a good the scaling package. example of a question concerning competition and Martin Taylor: You are quite right to suggest that consumer choice that would be squarely within the there is a question here because if you contrast the remit of that body, and it underlines what we see as behaviour in the last 10 or 20 years of the European the importance of having a strong pro competitive banks bound by risk-weighted assets, not constrained remit for that new entity to take issues of that kind by total leverage, they tended to run very large total and many others forward. asset balance sheets, running their risks by taking enormous quantities of relatively small risks. Whereas Q97 Mark Garnier: Just going back to this ring- the American banks, bound by a total leverage ratio, fencing and potential problems of pooling of liquidity cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 17
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf and capital, presumably the whole point of the ring- Sir John Vickers: European non-financial. fence is to stop money being moved from the Martin Wolf: Let’s suppose you have surplus funds ring-fenced entity into the universal bank in order to beyond your normal SME mortgage and other loans protect obviously that ring-fenced entity. What is the in the retail ring-fenced bank. You can lend to BP. provision for moving capital from the universal bank This is an example. You can lend to very, very large into the ring-fenced bank? Is there a free valve going corporates within Europe who have a demand for this. in that direction? The likelihood of trapped funds with no outlet seems Martin Taylor: When we talk about moving money to us to be extremely low. we have to be careful to distinguish between moving Martin Taylor: The head of the Association of capital and simply making loans from one to the other Corporate Treasurers made a speech saying that this by having exposure, if you like. Movements of capital was a great danger of the ring-fenced bank, but he are governed, or at least are limited, by the need for made the speech two weeks before we published the each of the organisations—in terms of the ring-fenced report. One can quite literally say that he did not know bank a slightly higher number—to keep capital at a what he was talking about. We have been particularly certain level. Clearly, the directors of the ring-fenced careful to stop that because it is indeed dangerous if bank could only move capital across by a dividend if you do not let this valve out. they had enough capital for themselves. So that is Sir John Vickers: Some forms of full split might have capital. On lending exposures— given rise to that problem as well, among others. If I could just say one thing in response to your previous Q98 Mark Garnier: This is liquidity? question— Martin Taylor: Yes, and the ring-fenced bank having Martin Wolf: The same problem with the arrangement more deposits than it needs, to what extent can it lend in the full split. to its sister organisation. The answer we came up with Sir John Vickers:—about the flow. Money can flow there was that it could lend to it exactly as it could in various circumstances. If the ring-fenced bank is lend to a third party in the market. It is limited— comfortably meeting all its requirements, then dividends can be paid, as it were, over to the parent Q99 Mark Garnier: It is exactly the normal or rest of bank. I think you had a question, what about counterparty risk? the reverse; is it completely unrestricted in the other Martin Taylor: It is actually slightly tighter. direction? What about the rest of the bank to the ring-fenced bank? That partly depends on the Q100 Mark Garnier: The reason I ask is because corporate architecture of the rest of the bank. There one of the criticisms that has come up from a number are all sorts of different ways in which that could be of people is that assuming that the ring-fenced bank done. There may be, and typically would be, is successful and assuming it is doing a very good job, constraints on the different elements of the rest of the then it will end up with a pool of liquidity in it. As bank in terms of capital requirements, so it is not you have just so rightly said, then it needs to lend that unrestricted. Typically it would not be unrestricted because that is what banks do. They have a balance going into the ring-fenced bank, because of the sheet with the customers attached and they need to regulatory landscape as it applies to the rest of the lend that money out. But is there not a possibility that bank. if you find yourself with trapped liquidity in that bank and it is, therefore, going and lending it out you might Q103 Mark Garnier: As long as they meet all their not get back to the same problem that we have had in liquidity requirements? the past, which is back to irresponsible lending Sir John Vickers: Exactly, exactly. because they have to get it out? Mark Garnier: That is very reassuring, thank you. Martin Taylor: But you won’t have liquidity traps because whereas some elements— Q104 Chair: In sum, the trapped deposits argument is a non-problem; that is what you are saying? Q101 Mark Garnier: It has to go somewhere, Sir John Vickers: We believe so, given the flexible doesn’t it? design that we recommended. Martin Taylor: No, let me explain. Some elements of Martin Taylor: We think it has been solved. the ring-fence are absolutely rigid. You have to have personal current accounts and SME current accounts Q105 Chair: Let’s sort out one other thing. In in the ring-fenced bank. You may not undertake response to an earlier question from Jesse Norman trading activities in the ring-fenced bank, but others you said that ring-fenced banks’ executive are flexible. For example, lending to large companies, compensation would be set by its board. I think you large non-financial companies, which is a huge asset did, Mr Taylor. Where is that in the report? I have class, can go on either side of the ring-fence. We did read it fairly carefully. this deliberately in order to stop liquidity being Martin Taylor: Give me 30 minutes. trapped. Q106 Chair: Perhaps you could try and find it. I Q102 Mark Garnier: Just to be clear, are you saying thought it would be in the section on the structure of that you could bring a huge corporate customer, say banking groups, which seemed the most logical place, pharmaceuticals, into the ring-fence— but I cannot find it there. Martin Wolf: They would be from the ring-fenced Sir John Vickers: I took it simply to be an indication bank. of what boards do. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 18 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Chair: While you are looking for that, I am going to Sir John Vickers: Yes, that is right. I think any bring in Andrea Leadsom on competition. corporate integration has challenges on many fronts and that is certainly part of it. One that we gave quite Q107 Andrea Leadsom: Yes, I would like to ask you a lot of attention to in the final report, more so than about the competition aspects of the report and the in the interim report though I think we flagged it there, switchings, focusing on the PCA and the SME market. was the question of funding gap. It is a completely First of all, I feel you were not nearly radical enough. different point from the one that you are raising but Clearly, the Commission was minded to agree with our assessment and evidence pointed to it being quite the Treasury Select Committee in its desire to see the a big challenge. The question about the number of proposed Financial Conduct Authority with a much branches, shares of personal current account market, stronger competition objective, but you have not is extremely important. We wanted also to add really gone that far either. My first question is did emphasis to the funding gap point, so that was very you consider, and if so what did you think, about the much part of the recommendation here. prospect of reversing the Lloyds HBOS merger? Sir John Vickers: We thought about that general Q112 Andrea Leadsom: Let me ask the question in question but recognised that the facts have moved on. another way. Do you have in your minds an idea of One can’t go back to the situation as it was. We are who it is that might become this new challenger bank? now talking three years ago from where we are now. Did you have in your minds who might take on this Instead, and I think this was the much more practical potentially poor mix of an esoteric group of branches approach, we focused on opportunities arising from that probably would not be the most successful in that the divestiture under way as a result of the European bank’s set of potential choices to sell off? Did you Commission process in the context of the state aid that have a view on who might take up the challenge to Lloyds Banking Group received and we hope made become the new PCA 6% of the market provider? very clear in the final report that we think that the Sir John Vickers: As to the mix of assets and primary aim should be to ensure that a strong new liabilities, not everyone would agree with your challenger arises on the scene as a result of that description of it, and in particular Lloyds Banking divestiture process. Group. We were careful in what is a developing commercial context. It was not our role, as a Q108 Andrea Leadsom: But you set a target for that Commission, to intervene in that process and think, new challenger to have 6% of the PCA market, which “Yes, let’s hope it is player X rather than player Y”. rules out a completely new entrant, doesn’t it? That Rather we focused on the desired outcome for would imply an existing player rather than a new competition and consumer choice in the marketplace. entrant, or do you disagree? So we have not formed a view, either publicly or Sir John Vickers: Or an enhancement of the assets to privately, about desired acquirers for that or whether be divested. it should be an IPO or whether it should be enhanced this way or that. We hope we have stated very clearly Q109 Andrea Leadsom: What consideration did you the desired outcome of a strong new challenger bank, give? Talking to the chief executive of the only new which we think is important for the marketplace as entrant, so it is not hard to work out who, their view a whole. is that the biggest challenge in banking in terms of the single customer view is the IT aspect of it. If you take Q113 Andrea Leadsom: It is fine to wish for one but a conglomerate like Lloyds HBOS now and tell it to if there has only been one in the last 100 years, one divest itself of another 300 or 400 branches or new full service UK bank in the last 100 years applied whatever, you are still faced with probably seven or for, and the likes of Tesco Financial Services, M&S eight different IT systems, so that is a significant Financial Service clearly have not or have chosen not handicap to any new player who truly wants to be a to scale up, you cannot have a policy of wanting more new entrant and achieve a single customer view. Did competition but not have any idea of who is going to you get into that level of detail? be attracted to that. On that point you have not really Sir John Vickers: In terms of IT and so on? dealt in your report with the issue of diversity of sources of financial services. Do you envisage Q110 Andrea Leadsom: Yes. Specifically, to be a retailers becoming banks? Do you envisage all sorts new player you have to have a level playing field and of new players, and who are these new players? if you inherit little odd bits of six or seven different Sir John Vickers: I think there is a variety of ways in IT systems—and let’s face it, banking is incredibly IT which the desired outcome could be achieved and it driven, having a customer view and personal current could depend on the nature of the acquirer or it could account and SME lending is incredibly important— be a de novo thing, it could even be an IPO. It depends those hurdles to successfully becoming a new entrant on the portfolio of assets and liabilities, branches, make it nigh on impossible to achieve that. personal current account, the funding gap point. There Sir John Vickers: Are you referring to the different IT is a variety of ways of doing it and I think it would systems in the different parts of the Lloyds package? have been wrong for us to specify our favourite among that possible menu in terms of doing it. Q111 Andrea Leadsom: Absolutely. If you say On the point of diversity, we hope that our Lloyds HBOS, it could be Cheltenham & Gloucester, recommendations, as a whole, are entirely friendly to it could be TSB, it could be Lloyds, it could be diversity in the sector. We have sought to avoid some Midland. rigid template that everyone has to fit, and that relates cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 19
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf to the question we had or the responses about the recommendations in the practical context that we flexibility of ring-fence design, which I think allows faced. a variety of business models within that architectural Bill Winters: I wanted to go back to the earlier framework. It relates too to the questions about comments because the overriding objective on the mutuals that came up earlier in the context of the competition side has been to create a level playing leverage cap. So, we hope there is plenty of scope in field, to the extent that the bigger banks have enjoyed what we are doing that would be helpful to diversity. the too big to fail benefit, the subsidy, and we think we I think to go beyond that and trying to engineer have addressed that head on through both the financial particular kinds of diversity would have been a step stability actions that we have taken, or that we are too far, at least for this Commission. recommending, and also through the competition powers that we are intending or suggesting be put in Q114 Andrea Leadsom: Yes, but I am not talking place for the new regulator. about engineering diversity. I am just saying it is all To the extent that we have a level playing field, that very well to say to Lloyds HBOS, “You’ve got 42% extends to the way that capital rules are determined of the British mortgage market and now you need to for new entrants and you will obviously have noticed give somebody else a bit of a bite at the PCA market” that we scaled the capital requirements to effectively but you have to have an idea of whether that is an benefit smaller entrants or smaller participants in the attractive business model for somebody. It is one thing market at the expense, effectively, of the larger to simply throw it out there and it is another thing to participants, purely reflecting the degree to which the see that it is a realistic opportunity for a new smaller participants are not systemic. To the extent challenger bank. that they are not systemic, we do not need the same level of protection in order to assure ourselves that the Sir John Vickers: I agree. taxpayer is not on the hook. Of course, many of these initiatives will make their Q115 Andrea Leadsom: We have had endless way into the way that the regulator, the PCA or the discussions in this Committee about the fact that the competition regulator in the future, approach the lack of new entrants and the lack of competition is detailed rule-writing. So, for example, the use of stifling the PCA market and the SME market. They internal models and the degree to which the buyer of are oligopolies. There are no new players, no choice the Lloyds branches will be able to benefit from the for personal account customers, no choice for SMEs; internal model credibility that Lloyds itself possesses they cannot shop around. You cannot just simply say, today that does not naturally transfer to a buyer. “We’ll divest a few more branches”. Did you look at I think we would encourage the regulator to look at breaking up RBS where, quite clearly, the taxpayer the efficacy of the system itself and the people owns it? You could break up RBS into bite-sized attached to it and not purely at the track record of the chunks. Who would buy them and did you consider acquiring entity, because the acquiring entity may not that at all and, if so, what was your conclusion and have a track record, especially to the extent that it is why? a brand new entrant. But it is impossible to anticipate Sir John Vickers: I am sure Bill wants to come in but all the twists and turns that could take place in that if I may make a couple of points, one on Lloyds and divestiture. The important overarching principle is to one on RBS. I certainly do not think we have made establish a level playing field on which new entrants just an abstract recommendation on new entrants. In can compete in the same way they compete in terms of the funding gap and its importance for a new manufacturing businesses or transportation businesses bank, the need to address that problem strongly is a or servicing businesses. very important practical point about running a business. If that point is not addressed you have a Q117 Andrea Leadsom: Do you predict then that double problem. The new entity will not be an your report is going to lead to a complete flood of effective competitor in credit markets to lend. If you new entrants to the banking sector in the UK? Is that have a very big funding gap, adding loans is the last your expectation? Is that a specific outcome that you thing you want to do. Secondly, if there is a funding expect to see? gap problem, the whole competitive and funding Sir John Vickers: Do we expect a flood of new dynamic of that entity might have a cloud over it, entrants? No. I think this is a market that for which would make it a less effective competitor reasons— more generally. On RBS we are at a very different point in the Q118 Andrea Leadsom: Do you expect more than divestment cycle. We do not have the issue to the one in 100 years? same extent as we do with Lloyds about personal Martin Taylor: This is a very difficult juncture. current accounts and we do not have 100% Andrea Leadsom: Yes. Government ownership, so there are a number of Martin Taylor: Let’s be realistic about this. All the corporate law points. recent challengers pretty much have failed, have had to be rescued or closed down. The economy is not Q116 Andrea Leadsom: I think as we have said, that exactly booming. There is an enormous financial crisis would be achievable under the Stock Exchange rules. brewing just across the Channel. There is an interest Sir John Vickers: If the facts change then the facts rate structure that makes it almost impossible to make may change, but in terms of the evidence we had money on the PCA business. It would be simply before us that is not the situation, so we made our astonishing if there were a flood of new entrants into cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Ev 20 Treasury Committee: Evidence
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf the market, as it stands at the moment. I think we within five business days or else” and have some would be smoking illegal substances if we were to system of fines, not just for banks but also the big suggest that that was going to happen, and I do not standing order providers? Rather than creating a new feel that way. entity on a suck it and see basis, would it not be better to just give them the problem and say, “You work out Q119 Andrea Leadsom: Okay, but it is clear from a solution. If you don’t we will then come at our recent inquiry that the PCA markets and the SME something far more catch all”, like the idea that we markets are an oligopoly at work. In terms of the free- have talked about of full account portability? Clearly while-in-credit current accounts, it is clear that the less that has a big cost. well off or those who cannot manage their bank Sir John Vickers: On the evidence we have received, accounts at the end of the month are subsidising the we believe that this redirection service is the right next wealthier who can and do not need to go overdrawn step, that it can be done in a short timescale of a at the end of the month. In addition, there is that sense couple of years and that the industry should get on of no consumer choice because you cannot with it and do it. There will then be a need to take differentiate because it is all free, so free means free. stock and see how that works. Some claim it will be We went to great lengths to try and identify what the transformative, others say it might not do very much. banks are making out of this. I think it will depend a lot on the surrounding context But the clear problem with that is that for any new of consumer choice, with transparency in effective entrant it is just a completely opaque market that you ways for the ordinary consumer with ordinary cannot get into unless you are able to buy a very financial literacy levels to exercise choice. But who significant market share with all of the funding and knows, no one can say how well that will work. I deposits that go with it. Likewise, in the SME market, think it would be— there has been a lot of talk just recently about the vast credit spreads being charged, that you referred to Q121 Andrea Leadsom: But wouldn’t you agree that yourself earlier, Mr Taylor, where SMEs—and there is a big bill? was a case just at the weekend of an ex-CEO of a Chair: I think we really have to move on. FTSE 100 company lending a substantial amount of Sir John Vickers: Then there is the question of why money to a bank at 0.5%, going in to try and borrow not take the further step of account number portability. the money and being quoted a rate of 10% with I do not know, we do not know, what the incremental security. That is the kind of spreads we are talking costs of that would be. I think they would be quite about and that is because, according to my substantial, but most of the estimates come from the constituency bag, SMEs cannot shop around. Their industry and I think there is a lack of independent bank is the only game in town and there is not any estimate of that. What would be the incremental choice. These are very real problems, aren’t they? benefit? That question, that last one, partly depends How do you solve that? It is not clear to me that the on how well the redirect service works in terms of ICB report has done anything that is going to improving switching. We are completely open-minded structurally change that. about that second step, and whether it would be worth Martin Taylor: We have talked about continental taking. We are persuaded absolutely that the first step banks, other EU banks branching in in the rather should be taken asap. excitable context of HSBC going to Paris but I think it is more noticeable to see what a business like Svenska Handelsbanken has done in providing business in a Q122 Chair: Could I have a couple of quick number of provincial cities in the UK. I wish we had clarification points on a couple of other things just to two or three more of those. I remember when I was finish with? Have you discussed this with the at Barclays in the 1990s, a lot of the SME competition European banking supervisory authorities and, in came from the Scottish banks because the Bank of particular, have you discussed whether their proposals Scotland, although it was not a branch in England, for maximum harmonisation would be in conformity had corporate loan offices in Leeds and Manchester with your proposals? and Bristol and Birmingham and it was not difficult Sir John Vickers: By “this”, do you mean everything? to find out who the interesting customers were. They Chair: Yes. were a source of very significant competition. That Sir John Vickers: We have certainly had several has all gone of course. But I think a few skilled, discussions with the European Commission, and I medium-sized continental banks are the best hope for think that is particularly relevant to the second part of this, not retailers. your question. As we make very clear in the report, we believe that maximum harmonisation is not the Q120 Andrea Leadsom: Right. One last question. right approach in principle because stronger banks in Chair: Be very, very quick and a very quick answer. Member State X is good for the community generally Andrea Leadsom: You have proposed a new and one should not constrain Member States. organisation to make switching happen and just talking to a couple of banks recently their expectation Q123 Chair: But you are confident they are not is that might cost around £600 million to put that in going to stymie this. place. According to your report, it is a, “Let’s see how Martin Wolf: By the way, that is a Commission it goes and if it doesn’t work enough we will do proposal, I think, and not a European Banking more”. Would it not be better to try, in an initial stage, Supervisory Authority proposal. to simply say, “Right, you have to switch accounts Sir John Vickers: Exactly. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG01 Source: /MILES/PKU/INPUT/017688/017688_o001_db_TC 10-10-11 corrected.xml
Treasury Committee: Evidence Ev 21
10 October 2011 Sir John Vickers, Martin Taylor, Bill Winters and Martin Wolf
Martin Wolf: It is important to differentiate. There are Martin Taylor: Yes, the question is that the Chairman members of that, the board of the EBSA, who are very was right, as always, and it isn’t explicitly laid out in doubtful, to put it mildly, about that proposal. the book. Chair: We don’t have to go around checking all your Q124 Chair: I have one other question that I think other advice, do we? needs to be asked. You have set out very well what Martin Taylor: No. We were relying, I suppose, on you think the minimum capital ratio should be for the duties of a board and this board should certainly today and for this environment and for the next few have an audit committee on remuneration, a bit like years, but over time this is going to change, isn’t it? the board of a public company. There is an overriding Who should be in charge of varying what that is? duty that we do spell out to preserve the integrity of Should it be the FPC, should it be some other body? the ring-fence. You do agree, I hope, that we need flexibility built into this. Q127 Jesse Norman: I think that is a very important Sir John Vickers: I think that has two parts. One is, clarification, but just for the record your position is as it were, through the business cycle there will be a that the compensation should be set by the ring-fenced role in terms of macro-prudential regulation for the company board? FPC in the UK to vary the parameters of the— Martin Taylor: Yes. The Commission is dead but I think if we had thought to include anything we would Q125 Chair: Let’s just set aside the macro- have included that and I am sure Clare would approve. prudential. Chair: I thank all of you for coming in today and for Sir John Vickers: Right. The second and I would the huge amount of work you have put into this over think much longer-term question is if in 30 years’ time the year that you have been running. It is a there were to be a review of all this, in the light of tremendously valuable exercise and I think most the evidence in between, how should that be people would agree, almost everybody would agree, conducted, by whom and so on? We have set our and even the banks would have to agree with Bill proposals in the international context and we are very Winters when he said this has probably been a more much influenced by where the Basel process has got thorough job than anybody else has attempted in this to, where it is headed and so on. I think internationally field and a very worthwhile exercise. Of course we the Basel framework will continue to be tremendously will now take further evidence on it and you have important. In that wider context we hope that the other evidence to give elsewhere, whether or not you measures of this kind would get us on a much sounder are calling yourselves the Commission or just footing than we have been. individual ex-members of it. We are very grateful that you have come in today and thank you for coming. Q126 Chair: Do you have an answer to Jesse Norman’s question about compensation? cobber Pack: U PL: COE1 [SE] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 22 Treasury Committee: Evidence
Tuesday 18 October 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon John Mann Mark Garnier Mr George Mudie Stewart Hosie Jesse Norman Andrea Leadsom Mr David Ruffley Mr Andrew Love ______
Examination of Witnesses
Witnesses: Mr John Hitchins, Senior Banking Partner, PricewaterhouseCoopers LLP, Mr John Grout, Policy and Technical Director, Association of Corporate Treasurers, and Mr Matthew Fell, Director, Competitive Markets, CBI, gave evidence.
Q128 Chair: Thank you very much for coming in assets, the credit supply will be impacted. If you allow this morning. I apologise that we are starting just a the proposals sufficient transition time, the banks may little late. We intend to run the session for an hour. I be able to adjust through pricing and cost savings would like to begin by asking each of you where you without deleveraging, in which case, although the agree with Martin Taylor’s—and, as far as we can tell, price will go up, the supply should be unaffected. the Vickers committee’s—view that there is no reason Chair: If the price goes up overall, there will be less why banks should be claiming that there will be a lending. reduction in the supply of credit as a consequence of John Hitchins: Yes. the Vickers proposals. Perhaps we should start with Chair: So therefore, you disagree with Martin Taylor John Grout and then we will move, as I am looking, and you think that there will be— from left to right. John Hitchins: An impact. John Grout: Good morning. I would have to say that Chair: An impact. It is difficult to judge how much. I have no idea which is right. The reason is that this That will be assessed on the basis of the time and the is on top of the working through of the G20 proposals taper, as it is put. Matthew Fell. on bank regulation generally, so this is a variation on Matthew Fell: Good morning. Right at the outset, it quite a big theme. is important to say that, when we speak to the entire Chair: Sorry, I just want to narrow down the question breadth of CBI’s membership, they say they are though. It is clear that there will be aspects of other absolutely up for reform and they see additional proposals that will tighten credit, but I am asking only capital as a key layer of defence against future shocks. a very narrow question, which is about the Vickers But precisely for some of the reasons that John has proposals. That is what we are looking at at the just alluded to, they are just as concerned with the moment. manner and the timing of the way that these proposals John Grout: Yes. I think that there are clearly risks are as to the absolute nature of reform, and I think of there being an effect from inefficiencies introduced, regardless of what you think about the merits of any but I would also see the possibility of offsetting of the proposals, it seems fairly clear to us that they factors that would tend to reduce that. If you look at will challenge lending, and in a number of ways. the return on bank capital, which was the target of Firstly, the Vickers proposals, both through requiring banks in the run-up to the crisis, this was very high. higher minimum levels of capital and by imposing a It was perhaps returned to a more normal return by ring-fence, that puts more capital requirement on to destruction of value in the crisis. If a more reasonable banks, and if you do that, it is pretty inevitable that return is established as more of a norm with less the cost of lending does increase. Secondly, it seems volatility, I would expect to see the requirement for to us that the ICB’s proposals go beyond the bank return on capital to be so high falling, and that international consensus, looking at G20, Basel and so is likely to significantly offset any inefficiencies on, and that we think has a knock-on impact for the introduced by ring-fencing, for example, and by the cost and availability of credit to UK businesses extra capital requirements. relative to their international rivals. Chair: Am I taking that as a tentative endorsement of Thirdly, I think it is worth while noting that these are Martin Taylor’s view? very significant structural changes proposed on banks, John Grout: Absolutely. and when any organisation goes through Chair: All right. So you agree with him. Good. John organisational change, there is an inevitability that Hitchins. there is a period of inward looking-ness about them John Hitchins: I think that the proposals will add a while those reforms take hold, so it is impossible to layer of additional costs to banks which they will seek quantify the exact impact, but our reading of the to recover from customers, or if they are pushed into situation is that there is quite a lot of downside risk to meeting the new capital standards too quickly, they these proposals in terms of their impact on the supply will not be able to do it through price increases, which and particularly the cost of lending. Given where we take quite a long time to work through, and will be are in the economic cycle and the subdued nature of forced to remove assets. If they are forced to remove lending right now, I think our message is take time to cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 23
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell make sure they are carefully and properly ring-fenced part of the bank, which has the higher implemented, have a relatively lengthy flight path for capital levels imposed upon it, so that would suggest their introduction, being mindful of the fact there are it is more likely to be a cost than supply issue, we downside risks to supply and credit. think, for credit, but the cost risk is there for small firms. Q129 Chair: Ascending concerns as I have moved Thirdly, for small businesses, particularly if they are from left to right. You are clearly very concerned that typically banking inside the ring-fenced part of the there could be risks to lending, notwithstanding your new bank set-up, then if they wish to access any of support for the ring-fence. those services that sit outside of the ring-fence from Matthew Fell: Correct. where you do your day-to-day banking activities—I Chair: All right, I have your three positions. am thinking there particularly of some of the day-to- day risk management services, like wanting to manage Q130 Mr Mudie: Mr Grout, in your paper though, exchange rate risk, interest rate, commodity prices and you said it is important that any structural changes, so on, which many small businesses do on a fairly “be accompanied by significant and practical frequent, regular basis to manage risk in their measures.” Firstly, are those absolutely necessary to business—I think the cost of those services will again continue the supply, but secondly, what are they? increase if the bank has to go to additional measures John Grout: The reason that we put that comment in to enable you to access those. Again, it is very difficult is that business uses a lot of services from banks, not without seeing the precise detail of the proposals to just lending and not just as a home for surplus funds. say who is categorically right and who is categorically They take a lot of services in terms of risk wrong, but I think, for those reasons I have just management products and that sort of thing. The outlined, the risks are that there will be an increase in attention therefore to the way in which those services cost, if not an inhibition in supply of credit to small are provided, the systems that support trade finance business. activities—simple things like issuing letters of credit, guarantees, dealing with bills of exchange and so on Q132 Michael Fallon: But your submission is and so forth—all need to be thought about. Are they categorical. It says, “It will lead to an increase in to be duplicated each side of the fence? Are they to cost.” When we asked the ICB about this, they said it be farmed out outside those activities altogether and would be ten basis points or less. Is that really such a separately contracted in from another subsidiary of the big deal? holding company at the bank? These practical issues Matthew Fell: We think that the cost will be higher need to be thought through, and sufficient time needs than that. to be allowed for implementing the regulatory proposals for all those adjustments to be made and for Q133 Michael Fallon: Do you disagree with their corresponding adjustments to be made in the clients way of working out how the additional costs are of the banks. That sort of time allows banks that are spread across the balance sheet? Is that what you not affected by these proposals, such as banks disagree about? branching in from overseas, for example, and banks Matthew Fell: Our disagreement is that when you who are not undertaking retail business in the UK of look at the range of risk factors under a ring-fence the kind that is ring-fenced, to see ways in which they setup, for small business in particular, the cost of can come into the market to bring in additional accessing those services could well increase and be alternatives that can reduce the impact of the changes higher than that. of the ICB. That is one of the reasons I am less concerned about it than my colleagues. Q134 Michael Fallon: All right. What about the cost Mr Mudie: Thank you. to households of mortgages, for example? Matthew Fell: It is not an area that we have looked Q131 Michael Fallon: Mr Fell, last week we asked at in as much detail. Obviously, our constituency is a Martin Taylor about the increase in the cost of credit, business one, so the focus of our analysis and and he said, “There is absolutely no reason why the consultation has been at the business banking end of banks should claim that anything in this report should the market. reduce the supply or increase the price of credit to Michael Fallon: Okay, thank you. small companies, nothing at all”. That is what he said. Your written submission is pretty clear to us that these Q135 John Mann: Good morning. Mr Fell, proposals will lead to an increase in the cost of “increased costs”—could you quantify how much? banking, so who is right? Matthew Fell: As I just outlined, we have not been Matthew Fell: Our view, particularly at the small able to put a precise figure on it. I think there is a lot business end of the market, is firstly just to note that in the proposals. small and medium-sized firms are much more heavily reliant on bank financing than, say, larger corporates, Q136 John Mann: A reasonable estimate to give us who can access a more diverse range of financing an indication would be sufficient. options, so the pinch point could particularly come at Matthew Fell: It is not a figure that I have to hand, I the small company end of the market. am afraid. Secondly, when you look at the Vickers proposals, it seems to us that it is a reasonable assumption to make Q137 John Mann: You must have some basic that the majority of SME banking would sit within the impression. We cannot consider your evidence cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 24 Treasury Committee: Evidence
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell credible without some indication of what “increased Q141 John Mann: Is what you are saying that the costs” would mean. Governor and the Chancellor, in concentrating on this Matthew Fell: I don’t have a percentage to give you area, are missing that bigger picture? They keep today, I am afraid. What I can say is that, again, purely saying, “This is the critical one. This report is the as a statement of fact, if you put higher levels of critical change”. Are they missing the picture and at capital on a bank, that might be for very good reasons the same time disadvantaging British business and and brings increased stability, which is a good thing, British consumers? but there is a trade-off there because the higher levels Matthew Fell: I am not sure I would agree that they of capital you impose on banks, then the cost of are “missing the bigger picture”. That would be a lending against that capital, the logic is that that question for them to answer. But I do think that if you increases. think about the major global financial institutions that operate in the UK, of course the Vickers Commission Q138 John Mann: That is the theory, but we are is a very significant regulatory reform facing those dealing with what is said to be part of a solution to institutions, but if you think about the spread of their the biggest financial crisis in 50 years, so we need an global operations, I would say those three that are the impression. If you are saying there is an important pillars of reforms that are happening globally will be flaw in what has been put to us, to the British people, just as significant. we need to be able to quantify that in some way, rather than vague generalities, or rather, you need to be able Q142 John Mann: Mr Hitchins looks like he is to quantify it to convince us. bursting to come in. Finally, isn’t this a huge missed Matthew Fell: I can only repeat that I don’t have a opportunity, as the 300 Club is intimating? The big specific percentage figure to give you today. point has been missed and was diverted into an important but small side point at the expense of Q139 John Mann: I must say that does weaken your dealing with the heart of the problem that created this argument then. Yesterday, the 300 Club spotlighted financial crisis. what they describe as, “irrational and dangerous John Hitchins: I agree with Mr Fell that you need to market behaviours” and indicated that they regard this see the Vickers report as part of the overall jigsaw of as the serious issue that has been unaddressed, and financial reform, and it is only one piece of that. To they specifically identify three problems in terms of deal with investment banking, which is a global investment banking: complexity of instruments and business, you have to have a global reform. You models, which creates a feeling that a “free lunch” has cannot deal with it solely on a UK basis. What the been possible; increased focus on products as opposed Vickers report proposals do is essentially produce to investor needs, and relatively benign markets, protection for UK retail banking, the banking within which have created the view that in the medium and the ring-fence, from a disaster in the investment long term, markets will always rise. They have got it banking market. right, haven’t they, in their assessments of the John Mann: We hope. problems with investment banking? Matthew Fell: I think some of those concerns are Q143 Jesse Norman: Mr Hitchins, you have certainly there, absolutely, yes. obviously spent a lot of time advising banks over the last 20 or 30 years, and it looks from your CV as Q140 John Mann: But the problems in the world though you have a very long list of big banking financial markets did not come from retail, they came clients. Could you just talk for a second about how from investment, yet we have this report, and all it the cost—whether it is 10, 20 or 50 basis points, does is suggest some British tinkering not adopted, as whatever it may be—of the reforms is going to be you point out, elsewhere in the world, and totally spread? There seemed to be some suggestion among misses the problem in investment banking that these the Vickers Commission panel members when they investment specialists say created the problem. So came to see us that, as it were, the banks might be isn’t this report a huge missed opportunity? able to eat part of the costs themselves rather than Matthew Fell: It is important to say that the pass it on, yet we are hearing worry here that the costs Independent Banking Commission’s report is not the will just be passed straight on. What do you think the only game in town, so there are, outside of the scope likelihood is of that? Certainly when John Vickers was of this, a number of other very significant reforms talking about this, he drew attention to the fact that taking place that will perhaps have even greater the cost of the reforms would be £7 billion, and also ramifications for the investment banking community, pointed out, rather mischievously, that bonus including major reforms to require them to hold compensation in the City of London was about £6 significantly higher levels of capital, particularly for billion, and therefore clearly thought that there was globally important institutions. Much more robust and scope to eat some of that cost within the banks. intrusive regulation and supervision I think is going John Hitchins: The problem with that remark, of to be there as well, and then proposals to operate course, is that a large part of that compensation is globally on so-called recovery and resolution models paid to banks that are foreign-owned and therefore so that in the event of a crisis there is a plan and unaffected by the ring-fence, so to a certain extent the people know what to do, and that will prevent the compensation issue is just in the investment banking spread of problems. That combination of three aspects piece as a principal issue. of very important reforms will do more to address Clearly, like any other business faced with the some of the concerns that you have just outlined. substantial increase in one of its core costs, a business cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 25
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell has a choice of trying to pass it on to its customers or would that individual be properly independent and absorbing some of it, and the likelihood is that it will able to take a stand on behalf of the depositor base do both. Because of everything else that is going on, against the less responsible, potentially, elements? this is a piece that is overlaid on top of a lot of other What is your view on that? Do you think there are costs that banks at the moment are having to absorb, things they could do to strengthen that? In fact, they so the scope they have for doing it through cost- promised in their report—they suggested that the cutting is reduced by the fact that they are having to compensation for that individual and the absorb a lot of other costs as well. Their returns on compensation within the ring-fenced bank should be equity are currently depressed, and they face a set by a board, but they themselves will be appointed business need to get those returns back up to a level by the shareholder, so you have the question of where they at least cover and give them a margin whether they would be really independent. above the cost of capital, because without that, they John Hitchins: The other piece of the jigsaw that are unable to attract future external investment and we helps in this situation is that they would all be subject go into a potential spiral down once again into another to the FSA-approved persons regime, so to a certain crisis. So they are not in a strong position at the extent, the regulator has the direct power to monitor moment in order to absorb much of that cost how they behave. The other part of the report is that themselves, which is why we believe they will they are tasked with a specific duty to monitor the inevitably seek to pass it on. Where they pass it on ring-fence. In other words, as directors of the ring- will of course be partly driven by the power the fenced bank, they have an additional duty on top of customers have. Customers who have the ability to go their normal fiduciary duty as directors. elsewhere will probably suffer less than customers There is always a risk that there will be a conflict over who are more dependent on bank finance. strategy, and that is the situation that will have to be managed when it arises, but one would hope that the Q144 Jesse Norman: There are certainly segments approved persons regime and the close and continuous in the banking market that we have examined supervision regime that the FSA has would enable the witnesses on that appear in many ways grossly regulator to intervene if that became serious. uncompetitive in relation to equity origination, for Jesse Norman: That is helpful. Thank you very example, on the wholesale side, or some of the client much. services personal banking on the retail side. Presumably, those will be areas where it will be easier to pass on the cost to the customer. Q149 Chair: Just on the fiduciary duty, and to be John Hitchins: I cannot predict exactly where it is clear, is it correct that their duty to monitor the ring- because I don’t have a detailed study of the market in fence stands alongside their general fiduciary duties front of me, but as a general principle, if a customer or ahead of it? has an alternative, he has more buying power than John Hitchins: We don’t know that answer yet someone who doesn’t. because the report merely says that they should have that duty. Q145 Jesse Norman: Who would you expect to lose out? Who takes more of the loss and who takes less Q150 Chair: It seems a pretty crucial question, does of the loss? it not? John Hitchins: The market that is probably the least John Hitchins: That is the quote. Yes. affected is the large corporates, because they always Chair: If it sits alongside, their job would be to have the opportunity of raising money directly and balance these various duties off against one another, they are not as dependent on bank finance. Smaller which would lead to radically different outcomes. businesses will probably suffer a bit more than larger John Hitchins: I would agree that is certainly businesses. something that needs to be dealt with in implementation. Q146 Jesse Norman: And presumably individuals. Chair: All right. Mr Grout, you wanted to come in John Hitchins: And possibly individuals. earlier. John Grout: Only in respect to the relative impact Q147 Jesse Norman: So it is not just that the cost of between large and small companies. Certainly large the Vickers report would be higher in the shared view companies do have the opportunity to use other of at least two members of the panel, it is also that sources of funding. They also have access to non-UK- they would disproportionately fall— based banking. They can shift the relationship John Hitchins: It is likely that the proportion will not between the funds they raise overseas for deployment be even across the portfolio. overseas and funds they raise in the UK for deployment overseas. That is one of the sorts of Q148 Jesse Norman: All right. That is helpful. We examples of adjustments that you will see on the went around this a little bit with the panel from the customer side, and this is easier for larger companies. Vickers Commission when they came in, which had to Mid-sized companies and SMEs have much smaller do with the Government’s arrangements for the ring- freedom. I think the key there is they have not only fenced bank as opposed to the non-ring-fenced bank. in practical terms less access, but their negotiating The worry was that the ring-fenced bank would have powers with the banks are smaller, and you will see a chief executive appointed by the shareholder, that is that banks tend to bundle what they sell to them, the non-ring-fenced bank, and the question was, particularly the mid-sized companies between SMEs cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 26 Treasury Committee: Evidence
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell and very large companies. John Kay I know is very that he received no representations during the course interested in bundling. of his time sitting on the Commission from any of the When you price the whole relationship, it is very hard likely candidates: Barclays, HSBC, Standard for the customer to understand what the expensive Chartered. Is that the assessment that your firm has as service is that he is buying. Is it the borrowing, it is well of the situation, that it is highly unlikely that some kind of derivative activity? Is it advice? In the there will be any moves? In fact, Martin Taylor went UK, mid-sized companies will often contractually further. He said he had not heard any suggestion that undertake that they will only do those ancillary any UK bank would relocate abroad. What is your activities with the lending banks. In the United States assessment? of course that would be illegal, but in the UK, it is John Hitchins: I think our assessment is that it quite tolerated. That is where the pressure to recover remains unlikely, but there will be a point at which the more will be more successful. cost-benefit equation may change and it might become worth moving overseas. There are— Q151 Mr Ruffley: Some questions for Mr Hitchins on the competitiveness of the City of London and how Q153 Mr Ruffley: Could you say a bit more about it will be affected by these proposals. The ICB that? Absolutely, this ICB set of proposals is but one conclude, and I quote, “The historical record does not part of the equation. suggest there is a strong link between the success of John Hitchins: There are a number of factors here. UK banks in wholesale investment banking and the There is always a potentially significant tax cost in success of the City.” Do you share that assessment? moving headquarters overseas. That is one, and that John Hitchins: It is certainly true that historically the will differ significantly from institution to institution. City has not suffered from having an increasing The second issue is the regulatory cost, and we regard foreign ownership of its activities. There are certain the argument that a bank might move overseas aspects of this report that will give UK-owned because they would get a softer regulatory touch investment banks a potential competitive disadvantage somewhere else as probably unlikely, because the way against foreign-owned within the City. That will not regulation is changing and the way regulators are necessarily impact the overall City, but it is a separate coming together, I am not sure that there is a major policy question as to whether we want to have financial centre in which you would get “better national champions in investment banking. treatment” from the perspective of the bank. Matthew Fell: Could I comment on that as well, just Within the Commission report, there is the possibility very briefly? that a bank that has a European subsidiary could try Mr Ruffley: Sure. to move its UK banking business into the ownership Matthew Fell: I think it is clearly right to say that the of that subsidiary and then branch back into the UK City and the UK more generally have benefited from and avoid the ring-fence. foreign banking institutions being here, but I think it is equally true to say that it is important that we retain Q154 Mr Ruffley: Do you think that is a possibility? a strong domestic banking market, because the two of John Hitchins: That is certainly possible. It is a them are important for a number of reasons. First, we hugely complex thing to do, but the ring-fence itself had a pretty vivid illustration in 2007/2008 that is quite complex. The unknown is the attitude of the foreign institutions have a tendency to pull back from regulator in the territory concerned. It might fail overseas markets in times of a crisis, which would simply because the regulator in the territory concerned leave UK businesses and consumers more exposed in does not wish it to happen. the event of any future shocks, if we hadn’t a strong domestic banking market to fall back on. Q155 Mr Ruffley: Without naming any names, is Secondly, it is very important for competition reasons PwC advising on any structure like that? as well. Business is pretty clear that it wants a diverse John Hitchins: Not that I am aware of. and competitive banking market, and if you have that mix of domestic and foreign players, it is important Q156 Mr Ruffley: Final question. Where has that for that. proposition come from? I understand it, and it looks Finally, as with any other business, headquarter an elegant way of circumventing the ring-fence. location really does matter for the UK’s general John Hitchins: It comes from reading the rules that competitiveness and our economic potential. If you the ring-fence cannot override the European law that think about the impact in terms of employment, permits European banks to branch into the UK, so a investment, tax contributions and so on, we would not branch of a European bank in the UK cannot be made want to jeopardise a strong domestic market as well, subject to the ring-fence, because European law would not least for the cluster impacts it can have with a lot trump the ring-fence. It is an obvious theoretical of other professional services, firms and things like possibility. It is an extremely complex thing to do, and that congregating around that activity, so there are therefore the point at which someone does it is when good reasons why we would want a strong domestic they decide that it is not that much more complex than market as well as making sure the UK stays a good complying with the ring-fence. home to foreign institutions. Mr Ruffley: That is fascinating. Thank you.
Q152 Mr Ruffley: Back to Mr Hitchins. Martin Q157 Andrea Leadsom: Apparently, Mr Fell, in Taylor, when I asked him about the possibility of UK your submission from the CBI, you said, “The ring- banks moving their headquarters abroad, suggested fence will increase the total capital and liquidity cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 27
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell requirements on banks, as capital and liquidity will would like to use outside the ring-fence but is become ‘trapped’. This will both restrict and add to restricted from doing so in that situation. the cost of lending, which at least in part will inevitably be passed on to customers.” The ICB denies Q161 Andrea Leadsom: Yes. Specifically with this. They feel that liquidity will not become trapped, regards to the difference in equity requirements and specifically they have said it is because you will between ring-fenced and non-ring-fenced parts of a be able to choose which parts of your large wholesale group, could you see that there might be an incentive lending can sit inside of the ring-fence so that liquidity to transfer activities from the ring-fenced part of the does not become trapped. Do you still believe that group to the non-ring-fenced and vice versa for your concerns are right, and if so, why? reasons of simply the lower equity requirements? Do Matthew Fell: The level of flexibility that the ICB has you think that there is a risk of that? put forward in its final proposals is very helpful and John Hitchins: Clearly the banks need to do some mitigates some of that risk. I don’t think it takes it long-term capital planning in deciding, for those away entirely, particularly on the liquidity side of activities that are optional, which side of the ring- things, because you still need to have assets and fence they would fit them. Moving whole businesses, liabilities on either side of the ring-fence in kilter, and once they are in the ring-fence, back out again will be the job of balancing those off is trickier if you are quite difficult, but it is possible that they might try to doing it in the two separate bits of a ring-fence set-up book certain transactions outside or inside the ring- than it is under the entirety of a bank, so I would say fence, depending on where the surplus capital is. I those concerns are mitigated by what the ICB has put don’t personally see that as a problem, because that is forward in terms of flexibility, but it doesn’t take away subject to the normal capital management of any bank. that risk entirely. Q162 Andrea Leadsom: In answer to Mr Ruffley’s Q158 Andrea Leadsom: Do you think that that has question on passporting, I think you are saying that an inevitable impact on the cost of activities inside the all of these things—artificial moving around of retail ring-fence? Will that be passed on from the bank businesses between ring-fenced and non-ring-fenced, to the customer? between European branches and UK branches— Matthew Fell: If the situation arises where there is would be theoretically possible, but potentially too an element of capital liquidity that becomes trapped, difficult and not really worth the effort unless the ring- clearly if it is on the liability side, you would need to fencing becomes truly onerous. Is that a fair take on additional assets to get them back in kilter, assessment? and those assets at that point are not being put to John Hitchins: Yes. That is a fair assessment. productive use, so that would result in an increase in cost. Under that set of circumstances, yes, I think it Q163 Andrea Leadsom: Mr Grout, do you have would add something to the cost, and I think it is anything that you wanted to add to that? naive to think that at least part of those costs would John Grout: On the trapped liquidity and capital, I not be passed on to the end customer. think the trapped capital point has been dealt with. On the trapped liquidity point, remember that UK banks Q159 Andrea Leadsom: You might feel this is tend to have a shortage of deposits against loans, and slightly outside the remit of the CBI, but do you think the ability of banks to bid for deposits or to reduce there is a risk that if there were excess assets in the the competitiveness of their bidding for deposits retail ring-fence, it could lead to again foolish or means that liquidity, I would have thought, is uneconomic loans being made that kind of fuel the manageable over a sufficiently long period and that fire of the next bubble? Is that a potential unintended you are unlikely to get long-term effects like this. It consequence of trapped liquidity? is perhaps something that I am less concerned about. Matthew Fell: As you say, our focus has been very Andrea Leadsom: Okay, thank you. much more on the business impacts of this, but it would seem on the face of it that that danger of Q164 Chair: Could I just clarify one point? Do all increasing a moral hazard style set of circumstances of you think that over time the regulators are going to could be there if the assumption is that that is the be capable of keeping up with a flexible ring-fence for much more protected bit of the bank. the purposes of wholesale lending and the innovation that is likely to take place in the market? Q160 Andrea Leadsom: Mr Hitchins and Mr Grout, John Hitchins: They will need to be adequately do you have any thoughts on that trapped liquidity, resourced to do it. Part of the flexibility—providing trapped capital? the way it is implemented is done through something John Hitchins: I think that the two are different, like an FSA permission, so something that can be because it is clear that the ring-fence was designed changed fairly quickly—is a strength, because it does with the flexibility to allow surplus capital to be give the regulator the power to act fast if somebody moved between the two parts. Liquidity is more designed an arbitrage opportunity. The danger with a difficult, because surplus liquidity in the ring-fence rigid ring-fence is that people do find ways of would be subject to the economic independence arbitraging it and then it is very difficult to stop it. constraints—large exposures and so on, restrictions on There is an advantage in the regulators having the transactions between the two sides—so you could get flexibility and power, but they do need to be properly surplus liquidity in the ring-fence that the group resourced in order to monitor it. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 28 Treasury Committee: Evidence
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell
Q165 Chair: Okay, but I asked you whether you If the Chancellor demanded that the public sector thought they would be up to it, not whether we would make their efficiency savings of 0.1% of a £6 trillion be capable of writing a— cost, you would say they are not going far enough. John Hitchins: I would say they need more resources Why are you so anxious that this fractional, additional than they currently have. potential cost by 2019 is going to be the problem you think it is? Q166 Chair: So you disagree with the Governor, Matthew Fell: I hope we conveyed in our response who says he thinks we need less resources to do this that our primary concern is with the timing of the job properly, not more? introduction of these proposals rather than the John Hitchins: In a steady state, he may be able to proposals themselves per se. If those costs come to reduce the resources, but the complexities of bear through to 2019, when with a fair wind the implementing this mean the FSA—or the PRA, as it economy will be much more resilient and able to will become—does need significant resources now, in absorb that cost increase, I think our concern is less my opinion. than it would be, which is good in terms of the Vickers proposals, than if the proposal on the table were a rush Q167 Chair: But do you think they are up to it, on to implement all of this over the next 18 months to the basis of evidence we have had so far of two years. That is why we have emphasised concerns regulatory performance? about the timing of implementation as much as the John Hitchins: If you set aside the regulatory nature of reforms. I think it is that timing aspect that performance leading up to the original 2007/2008 is the real concern. crisis, the lessons learned have significantly changed the way the regulator operates. Q173 Stewart Hosie: That is of course why the Vickers Commission gave the 2019 timeline, because Q168 Chair: These replies are not filling me with it was in tandem with the Basel timeline. confidence and enthusiasm for the— Matthew Fell: Correct. Why we have emphasised that John Hitchins: Well, I cannot sit here with my hand that is a sensible timetable is because we know that on my heart and say, “Yes, they are up for it. They we still operate in a climate where, for very good are fine,” because we have a relatively short period of reasons, people are keen to see bank reform and the new style of regulation working. greater stability measures introduced as soon as possible, and the trade-off there is the timing of when Q169 Chair: Your answer really is you do not know, the economy can withstand the reforms. I am just keen but you hope so, and it is going to cost a lot more. to put on the table that we shouldn’t lose sight of the John Hitchins: Yes, correct. fact that we think the Banking Commission has come up with a sensible timetable. Q170 Chair: Does anybody else want to add anything to that reply? It seems to be quite a crucial Q174 Stewart Hosie: That is helpful. John Hitchins, issue. the ICB’s recommendations do go beyond the current Matthew Fell: I would just add that having high- global consensus. Do you or PwC have any concerns quality regulation in terms of overseeing the flexibility that all of this might be in vain if we find out that the that would exist in the ring-fence is clearly an UK ends up being unable to deviate from common important part of making it a success, but high quality, European rules? I think, is not unique to this. It is something that has, John Hitchins: There is that possibility that if the as Mr Hitchins has suggested, been on an upward CRD IV gets enacted on a maximum convergence trajectory since 2007, much more robust, and that basis, the UK cannot impose any super-equivalent trajectory needs to continue. capital rules.
Q171 Chair: So we need regulators to up their game Q175 Stewart Hosie: How real do you think that pretty dramatically if we are going to make a success fear is? of the Vickers proposals, is what you have just told John Hitchins: It is a real one, but I don’t know us. Yes or no? Am I putting words in your mouth? enough about where the negotiations have got to as to John Hitchins: I think the point is they have upped where we are on that. their game significantly, and they will need to continue to do that. Q176 Stewart Hosie: Just on a more general point, whether we are able to do this or not, notwithstanding Q172 Stewart Hosie: Matthew, you seem to be the potential risks and whether they are real or not, why most anxious about the future loss of credit has no other major economy as badly affected by the availability or the potential increase in cost, but you financial crisis gone down this domestic restructuring could not put a figure on it. Could we assume Vickers’ route? £47 billion cost is correct, that the largest single John Hitchins: I can’t answer that, except that clearly element of that is the withdrawal of the implicit the two major economies most affected directly by it taxpayer subsidy through the special liquidity scheme, were the US and the UK, and the US has gone off in and that does amount, as Michael Fallon said, to a different direction with the Dodd-Frank legislation. somewhere around 0.1% of a £6 trillion asset base? If I don’t think the others have had quite as big a bail- the private sector were asked to absorb costs of 0.1% out as some of the others. Their own economies were of a £6 trillion asset base, you wouldn’t bat an eyelid. not as dependent on financial services, so although cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 29
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell they have bailed banks out, they didn’t have as big a Q180 Chair: In any case, Vickers is saying no later section of their economy affected. than the beginning of 2019 and you are saying no earlier. Q177 Stewart Hosie: Nonetheless, this is a question Matthew Fell: I am not saying no earlier than 2019; to all three. You would presumably still fundamentally I am saying, “Don’t rush to do it all in the next two agree that what we have with Vickers, in addition to or three years.” Basel, makes sense in terms of long-term macroprudential stability and the removal of systemic Q181 Mr Love: I really wanted to just get a risk, or would you not? comment on the idea that the UK is in a unique John Hitchins: I agree with the principles of the ring- position. It is a major international financial centre, fence. I think there is a question about where you but in terms of comparison with bank balance sheets calibrate the capital. You could do the ring-fence and and GDP, it is really closer to the range of Switzerland still just have the Basel III capital arrangements. or Ireland than it is to the United States or indeed Chair: John Grout, I know you wanted to come in. some of our European competitors, and therefore there John Grout: Just on the timing of the implementation was much greater onus on Vickers to come up with of Vickers and its relationship to the timing of the the long-term solution that would address the need to Basel III implementation through CRD IV and the ensure that we didn’t get ourselves into the position other changes that are being put through, the one thing we were in in 2007/2008, even more than the United we do need as early as possible in that process is States. Don’t you think that Vickers had the clarity of what the rules will be by the end of it, responsibility to ensure that the package he was because these adjustments, both on the part of the delivering would ensure that we did not find ourselves financial institutions and on the part of their customs, in that position once again? take a long time. If you are an ordinary company now John Hitchins: I would take exception to the word thinking of undertaking anything significant that is “ensure”, because I don’t think anyone can ever do going to require banks providing you services—even that. lending you money down the track, you will need Mr Love: Absolutely. more money once the factory is built and you are John Hitchins: Vickers is a mechanism for making funding working capital and you hope your business sure that the cost of resolving another crisis is a lot is growing—there is a need that investors now can see less, because it would be a lot easier to do, and it also clarity that the banks they are currently dealing with will be there and able and willing to do things for gives a degree of protection to the retail bank for a them down the track. They will not have that clarity sister investment bank getting into a disaster, as I have until we know precisely how Vickers may be said earlier. It is clearly a fact that the UK was more implemented and precisely how CRD IV will come dependent upon financial services as a proportion of out and all the other changes are clear. As soon as the economy than many others, as you say, possible, we need clarity. Implementation can come Switzerland probably and Ireland. That in itself means later. that this is a more serious topic for us, yes. Matthew Fell: I would like to put on record that I agree with that, the clarity. Q182 Chair: Thank you very much for coming today. Before I close the session, is there any major Q178 Chair: Just while we are on this timing issue, area that any of you felt you wanted to get on the do you think that there is a risk, as we are already record that you have not had the opportunity to talk seeing with some of the capital and liquidity about? requirements, that the markets are forcing the banks John Grout: There is one I would just like to mention, into early action, which is therefore leading to which is the reaction you were alluding to in terms of unnecessarily tight conditions at a time of stress? This people beginning to early-implement what is is what the banks are arguing. If so, how are we going proposed. The reaction is already underway in the real to protect ourselves from the risk that this happens economy as well as in the banking sector. Companies with Vickers? are reacting, for example, to the downgrading of the Matthew Fell: I would agree that that threat is there, British banks, particularly to single A recently. They and we are seeing patterns of that emerging, are responding to that. They began to respond earlier particularly in terms of capital ratios specifically. this year. We have seen a lot of companies seeking to reduce their dependency on borrowing from the two Q179 Chair: Do you have specific proposals on how now single A banks, and we have also seen companies we can protect from this, how Vickers can be beginning to experience difficulty in having enough designed, how the proposals can be implemented in a credit limit marked by the company for the bank for way that protects us? both depositing and doing derivative and other risk Matthew Fell: The next steps, if you like, in terms of management product business with them. Those Vickers, will presumably be a further set of detailed adjustments are already taking place. You see proposals from HM Treasury. I think the political companies inviting in, for example, Japanese banks response and mood music around that will be very they did not used to deal with in order to bring in important in terms of confirming the table that Sir more possibilities. That adjustment is underway. That, John Vickers has outlined in his report. The political I think, is benign. reaction to that could be a strong signal to send to There is also a possibility that there is a negative early the markets. adjustment, which is investors in banks demanding cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 30 Treasury Committee: Evidence
18 October 2011 Mr John Hitchins, Mr John Grout and Mr Matthew Fell that their balance sheet look as soon as possible as it to make competition a primary objective of the is supposed to look in 2019. regulators? Chair: That is the point to which I was alluding. Matthew Fell: We certainly agree that competition John Grout: I think that second point is to be urged should be an important objective for the regulators, against. and my point on— Chair: Urging against it is one thing. Stopping it is Chair: Cautious man. another. Do you have any ideas? Matthew Fell: Cautious, yes. I don’t have the full John Grout: It is very difficult. report in front of me, but there was a lot in there that John Hitchins: The only other point I would raise is we recognised and echoed. that I think it may be very difficult for the UK to go Chair: This is prompting more comment. it alone on bail-in-able debt, given that the investor market in bank debt tends to be an international Q184 Mr Love: I just wanted to get your comment market. on whether switching should be, as has been Chair: That is very helpful. You are all chipping in suggested by the Commission, a procedure, or now. whether we should take on board the hardware Matthew Fell: We have not spent much time on necessary in order to allow account number switching, competition today, but I just emphasise that it is which would be much more efficient but at important that competition, particularly in the small considerably greater cost. and medium-sized business banking market, receives Matthew Fell: From the business banking market, I as much attention as it does in the consumer space, think that number portability is of lesser importance and quite detailed but small pieces of proposals in than this ability to transfer security. That is what we Vickers in terms of switching processes and the ability see as the major driver for the small business banking to transfer security from one bank to another is pretty market in particular. critical if you are going to— Chair: Thank you very much for coming before us today. If you have further thoughts as a result of this, Q183 Chair: You have seen this Committee’s report which experts often do, please put them on paper and and those proposals. Does the CBI agree with those we will consider them in written form. Thank you for proposals? In particular, does it agree about the need coming in today.
Examination of Witnesses
Witnesses: Mr John Kay, Cass Business School, and Dr Peter Hahn, Cass Business School, gave evidence.
Q185 Chair: Let us get underway, because we are Chair: Dr Hahn, have you any preliminary thoughts overrunning slightly already, but we will allow you to on those two questions? sit down. Thank you very much for coming before us Dr Peter Hahn: I would disagree a little bit. There this morning. First, I would like to ask a few questions are banks, some like Standard Chartered, which have of both of you about what you think the behavioural limited activity within the UK, where it would make response will be from banks to the ring-fence a decision easier on this if it starts to affect them in proposals. Why don’t I start with John Kay? I will certain ways. It is not clear necessarily how it would divide it into two questions. Do you think any UK affect them. Other banks, would they leave? As I think banks are going to relocate as a consequence of the you heard before, the costs of leaving are so high that Vickers proposals? we have to see what the eventual costs would be. John Kay: A possible consequence is that Barclays will split itself up and Barclays Capital would relocate its headquarters. Q187 Chair: Yes, but that is not a very happy Chair: So the answer is yes? situation, is it, trapped banks who decide not to push John Kay: I think that is certainly a possibility. off? What we really want is a globally competitive industry. Q186 Chair: Okay, and do you think that investment Dr Peter Hahn: No, and I think there were a number banking net will be attracted to the UK or will move of allusions before about looking at doing business in out of the UK as a consequence of the ring-fence? the UK through foreign entities that raised a number John Kay: Overall, it will not make much difference. of long-term questions, but I would go back to the The majority of the investment banking activity that foreign investment banks that are in the City. Firstly, takes place in London is undertaken by foreign a number of them do business here through branches companies, the subsidiaries of foreign companies, and and those branches have activities that tend to fall will continue regardless. I think what we are talking under ring-fence restrictions. We might find that some about is, as a whole, relatively modest compared to of the investment banks that are here will curtail the total investment banking operations of the UK- certain of their business activities in the UK. Many of located banks. Of course, in relation to HSBC, which them have retail accounts to a limited extent. They do is one of the big ones, that is a global bank whose lending, certain lending activities out of the UK. Will UK retail activities are relatively small in relation to that force them to do headcount and some of their the total. business activity here? Potentially, yes. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 31
18 October 2011 Mr John Kay and Dr Peter Hahn
Q188 Chair: In the scale of things, where would you as a separately conducted activity. That is one group place Vickers against other alleged causes of decline of issues. in attractiveness of the UK with respect to location; I am also concerned as to how we regulate the treasury for example, the bank levy, the 50% tax rate, the activities of the retail banks we are creating, because adverse alleged political culture? one of the things that happened in the past was that Dr Peter Hahn: Vickers right now is about the banks’ the treasury operations of retail banks grew until in reaction to it. If I were running a bank, I would be effect these businesses were running investment banks quite passive in my response right now and I would through their treasury, or certainly activities with like to see how it plays out, how some of these details many of the characteristics of investment banking. are fleshed out going forward over a number of years. Finally, I am concerned to re-establish the culture of I do not think I would stand up and protest quickly. I retail banking. I think the majority of people in these would wait and see, so I had more— retail banks would like to do the kind of business they did traditionally and we all want them to do, but I Q189 Chair: In the scale of things, do you think think they have been infected over the last decade by Vickers is likely to be a major driver of location or do the transaction-oriented culture of investment you think it’s more likely to be a 50% tax rate or a banking. That is behind a lot of the complaints that bank levy or none of them? your constituents would now have about the nature Dr Peter Hahn: They all add up, certainly, but I do and kind of services they have from their retail bank. not see the Vickers report as really being a major issue with that, with perhaps the exception of Barclays. Q192 Jesse Norman: That is an incredibly helpful Chair: Okay, that is the same point that John made answer. We have four issues you have identified. One earlier. is, as it were, the “lobbyability” and the Dr Peter Hahn: Ultimately, when one thinks about “implementability” of these proposals. The second has where one wants to locate, part of that equation is to do with the indirectness of the policy levers that where your major business is. Many corporations are remain to Government, given the universal banking located in the UK because it is easy to raise capital model. The third would be potential abuses of the here, but capital is now easier. For Barclays’ treasury function even within the ring-fenced investment banking activities, will they be more in businesses. The fourth would be the culture of retail New York in a few years than in the UK? banking. Could you talk a little bit about the treasury issue for a moment? As you said, treasury functions Q190 Jesse Norman: Professor Kay, can I just talk have become enormously expanded under universal to you about the ring-fence? Would it have been banks into significant profit centres in their own rights. better, in your view, to have gone for full separation? Do you think they have been materially affected by You have certainly argued in the past that there have the Vickers proposals? been concerns that might motivate that kind of fuller, John Kay: It depends on more detail of the more direct approach. implementation of the Vickers proposals than we yet John Kay: On balance, I would have preferred full have. The objective of clamping down on the treasury separation, but I think 98% of a loaf is pretty good operations can be done. As I see it, what we want is and I am fairly happy with that. If one went for full treasury operations that do what banks traditionally separation, there would be a set of additional use the treasury for, which is essentially to manage complications, just as there are a set of additional their day-to-day imbalances between deposits and complications with this solution. This solution, I think loans and should not regard them as activities from if it is properly implemented, achieves most of what I which they seek to make a profit in their own right. was hoping to achieve through a separation. That is the key distinction. That can be implemented partly by sets of rules about what these banks can do, Q191 Jesse Norman: What are the parts that are but probably better and more effectively by a missing? What is the bit you would really like to have supervisor, whoever he might be, saying, “Come off seen that is not in here, because it did not go down it. This is not a treasury operation. This is an the route of full separation? attempted profit-making activity”. Now, that is a hard John Kay: One large issue which has just been raised line to draw, but there is a difference in scale which is that we now have years for the banks to fight you can see. If we have the right kind of supervision, against this, so I have a serious worry as to whether that might be possible. the ring-fencing that is ultimately implemented will The other thing I think we need to do, which is in be what most of us want and need. That is one worry. Vickers, is restrict the derivatives transactions that the This may come up in some of the other questions that retail bank can conduct. Basically, a properly you raise, but I would have preferred to have had a conducted retail bank would want to be trading in cleaner solution that had more separation between the interest rate swaps just to manage its book, but I different banking activities of a universal bank that cannot see that it needs to engage in other derivative would have enabled us, for example, to direct transactions. Government funds to the support of business lending and mortgages, if that is what we want to do, or not, Q193 Jesse Norman: As a final question, I note in if it is not what we want to do, instead of remaining what you have just said that you would be supportive in the business as we are at the moment of feeling we not only of potentially regulation and legislation, but have to support a very large operation or not do so. I also of a specific duty on the regulator to manage the would like, for example, to see small business lending relationship with the management of the ring-fenced cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 32 Treasury Committee: Evidence
18 October 2011 Mr John Kay and Dr Peter Hahn bank to ensure that the treasury function was properly I would hope that you might think about a different carried out along the lines you describe. concern on the cost of capital, which is not the cost John Kay: Yes, and I have also wondered about of capital calculations that are being made by the putting that kind of duty on the board of the retail banks on the one hand and the critics of the banks on bank. the other, but the fact they cannot raise these huge increases in capital requirements that we are imposing Q194 Jesse Norman: That is the question I wanted on the banks in capital markets, which are not willing to come to, which goes into really the issue of culture. to provide to the current banking structure the scale If that board is being appointed, with the exception of of capital that would be required either under Basel or non-executives, by the shareholders, that is by the Vickers. The money is very largely going to come larger entity, and if that board is setting the from their own retained profits. One of the problems compensation arrangements for the chief executive, as we have is that the small business part of the banking we now learn—it may be in response to questions that system is seen as a source of these earnings, which we had at the last meeting with panel members—do can go and build up their capital base. That is what you think that culture can ever really be retained, or concerns me a lot. The other restrictions that we have do we need stronger promise of corporate governance imposed have rather made it easier for them to and stronger cultural signals to the ring-fenced entities cartelise that activity. to return them to the kind of banking that we all want? John Kay: I think it is a real difficulty. As we all Q197 Andrea Leadsom: Are you saying that the know, and you have heard these people in front of costs will rise to SMEs? You are not commenting on you, investment bankers who now run large the availability of lending, but you are saying that conglomerate banks are rather strong personalities and banks will need to make more out of their SME so are the group of people they lead. Whether you business to keep in retained profits to meet their can create entities within holding companies that are capital requirements? effectively insulated from that kind of approach I John Kay: I think we have to worry about the impact think is a real difficulty. of capital requirements, which is a different worry Jesse Norman: Thank you very much indeed. from the worry that the withdrawal or the partial withdrawal of the Government guarantee on the whole Q195 Andrea Leadsom: Very interesting, thank you. of the activities of the universal bank will raise the I would like to just talk to you a bit about the impact cost of capital. Ideally, looking ahead, one would see of the ring-fence on the cost of lending into the wider there being a different cost of debt to the ring-fenced economy. In particular, last week Martin Taylor told entity, if it was properly ring-fenced, than to the us there is absolutely no reason why banks should universal bank. If a retail bank was being well claim that anything in this report should reduce the managed, it ought to have a lower cost of debt than supply or increase the cost of credit to small the investment bank. It is only in the interim that we businesses. Now, to the contrary, we have heard a lot have a single cost of capital against the whole. of reports from industry that that is not the case, that in fact there will be restrictions on both credit and Q198 Andrea Leadsom: I know Mr Garnier is going increases in the cost of credit. I would be grateful if we could get your views on that. to come on to talk about competition, but specifically John Kay: One very clear starting point, which I think in answer to my question, all things being equal, is came out a bit in the evidence you had last week, is the ring-fenced arrangement going to lead to an many people do not realise just how small, in the increase in the cost of lending to small and medium- context of overall bank balance sheets, lending to sized enterprises and is it going to make it harder to businesses and SMEs is. Lending to non-financial, get loans for them? non-property businesses by UK banks is about John Kay: I take the view that the Commissioners £200 billion. It is between 3% and 4% of their total took last week that this is not a significant element, balance sheets. either positive or negative, on the cost of loans. Andrea Leadsom: Right. Q196 Andrea Leadsom: Yet that is what drives the John Kay: I would hope in the long run if there is a real economy, employment and all the rest of it. proper, effective ring-fence, it should reduce it and John Kay: Yes, and that is why I was talking in my make obtaining loans easier for the reasons I have answer to Mr Norman really about separating out that described. element of the overall bank, because it is so vitally Dr Peter Hahn: And segment the market quite a bit. important from a public policy point of view and yet Overall, costs of borrowing are going to go up for subsumed at the moment in this great universal funding, capital, everything. There are a number of banking activity. The fact there is a rise in the cost of requests that are going to be pushed through. When capital or may be a rise in the cost of capital to the we look at small and medium-sized businesses, the universal bank as a whole, the part of that that relates term is a little bit too generic. If we have really small to this crucial activity is really quite small, but the key businesses, my little business, I have to put up a point I would want to make is that margins in that are guarantee to borrow money. That is easy for banks to going to be dependent primarily on the competitive do. Essentially, those are wealthier people putting up structure of that particular part of the industry. We their personal assets behind their businesses. That know it is not very competitive. There are not many business is a good business. In fact, it tends to almost players in it. fund itself, the amount of assets they have in the bank, cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 33
18 October 2011 Mr John Kay and Dr Peter Hahn compared to what banks lend, it sort of self-funds were saying, “No, no, no, you have nothing to worry itself. about. They will manage to find a release valve into It is above that level—the sort of mid-sized business, large lending.” Who is right? which I think is much more the core of employment Dr Peter Hahn: Did you see the news yesterday from to the country—that is the real problem, because it is Wells Fargo Bank in the United States? that group that borders on the area of buying multiple Mark Garnier: I have to say no. services. You have heard a little before about Dr Peter Hahn: It announced that its earnings were packaging of services and all these things. Cutting up down because it is attracting deposits as one of the the provision of those services between the non-ring- stronger banks and they cannot lend it, so they now fenced, the ring-fenced creates inefficiencies. It may have this problem. I think there is the whole liquidity make it undesirable to provide credit to some of those question with what is inside the ring-fence bank. I companies and to monitor what the profitability of heard also a bit of amusing news yesterday. I am sure doing business with one of those companies might be. you saw the Deutsche Bank casino exposure. I think there is a potential risk for the mid-size. The Deutsche Bank apparently has US$4 billion to $5 large companies have choice. billion exposure to Las Vegas casinos that are in It further boils down to the concept of even though it difficulty, all of those made as loans conceivably is a small business and we have five players there, by could have been in a ring-fenced bank. They are not region, we often find—and have discussed this—that derivative securities and so this concept that it is there is often one or two players in a region. While it purely safe is one that we need to probably focus on may look like there are even five or six players in the a lot more. country who play it, you may find that your choice Having liquidity, traditionally the more restricted the is one bank. I do not see new entrants coming into activity, you found narrow banks, eventually with that business. management trying to try to find a way to use that. Can regulators stay up with that game? Q199 Andrea Leadsom: Just turning back to what Mr Kay said earlier about the cultural change, just to Q201 Mark Garnier: Let me create a scenario for pursue that slightly, within this ring-fence, because of you. You have a situation where you have a ring- the fact that by definition it will be a tiny proportion fenced bank, which is essentially a kind of retail bank, of the overall activity of the group and it will tend to which does have potentially this ability to lend to the be focused on the SME and personal current huge corporates, but possibly may not, as we have account—although there might be one or two other found in the case of Wells Fargo. We have huge things in there—does that mean that there could be a corporates who we know have quite a lot of cash cultural return to that sort of old style of banking that anyway, plus they have access to capital markets and we loved, where your bank manager played golf with all the rest of it. You end up with a retail ring-fenced you and understood your business and so on? Is that bank with a pool of liquidity that then has to go and a possible silver lining to this? lend this money, because of course they have to have Dr Peter Hahn: I would be very, very careful with two sides of the balance sheet. They go and lend this that. The ring-fenced side will not be that tiny, money and we get back to a situation where we are because it has the retail aspect to it, which is bigger lending irresponsibly, creating a bubble in terms of than the SME side in many ways. We forget about credit and creating a bubble in terms of property technology of banks. Today, when you apply for a market. Why is that scenario not going to happen? mortgage, if you do it online, by the time you get the Reassure me that it is not going to happen again. money it is totally automated. We do not want Dr Peter Hahn: No one knows. This is obviously the somebody to go back from that. It will make it more challenge. Do you know when you are there? The expensive for everybody. The work that is done at the banks that will make those decisions at first will coalface is a lot more customer service, but it is not probably look like they are doing the smart thing or it in the provision of credit and the efficiency of is an interesting opportunity or maybe they have seen providing credit. a few other banks do it, but it is as you go further That is one of the critical things that we forget in this along the line. In a way, this potential liquidity trap— kind of report about SME-type lending. We automated and I think it is a potential one—does create those a lot of what amounts to retail credit, but business problems, very clearly. credit cannot really be automated. Every business is John Kay: I am puzzled by this whole line of unique. So it is against this tension of how we think argument, because until very recently we were told about providing credit to the industry. Should Vickers that the problem in the UK was that UK deposits were have addressed more about ways potentially to not enough to support UK lending. If you go through standardise provision of credit to smaller businesses? the numbers, the huge element that we have not really I think it would have been very helpful, because it is discussed at all this morning is mortgages and just going to grow as a problem. mortgages are by far the largest part of bank lending Andrea Leadsom: Thank you. to the non-financial economy. In terms of the potential lending by banks, if we just look at the numbers as Q200 Mark Garnier: The CBI, when it put in a they are at the moment, there is £1.3 billion to written submission, talked about the fact that there £1.4 billion of residential mortgages. would be pools of liquidity gathering in the ring- Mark Garnier: Trillion, not billion. fenced bank, and yet when I was talking to Martin John Kay: Sorry, trillion, yes, of residential Taylor and Martin Wolf last week at the ICB, they mortgages. There is £200 million, I was describing, cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 34 Treasury Committee: Evidence
18 October 2011 Mr John Kay and Dr Peter Hahn of lending to non-financial, non-property businesses, utility part of the banking structure might have a another £200 billion to £300 billion of lending to common infrastructure company. When we look at property businesses. In addition, the Government, as eight or nine years of implementation to have a we know, has a total funding requirement which is common company that services bank accounts behind now in excess of £1 trillion. The idea that there are banks, it creates an amazing advantage to potential not enough safe assets around to absorb considerably resolution of bank failure, maybe allows other front- more than all of UK deposits is just not supported by end providers to participate in it. That just seems to the numbers. I do not see it. have been totally not addressed.
Q202 Mark Garnier: The point I am trying to make Q204 Mark Garnier: That is a US model, is it not? is that still we have a pretty inflated property market. Dr Peter Hahn: No, I do not think it is anywhere, but We have a huge amount of debt against that. Part of I think we have to face the fact that retail banking—I the reason the property market got to where it is is speak to a lot of banks and hope they are not that we had a credit bubble. What is to stop that offended—is a commodity business. It is a mature happening again in the future under the ring-fenced commodity business and it is a utility. We need to bank? I suppose my question could be asked in a think more about it as being a utility. Now, that means slightly different way. Will the ring-fencing of banks basically different people, but a common potentially increase the risk of another property and infrastructure company that provided the same service credit bubble in the future because there is a lack of would cut massive costs out of the retail delivery ability or reduced ability to move the money around systems. within the universal bank? Mark Garnier: It would allow more competition— John Kay: My answer to that is I do not think we have Dr Peter Hahn: And risk resolution. You just switch done very much to stop there being another property the accounts. The failed, you just switch them to bubble, particularly in the commercial property another bank. market. Insofar as we have done anything, we have to John Kay: I have pushed these utility analogies very hope that the FPC will do something in relation to hard, because I think even if people have been fussing that. I rather share your reaction to that observation. in the last few days about not enough competition in That takes me back to the point I made earlier that I energy, taken as a whole, utility regulation has been a would like to see a lot more siloing of banking lot more successful than financial services regulation activities so that we can direct policy to particular over the last 20 years. What we do in an area like this areas of banking instead of doing what we have been is exactly what Peter has described. We set up a rather unsuccessfully doing in the last three years, separate company for the monopoly infrastructure, which is attempting to pull these very long and bendy which is not allowed to be vertically integrated, and strings on universal banks in order to have some we regulate its costs and we impose requirements of specific part of the universal bank to do what it is access. That is the way we regulate the gas and we want. electricity grids. We have moved not quite far enough, but a long way towards that in telecoms. We should Q203 Mark Garnier: Is it not the case that the real do something similar here. answer to the problems that we have here is that we should have a lot more banks? It should be much Q205 Mark Garnier: Why do you think the ICB has easier for new banks to set up ab initio in not addressed this? Kidderminster or in Leeds or wherever it happens to John Kay: The ICB was asking what is the minimal be where there is a demand. Part of the problem is change to the structure of the industry they could that we have a very poor clearing system that does not propose that would achieve the objective of allow for ease of access and we have a regulatory eliminating or reducing the tax-based subsidy to regime that seems to be causing slightly more investment banking. That is the framework in which I problems for new entrants to the market than it does see it. in terms of helping. Dr Peter Hahn: The regulatory regime is always Q206 Mark Garnier: This is a patch rather than a going to be penalised for failures in banks and it will new boat, as it were. Here is a million dollar not receive an award for the economy doing well. The question—or a trillion dollar question, sorry—do you Government in a sense gets the upside and the think we should start again and have a think about downside. The regulator only has the downside. The this type of model that you are discussing and really regulator trying to be more conservative is going to have a serious conversation about this to resolve the be part of the process. problems once and for all? Another omission that the Vickers report made, which Chair: That is not a leading question. answers some of your question, is that the retail side Dr Peter Hahn: No, no. The driver for all of us as of banking, even paying out the SME side of it is taxpayers is eliminating what costs are in a failure. We largely a utility. The average person chooses their have to allow failure. That is the point of capitalism. bank because it is close to where they work or where Coming up with structures like a common their house is or some other convenient factor that is infrastructure, for example, allows easy failure there. They look at it similar to the water company, in without disruption to the system. Here, I think this is my view. If you think about the way we regulate tinkering rather than stepping back and saying, “How utilities, in large part it is about cost control and do we get there?” Now, the Basel regulation on making sure that costs are not pushed through. A resolution, the resolution side really focuses on cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 35
18 October 2011 Mr John Kay and Dr Peter Hahn isolating key services and how to do that, but it does Q209 Mr Love: Mr Kay, I was intrigued by your not really give us a guideline. Somehow moving comments about diversity. We are just about to start an towards common infrastructure companies does investigation into a new financial conduct authority. I provide that, so the resolution effort of regulation is have been one that has been quite engaged with the heading in that direction. idea that there should either be an objective of a John Kay: If I could come back to an issue, there is financial conduct authority or they should have regard less of a need for more banks than there is for more to diversity. What is your view on that? diversity of banks. Our problem is not simply that John Kay: I think they should have a primary there are not very many banks, but that to most people obligation to promote competition. Implied in the they all look the same. That is something that promotion of competition is the promotion of historically regulation has encouraged and still does diversity, because for me the essence of competition encourage. If you want to have a licence for a new is not just that several people do things. It is that bank, not only is it hard work, but in order to do it, people try to do things differently. If they do them you have to promise to behave like an existing bank well, these things get imitated. If they do things badly, and recruit the people around existing banks in order then they bear the consequences. That is how to operate it for you. competition creates progress. Mark Garnier: That is a very interesting point. Dr Peter Hahn: On the competition aspect for the Thank you very much indeed. FCA, there is an inherent conflict in that a bank has a product that needs to be approved. It is looking at a Q207 Chair: So the regulation is a barrier to certain profitability of that. Encouraging competition increasing competition. in certain product streams, does it create a lower profitability for the institutions that want to be the John Kay: In that sense, it is a barrier to entry and innovators? Do we stifle innovation by having a competition. regulator look at safety and look at competition at the Chair: Before bringing in Andy Love and George same time—the same regulator? It is a point that Mudie, Andrea Leadsom wanted a quick rejoinder on confuses me, because they are normally looking at one of the points. safety. To give them the burden of competition may create quite a conflict for them. Q208 Andrea Leadsom: Yes, it is just this idea of common infrastructure. I spoke to members of the Q210 Mr Love: I am interested in what you have ICB before they did their paper and put it to them, to say. I was not primarily interested in the issue of “Surely this has to be worth considering”. The competition. We have a view as a Committee in response was that it was out of scope. It seems to relation to a primary objective of competition. me—and I would be interested to probe you slightly Coming back to the diversity point, as we spoke about more on it—that if you had a common system that earlier on, there is likely to be—because of the ICB was perhaps owned by the Bank of England, any recommendations—greater competition for retail financial institution that wanted to plug and play could deposits. That may well squeeze out certain sectors of do so. It would even be set up by PFI. It does not the marketplace, particularly in the provision of even have to burden the banks or taxpayer with the mortgages. I wondered whether you think that your cost of setting it up. The receipts obviously would be limited support for diversity would be enough to the licence fee. You would have a common system ensure the continuation of a diverse market or will we where every bank was in effect white-labelling its see further concentration as a result of the products on the top of a common system. You have recommendations of the ICB report? then immediately full account portability, but also in John Kay: I do not see myself why it should promote addition you have the ability for the Bank of England concentration. I think you are thinking about your to withdraw access from its own customer accounts to small specialist mortgage lenders. I do not see why a particular bank if it thought it was in difficulty. I they should be disadvantaged. I guess they might be have, as yet, to find someone who can really say why disadvantaged if big retail banks become better at that is not going to work, so the Chair is kindly serving their customers than they have been in the last allowing me to challenge you to prove that it would ten years. But if they do that, I think that is the way work. the market works. Dr Peter Hahn: Why should it not be owned by the banks? As much as their accounts go into it, they can Q211 Mr Love: You reassure me. You also be mutually owned. mentioned this issue of implicit subsidy being at the John Kay: I am sure you will hear from people as core of the ICB reports. When they came before the to why it would not work. I can remember having it Committee, they were confident that they had either explained to me in enormous detail why separating eliminated or certainly were very close to eliminating the electricity grid from the supply of electricity it. Do you both have a view? Are you as confident as would not work and so on, but of course it did. they are that this will be eliminated as a consequence Chair: The banks will be listening to this hearing. of the changes that they are recommending? Even if there are not many people in the room, I am John Kay: If the ring-fence is tight and effective, then sure someone down there is listening. If they have I think it very largely will be. good reasons for objecting to the proposal that our Mr Love: How about you, Dr Hahn? witnesses seem to think it is a good idea, they had Dr Peter Hahn: The practicality of it is quite better put it on paper and send it to us. different. If you have a very large investment bank cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 36 Treasury Committee: Evidence
18 October 2011 Mr John Kay and Dr Peter Hahn and non-ring-fenced operation in the same company, banks will start to look like—those are the ones that it has long-term swaps with major pension funds, the Government will choose. insurance companies, it is spread out all over the It goes into a much greater stream. What ICB did not system and it has a crisis, is their confidence shaken grasp is that the forces in regulation and economics in their ring-fenced bank at the same time? Possibly right now are creating an atmosphere where no it is. As I pointed out, I am not sure the ring-fenced country wants to be seen going forward bailing out a bank is as safe as it might be built to be. The question banking business in another country. No government is if there is a problem in a ring-fenced bank, does it wants to take it to its taxpayers and do that. That poison the non-ring-fenced at the same time? These creates a burden both ways for us in the UK, because things are maybe years and years away where the we have foreign banks that are here and our banks are market can look at them quite differently. Maybe they going there, of course. In this, there is an acceptance need to have different names on the front door as well of the EEA rules that are there. I wondered whether to establish that they are totally separate, even though the Commission should have flagged the point that the they may have the same ownership. For the time problem going forward is those rules and that we as a being, I think they will feed off of each other and will nation need to make it clear that our resources can be that way. only provide support for what is done in this country. John Kay: If I go back to my analogies with utility Other countries are moving that way. How do we get regulation, we have experiences there of these kind of together and fix that problem in Europe, as opposed mechanisms that they worked. When Enron went bust, to just saying we cannot do anything about it? Wessex Water was essentially unaffected, both John Kay: There are several important issues there. operationally and financially. In a slightly different One is I think it is the case that if we set up the regime form of ring-fencing, we were able to liquidate that is being described, we will not allow retail banks Railtrack and Metronet without that affecting the to fail. What I hope will happen will be that if they operation of the trains or the tubes. We have come close to failing, we will put them into resolution, experience in getting the kind of resolution and ring- take over and sell the operations, and perhaps some fencing separation, not only of having proposals of creditors will take a haircut in that event, certainly the that kind, but of making them work in practice. They people who are in the bail-out capital that Vickers has could be improved, but I do not think we should throw proposed and conceivably other creditors. We will go up our hands and say, “When the crisis comes, we through the kind of resolution that we should have will just have to sign very large cheques anyway, as been able to do, but were not able to do for the banks we did in 2008.” that failed in 2008. Yes, the reality is that the retail banks will be protected. Q212 Mr Love: You may well have started a What I think we will, however, be able to say with completely new line of inquiry in terms of utilities, reasonable confidence, is that protecting the retail but we are here to deal with the ICB report, bank does not oblige us to bail out any failed unfortunately. I just wondered, the credit reference investment banking activities. We are not in that agencies, at least certainly in the shape of Moody’s, position at the moment. We are very far from that seem to have taken a view. It downgraded 12 banks, position at the moment. We have created a global but it said about the five larger, more systemically expectation that essentially any large, failed financial important financial institutions that it was a reduction institution should be bailed out. of systemic support by one to three notches. How do Could I also just pick up the very important points Dr you read that? Do you read that as they are confident Hahn has made on the international side of things? that the ICB recommendations will eliminate it or do One is to say that there are issues here we have not you think they are hedging their bets? dealt with yet. If you remember, in 2008 Kaupthing John Kay: I think they are not sure yet. It is clear that operated a subsidiary in the UK; Landsbanki operated the British Government is moving towards the door, a branch in the UK, which meant it was regulated and but it is not clear it has got there yet. For the moment, ostensibly protected in Iceland. That was a mechanism it plainly has not got there. that did not work. It is the mechanism that is still there. The corollary of that, as he says, is it is not at Q213 Mr Love: Do either of you have any sympathy all clear why the British taxpayer should want to bail for the view put to us by a leading universal bank out depositors in other countries of UK financial chief executive that contrary to the ring-fence institutions. The population of Iceland who did not improving the situation, over time the ring-fence will think that Landsbanki was their problem had a point. be seen to “have a protected status”? Do you think As it happens, I have a Barclays France account, there is any danger that the market will come to look which I recently learned is now the responsibility of on the ring-fence as where the Government could not the UK taxpayer, rather than the French taxpayer. I possibly allow it to go bust, even in desperate am not clear why, as a UK taxpayer, I should be circumstances? pleased to know this. Dr Peter Hahn: Yes, I think that is very much an appearance of, “How do you stop that from Q214 Mr Mudie: John, you put great attractiveness happening?” I think that is a real danger. Again, there into diversity. As that was the sort of thing that got us is that example of good old Wells Fargo Bank across into the mess we are in in the first place—the the sea. There is a perception it is a big retail bank movement of banks into casino banking—what is your and it cannot be allowed to get in trouble. Ring-fenced limit on diversity? cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Treasury Committee: Evidence Ev 37
18 October 2011 Mr John Kay and Dr Peter Hahn
John Kay: Diversity rather than diversification. What coming at them at the same time. Which ones go first? I meant by diversity was really different business Which ones do they do? Then dealing with capital models, the kind we were closer to having when we shortfalls and sovereign problems, it is almost too had at least building societies as well as banks, which much change happening at one time. operated in a different style with somewhat different products. Q219 Mr Mudie: My wife says men cannot multi- task and it sounds as though this is the same as that. Q215 Mr Mudie: Were they really that different? Dr Peter Hahn: My wife says the same thing. I have John Kay: No, they were not that different. By the made three dinners at the same time for my children. end, they had become much the same. That was the process we saw really from the 1980s, in which Q220 Mr Mudie: Are we not all falling into the same almost all financial institutions turned themselves into conventional thinking that the banks would love it? these large, multi-purpose universal bank-based The Government does not want to rush them so they financial conglomerates. conveniently forget those phrases in the report that say “as soon as possible”. Q216 Mr Mudie: They did that themselves. The Dr Peter Hahn: Yes. government helped them and encouraged them, but John Kay: Yes, eight years seems to me ridiculous. In they did that themselves, because of the rewards the the life of an investment banker, eight years is infinity. boards and chief executives saw that were available. They did not do that because the original model failed. Q221 Chair: Before I ask one more question, do Maybe the board or shareholders thought in terms of either of you have anything that you feel is crucial to returns, but it was a good going model. The whole have on the record that we have not given you an purpose, as I think you are saying, is it comes back. opportunity to say so far? John Kay: Yes, and what happened, as you are Dr Peter Hahn: The one issue I would like to leave describing, is the people around these institutions you with is a focus on the coming legislation on thought it would be a lot more fun and certainly a lot enabling bail-in to work in the UK. It needs better paid— international agreement. There is a long way to go, Mr Mudie: Yes, absolutely. but the choice seems to be right now that we could John Kay:—to be chief executives of whizzy, global, wait until European legislation comes along in a financial conglomerates, which they were not very couple of years, then has a two-year implementation good at running. period. It could be four years or more until that happens. For the UK to start enabling that—because Q217 Mr Mudie: In your answer to Jesse Norman, right now we have a situation where bail-in works the top point you raised was the timetable and your when a bank gets to resolution, but we do not have a fear of what I call political arbitrage, that if you leave situation when it is before resolution— it on the table for so long, the bankers will move all Chair: Vickers points that out. the politicians and the politicians, the further away the Dr Peter Hahn: Yes, that aspect is to me the most crisis grows, will get weaker. Now, in the ICB’s report, it specifically says that it would like this ring- critical part of that report. We have to get that done fence introduced as soon as possible. It gives the because we want to be able to be in a situation where, Basel III date as the maximum time, but not the if a bank gets in trouble, we can fix it and it stays out minimum time. Have you any idea how reasonable it of resolution. Once it goes into resolution, we have would be to see this ring-fencing introduced well powers, but the cost of resolving a bank is so before Basel, and if so, when roughly, if you can? enormous that we want to do everything to make sure John Kay: I would have to listen to the banks’ they do not get there. To me, that is the critical factor. arguments and explanations on that, but I would start with scepticism. Q222 Chair: I wanted to ask John Kay one final question. You said a moment ago that you thought Q218 Mr Mudie: Why go to them, because they will investment banks were a long way from being allowed want Basel III, will they not, in the hope of that to pay at the moment. Once all the global regulation, arbitrage. You should not listen to them, really. You as far as we understand it, is in place and Vickers is should be saying it should be done as quickly as also implemented, do you think it would be safe to possible, as the ICB has said. allow BarCap to fail? John Kay: You are right. It should be done as quickly John Kay: Yes, I think the sooner the British as possible. The question is how quickly “possible” Government feels able to say that if BarCap failed is. I cannot believe “possible” demands eight years. we would not stand by it, the better, but I think that Dr Peter Hahn: I do not think it would take eight can be— years to do it. There is no question about that. How long it would take, yes, it is separating businesses, Q223 Chair: Yes, that is true, but I am asking if they putting in employees, having different action plans. It have the right recipe. It is a considerable endorsement is going to be at least a few-year process to do that. if you think that they have. Maybe it is two years, maybe it is three years. It could John Kay: I do, although we would obviously be be done. under immense international pressure to do so. Part of the argument the banks are making is that there are other forces of regulation and control that are Q224 Chair: “To do so” meaning to bail them out. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:02] Job: 017688 Unit: PG02 Source: /MILES/PKU/INPUT/017688/017688_o002_db_TC 18 10 corrected.xml
Ev 38 Treasury Committee: Evidence
18 October 2011 Mr John Kay and Dr Peter Hahn
John Kay: To bail them out. This is why, if BarCap today and giving us such interesting evidence. It will were to go to New York I would be very happy, and be extremely useful to us in the preparation of our I think a good deal happier than SEC and the Federal report. I am very grateful. Reserve would be. Chair: That is a very interesting remark, which I will not develop, but thank you both very much for coming cobber Pack: U PL: COE1 [SO] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Treasury Committee: Evidence Ev 39
Wednesday 26 October 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Andrea Leadsom Mr David Ruffley Mr Andrew Love John Thurso ______
Examination of Witnesses
Witnesses: Andy Caton, Corporate Development Director, Yorkshire Building Society, Graham Beale, Chief Executive, Nationwide, and Chris Rhodes, Group Product & Marketing Director, Nationwide, gave evidence.
Q225 Chair: Thank you very much for coming to Andy Caton: I support everything that Graham said. see us this afternoon. We are taking some more The Yorkshire Building Society also got downgraded evidence on the ICB. I would like to start by asking in this process. Fortunately, like Nationwide, we have whether you feel the downgrade has affected your been upgraded on a stand-alone basis so this again ability to raise wholesale funding? purely reflected Moody’s own view of potential Graham Beale: We have been talking to Moody’s for sovereign support. Like Nationwide, it does not stop most of the summer so we knew this was coming, us from accessing the market in our view. All of our and they made it quite clear that this was a sectoral wholesale funding in terms of term issuance is adjustment to remove systemic support, very much on collaterised these days, so that is either through the back of the Government and the ICB making it covered bonds or through securitisation and there will very clear that systemic support would be removed be some mandates that we will no longer be able to and taxpayers would not be put at risk. So we had a issue to because we are not— long discussion with Moody’s and they made it quite Chair: So it will affect you quite a bit. clear in their announcement that this was not a Andy Caton: It will limit our pool but fortunately we reflection on the financial strength of Nationwide, do not have a huge appetite for wholesale funding and which was unchanged, but this was a sectoral we have already proved that we can issue in the core adjustment. European and UK markets as a split-rated issuer so In terms of the consequences, at the very fringes of we can cover bonds with AAA on one side with one what we do, I think there will be some investors that agency and with AA with Moody’s. The irritation is for rule-driven mandates will not be able to invest in that there will be a lot of work behind the scenes in Nationwide, but I think in terms of its impact it will restructuring programmes. There will be increased be minimal, so we do not expect any consequence and costs in terms of swaps and credit that has to go we have been active in the market very recently. We behind that, so certainly more cost comes into it and are not getting any sign of any breakdown in obviously that means ultimately that may get passed to customers. confidence. The impact is further down in the sector with the We did see a very small blip in consumer driven smaller players who perhaps do not have such activity, particularly balances in excess of the FSCS established wholesale franchises, as Nationwide or limit because it does not help when they see Yorkshire does, and maybe are looking to enter the Nationwide on News at Ten alongside some of the market for the first time and where their ratings have bank names. come out, where there have been many more penal There were again tiny movements in what we do, so reductions in perceived sovereign support, their I think net it will not make a big difference at this options may be more severely limited. At the end of stage but it is disappointing because we think that the the day I think the Moody’s review is taking a view raters have been quite heavy-handed with their of sovereign support or likelihood based on size of assumptions and there is a lack of transparency about organisation, potential support from Government, and the way that they operate, so it is very difficult for us complexity of organisation. That seems to me to run to engage with them at any level of detail to either against what the objectives of the ICB report are about demonstrate that we are stronger than they are where effectively a lot of the provisions around the assuming or at least to understand where they are retail ring-fence are looking towards the building coming from. society legislation that if not coming up with the quantum of some of the limits then at least some of Q226 Chair: On that last point, the Committee is the principles, things like wholesale funding, use of becoming increasingly interested in the way the derivatives for hedging, and so on. ratings agencies are operating. It would be extremely Chair: That is an important point. Mr Rhodes? helpful to have a detailed note on exactly the point Chris Rhodes: No, nothing to add. you have raised, which is the opacity of their approach, and if you feel it is defective as well as Q227 Andrea Leadsom: Do you think your opaque in other ways to let us know. Would others downgrade was fair? Do you think it was justified? I like to add anything that has not been said? am looking at all three of you. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Ev 40 Treasury Committee: Evidence
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Graham Beale: I will start with our position. We made to the rating agencies is that they are taking obviously perform our own stress test. It is a the view that certain institutions are more systemically requirement of working with the FSA to see what important than others—and I think at certain levels could happen to the business model in some extreme they are—but for Nationwide with 15 million retail situations and you come out with loss projections and customers, 15 million taxpayers, we will never get provision requirements, and so on. We compare that into a situation where we need taxpayer support, but with the sort of spectrum of numbers that we get out in the hypothetical situation that we did I am of the rating agencies, and they are so far apart that absolutely convinced that the Government would look you feel that they just have some extreme, bordering very seriously at supporting Nationwide, certainly on unrealistic, assumptions. relative to an equivalent position for Lloyds Banking Group or Royal Bank of Scotland, but LBG and RBS Q228 Andrea Leadsom: So you think it is wrong? have more support assumed within their rating than Graham Beale: I think it is very prudent and very the equivalent support assumed within Nationwide’s difficult for us to reconcile that to our own stress rating. analysis, which we share with the FSA and is based on assumptions that the FSA are comfortable with. Q232 Andrea Leadsom: But do you think that the Chris Rhodes: Nothing to add to what Graham said. Government would be supporting Nationwide or just Andy Caton: If I could add a few things. I absolutely the depositors? think it is not fair and unfortunately some of this is Graham Beale: I think their principal concern would quite methodological and detailed and we are clearly be the depositors, but the depositors are Nationwide talking about one rating agency here, not all rating at the end of the day. agencies. There was an exercise done some years ago right across the UK banking/building society sector, Q233 Andrea Leadsom: Final question: do any of which was looking at stress testing, and I think the you anticipate that as we get closer to the ICB’s average downgrade was two notches, which is quite proposals being implemented that there might be extreme, and in one particular case, Chelsea Building further downgrades as a result? Society, it was four notches. Any institution that gets Graham Beale: We know that Standard and Poor’s a one-off four-notch downgrade, that is a bad day at and Fitch are going through the same process that the office, and ultimately that was one of the reasons Moody’s are going through, so our rating with why Chelsea ended up merging with Yorkshire. We Moody’s is stable and therefore that suggests they are have subsequently taken that institution on. We are content for the immediate future. But the same process perfectly happy with the portfolio we acquired that led is going on with the other two principal agencies so I to that four-notch downgrade, so we obviously did our expect that there will be more ratings adjustment as own quite severe stress analysis, as did the regulator, a result of removing systemic support from financial and we came out with two very differing opinions. institution ratings. Andy Caton: I would not have a view on that. I would Q229 Andrea Leadsom: What has been the impact have thought the action has been done in terms of the on your cost of funds? building society sector, and potentially as the Andy Caton: It is quite difficult to judge that in a implications of the ICB report for universal banks market that is still, frankly, quite dislocated in terms come in, there may be more action in terms of those of pricing. I would have to look at Yorkshire’s cost of larger players, but obviously that is for the rating funds versus if we were AAA-rated. I guess that agency to decide, not us. would be 30, 40 basis points on a new five-year issue. Chair: Very interesting and helpful evidence, thank you. Q230 Andrea Leadsom: You mentioned the fact that your wholesale funding is now collateralised. Q234 John Thurso: Mr Beale, in your evidence to Andy Caton: Not all of it; new funds. us you have one of your big bullet points as being Andrea Leadsom: But is that largely since the 2008 a leverage ratio over and above Basel III is wholly financial crisis? Were you previously issuing inappropriate for low risk institutions. Nationwide is unsecured, uncollateralised products? the sixth-largest; I think you come after Santander, do Andy Caton: We were doing both. Fortunately we had you not? entered, as Nationwide have done, the main European Graham Beale: We are the third-largest, actually. covered bond market, which is the way European John Thurso: Whatever, but in the banks after the mortgages are basically financed, and we did that in big five, you are number six. Why is it appropriate or the latter end of 2006, so fortunately we had funding what is the problem that you have with the same already in place and we had an investor franchise leverage ratio that they have? already in place. Graham Beale: It is quite a complicated topic. The leverage ratio is a fairly crude metric. It is a crude Q231 Andrea Leadsom: Mr Beale, Moody’s report measure of the financial strength of the balance sheet says that Government is likely to continue to provide and the ICB, I think quite rightly, said that it should some level of support to systemically important be a backstop measure. The concern that we have is financial institutions. Would you consider that that that where you have a balance sheet, such as the would cover Nationwide? Nationwide balance sheet, which is very large, but is Graham Beale: Yes, I do, and there is still one notch also populated by very low-risk assets, it does tend to of support assumed in our rating. The point that we discriminate against that type of balance sheet. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Treasury Committee: Evidence Ev 41
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Q235 John Thurso: Let me tease that out because Q238 John Thurso: The critical point in all of this that is the point that I want to get clear. Looking at is if you carry on behaving as the Nationwide, as a the banks, they effectively had not enough tier one trusted, respected low-risk mutual, you probably do capital and were therefore unable to absorb the losses not need any more capital, but there is always the risk and that effectively is they were inadequately that your successors might decide to become more capitalised because they did not have sufficient equity. aggressive and do things other building societies did, A mutual does not have equity as such, so how do so there has to be some mechanism to deal with that. you respond to or how should you respond to or why What would your suggestion be? If you could come are you different to that circumstance? to Government and say, “We recognise the problem Graham Beale: I think the first thing is to be but you are trying to solve it the wrong way,” what absolutely clear that the majority of the assets that would you want done to deal with that that allowed sit on our balance sheet are prime loans secured on you to continue to operate the way you do? residential property, so they are very, very low risk in Graham Beale: We operate very comfortably under terms of their characteristics, and if you look at the the current Basel regime, so if you look at the capital that you require to underpin the losses that you solvency ratios, which are risk-weighted, they do take would experience from a portfolio of that sort, it is a into account the characteristics of the balance sheet very low amount of capital. It is a lot lower than the and the risk profile of the balance sheet, and we leverage ratio either at 3% or 4% because within the operate today with a core tier one ratio of 12.5%, ICB recommendation at the moment their which is stronger than any of the banks’ equivalent recommendation would be that we should operate at position and that is without having done anything a 4% limit. We can get to 4% but we have no margin other than operate the way that we have always for headroom or error in any sense. We would be right operated. We did not have to take any emergency on the line at that sort of level. actions throughout the crisis. I think the solvency ratio is the real mechanism Q236 John Thurso: Can I just ask you, if you are because it is a much more sophisticated mechanism. asked to increase from 3% to 4%, and you obviously It is risk-orientated so it takes into account the cannot do a rights issue, how do you increase your characteristics of the balance sheet. The ICB are capital? arguing that the leverage ratio should be a backstop ratio and, to a degree, while I can pick holes with the Graham Beale: I think there are three things that we logic of the ratio, I can understand to have an absolute can do, none of them very palatable. We could backstop. I think as far as I am concerned, to calibrate increase our pricing so that we generate more profit, Nationwide alongside some of the much larger and which generates more capital. much riskier banks, which is where they have slotted us, has been quite penal in its consequences. Q237 John Thurso: You would just retain the profit basically? Q239 John Thurso: You only have Nationwide Graham Beale: We would retain the profit, which capital markets, you do not have all of that stuff. You would not be the right consumer outcome, and I think are a ring-fenced operation. in terms of our competitive position it would Graham Beale: The Basel regime is coming up with undermine our position. a leverage ratio around about 3%. We are much more We could move into new lending activities, which are comfortable with operating at 3% than operating at significantly higher risk than the ones we would 4%. It does not sound like a big difference but it is traditionally undertake, which would generate— quite a big difference in terms of the consequences on John Thurso: Sorry, I keep interrupting. But that is the business model. While I agree with a lot of the what various smaller building societies did to try and content of the ICB’s report, I think when it comes to compete, because they went into corporate property the calibration of capital of leverage ratio there is rather than— another process, which is the Basel process, which is Graham Beale: But you asked me the responses and much more sophisticated, it is based on much more one response would be to change the risk profile of detailed information and I would much prefer to rely the balance sheet so we would take more risk, we upon that process to come up with the right calibration would generate more revenue, we would therefore metrics than the sort of recommendations coming out generate more retained earnings and capital, so we of the ICB. would respond like that. Again, counterintuitive both to what the ICB are trying to achieve and counter- Q240 John Thurso: Very quickly, because this is cultural to the way a building society would operate. obviously—I see you nodding to all of that, I take it The third option would be to de-lever, to reduce the as read that—do you have anything to add? size of the balance sheet, so we could retrench from Andy Caton: If I could just add one thing, there is a the marketplace and we could reduce our asset size. It lot obviously there about Basel and the leverage ratio. puts you in a strange position because with the assets Clearly the point is that mutuals do not have access to that are left to generate the capital required by the a core tier one equity instrument that can issue in business going forward, again I think you have to go place of share equity, and the regulatory framework is up the risk level a little bit, but the outcome from that clearly focusing not so much on top level solvency or would be a reduction in supply of credit to consumers capital ratios but on core tier one, and our old tier one and it would undermine our competitive position instrument that we used to issue, permanent interest again. So again, not a very satisfactory outcome. there in shares, is now effectively irrelevant. The cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Ev 42 Treasury Committee: Evidence
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes replacement instrument is a gone-concern instrument, insight into the way our business model works. I went PPDS, only been issued once, and there is no primary through some of the evidence that Sir John gave to market issuance opportunity there. this Committee on this point, and I think he made a So there is work going on, on a replacement statement along the lines that a leverage ratio of 25, instrument, but the jury is very much out as to whether which equates to a 4% leverage ratio, is not unduly there is any demand for that from the institutional prudent. I would disagree with that in the context of investors. Until that is solved I cannot see that there prime residential mortgage assets. Let me give you an is an external capital market issuance solution. If it example, just to try to illustrate the point, if you look has been benchmarked off a joint stock company at our balance sheet, we have about £100 billion prime share, as being the benchmark for capital, with mortgage assets sitting on the balance sheet and our variable returns based on profit, there are clear charge for bad and doubtful debts last year was conflicts with the objectives of a mutual organisation. something of the order of £33 million, quite low within the context of our numbers, but that was one Q241 Chair: Mr Caton, in your evidence a moment year, and if you assume that the average life of the ago, you said that the cost of funds to you might be mortgage asset is five to six years and you made £33 30, 40 basis points, that is a heck of a lot. I have just million of loss each of those five or six years you been reminded that the ICB make an estimate overall would be in the territory of £170 million to £200 for the effects and put it at 10 basis points. I admit million of losses from a portfolio of £100 billion of that this is based on some estimates in their annex 3, which I have just reread, which looked pretty general. assets. How do you reconcile these two figures? We set aside, under our own calculations, the capital Andy Caton: That is the impact of ICB. That will be underpinning that portfolio which is around about the impact of the downgrade activity that has gone on £1.2 billion, so against the £200 million of losses, in the markets, so for example in the senior unsecured taking the top end of my range, we have capital bond markets Yorkshire Building Society’s cost of underpinning it of in excess of £1 billion. If you funds would be quite materially different to a large applied a 3% leverage ratio, which is at the lower end UK institution that is perceived as a national of the spectrum, between 3% and 4%, the capital that champion. that would require is £3 billion, so you can see £200 million of losses. We, on a very prudent basis, have Q242 Chair: So you get hit disproportionately? capital in excess of £1 billion, the leverage ratio Andy Caton: Absolutely. And in the markets that we would require £3 billion, so that is the sort of are funding in, which are largely collateralised, spectrum, if you like, of difference in terms of currently we can issue AAA AAA in the securitisation assessing the risk of the assets. markets, the difference in funding between us and any Part of the difficulty is that where you have a balance other AAA AAA issuer would be very, very small. In sheet, which contains prime assets, prime is a very the covered bond market where we are not AAA AAA broad definition. We go out of our way to write the we would have a fairly material funding cost, and that lowest risk business that we can so the average loan comes from two areas. One is what we have to pay to to value of our portfolio is less than 50%, but within the investor and the other one is all of the credit the same definition you could have £100 million of charges when we bring euros into sterling, for assets, which are loan to value of 50%, income example. multiple, say, an average of 2.5 times, seasoned, fully performing. On the other hand you could have a Q243 Chair: You were criticising the ratings portfolio, same value, where the loan to value is 75%, agencies a moment ago, though the primary cause, the 80%, 90% where the average income multiple is four primary driver of that huge increase in costs—and it or more times, where it is fairly recently written, so is a large increase—40 basis points, that is being there is no maturity in there. They would both be driven by the ICB proposals themselves, isn’t it? called prime under the IRB, which is the method that Andy Caton: No, I would not be saying that. I think we use to assess risk. We would take those that is purely downgrade-driven. I am not saying that characteristics into account and come up with quite the ICB proposals are doing that. What I was trying different risk factors for the two portfolios. to say, in some of my comments around rating But they are both called prime and when you apply agencies is I am not sure the rating agencies are the leverage ratio, which is just this blanket 3%/4%, recognising the principle and direction of travel I think the ICB are going in. it just fails to recognise the inherent qualities of the Chair: I will not pursue that point for the moment in two portfolios, which is why it is a very blunt and the interests of brevity. crude instrument, and which is why the solvency ratio, which does look in detail at the characteristics, is a Q244 Mr Love: Mr Beale, I just wanted to ask you much more accurate assessment of the risk and the the wider question that arises from John Thurso’s level of capital that you require. contribution a minute ago. Do you think there is a failure to understand the mutual model inherent in the Q245 Andrea Leadsom: I am interested to know, Mr ICB’s recommendations and their failure to recognise Beale, what percentage of your mortgage portfolio is the unique position that you are in? interest only versus repayment mortgages? Graham Beale: We did spend quite a long time giving Graham Beale: We would need to confirm, but it is evidence to the ICB, so I hope we gave them a good going to be 20%, 25% at the most. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Treasury Committee: Evidence Ev 43
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Chris Rhodes: I think it is worth knowing in the margin out of that. But that is a consequence of the context of that, the average loan to value of the market conditions today, nothing to do with the ICB portfolio, which sits under 50%. and retail ring-fencing. Chair: That has fallen a lot. Chris Rhodes: No, it has always been that kind of Q247 Mr Mudie: In your evidence you put forward number. some changes in the Building Societies Act; is that Chair: Been high for you? related to these changes and are you in discussion with Chris Rhodes: Yes. Government about such changes? Graham Beale: We have preliminary discussions Q246 Mr Mudie: There is some suggestion that there going on with HMT. What we are saying is that with will be increased pressure on you to attract deposits; all of this regulatory change the Building Societies do you see that? Are you concerned about it? Are you Act has not been reviewed for 25 years now so it is concerned about its effect on your smaller societies, quite out of date in certain respects. There is one and is there anything that you would want the policy particular section—it is section 9B—which prohibits makers to do to head that off? a Building Society from offering a floating charge, Andy Caton: The concern I might have is that within and yet the provision of a floating charge is a standard the retail ring-fence quite rightly there is a very mechanism, where you are doing a repo transaction sensible suggestion, there is a legislative cap on the and other financing transactions. use of wholesale funding for the universal banks, the So what we are saying is we do not want to change bits of their retail business that have been separated the fundamental nature of the Building Societies Act off and been put into the ring-fence, that absolute and the nature of limits that apply to our business number is not set down for building societies and model, but in the detail there are things that today just legislation, it is 50%. We all operate with lower levels make day-to-day operations, particularly in Treasury, of that in reality. Yorkshire’s is about 20%; historically quite complicated. it has been 20% to 25%, for example. So my concern would be within the retail ring-fence if there is still a Q248 Mr Mudie: Mr Beale, the real thing is, are funding gap, and obviously the quoted banks have these changes in your eyes necessary before these quite a significant funding gap in aggregate, would changes, these reforms, come in or are they just that provoke them in rapid order to try and become incidental? very competitive in the retail deposit market in quite Graham Beale: I think they are incidental. a short term way? We saw just that behaviour in the mortgage market, from players like Northern Rock, Q249 Mr Mudie: Last question in terms of the where we had illogical pricing, if you like, which national savings index-linked scheme that was just created competitive distortions, ultimately was not in withdrawn. Did that have an effect on you? Is there customers’ interests, ultimately created other knock- anything you would like to say and put on record in on consequences where, for example, smaller players terms of a more level playing field? might have gone at the risk curve for the wrong Graham Beale: It had an effect on the sector. There reasons because they were squeezed out of the core would have been a marginal effect on Nationwide. market. If that type of activity happened in the deposit Mr Mudie: Yes, sorry, I did not mean that. market, clearly I do not think that would be very Graham Beale: The position is that it is a very helpful. attractive proposition and it typically allows an Graham Beale: It is difficult to judge what the investor to invest up to £15,000 tax free, which is in consequence of the retail ring-fence would be in terms excess of the cash ISA limits, and what I do not want of pressure on taking retail deposits. I think we need is to see that sort of product offering withdrawn. What to get a lot closer to understand the construct and how I do want is to be able to see Nationwide and it would operate before we could say with any Yorkshire and any other mutual being able to offer an certainty what the outcome would be. equivalent product on the same terms in terms of the In terms of funding today, I think the bigger issues are tax free status, which would then give us the level the more immediate problems that we have with the playing field and we could compete on equal terms. impact of the concerns in Europe on the wholesale There is nothing I can do to get anywhere near close markets and the difficulty in funding, and I think a to a £15,000 tax-free limit, which is offered by NS&I. combination of ratings actions and the dysfunctional Andy Caton: I do not need to add to that at all. market conditions that we have seen over the last few months. Some players are having to refinance their Q250 Chair: Very helpful again. I wonder whether it balance sheet using retail funds whereas they would would be possible for you just to set out for us traditionally use wholesale funds. So they will come numerically your rough estimate of the division of the in and they will take the price of retail funding. And exceptional market conditions that you described a retail funding today is incredibly expensive, where we moment ago, the effects of weaknesses in the rating have Bank of England base rate at 0.5% and if you methodology and the ICB ring-fence itself, so we can want to bring one-year fixed-term money on your see the relative contribution each of these is making balance sheet today you would probably have to pay to forcing up— in excess of 3%. It really has ratcheted up. Graham Beale: I think that is going to be quite That is putting a pressure on access to funding for difficult to do without giving— some of the players because it is price-driven and at Chair: I am just trying to extract what you just said 3% it is quite difficult for some players to make a and translate it into some numbers for us. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Ev 44 Treasury Committee: Evidence
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Graham Beale: I think in terms of trying to deal with external market in which we compete in then we them in a certain sort of order, and, Chris, you will would not change our pricing stance as a result of that. have to help me if I struggle— Chair: Take it away if you want to think about it. Q254 Mark Garnier: What you are all agreeing on Graham Beale: I would rather take it away, but just is that the ICB is not going to make the slightest bit very briefly as an overview, in terms of retail ring- of difference to the concept of free banking? fence, I think today the impact on Nationwide from a Chris Rhodes: I do not believe so. When we talk cost perspective will be minimal because we do not about the cost of funds, it is going to be difficult to have to do any major restructuring to satisfy the respond to that question. My estimate is the euro issue component parts of a retail ring-fence entity because over the last three months has put 30 basis points on we are that already. I do not think it is going to the cost of new retail funding, so the uncertainty in massively change any of the other factors that would the marketplace, which has caused the dislocation in be influenced by cost. We did not see, as a result of the wholesale funding markets, has added 30 basis Moody’s, any material increase in our ability to fund. points to savings and cost of funds, and that is, to my mind, far bigger than anything that will flow from the Q251 Chair: Consumers feel they are being ripped retail ring-fence. off because they see this gap opening up. Part of it is not your fault at least—or any financial institutions’ Q255 Mark Garnier: If you remain with free fault, perhaps none of this is your fault. It is helpful banking, does that not provide a significant barrier to for us to have it illustrated in a simple way. entry for any other entrants coming into the Graham Beale: We will take that away and we will marketplace or wanting to come into the marketplace? try to come up with a quantification, but I think from Graham Beale: They have to take a very long-term our perspective it is not going to be a large number. I view because the set of costs of establishing a do not think it is going to explain this perception that personal current account as a product is probably the you have just outlined. most expensive product that you could offer, and you do need to build quite a large critical mass in order to start to get the numbers to work, so you have to take Q252 Mark Garnier: The Daily Telegraph on 12 a very long-term view. So it is a barrier to entry in September quoted a London-based banker as saying, terms of the current conventions. We have to “The ICB report essentially takes free banking outside remember that 80% of UK consumers enjoy so-called and shoots it in the back of the head.” Fairly dramatic free banking, and it would be incredibly unpopular to words. Do you think that is a fair assessment of the have an alternative pricing convention for current prospect of free banking, and does it matter? accounts. Chris Rhodes: I do not think it does impact free banking at all. The reason why I would say that, Q256 Michael Fallon: Mr Caton, would you have although there is a lot of detail yet to be worked liked to have seen Northern Rock remutualised? through, effectively the retail ring-fence replicates Andy Caton: Yes, I would. what Nationwide and Yorkshire and others already do, so we are a retail institution. Most, if not all, of our Q257 Michael Fallon: Why didn’t you buy it then? activities will sit within the retail ring-fence and we Andy Caton: We have been quite busy doing a few currently offer free current accounts, accepting all the mergers recently and we recently were interested in challenges that are about nothing is free and foregone acquiring the residual part of the Egg banking interest, and so on. But the actual structure of the business. But in terms of market structure that, I think, products today will not need to change because of the was a great opportunity for putting some more critical ring-fence. mass into the mutual sector as a whole. I do recognise that there is a fiduciary duty, if you like, to return Q253 Mark Garnier: Mr Caton, you said earlier, value back to the UK taxpayer through sale and that the cost of your funding is going to go up so the disposal of Northern Rock. The complexities of taking mutuals are going to be much more difficult. If we try that organisation on, in our view—as an organisation or if you try to hide the extra costs within the account, we did look at it—were a little too large. But I think at the end of the day still the cost of having a bank there may be a prospect that you could still put account has gone up. There is no such thing as free Northern Rock genuinely back into the mutual sector, banking, it continues to be lower returns on the but you would have to come up with a financing deposit accounts, higher costs of credit; is that the structure that maybe Government and taxpayers got case? Is the consumer going to be spending more their returns over a longer timescale than could be money or rather losing more income as a result of achieved with a clean sale. these changes? Andy Caton: I would almost reiterate the answer that Q258 Michael Fallon: The interest you expressed in Chris has already given. First of all, let me re- July you are no longer looking at it, is that right? emphasise I am not saying our cost of funds would go Andy Caton: We formally withdrew from the process. up because of the ICB proposals; it is the ratings impact and the consequent knock-on in terms of Q259 Michael Fallon: That is not what I asked you. wholesale funding markets that would increase cost of I know you withdrew from the process. Is it still the funds and, again, all of our activities would sit within position that you are not looking at it? the retail ring-fence so unless there is a change in the Andy Caton: We are not looking at it, correct. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Treasury Committee: Evidence Ev 45
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Q260 Michael Fallon: Mr Beale, tell me more about Graham Beale: I am not sure. We have dealt with that challenger banks. Do you agree with the ICB’s question. I am not sure that it does spell the end of assessment? that. I come back to my earlier point about while there Graham Beale: I understand the concept and the point is no interest on certain credit balances, because of the that they are making, which is that there are some provision of the products and all of the benefits that brands, which are still striving to achieve significant they bring, it is still for a large proportion of the market share and get to a critical mass, and consumer population a very good and attractive Nationwide, while not a bank, we do regard ourselves proposition, certainly compared with what you get as a challenger brand and we do try to put a outside of the UK. If you were to compare it with proposition that is a challenge to the established personal current account pricing conventions in players. We have been doing that for quite a while, Europe or America, it would be a quite different particularly with our personal current account proposition. activities. But back to the earlier point about the cost of entry, and so on, it has taken us many years to get Q264 Michael Fallon: Turning the question round; to a portfolio of accounts, which is, in the great does the existence of free in-credit banking remain a scheme of things, still relatively small. We have a barrier to increased competition in the retail market? market share of accounts of around about 7% and we Chris Rhodes: I think to some extent it does because need to get that up to at least 10% to make the product it is both expensive to recruit retail current accounts, truly viable in terms of the costs of running the so you only need to look at some of the adverts that product. are out there at the moment—£100, £200 to switch an account, so it is clearly quite expensive to recruit a Q261 Michael Fallon: What is the difference new customer. Then the earnings stream is delivered between a challenger brand and a challenger bank? off the back of in-credit balances, which take time to Graham Beale: I think that is just playing on grow, and fee income in respect of overdrafts, which semantics. We are a building society, not a bank, and again take time to grow as the book matures. In order I think the ICB used the phrase “challenger brand” to grow a current account book you have to accept a rather than bank. relatively high acquisition cost and quite a low return on capital for a period of time. If you classed that as Q262 Michael Fallon: During the crisis it was some a barrier to entry, then yes. of the challenger banks of the day, former mutuals, that overstretched themselves and failed. Do you think there is some tension there between the desire for Q265 Mr Love: Can I bring us on to cash machines? financial stability that everybody now seems to want, There was a recent announcement in August by RBS and competition? to restrict the use of other banks’ cash machines to Graham Beale: I think that they adopted quite their basic bank account holders. Can you tell me how extreme business models. They were outside the many basic bank accounts Nationwide and Yorkshire confines of the building society because they had have and whether you have any similar restrictions to demutualised. They demutualised because they the use of cash machines? wanted greater freedom to embark upon high risk Chris Rhodes: We have about a million basic bankers activities, upon Treasury activities, activities that by and we have no restrictions on the cash machines. But law—because we are a building society—we are not I think the move you talk about by RBS will create permitted to undertake. There are very strict some challenges for those of us who have not made guidelines about the shape of the balance sheet and that change because the ATM system is effectively an the assets that sit on the balance sheet, which makes ecosystem with a reciprocity agreement between all us naturally a very low-risk institution. Some old institutions. Our customers can use Nationwide ATMs societies decided that because of those constraints, for free, and we just incur the cost of running the and particularly the constraint around being contained ATMs, or they can use another institution’s ATMs. by a 50% wholesale funding limit, they would be The cost of that is about 26p for each cash withdrawal better off changing their status and that was the and 16p for each balance inquiry, so we benefit from perceived wisdom of the time. I think the plain fact is income from other institutions using our network and that there is not a single ex-mutual that has survived, we pay costs for our customers to use other peoples’ and they have all either closed for business or have ATMs. become embedded in a larger banking group. As soon as somebody restricts access to the whole To me, I think if you look at the performance of strong estate then effectively someone else is going to pay mutuals like the Yorkshire, like Nationwide, the last the income cost and the ecosystem moves. The cost few years has seen an endorsement of having a to Nationwide at the moment of basic banker business model, which is designed to be inherently transactions at other peoples’ ATMs is £14 million. prudent in terms of the way that it operates, and I We get some offset because other institutions use our think it has demonstrated that it is resilient within very ATMs. If that changes so we no longer have the stressed market conditions. income the net cost grows. So they are taking a benefit and effectively imposing costs on others, which may Q263 Michael Fallon: Some people have suggested cause other people to have to change their stance that the ICB reforms spell the end now for free in- because it is moving cost around. Cost does not credit banking; do you think that is a good thing? disappear, it just moves around. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Ev 46 Treasury Committee: Evidence
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Q266 Mr Love: You agree with all of that? How Chris Rhodes: If you take the big institutions, and I many basic bank account holders? include Nationwide, it is two out of six so far. If it Andy Caton: There have been attempts in the past to becomes three or four out of six, maybe that is a better put charges on ATM withdrawals from certain larger way of describing the point at which it becomes players in the market and we have always fought very unsustainable. heavily against that. Q270 Andrea Leadsom: It is an outrage because I Q267 Mr Love: RBS have tried to justify this think you are describing you are upset about the decision basically on cost grounds. They are trying to collapse of a classic oligopoly. I have heard this put save money. to me privately outside of the Treasury Committee, Chris Rhodes: They save their costs. and it seems to me that free banking, and particularly Mr Love: They have 1.1 million basic bank account the reciprocal use of ATMs, is a classic oligopoly and holders. Roughly how much would they save and do what you are effectively arguing against is the you believe there may be other reasons why they are competition that has been created by some banks restricting it in this way? saying, “Well, we are not going to reciprocate any Chris Rhodes: We have a million, and we would save more,” and you do not like it because you want to £14 million. I do not know their numbers and how keep that comfortable oligopoly. I just find it their customers transact but we are not of a dissimilar completely the opposite of competition. You have just size and it is £14 million for us. described the barriers to entry of freeing banking and the fact that it takes a very long time for any new entrant to come in and yet here you are justifying that Q268 Mr Love: The centre of all of this is the idea this reciprocity needs to stay. Clearly, that is yet of free ATM use. Where would the tipping point another barrier to new entrants. I do not know how come? If other banks continued to restrict the use of you can justify it. ATMs, in particular free ATMs, where would it come Chris Rhodes: I think it is probably worth responding to a point where there was too much being paid by a on a couple of points. First of all, we are talking about smaller and smaller number of institutions towards the basic bankers. So we are talking about those where overall costs of the— we have all clubbed together to provide a specific Chris Rhodes: I think that one is hard to answer product to deal with the unbanked, so it is that because at what point does that £14 million, which particular population we are talking about. Whether will grow over time, become an unacceptable cost to we should have a social conscience for that or not, I the Nationwide membership? I am not sure I can will leave for you to reflect on. answer that now because we would have to see over The second thing is, and from our point of view, to time in terms of what it did. remove it for the basic bankers would be a net benefit Graham Beale: I think in terms of the actions that and maybe we would not attract as many basic have been announced so far, while I think it is bankers as we do, but that would be a net benefit to uncomfortable and it starts to break down the the profit and loss account of Nationwide. reciprocity that the system requires, it is something The second point, is if you have to establish an ATM that we can absorb. But if it became the convention network these things are very expensive. I would that most institutions were starting to restrict some or argue that is a bigger barrier to entry than a known all of the cash machine transactions, then I think the tariff for the use of someone else’s machine. If you process will be broken. I do not think we are were to invest, say we have 2,350 ATMs on the high anywhere near that yet but I think you would probably street, that is a big cost to invest whereas a new need a critical mass to say, “Actually we are now entrant at the moment can join and pay 27p for a going to restrict usage of foreign ATM machines,” and withdrawal. I think that is less of a barrier than then I think we would all be in a position where we needing to invest in 2,500 ATMs. That is an would have to go back and just rethink how the cost observation. of the ATM network is shared among the principal Andy Caton: We have, in relative terms to players. Nationwide, a minuscule ATM network so what we are concerned about is our customers’ access to their Q269 Mr Love: Let me ask you the same question, money on a free basis, and this principle of having to in a sense, another way. It is an open secret that there pay to access your own savings, which does not sit are a number of large financial institutions that have very well with the mutual model. never been quite at home with the idea of free ATMs, that have attempted in the past to end the system and Q271 Mr Love: We normally accept in this to allow charging to take place. Does that play a role? Committee that competition is good for the consumer. I do not want to single out RBS, because Lloyds TSB Are you confident if we ended up with the ending of have already done this some time ago, but are you free ATM use that would be good for the consumer in concerned that this may be the first of many steps that the loss in having to pay for ATMs would be towards what would, in effect, end the free use of made up somewhere else in the banking system for ATM machines and end up with introducing charges those customers? Do you have any confidence that for the customer? that would happen? Graham Beale: If that trend of behaviour continues I Chris Rhodes: It is a slightly complicated question think it does jeopardise the concept of free use of because there are non-banks in the ATM market, so ATMs. there are institutions who make a profit out of this cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Treasury Committee: Evidence Ev 47
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes reciprocity agreement. Mostly, if banks said you can be the favoured solution that should take most, if not only use our ATMs and you have to pay to use all, of the issues away. someone else’s ATMs accepting the fact that, if you like, Yorkshire’s customers only have access to very Q274 Mr Ruffley: Could I just move very quickly few and that creates a barrier to competition, we on to the FCA, which this Committee is looking at. would all be financially better off because it would be Do you agree that the FCA should have a primary the supermarket ATMs, the convenience store ATMs, duty to have regard to or consider competition? where the income would disappear from. Graham Beale: I think if you look at the principal objective the FCA have, which is to protect and Q272 Mr Ruffley: Just following on from Michael enhance confidence in the financial services sector, Fallon’s questions about competition, we have seen and then you look at the three operational principles evidence from the Building Societies Association that that underpin that, which are enhancing and protecting they see the low level of switching between providers the integrity of the financial system, making sure that of personal current accounts—the fact that it is low, there is efficiency and choice in terms of consumer relatively low—as showing high customer activity, and protecting consumers, as a package of satisfaction. We, as a Committee, are generally objectives, it seems to me that inherent in all of that sceptical about that, but if you shared our scepticism there is a responsibility to make sure that there are would not one way of engendering competition be for appropriate levels of competition within the UK. I am a portable personal current account? How do you view not sure what is achieved by adding, as a principal that prospect? objective, a competition clause, if you like. I think as Graham Beale: There are a few points there. The first well, the closer you get to that situation we all need thing to say is that typically in the UK there are to understand the relationship between the FCA and something like 6 million new current accounts created the OFT in terms of who is responsible for per annum and around about a quarter of those, 1.5 competition within the UK. million, are switchers. So there is some switcher I take the view, which I think is the Government’s activity and it is 25% of the current flow of new view, that what the FCA has been designed to do will accounts. I am not sure I would agree that it is a low appropriately accommodate competition level. 25% is quite a big proportion and is growing. considerations but that we have established bodies that There is a lot of satisfaction certainly with the way have principal responsibilities for competition within the current accounts operate and typically we are the UK. seeing net satisfaction. This is people who are incredibly satisfied less those that are very dissatisfied, Q275 Mr Ruffley: You are going to be regulated in the high 70% spectrum. So, yes, they have no desire twice over, PRA and the FCA. Having regard to your to move because they have no motivation. experience of dual regulation in the tripartite structure, We are trying to increase switching and transfers do you have any concerns, any fears or worries, about within the UK by increasing our proposition, by dual regulation under the new regime? giving certain commitments and guarantees that the Graham Beale: I think it is going to be more process will run smoothly and if it does not we will complicated. There will be an overhead, because we sort it out and we will take all of the pain. The notion will have two sets of day-to-day supervisors to of having a portable account number, as similar to a respond to. I stand back though and if you look at the mobile telephone number, for example, is very direction and the focus of regulation over the last, say, conceptually simple to understand and sounds quite decade, pre-crisis we had a regulator that was almost attractive. The trouble is that the British banking obsessively focused on conduct of business matters system is the product of many years that revolves and totally overlooked prudential issues, and since the around unique sort codes and account numbers, and crisis they have swung right the other way and they just the cost and complexity of moving from where are focused entirely on prudential issues. we are today to your suggestion would be incredibly I therefore think that a model that says that we have expensive and very difficult. I am not even sure it is a team that are specifically focused on conduct and a possible to deliver. team that are specifically focused on prudential, one I think if you were starting again, you would design hopes we will get a more balanced approach. I am something along the lines that you are suggesting, but looking at this from a macro level in terms of the the plain fact is we have 67 million current accounts quality of the regulation within the UK. We will not in the UK right now and just the cost and complexity know until we get there but the concept and the of moving them into this more mobile process would principles looks to me that we should end up with a be incredibly difficult to deliver. more balanced outcome than we have experienced in the last decade. Q273 Mr Ruffley: Is there any institution in the banking sector and the building society sector that is Q276 Jesse Norman: Mr Beale, could you just advocating this at all? expand a bit further on the current situation that you Graham Beale: Not that I am aware of. find yourself in on the funding side? You can imagine, Chris Rhodes: Within the ICB report the Payments there is a lot of concern running around political Council have picked this other system that effectively circles about the impact not merely of the eurozone will act as a redirection of payments while the account but of the situation in money markets. is moving from one institution to another. It seems to Chair: We have had a preliminary chat about that. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG03 Source: /MILES/PKU/INPUT/017688/017688_o003_db_Treasury 26-10-11 ICB CORRECTED.xml
Ev 48 Treasury Committee: Evidence
26 October 2011 Andy Caton, Graham Beale and Chris Rhodes
Jesse Norman: It would be nice to revisit that for be member-owned, customer-owned, and that a second. Government ultimately got back the money that it put Graham Beale: In terms of our own funding levels into the organisation. we have a liquidity ratio today, which is round about 14%, which is as high as it has ever been. We have Q278 Jesse Norman: Inevitably though, whether you adopted a slightly defensive position, that is, carrying did require, as it were, a vendor note or some kind of more liquidity than we would ordinarily do just equity structure, there would be a very long repayment because of the market concerns. But in terms of our process given the number of people who will be ability to fund, two weeks ago, within a matter of repaying versus the amount of money to be repaid? days, across two collateralised issuances we raised Andy Caton: I think you would have to put a £3.5 billion, which was more than we required in reasonable timescale on that, yes, absolutely. But one terms of our day-to-day funding requirements, and we of the issues, as you know, with Northern Rock is it are funding quite comfortably, albeit expensively, has a very large excess liquidity position, it has more within the retail space as well. cash on the balance sheet, which in many ways is a We are not seeing any pressure from the immediate good thing. That cash obviously has to be put to work uncertainty within the marketplace, but we are within the mortgage market. It would not be sensible adopting a very prudent and defensive position to try and do that in very short order. You would want because my concern is how things will play out in the to do that progressively over time as well. As you did future rather than the more immediate past. that you would then obviously rebuild hopefully the profitability of the organisation that would then follow Q277 Jesse Norman: That is very helpful, thank you. through to the ability to pay dividends back. Mr Caton, on Northern Rock, imagine the Government was keen to do a mutualisation of Q279 Jesse Norman: Why do you think that cash Northern Rock now. What preferred structure would has not been remitted back to the taxpayer now? you recommend, briefly? Andy Caton: I think probably ahead of the sale Andy Caton: That requires quite a lot of thinking process. I would not like to speculate about that. about, but there might be a solution for using the Chair: Thank you very much indeed for coming to Industrial Provident Society legislation, the Butterfield give evidence today. It has been extremely useful. I Act, and if an existing mutual or a stand-alone have picked up a lot and I think a number of remutualisation was to exist, capital would have to colleagues also feel the same way. I know we have be—we would have to make sure that the ex-Northern ranged widely, somewhat further than the narrow Rock was adequately capitalised and the form of that issue of the ICB but we appreciate it and it will help capital, I think, would have to require dividending us with our report. Thank you. back of value to UKFI over a period of time. But I think that would be the route to make sure that it could cobber Pack: U PL: COE1 [SO] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
Treasury Committee: Evidence Ev 49
Wednesday 2 November 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Jesse Norman Andrea Leadsom Mr David Ruffley Mr Andy Love John Thurso Mr George Mudie ______
Examination of Witnesses
Witnesses: Peter Vicary-Smith, Chief Executive, Which?, Dominic Lindley, Principal Policy Adviser, Which?, Christine Farnish, Chair, Consumer Focus, and Gillian Guy, Chief Executive, Citizens Advice Bureau, gave evidence.
Q280 Chair: Let me begin by asking about the ICB’s that that resolution will involve increases in market competition proposals. Since Dominic is still pouring concentration and reductions in competition. himself some water, I’ll start with Peter. Are they enough? Q282 Chair: We had better give you an opportunity Peter Vicary-Smith: I think the issue for us is in, if to answer the first question of the last session, which you like, the response of Lloyds to the proposals is whether you think that these bodies have the right around enhancement of divestment to create more objectives. competition. We also say that UKFI is not taking a Dominic Lindley: I think generally, as Peter said, the proactive role in promoting competition either. So I FCA needs the objective of a fair, transparent market think our feeling is that, with Lloyds not playing ball, in financial services, but certainly the PRA does not with UKFI not seeming to have the appetite to pursue have a competition objective and also we are worried this, we are concerned that if we just wait until 2015 about the scope of its insurance objective. and then decide whether there is an issue and then we Chair: You are arguing that it should? need to refer it to the Competition Commission, an Dominic Lindley: We are arguing that the PRA should awful lot of water has gone under the bridge. So I have a competition objective. That is what we put into think we need seriously to consider whether, if they the Independent Commission on Banking. are not willing to play ball, now is the time for referral Chair: But not the FCA? to the Competition Commission. Dominic Lindley: And the FCA should have an Chair: Other thoughts? Mr Lindley? operational objective for competition. Dominic Lindley: I think that is right. It is about the mechanism for implementing the competition Q283 Chair: Back to the question I was asking, proposals. If we look at market concentration, even which is about the ICB’s competition proposals. after the Lloyds’ divestment the market is still going Christine Farnish: Perhaps I could pick up on to be far more concentrated than at the time of switching. We were very pleased to see the Cruickshank let alone before the financial crisis. If recommendations about a redirection service to be you look at the seven years leading up to the financial done in short order and with no risk or cost to crisis, the big four banks were steadily losing market consumers. The research we have done on switching share to a series of challengers, but then, when the of bank customers shows that the prospect of things Government intervened through distorting subsidies, going wrong, particularly with direct debits, is the it almost led to massive consolidation and distorting main reason why people are sticky and don’t bother subsidies benefiting the big at the expense of the to switch. They want the hassle taken out of the middle banks and the smaller banks that were allowed process, sure, but they also want to be absolutely to be consolidated. That is not a good market certain that all their direct debits and standing order dynamic, whereby you don’t particularly have to serve arrangements will be properly dealt with and nothing your customers well to get a dominant position in the will come back to bite them. That has been the real market, you just have to get some kind of Government problem with the current arrangements, and we are subsidy or intervention. very pleased to see this recommendation. I think someone—hopefully yourself, Chairman—needs to Q281 Chair: Maybe the answer is not therefore hold the industry’s feet to the fire to make sure that it necessarily divestment, but the creation of conditions does happen in the timeframe that is proposed. for easier market entry. Gillian Guy: We generally welcome the proposals but Dominic Lindley: Yes, conditions for easier market would like to see a bit more analysis around their entry and easier market exit. You talked earlier about impact, particularly on consumers and particularly on the competition remit of the Financial Conduct what we would say are marginalised consumers—so Authority, but if you look at the remit of the PRA it understanding the impact and pace of change and how doesn’t have any competition remit at all, despite the that affects particular groups of people who can’t fact it is going to be dealing with the arrangements swiftly make changes. Just talking about switching, a for failing banks and what happens to them. Without large number of the people who we see, through a clear competition remit, there is always the danger nearly 400 bureaux, would say they are not au fait cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
Ev 50 Treasury Committee: Evidence
2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy with, they don’t understand necessarily, the pros and reading that leads you to have a huge bill and you are cons and the process for switching. It is not really a on a limited income, without much to spare at the end fair or even market as far as they are concerned. Some of every month, that could tip you into overdraft. It is of them are not even allowed into the market because absolutely no fault of yours, and you will end up they can’t get basic bank accounts, which is a whole paying and that can be a real shock to a household other issue. that is living on a fixed income or that is really There is also the issue of tightening credit under these struggling to budget. So I think there needs to be proposals, and just worrying that there could be a much wider public debate about this and it is a shame, credit crunch by regulation, which again could well to our mind, that the ICB didn’t at least flag this issue give difficulty to those lower income families who, in their report. frankly, at the moment rely on credit for their wellbeing and lifestyle. So, disproportionate detriment Q285 John Thurso: The evidence says that the again and thinking how that will impact on people, model of banking seems unsustainable and that that is squeezing them out of financial inclusion, whereas the not a great problem provided there is a clampdown drive ought to be to include more people. on unfair ancillary charges and a move to transparent Peter Vicary-Smith: Let me make a comment on the charging. We have sort of dealt with the transparent switching argument. There is one bit where we would charging. Broadly, from a consumer point of view, like to have seen a marker put down, which is the given that everybody pays for everything somehow, redirection service—of course, it is going to be the somewhere, is there not a strong argument that Payments Council that takes it forward. We have seen appropriate charges that are upfront is a better model that as not always a quick process, shall we say, when than free-in-credit with hidden charges? things have been given to the Payments Council. We Christine Farnish: We feel it would be because the would like to have seen something that says, “Okay, charges would be clear. They would be certain. we think that ultimately there is an argument for Consumers need and want certainty; all our evidence introducing portable account numbers here. We with our research shows that. They would, if levied recognise that that could have huge cost in terms of across the whole banking customer base, be at a very systems changes, but in 2025, 2030, whenever it is, modest level so they should be affordable. I think you we will expect you to have introduced portable could still have a place for basic bank accounts that account numbers and built that into your systems were free for people on low incomes, and that is upgrade proposals between now and then. Meanwhile, another debate for Parliamentarians to consider, but I get on with redirection services so that at least we see no problem with that. The problem at the moment know that there is a date by which it is happening.” is because something is being given away free and That is what happened in the mobile phone industry. because you need banks to be profitable, if you clamp Switching took over in the mobile phone industry only down on this perverse behaviour, it will pop up when the industry was dragged kicking and screaming somewhere else. by the regulator to portable mobile phone numbers. That is when switching happened, and the same is Q286 John Thurso: I am sure my colleague will going to be true here. follow up on that question with regard to people on Chair: We might come back to that later this lower incomes. To what extent does free banking afternoon. remain a barrier to competition as opposed to something that is not very transparent? Is it an active Q284 John Thurso: Christine, can I come back to barrier to competition? you, because I have been reading your evidence Peter Vicary-Smith: I would like to see a diversity of again? On the free-in-credit model in banking, you models because, after all, we are all paying for stated that you had no particular opposition to the fact banking services, as you say, one way or the other, that free-in-credit may go. Do you think the ICB and there are some people for whom a credit balance reforms actually spell the end of the model and do on which they receive interest is a valuable dimension. you think that is a good or bad thing? Those people may well want to have that and pay for Christine Farnish: Well, actually I don’t. I think the their banking separately so they have defined charges. ICB completely fails to look at the fact that the Other people are not bothered about getting interest business model operated by the UK retail banks is on their balances, but they would rather have quite odd in many ways and it is not a model that is something that didn’t charge them upfront. I think in copied anywhere else in the world—it is unique to other industries we see different people saying, “I am this country. It is a model whereby charges and who after this group of consumers and I would like to is paying for the delivery of the service are completely package what I want to get. I can package it in the unreflective of where the costs are built up. As we way that attracts those people, knowing it is less said in the earlier session, one of the consequences is attractive to somebody else.” At the moment we have that it makes it very difficult for new entrants to come a bit of a one size fits all. in and offer something different. Everyone is forced into this particular model and it is one where, of Q287 Mr Love: In the last few weeks we have seen course, there are current winners like myself, because Royal Bank of Scotland limiting the access of the my account is always in credit, and there are also basic bank account holders to cash machines—non- losers. For example, if you have had estimated bills branded cash machines—and, of course, that follows from your electricity company for the last few up action that was taken by Lloyds about a year ago. quarters and you suddenly get a catch-up with a meter We are also aware in this Committee from some of cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
Treasury Committee: Evidence Ev 51
2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy the evidence that was submitted to us that there are Q289 Mr Love: Ms Farnish, in relation to the other ways in which basic bank account holders are withdrawals, I asked last week some industry mutual limited in the services that they can access from representatives when the tipping point would come banks. Is there anything in the ICB report that when they would seriously cast in doubt the free ATM addresses the issues of the service provided to low access that is currently available at most cash income customers? machines. Is that a worry for you? Christine Farnish: No, there is not. The report is Christine Farnish: It is a worry. We have written to silent on low-income customers. We understand the the BBA about the action taken by RBS and Lloyds pressures the ICB were under and the time constraints Banking Group on basic bank accounts and link on their investigations. They had very complex, big access recently and we are urging the industry to reach issues to look at but, again, we feel this is a bit of a an agreement to maintain common standards in basic gap, simply because access to banking services, bank accounts that meet the needs of lower income transactional banking, is an essential of life these consumers. We are waiting for a response. days. If those services are not available to a section of society or are unaffordable or will give them nasty Q290 Mr Love: Ms Guy, basic bank account holders, surprises in terms of surprise charges that they can’t what should we be doing? afford, we have a very real problem. Gillian Guy: We would have liked the Commission to The basic bank account has been very successful in look at low-income customers because they are not filling a big gap and I think a lot of progress has been popular with the financial institutions and that is why made by the banks since this Committee started they suffer time and again, and we don’t necessarily focusing on it some 10 years ago. It made a big difference. However, it is important that the banks do have the impact drawn out. We campaigned long and not now start rowing back from the arrangements that hard to get ATMs available for everyone free and they made previously and start to limit the service don’t want to see that disappear, but as soon as the offering. There is further to go. We would like all the market breaks ranks then, in the same way as bills go basic bank account providers to have those accounts up, you see that gathering ground, and we have a available through the post office, for example, and we serious concern that that might be general. It does not would like people to be able to access cash at ATMs stop there and it feels to us that there ought to be and make payments—maybe limited payments minimum standard facilities that should be available functionality, but there should be some. to everybody to include them in the general market. As has just been said, you are out of the labour market Q288 Mr Love: Anything you would like to add, Mr if you don’t have a bank account. Undischarged Vicary-Smith, about what the ICB should have bankrupts can’t get them other than from a couple of recommended in terms of addressing the issues that banks. There is no good reason why they can’t be affect low income customers? given by all banks and we have engaged the BBA in Peter Vicary-Smith: I agree entirely with what that. The BBA is a trade association so it takes the Christine has been saying. One other dimension in views of its members and if they don’t want to shift terms of the behaviour of RBS is that this is not just on that, they don’t shift on it. There needs to be about basic bank accounts, because I think we have something more to make financial institutions live up seen over the years sporadic attempts by the industry to a responsibility to low-income customers. to charge for ATM usage and I think this is a first step in that process. I could envisage a position they would Q291 Andrea Leadsom: I would like to come back like to reach whereby they charged you to get cash to the issue of competition. I would be grateful for out, you can’t use cheques, you do not have a cheque your thoughts on whether the requirement for Lloyds guarantee card, you are charged to use credit cards or to divest further branches from the ICB proposals debit cards. I can envisage something whereby goes far enough to be able to promote competition. transactions became all taxable. I think it is important Particularly, I think it was Which? that said there is a that we fight at each stage that this comes up and it risk that Lloyds will proceed to sell the 300 branches, has come up with the RBS basic bank account, so I thereby hopefully avoiding having to sell further think we need to push back very strongly against that. branches so that it is a fait accompli. I would be Dominic Lindley: The RBS decision is going to interested to know whether you all share that view. withdraw access for 1.1 million of your constituents Christine Farnish: The real problem with the Lloyds to over 80% of the free cash machines in the UK, so issue, it seems to us, was the decision in the first place. they are going to have to travel further, and they might It was done in the heat of the financial crisis. There incur extra inconvenience. It would be a disaster if, because of that inconvenience, they chose to stop were much bigger things at stake for this country. In using their bank account and moved back to managing normal times or peacetime that decision would never in cash, when we all know that you can save money have been allowed as part of competition law. I think on your household bills by having a bank account and, we need to recognise we are where we are. of course, you need one to become an active participant in the labour market. So the RBS decision Q292 Andrea Leadsom: Would you see it reversed? is very disappointing and the real worry is that other Would you like to see the Lloyds HBOS merger banks start to follow suit, and that will overall reduce reversed? the convenience for millions of basic bank account Christine Farnish: I think it is very difficult once a holders. decision has been made and— cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
Ev 52 Treasury Committee: Evidence
2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy
Q293 Andrea Leadsom: Why? What is difficult consequences of merger, if you like, first and see about it? Obviously it has cost implications but you whether that can address the competitive dimension could just decide to do it, couldn’t you? Should the on its own. A proactive break-up of RBS, I am not ICB have done that? sure. I am not sure I would go quite that far yet. Christine Farnish: The ICB has the power only to Andrea Leadsom: Do either of you have any recommend. I guess one of the considerations at the comments on that? moment would be further weakening and Gillian Guy: I think it is appropriate to refer to the destabilisation of the UK banking system. I would Competition Commission. To have all this push have thought that might be an issue that decision- towards competition is limited if very few players are makers need to bear in mind. in the market in the first place, and that limits the It is possible that once our economy and the financial ability to have genuine competition, so freeing up the system and the current crisis over the euro is in entry and exit into the market is important. slightly less dangerous territory the whole structure of Christine Farnish: To go back to the earlier the banking market could be looked at properly by conversation, to have effective competition, I think the competition authorities and in a few years’ time you need choice for consumers and you need to know hopefully that will happen. That would probably be what you are buying in clear, simple terms. Part of the one of the best ways to deal with it and that is why problem with the retail market, regardless of how we have competition law. many entities you have, is that pretty well everyone is selling the same thing and it is very hard to see what Q294 Andrea Leadsom: Ms Guy or Mr Vicary- you are paying for. I think that is the most important Smith, do you think the Lloyds HBOS merger should problem with competition for retail customers in be reversed? banking. Peter Vicary-Smith: I think it should be seriously considered whether it should be referred now to the Competition Commission which, of course, has the Q297 Chair: You said earlier, Peter Vicary-Smith, power to do that. I don’t think we should be waiting that consumers and small businesses are suffering until 2015 and however many years it then takes to right now. Can you give us the evidence for that, if reach a decision, because there is an exploitation of not now, in writing? market position going on right now and consumers Peter Vicary-Smith: I can give you the evidence in and small businesses are suffering as a consequence. writing and maybe others can give it now. I think the other thing I would say is we have been Dominic Lindley: I think you can see an increase in continually disappointed by the role of UKFI in margins across many retail banking markets. If you looking at how it can enable competition to be look at the average quoted overdraft interest rate, it is strengthened. It has that objective in there. The first at a 16-year high despite the fact that base rates are a tranches, of course, were sold to Santander, which did lot lower, there is enhanced— nothing for competition, and we fear that UKFI should be applying a public interest test to these disposals. Q298 Chair: Many other factors may lie behind that. So we would like to see further divestment, possibly The question I am asking is whether you can a referral, and certainly UKFI being a public interest, disentangle various effects in the market in order to so we can get back to at least the competitive be able to identify. You said you can see the marketplace we had in 2009, if not something better consumers and small businesses are suffering right than that. now, Mr Vicary-Smith, and rather than have an extensive exchange now, why don’t you come back Q295 Andrea Leadsom: Bearing in mind the with something that looks copper-bottomed on that taxpayer shareholding in RBS, should we be looking point? at breaking up RBS and parcelling that off in its Peter Vicary-Smith: We can write to you on that, yes. entirety? Peter Vicary-Smith: I think how to sell RBS back, if you like, is a different issue from the Lloyds HBOS— Q299 Michael Fallon: Can we come back to Andrea Leadsom: Yes, it is absolutely a different switching and the redirection service that has been issue. proposed. One of you said a few moments ago this Peter Vicary-Smith: Because a merger was formed. was going to be cost-free, and I think that is in the report. Would it really be cost-free? If a consumer Q296 Andrea Leadsom: But you could potentially incurs some extra charge because they have fallen out then create new entrants, couldn’t you? You could of some time period, will that be borne by the bank? potentially sell RBS off in pieces to different UK Dominic Lindley: The Payments Council have told us organisations like Virgin Money, Metro Bank, M&S that there will be a guarantee that these will be Financial Services, Tesco Bank and others, and refunded and they want to impose an obligation on potentially create a new set of entrants. Would that be the bank you are switching to to deal with that. One something from a consumer point of view? Could you of the nightmares for consumers is when both banks see merit in that? are denying responsibility for a particular thing going Peter Vicary-Smith: I think that, first, we have to see wrong and then it is difficult to get a charge refunded, a greater appetite from some of those new entrants to whereas the Payments Council are saying that the take over large amounts of those large networks. My receiving bank will refund that charge. Whether that feeling would be deal with Lloyds—disentangle the needs to be backed up by regulation might be— cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
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2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy
Q300 Michael Fallon: Where will the legal Michael Fallon: Sure, but who else could provide it? responsibility for refunding that charge lie? Would you put the obligation on the banks to provide Dominic Lindley: They are saying the legal it, for example? responsibility will lie on the bank you are moving to, Gillian Guy: I think the banks should pay for it. so the bank you are switching to. Michael Fallon: They are saying that. How will that Q304 Michael Fallon: The Payments Council have bind the bank? estimated the cost of all this at between £650 million Dominic Lindley: Supposedly it will bind either and £850 million. Is that estimate right? through regulation by the FSA under the Banking Christine Farnish: It is almost impossible for us to Conduct of Business Rules and, if that is not know, I think. happening, consumers will ultimately have access to Dominic Lindley: We know that, when the Dutch the ombudsman to complain about that charge. introduced a similar system—we talked to our counterpart organisation called Consumentenbond— Q301 Michael Fallon: Do you think that will be the costs of the Dutch system were lower than that. What is not clear from the Payments Council, because enough to reduce or remove this fear of switching? they have not published a breakdown, is where exactly Christine Farnish: I think it will take time because the costs fall—how much are falling on the bank and this is a very deeply ingrained fear that people have. how much are falling on small businesses and others Most people are quite confused and can’t remember who will have to update their systems. You see this exactly which standing orders and direct debits they system being recommended, and it will definitely have set up and who they are to—obviously their bank provide benefits to customers, but it would have been knows—and they know there are serious nicer to do a proper cost benefit analysis first, which consequences quite often if one of those goes wrong. is almost what we are calling for on portable bank They can end up with surprise bills that pop up—all account numbers. When I switch my bank account, all sorts of things can happen—which is a lot of hassle these sorts of administrative costs are imposed on my as well as putting their budgets out of kilter. There employer, there are all the businesses and Government needs to be a proper communications campaign, departments that receive a payment from me if I get probably, to accompany this easy switching and safe paid any benefits. All those admin costs are, at the switching to make sure that consumers change their moment, spread out over the system but no one has mindset about switching. a clear idea about how much portable bank account numbers will lead to benefits for all those Q302 Michael Fallon: Are the recommendations as organisations. framed by Vickers on easier switching enough? Apart Peter Vicary-Smith: Portable bank account numbers, from the communications campaign and better if you get to it, is a cleaner solution. I don’t education and so on, are there other measures you intrinsically like something where you say, “We have would like to see to make switching even easier? a system here and if we don’t do it properly, you have Gillian Guy: I think there needs to be more the ability to have recourse and get your money back,” information and transparency around switching. We because you then get into a tangled process of redress, have just heard about the legal obligation on the you get into ombudsmen overload and all the rest of transfer bank, but there are two things about that. it, so something where you don’t have to get into that. You simply have a portable bank account number; it First, consumers have to know their rights before they is cleaner. The cost benefit analysis we call for would can exercise them, and they have to be confident that, say whether it is a better solution than redirection. At in exercising them, they will get somewhere. the moment we can’t tell. Secondly, knowing that something will be sorted out Michael Fallon: Nobody has answered whether this does not relieve the anxiety if you are trying to make £850 million figure is right. ends meet and support a family. I think that is very Peter Vicary-Smith: We don’t know. difficult. Michael Fallon: Do you think it sounds right? One of the things that is important to sustain, we Peter Vicary-Smith: What we are all slightly dancing spoke earlier about people having access to lawyers. around is that, of course, it has come from the The majority of clients who come into Citizens Payments Council and the Payments Council is a Advice clearly don’t. They need free advice to help representative of the banks, so I am sure they would them through the switching as well. Although that not want to underestimate the charges. would not take the obligation off the banks to make it clear and transparent, I also believe that people need Q305 Michael Fallon: But if it was right, would it some advice to go alongside that to give them comfort be reasonable? and to help them when they have to sort out any Peter Vicary-Smith: I am not trying to be cute with muddles. the answer, but without the cost benefit analysis it is hard to say because it has not been done on laying out Q303 Michael Fallon: Where would that what the benefits to consumers will be. Will that be responsibility fall? Who would provide the free enough to encourage switching? advice? Gillian Guy: The free advice at the moment is Q306 Michael Fallon: How much switching would provided through Citizens Advice—75% of our you like to see to justify the expenditure of £500 bureaux provide it, but that funding is under threat. million or nearly £1 billion? What is the percentage cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
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2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy you have in your mind? Should it match that in energy three. In terms of what does this look like, think how markets or telephone markets? When will you know hard Vodafone and 02 and all the rest of it fight for that switching has really started to take off? your business at the point at which you are wanting a Dominic Lindley: I think you need a number of new fancy phone—that is because it is so easy for you different mechanisms to judge a success. Firstly, you to move over. That is, to my mind, the nirvana. You need to know what is happening to switching rates might choose not to switch—a lot of people on mobile but, secondly, you need to know what is happening to phones stay with the same provider—but you often anxiety about switching. The whole purpose of this move to a different tariff, whatever it may be, and system is to increase consumers’ confidence in there is always the threat that you can very easily switching. At the moment, too many of the people we move over. If we could get to that, I think banks speak to who are thinking about switching say, “Well, would start to fight to keep existing customers rather it might be too much of a hassle, I’m worried about than spend all their time trying to tempt people to something going wrong,” so we clearly want those move over. That is where we would want to get to. Is numbers to be going down in addition to an actual it better to do that now? Again, I come back to the increase in the number switching. fact we need the analysis to be done. In what is a very good report, the disappointment in Vickers is there has Q307 Michael Fallon: Why do you think the not been an analysis over the cost benefits of those Commission came out against portable numbers? two dimensions. Dominic, on the third? Peter Vicary-Smith: I think they were worried about Dominic Lindley: On the technical details, there are costs of implementation and ease of it, and the banks’ two main methods. There is the portable customer concerns about system upgrades that would be number, which is where I have my own kind of required and so on. That is why I would like to have number that is attached to a bank account and that seen it as a long-stop solution that is built into their customer number can move to be attached to a plans over a long time, because the banks are updating different bank account. That is the Swedish bank giro their systems all the time. I would have thought, give system, which is available for corporates in Sweden. them a long time to do it but be clear it is going to The other one is the portable account number that I happen. would be able to move and take my sort code and account number with me, which might be more Q308 Michael Fallon: It ought to be possible, if you expensive but it depends on the analysis. What it are spending £850 million on a redirection service, to might require as well is changes to the international make that future proofed towards eventual translation systems for identifying bank accounts. to a portable number. Certainly, when we talk to all our counterpart Peter Vicary-Smith: You would imagine so. consumer organisations across Europe, Australia, the US, they are all interested in the system of portable Q309 Andrea Leadsom: I just love this idea, bank account numbers, but no one is grasping for it. I personally. My question is if we are looking at £800 know recently there was a report in Australia, and the million to redirect and the bank chief executives, Australian Banking Association cited the rejection of when we first put this to them, were sort of saying, portable bank account numbers in the UK to justify “Oh, it would cost £2 billion”. It seems to me if we rejecting them in Australia rather than doing their own are looking at spending £800 million to redirect kind of analysis, because it leads to significant payments, would it not be better to spend £2 billion, benefits. albeit a significantly bigger sum, I don’t underestimate At the moment we are expecting all these small that, but then you do have the utopia. That is question businesses to upgrade their systems, to be good at number one, why are we spending £800 million? If it moving the payments over and, of course, does not work we are going to have to spend the £2 Government departments. One thing that you might billion anyway because you would write off the £800 be able to ask the Government about on switching million because it would be a different target. bank accounts, if you go to the directgov website it is Secondly, what is your idea of how a portable bank very hard to find a single page that explains which account would work? Is it that there is a centralised people you need to contact to move your benefits over clearing system where all bank accounts are held and to your new account. You might need to contact then banks plug to play? They buy a licence, for HMRC or the DWP, so that might be one way of example, to play with that clearing system. If that is improving things. the case, could it also address the issue of the If we look back to what Peter was speaking about— complexity for new entrants, since they have to, at the what the telecoms regulator did, which was of course moment, go to a clearing bank as an agency clearer? Don Cruickshank who commissioned independent Sorry, three part question. The money that we would cost benefit analysis—the telecoms companies at the be writing off now, would it be better to go straight to time said the system is not designed for it, it is too the portable account system? Secondly, does that expensive, it won’t work, but armed with that analysis solve the competition issue? Thirdly, would you the regulator, which had a duty to promote thereby also create, in a sense, a system whereby competition, pushed it through. That is what we are people could instantly transfer their accounts? lacking in the financial services sector at the moment. Obviously they could change account number if they wanted and not if they didn’t want to. Q310 Andrea Leadsom: That comes back to the Peter Vicary-Smith: For Which?, I will address one competition objective potentially not being strong and two and then turn to my colleague for number enough because we are going with a halfway house, cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG04 Source: /MILES/PKU/INPUT/017688/017688_o004_db_TC ICB 2 November 11 CORRECTED.xml
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2 November 2011 Peter Vicary-Smith, Dominic Lindley, Christine Farnish and Gillian Guy if I can call it that, of a redirection service whereas Gillian Guy: I don’t think any of us know what it will potentially for the sake of competition you could go cost. It is great to shove a very large number at it to the centralised clearing system. Would either of you because it puts us all off. I suspect it is not dealt with like to comment? here because it is in the “too difficult” box. No one Christine Farnish: Could I simply say that I think wants to unravel it and certainly no one wants to prove you need to question technical experts because I on the cost benefit analysis that it is worth investing certainly am not competent to answer the questions in because someone has to make that investment. But other than to say that £860 million sounds a lot for I think someone should take it out of the “too quick switching and safe switching. I think you need difficult” box and have a look at it so that we are to add a few noughts if you want to do number dealing with facts rather than conjecture. portability. My understanding is we are talking Andrea Leadsom: That is very helpful, thank you. billions. There is a very significant cost. These Chair: Thank you very much indeed. This Committee payment systems are extremely clunky and likes having a go at the “too difficult” box from time complicated and they are enormous and getting to time and maybe we will take another look at that anything to go wrong could be pretty awful for both particular issue. Thank you very much for coming in consumers and the economy. I think a lot of work that and giving a second set of evidence on this tricky needs to be done about feasibility. subject. Peter Vicary-Smith: That is why if it is going to be done it needs a long lead time to enable the banks to do it. cobber Pack: U PL: COE1 [SE] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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Wednesday 23 November 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Andrea Leadsom Teresa Pearce Mr Andy Love Mr David Ruffley Pat McFadden John Thurso John Mann ______
Examination of Witnesses
Witnesses: Stephen Hester, Chief Executive, Royal Bank of Scotland, and Douglas Flint CBE, Group Chairman, HSBC, gave evidence.
Q311 Chair: Thank you very much for coming Douglas Flint: It is not intended to be a gun to the before us this afternoon. May I begin with a question head. It is a very big number. to you, Mr Flint? Your Chief Financial Officer has been quoted as saying that the cost of holding bail-in Q316 Chair: Mr Hester, have capital and liquidity bonds would be £2.1 billion, which is too high to requirements, which are being imposed by the justify staying in the UK. Will HSBC relocate if the regulators to strengthen balance sheets, restricted the Government implements that part of Vickers? amount you can lend? Douglas Flint: I think the figure of 2.1 billion is Stephen Hester: The amount that we can lend in the dollars, not pounds, but it is still a very big number. politically sensitive constituency that I think your What Ian was referring to was given that we are question is getting at we have not constrained as a essentially funded by deposits, adding loss-absorbing result of those two things. capacity bail-in bonds when we do not have them today would add a cost to being headquartered in the Q317 Chair: I am sorry to interrupt, but just to be UK because the proposals that have been put in front clear, what you are saying is it has had a of Parliament are that the loss-absorbing capacity disproportionate impact on one part of your activities should apply not only to UK-based activities but to but no impact on another part of your activities. Is the global activities of banks headquartered in the UK. that right? So there is an extra-territoriality in saying we should Stephen Hester: The constraint in our UK business hold bail-inable debt in respect of all international lending, which I think is probably what you are operations. We do not have that debt because we are driving at, has been our ability to find people who we funded by deposits, so there would be a cost and a thought were credit worthy to borrow from us. That spread between raising that debt, which would be has been the constraint, not capital or liquidity. That quasi subordinated, and placing it in risk-free assets. said, it is the case, of course, that RBS is carrying We estimate that in fairly normal conditions that three times more capital for every loan it makes than would be around $2.1 billion post tax; in today’s it used to—by the way I think appropriately—and the conditions, it would be a great deal more. That would cost of liquidity is huge. You see that in the be a very significant item to weigh up in consideration profitability of the bank and you see that in the current as to where one would choose as the optimal place for value of the taxpayers’ stake in the bank. I regard it headquarters. It is a hypothetical notion at the as one of the key building blocks of recovering RBS moment, but it would be a very huge cost. that those businesses that we designated as core to our future, of which UK corporate is clearly one of the most important and should not be in any way starved Q312 Chair: Okay, but a significant issue to weigh of resources, and so we have managed ourselves to up is quite different from saying it is too high to ensure that. justify staying in the UK. Douglas Flint: But we do not have a proposal yet. Q318 Chair: Do you agree with what Bob Jenkins of We only have a recommendation in a report. the Financial Policy Committee said today—that you can strengthen your balance sheet without reducing Q313 Chair: But anything that costs $2 billion is too lending? high to justify staying in the UK? Stephen Hester: Well, clearly I did not hear or see Douglas Flint: It is too high to ignore. directly what he said. I glanced over reports of what he said. Q314 Chair: That is not quite the same. Chair: It was the front page lead on the FT. Douglas Flint: I do not know what other jurisdictions Stephen Hester: But what I think I would say is that are going to, in the meantime, say they might do. the first point is the one I have already made in terms of our continuing willingness to support our core Q315 Chair: Okay, but it is a bit of a gun to the head customer base here in the UK and our ability to do it to the regulators, isn’t it? and the fact that we are doing it. Secondly, I did think cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE some of the points being made were surprising. I not levy, I am clear that part of my responsibility has could not understand how that would be the case. I been to articulate from the point of view of a failed understand, for example, one suggestion was that we bank what lessons I think we can draw from that. go out and raise some more capital and I would be That is not the same as saying that there can never be very interested to see the investor who wants to put a piece of proposed legislation that we would not more capital towards UK banks. At the moment they think is not in the public interest as well as not in are all thinking that is a dumb place to put capital. I the bank’s interest. I have been equally clear that ring think there were some strange things in what he said, fencing would fall into that category, but I think as it but as it happens the result for RBS today is that we relates to myself or to RBS the general charge of are not constraining UK small businesses due to lobbying against regulation is not borne out by the liquidity or capital constraints. facts, as indeed my witness testimony here has shown on many occasions. Q319 Chair: Do you put in the strange category of things that he said that you can strengthen your Q322 Mr McFadden: Do you wish your colleagues balance sheet by cutting your bonus? would, therefore, stop saying or hinting that new Stephen Hester: Well, I think that, of course, we are regulatory requirements would either impact on into politically difficult territory with a small “p”. I lending or force them to think again about where their think that there is a very legitimate discussion about headquarters might be? pay. Certainly, from a business perspective it is my Stephen Hester: Well, I think that it is a responsibility job to make sure that we pay no more than we need of people holding our kind of jobs to articulate to to get a given set of business results. I would make publicly and discuss publicly issues, and I think it the point specifically on small businesses that if there would be a shame if people felt gagged in so doing are large bonuses in banking, which of course is a just because others did not want to hear what they shrinking thing anyway, it is not in that area of the were saying or the answer. RBS has reduced its business. Changing investment banking bonus pools, borrowing, its balance sheet, during my stewardship however desirable it may be, will have no impact on by $1 trillion, £600 million, and so somewhere in the small business lending and, in any event, such world that is £600 million that is not available to bonuses are paid largely in equity, which do not cost whoever was on the other side of that. As it happens, capital. Again, it may be an entirely desirable thing to we have not taken that from UK small businesses. We do, but it will not have the impact of making even a have done it by dismantling other parts of RBS in the penny more available to small businesses. way that we all thought was appropriate, but there is no doubt that in aggregate the world is going through Q320 Chair: So the answer to my question is yes, it a period where it de-leverages, which means less is in the category of strange things that he said. credit is available. I believe that that is a good thing; Stephen Hester: It is in the category of things that we had excess before. Clearly, that has its effects and are entirely legitimate to discuss but will not have the we would be naïve to pretend it does not. The effects consequence of adding to lending to small businesses. will be different with each country, each institution and, of course, each managerial decision. Q321 Mr McFadden: He was making a broader attack on the banking response to some of the new Q323 Mr McFadden: Would it be fair in simple regulatory requirements and some of the new terms to sum up your response to Mr Jenkins as saying proposals that have been made. He says bank lobbying he is just going to have to put up with it? If we have is, “Intellectually dishonest and potentially damaging” criticisms to make of the proposals we will have to and says that, “It promotes fear for an economy which make them? the banks are there to serve and from which they draw Stephen Hester: As I say, I have not read his remarks their livelihood”. What is your response to that? and I have not had the opportunity of a discourse with Stephen Hester: Thank you for asking the question. I him, but I think I would simply repeat my position. think it is an important one and, of course, you are As it relates to RBS we are not constraining our probably getting bored with hearing me here; you lending to small businesses for capital and liquidity have seen me a number of times in the three years reasons; it is constrained by demand. But I do think it since I was appointed. As you know, those of you who is part of our duty to appear in front of bodies such as have been here for the same period of time on this yourselves and give honest answers to questions as Committee, from day one when the board of RBS and put and that is what I hope you would expect us to do. the Government both asked me to join to help turn around RBS post the crisis, I have been a consistent Q324 Chair: On that lending point, the Citigroup and a very clear voice in favour of tougher regulation report on Project Merlin concluded: “In aggregate, of the banking sector, higher capital and liquidity banks are meeting their Project Merlin targets by standards, and I think, if anything, outspoken in making credit available at a high price and on tough favour of the Basel process. You will never be able to terms that few firms can afford to meet”. Do you think find a quote from me criticising the international that is correct? I am asking Mr Hester. reforms around Basel or the impacts that they have Stephen Hester: I do not think that is correct. The on banks. Indeed, you will not find a quote from me average cost to small businesses of loans from RBS— criticising the extra tax put on the banking industry by obviously that is who I can speak for at the moment— the UK. I think that while it is true, of course, each in the current year is 3.75%. I do not believe that you bank must speak for itself about what it does and does would find many businesses who would have a hurdle cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE rate of return on new investment that cannot pay to, as you said, a loan application, because it is a big 3.75% in interest rate costs. In terms of whether we step forward. are profiteering on the back of that, our small business Stephen Hester: Yes. I promise you my own people division makes profits substantially below its cost of have been charged with giving me exactly this data, capital, obviously to the expense of the taxpayer in and so I would be very pleased to pass it on once we this instance, so I do not think that is right that it is the have some data for you. lowest level of interest rates ever for small businesses. Now, that said, it is the case that there are some areas Q329 Mark Garnier: Douglas Flint, you came of lending where banks have had to toughen up. Those before us in January and February and I talked to you areas come broadly under two categories. The first is about the possibility of relocating back to Hong Kong where there was manifest excess in the past and it is or outside the UK. You said to me at the time that a correction of excess and, indeed, our regulator, the every three years HSBC reviews where your location FSA, and I believe public policy, is highly supportive is going to be, but it was this year that you would be of those excesses being eliminated. Some of the high deciding where you are going to be. We have a few loan to value mortgage lending was one example, weeks left until the end of the year. How are those albeit not in the small business area. Property lending deliberations getting along? is another example where the regulators are massively Douglas Flint: I think Stuart Gulliver, when he was pressurising the industry, I think correctly, to be up before the Joint Committee, said that we were more conservative. probably going to push that back by maybe up to 12 The second area where businesses will be finding it months because we will not know the final outcome tougher is obviously businesses in a number of areas of the ICB in terms of what is going to be done in the have been weakened by the recession and, therefore, UK. While all the stuff we used to normally do around themselves have a more challenging credit picture just simply business climate and tax framework and today to anyone looking at them. As a result, the so on can be done and has been done, the big issue conversations will feel more difficult. But all I can tell in relation to where the regulatory map falls, ICB, you, as I have said again on every occasion I think Dodd-Frank and European directives implementation that I have been in front of this Committee, it is our around the world is still very much a moving target. I absolutely genuine and sincere desire and attempt to think we will not be in a position by the end of this make credit available where creditworthy demand year to draw a conclusion because the regulatory piece exists to small businesses and at prices that are will still be fluid. competitive. I believe we have done that. Approximately one in four of UK small businesses Q330 Mark Garnier: Of those three things that you use RBS as its main bank. We account for nearly 50% talked about, how important is ICB? of Merlin lending so far this year. Douglas Flint: Well, I think the most important thing that we are looking at is the loss-absorbing capacity Q325 Chair: That is why the questions are coming point. We have said that publicly on a number of your way on this subject. Could we have a note on the occasions and, indeed, we have talked about it publicly because a great number of market analysts 3.75% and any qualifications that may be important in have begun to draw out extrapolations of what they relation to it? I think that is a very important— think the costs will be, which is why we said we Stephen Hester: The only qualification I have is it reckoned it would cost us a bit over $2 billion on an is an average so some will lie above and some will after-tax basis if one were to take or if one were to lie below. interpret what had been said in the ICB report. That Chair: You will be able to give generic reasons for falls within a range that is broader on either sides as why they lie either— to what market expectations are and, indeed, part of Stephen Hester: Sure, of course. the dialogue we have routinely now with shareholders is simply saying, “Once we know we have a final Q326 Chair: You said that too many small figure we will be able to let you know what that is businesses are simply not coming to talk about their and talk to you about how we should respond”. But finance needs and you are running a three-month as I said, it is hypothetical at the moment because it programme to have a discussion with them and you is a proposal. We do not know how it will be received launched that at the beginning of the month. How when it is considered. many have come to talk to you? Stephen Hester: At the moment, because there is a Q331 Mark Garnier: I am quite interested in lag of quite a few weeks between phone call to credit loss-absorbing capital because you are talking about decision, I cannot give you any reliable statistics in having to issue £55 billion of bonds you do not want relation to increased loan applications or anything like in order to make it— that. I am certainly happy to report on it. Douglas Flint: Dollars. Mark Garnier: Sorry, $55 billion worth of bonds you Q327 Chair: But how many are having a chat? do not want to buy $55 billion worth of what is meant Stephen Hester: I do not have a reliable statistic for to be a risk-free investment but, as we know, you in terms of an increased number, I am afraid. Government debt is not necessarily risk free, although we like to think, of course, that ours is. That is going Q328 Chair: It would be useful to have some figures to cost you $3 billion a year and yet your loan deposit on that, starting with the mere chat all the way through ratio is 80%, I think. Do you feel that you are being cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE very unfairly targeted with your strong funding for international business and the international model? financial system responded to that. Time zone, Douglas Flint: In a way, yes. It seems perverse in a language, the cluster effect of the fact there are 500 way that a business model that is very conservatively banks in London, the expertise that exists here in legal structured in funding, i.e. funded by deposits, would services, trusts, accounting, custodianship, financial be disadvantaged by a mechanism that is designed to exchanges, transportation and so on and so forth, strengthen the system. The more you are funded by absolutely huge. The sanctity of law is a huge element core deposits the more the cost is of raising additional of a financial system and English law is a major capital to absorb losses. That seems a perverse benefit to the UK as an international jurisdiction. In outcome. terms of a place to do business, it has enormous advantages. Q332 Mark Garnier: Yet some people would argue that the more deposits you have the more individuals Q336 Mark Garnier: Should you choose in the there are at risk and, therefore, there is a better space of the next 12 months to relocate, where would argument for having more loss-absorbing capital. Or you relocate to? do you think that is a fallacious argument? Douglas Flint: I think again that is hypothetical Douglas Flint: The risk that you take is on the asset because it would depend upon what regulatory side of the balance sheet, but I think stability of being changes are enacted elsewhere in the world. Having funded by core funding has been for us through said that, it would undoubtedly be a place where we history an enormous strength because it means you have a considerable presence because I think a group are not exposed to the vicissitudes of the marketplace like ours has to be located in a jurisdiction where we in terms of investor preference, debt capacity and all have a significant presence. the turmoil that is going on at the moment where markets essentially in Europe are drying up because of Q337 John Mann: Mr Hester, you have been there uncertainty about what is happening in the Eurozone. for three years. How many of your top people, or those earning bonuses or decent-sized bonuses, have Q333 Mark Garnier: How easy do you think it you brought in from outside the financial sector? would be to raise $55 billion worth of loss-absorbing Stephen Hester: Certainly, none of my top team were capital? in their current jobs prior to me arriving. Roughly half Douglas Flint: I think it would take some time. I have come from inside RBS, been promoted or think it would be difficult and I think at the moment changed in different ways, half from the outside. I it is very difficult to speculate how difficult because cannot immediately think of anyone I have hired investors do not have clarity as to what the terms and without financial services experience. In fact, I think the structure of such an instrument would be, i.e. the the FSA would not allow me to even if I wanted to. fact that it would be bail-inable I think is easily Of course, there may be some areas like IT specialists recognised. The fact in what conditions and what or something like that, but one of the many areas in terms and who the obligor would be and all that kind which regulation has become dramatically more of stuff is not certain to them. I think in particular the intrusive is the FSA’s vetting of candidates and notion of loss-absorbing capacity at a group level is financial services experience is very important. somewhat confusing to us in the sense that within the Similarly, my chairman in restocking the board of ring-fenced bank one can understand what that means, directors of RBS, which is dominated by but to hold capacity, because we are headquartered in non-executives, has again sought to have people all the UK, that covers the entire global operations of the of whom have some financial services experience in group seems to us to create the contrary of a addition perhaps to some others. Again, that is both a ring-fence concept. It seems to create a nexus between business and a regulatory requirement nowadays. the UK Treasury and all of our operations around the world, which seems the reverse of what the ring-fence Q338 John Mann: The reason for asking is that you was trying to do. and others in your industry are very prepared and regularly willing to tell us how you have to pay these Q334 Mark Garnier: You are giving me a very huge bonuses in order to attract the best. But my convincing argument as to why you should leave the observation is that there is a shuffling of a pack within UK. Discuss. the industry and, therefore, it is rather a limited pool. Douglas Flint: That is a conclusion that you are Another thing that you are keen to tell us is that we drawing from what I am saying. What I am saying is have to give you enough time for what some people I think that the primary loss-absorbing capacity would regard as rather modest changes that Vickers is proposals have, I think, some unintended proposing—in fact, until 2019. Isn’t the truth that consequences both as to cost and in terms of their there is no good reason, if we chose to do so, that they structural implications for a business that would be could not be brought in a lot quicker—in fact, some headquartered in the UK, which would be people would say within two years? disadvantageous. Stephen Hester: What I have said in the past, which I would say to you again on the subject of this Q335 Mark Garnier: What are the good reasons for timetable, is that I think there are three different staying in the UK? moving parts. The first is how long it will take you Douglas Flint: Multitudinous. The UK set itself out and the regulators, whatever nexus there is depending 20, 30, 40 years ago to be the most attractive location on how you go about legislation and how much is cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE done by Parliament and how much is done pursuant response and the bailouts that took place, in particular to secondary legislation and how much by the by very quickly eliminating whole business streams. regulator. The first is how long will it take you to have Securitisation, structured credit, leveraged arbitrage the rules set out in a completely clear, unambiguous activities were simply closed and that is relatively and tested way? Of course, that is up to you. I cannot easy to do very quickly. You are just eliminating know what that is. I would observe that the US, which business. What you are talking about here is taking a has been attempting some similar sorts of things with business that is within a single legal entity and carving Dodd-Frank, two years later is nowhere close to the individual business streams and, indeed, the getting to the point where it is clear what has been individual customer relationships with the bank and legislated in terms of following it through. I think placing them within two separate legal entities, which there is a time amount that is under your control in is a significantly more burdensome task than saying, that sense. “Don’t do that activity with that customer” or, “Cut Once the things that are under your control are done, that activity out altogether”. You are splitting the then I think that there are two things that, if you like, activity. Effectively, you are creating two new banks lie on our side of the fence. The first is adjusting our out of every bank that exists, and that is a significantly business to be able to function inside and outside a greater challenge than changing the business activities ring-fence. My guess is that a lot of that can be done done within the single legal entity. from the time that we know the answer within, let’s Just to take the illustration that Stephen made, one of say, a couple of years that we know exactly what we the things the industry is grappling with, and we are are aiming for. The second is that there is a certainly grappling with, is something as mundane as phenomenal amount of what I sometimes call what to do with sort codes. A sort code is a destination plumbing changes that will probably be required to that defines the branch to which your account is enact in particular the ring-fence. That may mean attached and the number of the account. The vast moving many millions of UK customers across legal majority of our businesses will end up with activity entities, perhaps even different sort codes, different on both sides of the ring-fence, so are they going to contracts, enormous IT systems change, some level of need to have two different bank accounts, two disruption, and then perhaps, using Douglas’ example different sort codes, two different destinations, and before, some very considerable market activity. If, for just how that will work is a non-trivial question for example, HSBC has to raise £50 billion of new something that is really very mundane. It is very capital, there may be a number of years in which those different from saying, “Here is a banking product or kinds of things take place. These are the moving parts, an activity you should not do” as opposed to, “You which is why my own judgement is that it will not be can continue to do all these things but do them in a question of getting to the last day of the period and different legal entities”. then everything happens on the last day. Things will happen all the way through it, but it will take the full Q340 Chair: Before we leave the location issue period to sensibly cover each of those three points. completely, so I can plant the thought with you and That would be my judgement but, of course, a big part then come back for the answer in a few minutes, in a of that, the first part, is in broadly the authority’s word or in three words in a few minutes’ time I will control. come back and ask both of you, particularly you, Mr Flint, the three issues that at the moment would be Q339 John Mann: Change is difficult, but it did not most influential in deciding where you would want to take the banks very long to change to the new locate. What three things have led you to see Britain environment when taxpayers in this country and as somewhat less attractive than it had been during across the world had to bail out the banks. The change that build-up of the 34 years that we were talking came very rapidly. Indeed, there was an extraordinary about in your earlier answer? I will give you a change within banks in order to cope with new risk moment to think about it, but in the meantime, John profiles, new business operations, new people, new Thurso. banks, et cetera. I put it to you that in that timescale if that change had taken as long then we would have Q341 John Thurso: Mr Hester, I want to ask you been in a bigger problem. Therefore, it does seem about the investment banking side, but may I first pick incongruous that you cannot change quicker. One up on one thing you were saying earlier, which was commentator said this week that really what would be about Merlin and lending to smaller banks and so on. a lot better would be if we had dictatorship rather than How confident are you that the message you democracy to facilitate change. As you will know, Mr obviously are putting out at the boardroom level is Flint, the Communist Party of China just put its edict actually going down into the regional offices and that out about those businessmen who take too much they are following the lead that you are giving? money out of China should now be deemed to be Stephen Hester: I think that I am confident as to the traitors to China. I wonder in terms of where you majority. I can never be wholly confident. We deal locate what your perspective is in terms of how with millions of customers and we have 100,000 quickly such change would come if you were in people in the UK dealing with them directly and China. indirectly and so, of course, not every single one of Douglas Flint: I think you need to distinguish two those will always dance to the tune that we would like things. You are absolutely right that the financial them to. An example yesterday, and it happens to me system responded very quickly to the aftermath of the all the time, I was up in Nottingham yesterday, spent financial crisis of 2007Ð2008 and the regulatory a lot of time with our business clients as well as our cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE staff in the East Midlands. There was absolutely no things all blur together but they go in the same doubt whatsoever in my mind that from staff member direction—after a further reduction in investment after staff member at the most humble levels of the banking. organisation that they are very clear of our message in terms of concentrating on customers. The world is Q344 John Thurso: If UK banks, as you say, are complicated for them because they also have to being pushed out of that business, does that mean the grapple with credit issues and with customers who business simply will not be done or does it mean that maybe are not able to pay us back, with a whole set of that creates a gap that will be filled by people coming regulatory and other challenges, so I think it is entirely in from outside, a sort of “Wimbledonisation” of UK possible that mixed messages arise. Obviously, we are investment banking? doing our best is all I can say, and every day that goes Stephen Hester: First of all, I do not think it is black by we identify new things. A year ago, the bank set and white. I am talking about a reduction as opposed up a business task force to address about 20 specific to an elimination. Secondly, it seems to me that there issues to try and make the small business lending area are all sorts of changes going on around investment better. One of them was effectively what I will call a banking. Most of them are going to have the impact, small business ombudsman who can receive I think, of investment banking shrinking from perhaps complaints from small businesses about lending and what its peak level might have been as a per cent of pass them on to see if the banks are dealing with those GDP or whatever it might be, whoever it is owned by. things properly. The most recent report of the small I think there will be extra shrinkage from the UK, business ombudsman, I think for the period since which is the only jurisdiction ring fencing. But there March—I may be wrong; it was the first one that they will also clearly be some substitution that some other did—showed that RBS—as I say, RBS accounts for banks that are capable of offering their whole product roughly a quarter of small business relationships and line in a unified way to customers without the 45% of lending—accounted for 8% of complaints complexities of dealing with a different side and about bank lending. Of the complaints that were chopping it up will gain business. Some of that will upheld, which I think in the period was a total of 11, be located in London and some may not be. I think RBS accounted for only 4%. Those statistics give me we have made clear we regard this as a done deal. As comfort that we are in the right direction. I can never it happens, we have gone in that direction anyway. tell you that we have it absolutely right; of course we The vast majority of RBS is UK and retail and have not. commercial banking. We will need to go further, though. Q342 John Thurso: I know one of my colleagues is going to follow up on that so I will thank you for that Q345 John Thurso: Do you, Mr Flint, concur with extensive answer. What I really wanted to get to was the ICB proposals and how they affect the investment that analysis? Do you think it is inevitable that banking side of the business. For a universal bank investment banking in the UK will shrink as a result such as yourself, is there anything in the proposals of Vickers? that makes it more difficult to compete with foreign Douglas Flint: I do not think it is inevitable it will banks in the UK or makes it easier for foreign banks shrink. I think the platforms across which the activity to compete in the UK? will be done to an aggregate will tend to be broadly Stephen Hester: I think that it is clear—by the way, I the same. I think the platforms across which it will be think it is even public policy—that one of the aspects done may be different and, indeed, I think that ought of the ring-fencing part of the proposals will be to to be a policy objective of regulatory reform to say shrink the scale of domestic-owned investment which parts of the financial system, be it the insurance banking beyond what it otherwise would be. companies, fund managers, alternative fund managers, Obviously, not many people will like that as an banks and so on, are best suited to take this particular outcome, but I think that will be an outcome. risk and to organise financial regulation in a way that directs or incents that to go to the right place. I think Q343 John Thurso: May I just double check? You one of the issues that should be considered in all of think that that is actually an objective of what Vickers that is what happens in a stress condition. While one has said, to shrink the domestic investment bank? level might be relatively indifferent as to whether the Stephen Hester: I do. It is not a stated objective. I activity that the major corporates do through London think it is nevertheless a public objective. Whether it is done by a British-based bank or a branch of a is or is not, I think that will be the outcome. By the foreign bank, what was absolutely clear in the crisis way, there are some other things that are going to of 2007Ð2008 and is becoming increasingly apparent force that direction. We recently announced our third today that in a world of constrained risk appetite quarter results and at least as it relates to RBS I made banks are drawn back to their home market to use a series of statements about strategy evolution of RBS. their capital and liquidity for home customers. I think As you may know, we halved the size of our one of the things the UK needs to reflect on is take investment banking operations when I arrived three the absurd example if we had no domestic institutions years ago. I said in our third quarter that there would and you have a global funding crisis and all the banks be a further evolution of strategy and that there would take their money home, then who funds the companies be a still further reduction in our investment banking in Britain? You can see it today in all the regulatory operations that will result in part from regulation and challenges that have been made in terms of cross in part from market and investor changes—these border exposure that risk has increasingly been cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE concentrated, as you would expect, in domestic with you that are putative in terms of what might be markets. the case some years down the line, which lead me to the broad judgement I have given you. But there is Q346 Michael Fallon: Mr Hester, the Independent not a single piece of paper that says, “RBS cost is X”. Commission has costed its proposals at a maximum of £7 billion. Goldman Sachs now say £9.6 billion. Q350 Michael Fallon: It sounds very vague. Well, Who is right? Mr Flint, one reason for the difference between the Stephen Hester: Sadly, none of us know for certain Goldman estimate and the ICB estimate may be and none of us will ever know because we will never exactly the loss-absorption buffers that you were know the counterfactual. I have often said I think it is talking about earlier. What is the total cost to HSBC a done deal, but it will be put into action and we will of all this? You told us $2 billion for the absorption never know what would have happened otherwise. It buffer, but what about the rest? is my own judgement that the Independent Douglas Flint: Again, I have the same answer that Commission is likely to have underestimated the Stephen does, which is that none of us know where amount but, as I say, this is going to be a very hard the final regulation is that will implement the thing to prove one way or another. legislation that will give effect to the ICB proposals, so it is all hypothetical. We do not know yet finally Q347 Michael Fallon: But if you do not know, how what the final construct of what will go into the does the Government know? They can do the ring-fenced bank, what will not go into it, how the calculation. funding structures will change, whether in fact the Stephen Hester: They can come up with different ICB’s proposals on removing joint and several estimates. All I am simply saying is that I think that liability for pension schemes and VAT reform, both of the ability to apply certainty to these estimates is which could be quite big costs. The co-ordination of extremely low, especially given the unusually the ring fencing with the work that is already well uncertain external climate we have across many under way with the Bank of England and FSA in things. But in any event, I think it is unusually low. I relation to recovery and resolution planning and, in have not had the benefit of all the bank submissions particular, in a ring-fenced bank scenario what service that the ICB received. I only know where RBS’s relationship will be between the two parts of the bank thinking lies. There are many different scenarios but and what resilience that will have to have and what we broadly believe that they have underestimated the duplication that will have is still not clarified. It will costs. be a matter of consultation, so all of these things will have/could have significant impact on cost. Q348 Michael Fallon: What is the cost to RBS, then? Q351 Michael Fallon: Apart from the Stephen Hester: Again, I do not think that there is a loss-absorption buffers, where you have a particular useful single number I can give you, but what I can do is illustrate for you some sensitivities to it. For problem because of the nature of your bank, what is example, for every 10% more capital RBS were to likely to be the single most expensive part of Vickers? carry, that would be in capital cost terms £5 billion to Douglas Flint: Well, I think the second most shareholders or, depending on your hurdle rate of troublesome part at the moment as we look at our return, maybe £750 million a year of pre-tax profit business in the UK is the nexus between liquidity, equivalent. The running costs, the implementation capital and leverage. If I illustrate very simply, the costs, for RBS alone may be somewhere between half ICB proposal said that the core equity of a large bank a billion and a billion pounds in addition to running should be 10%. We have no challenge to that. It says costs. There will be lost business costs of customers that the leverage ratio of a systemically important who are put off by the complexity that is being put bank should be 4.06%, call it 4%. In order to get the upon them and go elsewhere; they are very hard to capital and the leverage in the same place, the average estimate but obviously you do not need big risk weighting has to be 40%, so effectively 10% of percentages for them to add up. These are the sorts of 40 is the 4% on the leverage issue. Because we have areas, and then funding costs, which will be higher, a very conservative balance sheet in the UK in relation which lead us to our belief that that is an to small business lending but, more importantly, to the underestimate. However, as I say, I think this is largely shape of the mortgage book, we find the capital that a done deal. I believe that we in the industry can adapt the risk weighting requires us to have is considerably to these things and that is what we are shaping up less than the leverage ratio. In other words, the more to do. liquidity we have in the bank, which is a good thing, and the less risk we take in the bank, which is I think Q349 Michael Fallon: This came out two months a good thing, means that the constraint is the leverage ago. If it is a done deal you must have done some ratio and you end up having to put a lot more capital base cost assessment of what the total cost is going into the bank for the leverage ratio rather than for the to be to your bank. You cannot just talk to us about risk or for liquidity. This means that you are faced sensitivities. You must have made an estimate. with reducing your returns or shrinking your business. Stephen Hester: There is no singular number that has That combination seems to be one that we are having been presented to our board of directors or to discussions with at the moment, but it seems to be a management. There are a whole range of sensitivities curious outcome that if the ring-fenced bank ends up under the headings that I have just been discussing being very low risk, it becomes very uneconomic. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE
Q352 Michael Fallon: All right, Mr Hester, can you elements of that that would be unique to the UK be less vague on this? What is the single most financial sector structure and so on, but I think clearly expensive part of these proposals for you? one of the factors that we will take into account is as Stephen Hester: I think that I would divide the to whether Europe and within Europe the UK offers a proposals into three buckets of cost. The first is what level playing field for all or some of our activities or I will call the extent to which the proposals effectively whether it has become very super-equivalent in the agree with the direction of international reform but go way it has applied regulatory change. Those will be a little bit further, which is largely around issues of the three areas: PLAC, the levy and capital and capital structure and bail-in and resolution. super-equivalence. I think that those will be pretty costly but, as I said before, they happen to be things that generally we are Q354 Chair: I note that the 50p rate has not appeared supportive of notwithstanding the fact that they are in that list of three. costly. I think that they could be easily comparably Douglas Flint: No. costly to the ring-fenced part of the proposal, which of course is the bit that no other country is following Q355 Mr Mudie: Since Lehmans we have had a and the first bit that many other countries are procession of bankers coming to this Committee and following. But the cost of ring fencing is the least speaking wonderful words about how they are helping easy to estimate because it requires a whole series of small and medium enterprises, and yet when we go behavioural guesses as to how customers will behave back to our constituencies we hear differently. Now, when being able to do business simply with JP you have done it today, but your trade union, the Morgan or Paribas or Deutsche Bank in an British Bankers Association, have just issued a survey uncomplicated way with a UK bank and how funders that they paid for, the biggest ever survey on SMEs, will behave. Then, as I have said before, the third over a million surveyed. Half a million said they were and smallest bucket—but still hundreds of millions of not even thinking about it at the moment because of pounds—is the implementation cost of the whole the state of the economy. Of the remaining half a thing. million, 250,000 businesses blame the banks, their lending terms and processes for their reluctance to Q353 Chair: Just following up on Michael Fallon’s borrow. Your trade union again found out in the last questions, perhaps it would be helpful if you—as three months 70,000 SMEs had applications for banks, you must have done assessments on best and overdrafts turned down. In the same three months, worst case assumptions about the cost of these 54,000 SMEs were turned down for a loan. That is proposals and with respect to partial or full between July and September, 54,000. Now, one in six implementation of them—could send us, both of you, applicants for an overdraft are turned down; one in your best assessment of the costs based on reasonable three applicants for a loan are turned down. Can you assumptions for each part of the composition of that see the difficulty we have in this Committee at the cost? We could then take it from there. gap between what is said to us and what is being said Mr Flint, I wonder whether you have had time to think out there and what your trade union has confirmed— about that relocation question I asked you in a few that it is desperate out there for small businesses? Go words. on, Douglas, you were poised to say something. Douglas Flint: In a few words, okay. You asked me Douglas Flint: What I can say is that we recognise the three most important elements. I think in order of the difficulties that exist in the economy today. We are importance, the most significant impact is the PLAC, approving the same high proportion—about 80% of the primary loss-absorbing capacity. Again, I credit applications that come through our system. I differentiate between whatever we do in the UK for think the business taskforce in terms both of UK activity done through a UK bank, that is entirely mentoring and offering an appeals service to small a matter for the regulators and legislators here to businesses has been very well received. I think legislate on and the industry will absorb that cost or regrettably, and this is maybe something that pass it on. What is done to headquartered companies collectively we need to do, there is an element of is simply a cost of being headquartered here. The best misunderstanding of the role of bank finance among estimate of the cost of being headquartered here and some small businesses. What we do is fund working having to have loss-absorbing capacity for our capital. We fund the acquisition of premises. We fund business outside the UK is a bit over $2 billion after the acquisition of businesses either from other tax. companies or companies themselves. As an industry, The second most costly element of being we are not particularly keen on funding losses. We are headquartered here is being required to pay the bank not particularly keen on— levy on our balance sheet outside of the European Economic Area, and that is another $400 million Q356 Mr Mudie: You seem to do it with other banks after tax. very easily. That is what gets me. All the money you I guess the third thing that would be of influence is the have lost in the past few years has not been to small whole area of level playing field super-equivalence. In businesses; it has been to fellow bankers and fellow their testimony to you, John Vickers said, “We tried financial corporations. You are all very well taking a to make a distinction between domestic business and risk when it is white collar, but if somebody is actually international business” and Bill Winters said, “But producing something you seem to regard it as high where we thought the international proposals were risk. The last Government came under some criticism wrong we also went further”. I think there are some because although the rescue of the banks was done cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE over a weekend, the lack of detail over the Q365 Mr Mudie: Are you saying you are taking arrangement, the agreement, allowed the banks to be 50% of that £76 billion? able to say anything they liked because there was Stephen Hester: No, I am saying somewhere between nothing written down. But Merlin was written down 40% and 50% of the Merlin lending to SMEs is in February. Now, this is the last quarter of the year. accounted for by RBS. It slightly varies quarter to Mr Hester, what is RBS’s share of that £76 billion to quarter— small and medium enterprises, the additional lending that— Q366 Mr Mudie: The other four are only dividing Stephen Hester: As I said to you, as far as we can tell up 50% between them? so far this year RBS accounts for between 45% and Stephen Hester: Well, I can only speak for RBS. 50% of Merlin lending to small businesses. Mr Mudie: Again, then, this seems strange to me. Stephen Hester: If I may, every quarter we publish Q357 Mr Mudie: No, may I just stop you there? I our lending, not just to SMEs but we publish them to heard that and was pleased with it, but this is Project all corporates and on mortgages and everything. Merlin. You agreed to do something, five of you. You Mr Mudie: No, I am not asking that. agreed to spend an additional £76 billion for small Stephen Hester: There is no great secret here. and medium enterprises. That was in February. What is your target? What is your share of that £76 billion? Q367 Mr Mudie: Well, there is such a great secret. That is all we— Are you saying to me that five bankers made an Stephen Hester: It is currently running in the high agreement with the Government to lend an extra £76 40%. billion to small businesses and did not make arrangements between each other what your share Q358 Mr Mudie: No. Well, Mr Flint, what is your was? share of the £76 billion? Five of you went in, made Stephen Hester: If I may, I think we are on—yes, we an agreement to lend £76 billion additional. Now, you each had amounts of that we thought that we could surely got in another room and said, “Well, how the accomplish. hell do we divvy this up?” Douglas Flint: No, there is a schedule. Yes, there is Q368 Mr Mudie: Can you supply the Committee a schedule that sets it out. with your stated share? Stephen Hester: I just want to— Q359 Mr Mudie: Yes. I am just asking you, what is Mr Mudie: Yes, Douglas says. Can you not? your figure? It would be very, very interesting. We Stephen Hester: George, if I may, RBS and I believe will do it with the next two. Tell us what your figure all of the other banks are not actually approaching it was as part of that £76 billion. in the way that you describe. The way RBS is Douglas Flint: No, we can, we actually publish it. We approaching it is we want to—may I finish? publish it in our interim report and our quarters. Mr Mudie: Okay, you are 45%, 50%. You are— Stephen Hester: May I finish? We want to lend as much money as creditworthy small businesses want Q360 Mr Mudie: Well, tell us. from us. If that is more than our target, terrific, we Douglas Flint: I cannot tell you the number off the have the money to do it. If it is less there is nothing top of my head. It is a public figure. we can do. Mr Mudie: There is a bigger question. Stephen, there Q361 Mr Mudie: Do you know your figure? is a bigger question. There is a bigger question. Stephen Hester: We publish it every time. I have just Stephen Hester: That is how I am approaching it as given you—do I happen to know the percentage? No. Chief Executive of RBS. I am not approaching it as some artificial number. Q362 Mr Mudie: I know you published it. You have Mr Mudie: Very good. published a lot but what is the figure? Stephen Hester: I am approaching it that it is our Stephen Hester: It is between 40% and 50%. In the responsibility to support our customers. I want to do last nine months it has been running, I believe, that as well as we possibly can. between 45% and 50% of the lending being done. Mr Mudie: Wonderful.
Q363 Mr Mudie: No, that is a percentage, what we Q369 Mr Mudie: I will come to you, Douglas. Can are simply saying is what was your share of the £76 you tell me how much you lent in total as a bank, say billion? in the last year? Stephen Hester: Of the lending being done I am Douglas Flint: Just over $900 billion, between $900 talking about. billion and $1 trillion. Mr Mudie: Sorry? Stephen Hester: Of the lending being done. Q370 Mr Mudie: Say that again? Douglas Flint: $900 billion to $1 trillion. Q364 Mr Mudie: Yes, what was your share of that? Stephen Hester: Well, I am sorry, I am obviously not Q371 Mr Mudie: How much do you lend to small understanding your question very well. I thought I had businesses in the UK? I would be very happy if you just told you that. would supply us with a number. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Treasury Committee: Evidence Ev 65
23 November 2011 Stephen Hester and Douglas Flint CBE
Douglas Flint: I will supply you the number. It is a have no control whatsoever of how much of an public number. overdraft is used by a recipient, be it an individual or a company. We know they can draw as much of their Q372 Mr Mudie: Lovely. Could you give us how overdraft but they do not have to. For two years, much do you lend? probably three years in a row but two years definitely Stephen Hester: Why don’t I just write to you with in a row, the companies at RBS Bank have paid down the numbers rather than guess and give you the their overdrafts—in other words, used their overdrafts wrong numbers? less than before, not because we have removed the overdraft; they simply are using less. Why are they Q373 Mr Mudie: You see, the Government, with a using less? Because they are unconfident about the great deal of support in turn—not the speed at which demand for their goods and their services. When you they are doing it—have got into the business of are unconfident as an individual or as a company you seeking to rebalance the economy. You will support tend to pull your horns in and be more conservative them in not doing it through public expenditure, so about your budget and so on and so forth. This they are looking for you to actually finance the growth phenomenon, which you see, by the way, across the of export-led businesses. Have you two, in your developed world, is that in times of lack of confidence respective banks—you are talking about leaving the from businesses in selling their goods and services, country, which is bad—but before you leave it do you they try not to get more indebted. In fact, they try to have any stated policy or stated work going on in pay down debt and you see that most indisputably terms of rebalancing your lending policies? with overdrafts where the banks have no influence Douglas Flint: Absolutely. One of the segments that whatsoever. It is entirely up to a company whether we believe we are competitively advantaged in they pay back their overdraft or not, and they have because of our network is import/export business. One been paying it down. I believe that the difference is of the things we have been doing with SMEs this year, that the actual amount of money that companies are partly in pursuit of meeting our Merlin targets, is has gone down. The amount of facilities available to saying to small businesses, “If you increase the them has not. They simply are not using those number of export markets to which you export, we facilities because at the moment they do not have the will give you reductions in your borrowing rate”. confidence that that money will help them sell more. All of the surveys, and a survey was quoted earlier Q374 Mr Mudie: The Chairman wants me to stop, on, every survey of business says by far the most but I just want to show you the TISCO financial important thing in whether businesses expand or not stability report. Half of the stock of bank lending in is whether they think they can sell more of what they this country goes abroad. Half of it. The biggest part make or the services they provide, by far. Until of the other goes to banks and other financial companies are more confident that they can sell more corporations. The next one goes to households, of what they make, they are not going to borrow a lot predominantly mortgages. The smallest part in that more. Nor, by the way, should we want them to. whole thing is non-financial corporates. Now, do you Our job is to try and remove obstacles. We are doing not see the task that the Government has and you an imperfect job and we are trying to do it better, but have? That is why I would welcome you putting on the provision of finance is a hurdle in the race, and record your share of lending to UK small and the race is about selling more of your goods and medium-size enterprises. It would be very good if you services and having the confidence so to do. I think put additionally to the Committee your objectives in that is the difference between the figures. terms of rebalancing that so we can rebalance our economy. Does that make sense? Q376 Mr Love: I want to come back to the demand Douglas Flint: Yes, it does. We will send you that. issue because I think it is an important one, but let me just clarify. What I think you are saying to us is that Q375 Mr Love: This lending to small and the more accurate figure is the amount of money medium-size enterprises is an issue of considerable drawn down rather than the facility made available, concern so I want to continue to press you on these and I think that is an important distinction that was matters. The most authoritative report published on drawn out by the Governor of the Bank of England lending to small and medium-size enterprises is done previously; thank you for doing that for us. by the Bank of England, based on figures provided by I wanted to come on to Mr Flint because the British your banks. In the last report, which is dated in Bankers’ Association who did a similar study but for October, they suggested that lending to SMEs is more just small businesses—that is business that have negative than the position six months ago, and that the turnover of up to £1 million—in a survey up to June growth rate was now at -5% up to August 2011. How this year showed that the growth rate for lending in do you square those figures with the very positive that particular sector stood at -10%, not -5%. Is there figures you are giving about Merlin? Mr Hester? some bias going on in the banking system towards Stephen Hester: Clearly, I am not in possession of the even smaller businesses rather than small and bank’s statistics and so I have read the report as you medium businesses? have but do not have the statistics behind it. I believe, Douglas Flint: I don’t believe so. I agree with what and I could be wrong, that the bank are referring to Stephen says that the big issue is one of confidence the amount of drawn loans and what Merlin refers to and our statistics are identical in the sense that people is the amount of loan facilities committed. Now, let’s are using overdrafts less and they are saving more take overdrafts just as one example. Clearly, banks because they want to be more resilient heading into a cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE more difficult economic climate. If I look at our own is always telling us that only banks can make those small-business lending in the UK, perhaps 30% of that judgements because they are the only ones with the lending was either secured on property or was for the experience. But let me say finally, the Bank of purchase of real estate, a typical use of bank finance. England report then goes on to say that some small Property prices have fallen quite dramatically in the firms were reluctant to approach banks out of concern UK so even if volumes are the same on an annual for an increase in the cost of existing borrowings or a basis, the amount of money lent would be less because reduction in their overdraft facilities and that as a the businesses being financed are less expensive. So result had resorted to the use of personal loans instead. some of the fall in the stock of lending is simply that How big a factor is that for you? Are some of the the asset prices being paid for real estate is less, which businesses not wanting to come in case they upset is a good thing. their existing credit facilities that they have? Is there evidence that this is happening and how harsh are you Q377 Mr Love: Let me come to the demand issue being on some of your businesses? because I want to come back to Mr Hester. You are Douglas Flint: I don’t recognise that. Indeed I think right that the survey shows the demand for finance one of the very positive things that has come out of remains muted, but the report then goes on to say that the business task force which all the banks signed up respondents felt discouraged from applying for to, many more than the five that are in Merlin, was a finance for reasons such as issues with the process of mentoring scheme and the BBA together with the borrowing from banks or an anticipation of refusal. banks, together with BIS and other government RBS has gone out of its way to suggest that it is trying departments are taking a roadshow round the UK to overcome those things. Do you think you are doing going to all the trade associations of small business enough to overcome the reluctance on the part of at and saying, “This is the way we are doing it; come least some respondents from small and medium-sized and get a mentor; come and be guided as to how better enterprises to the signals that are being sent by the to present your financial affairs to be more successful; banking industry at the present time? to be more confident that you will reach the criteria Stephen Hester: I am sorry to make a trite reply. I the banks are asking you to do”. I believe the take-up think we are never doing enough. There can never be of that service and the efficacy of it has been very a moment when we are doing enough. We are trying strong. It only launched this time last year so we are hard. We are constantly reviewing the things that we early days in terms of following through but we in the are doing; trying to take account of feedback. One of industry believe that that is doing a very good job. I the reasons that I quoted to you, the survey that the am simply not familiar at all with the move away from banks have set up, the small-business ombudsman, using banking facilities to personal facilities. Indeed when companies complain to them clearly that is an the advertising the banks are all doing, and certainly opportunity to understand what is going wrong and we are doing, in relation to encourage small-business that is why I pay attention to the answer. lending is more than we have done historically. A year ago we wrote to every single MP in the House of Commons giving a business hotline and asking Q379 Mr Love: May I interrupt you, because I am MPs like yourself to send us people who are being pressed? Let me just ask you this, Mr Hester. A complaining to you, who feel that we have turned lot of these reports about the banks’ failing as far as them down, so that we can have an independent group lending to small businesses are coming from their own review those things. The Chairman referred to an organisations, the Federation of Small Businesses and initiative we launched two weeks ago in terms of low- others. What discussions are you having with them to cost, fixed-rate, no-fee finance. We are constantly clear the decks and recharge at least the possibility of trying to eliminate obstacles we put in the way that agreement on where we are as far as small-business are not appropriate obstacles. At the same time we lending is concerned? have a responsibility to lend responsibly but we are Stephen Hester: I think each of us, both through the trying to do it. I would be the first to say we are industry it is true as well, but each of us individually, imperfect but I think we are making progress and the engages all the time. I mentioned my trip to macro statistics say we are doing a decent job. My Nottingham yesterday. My lunch was with the CBI ambition is to be thought of better than doing just a in the East Midlands and there were about 60 CBI decent job. members—most of them the small-business end— who came; I was the speaker and we had a whole Q378 Mr Love: Let me remind both of you that series of discussions. We are constantly affiliated with according to all the studies small and medium-sized the Chambers of Commerce around the country, businesses, in many senses, remain the engine of the which is a very important way of reaching small economy. If growth and employment opportunities are businesses collectively and I am sure my colleagues to come back into the economy it will be through in other banks do similar things. small and medium-sized enterprise. So this is an Again I certainly would not begin to say that we have incredibly important discussion. I noticed earlier on, reached perfection. Of course in stressed times people Mr Hester, you mentioned about whether they were are more stressed and their difficulties and problems credit worthy businesses and of course that is a critical come out and, as you say, there are very difficult judgement and many would say you are too harsh in judgements on creditworthiness where honest people your judgements. Some would say you need to be can disagree. All I can say is that we are doing our prudent. There is a difficult judgement there, I accept, best and where we see shortfalls we are moving to try to be made. The Governor of the Bank of England to correct them to the fullest extent that we can. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE
Q380 Jesse Norman: Mr Hester, I cannot let the which was in the high end of the group, but in balance moment of your being here pass without asking if you sheet terms, that our total liquid resources, having can give us some update on the bank’s exposures in once been £200 billion short of our short-term the Eurozone because that is a source of great concern borrowing is now £30 billion more than our short- to everyone around this Committee, I am sure. term borrowing. So on all what you might call the Stephen Hester: We published results about two external ratios, our position is a strong one. weeks ago for the period to 30 September, so I don’t Having said that, banks are part of a system that relies have an update since then. I don’t think it has changed on confidence, economies rely on confidence, and I very much since 30 September. We showed that our would be wrong to in any way sound complacent. exposure to sovereign debt in the so-called peripheral RBS funders have nerves about the system and Eurozone was negligible in our context anyway and I therefore about RBS, as funders of all banks do. We think, from memory, 75% reduced from the previous have experienced shorter maturities and closing of year-end. some parts of wholesale markets. All of us must We do have meaningful lending to companies, in regard the current situation in global markets with particular Italy and Spain. Our major peripheral utmost gravity regardless of the fact that some banks exposure though is in Ireland where we have the are in a relatively better or worse position and be privilege of being the third largest bank in Ireland cognisant that slips of confidence for whatever reason through Ulster Bank, the largest in Northern Ireland, are very dangerous things in this environment. That is and of course that has been a very expensive as true as we now know for governments as well as it experience for our shareholders. That exposure, is for banks. though, is not really cross-border—does Ireland fall out of the Eurozone—it is largely domestic-property Q386 Jesse Norman: Thank you. Apropos Vickers, lending which is hurting. That would be our major may I ask this quickly of each of you. You have gently exposure. As I say, I think Ireland’s problem is not its skirted round the issue of implementation for obvious membership of the euro or its ability to compete in reasons. It seems to me not impossible that it could current exchange rates. They are successfully running take Government a year or two to put in place the a balance of payments surplus. Their problem is regulatory structure that implements Vickers. Does working out of the domestic property bubble. that mean we do nothing for the next two years on it or what measures will you be taking over the next Q381 Jesse Norman: I think you said at one point two years to prepare yourselves for something that is that you had a £40 billion exposure. somewhat of a moving target, especially given that Stephen Hester: Including Northern Ireland, yes. it is implied that capital funding is off the table at the moment? Q382 Jesse Norman: Have you taken write-offs on Douglas Flint: In terms of a business model we have that? already begun to reflect on which business lines, Stephen Hester: Yes, billions of pounds over the last which products, will not make sense with the capital several years. liquidity structure that will be in place post the ring- fenced bank environment. We have begun to look at Q383 Jesse Norman: I would expect so. What is it the operational challenges in separating the banks and standing at now? just the sheer logistics of the communication of that, Stephen Hester: The total write-off, I can write to you the organisation of that, all within the constructs of a with the number. I am afraid I don’t have it with me. recovery and resolution planning framework that is, as I said also, under way. I think that will go on Q384 Jesse Norman: The total exposure. irrespective of how quickly the legislation comes out. Stephen Hester: The total exposure to Ireland? But how we ultimately operationalise the ICB Jesse Norman: Yes. proposals will depend on what the enabling legislation Stephen Hester: It is still between £40 billion and £50 is and then how the regulators take that enabling billion including Northern Ireland. From memory it legislation and turn it into detailed regulation. There is about £35 billion in Ireland itself. A lot of that is is a lot that we will be able to do in advance but the domestic mortgages final piece will obviously have to await final regulations. Q385 Jesse Norman: Thank you very much. Very quickly, if you would not mind, there is an equal sum Q387 Jesse Norman: Is it possible to think that the on the funding side, given the number of banks that bank could be forced to split as a result of the ring- are being funded by the ECB in Europe and the fencing arrangements that are being put forward? shortness of the money markets and the increasing Douglas Flint: The ring-fence will require two constriction. How is that affecting your funding side? separate legal entities; a ring-fenced bank and a non- Stephen Hester: I would say as follows, that at ring-fenced bank. RBS—I think in common with other UK banks but we had a particular need—we were able over the last Q388 Jesse Norman: But you do not think that that three years to transform our balance sheet and funding split could become closer to a full scale demerger? position for the good. It is not a finished product so Douglas Flint: That has not been remotely proposed we want to go further still but we were able to report and I think it would be disadvantageous because it figures at the end of September that showed not only would add a cost. At the moment there is an a so-called core Tier 1 capital ratio of over 11%, acceptance, albeit there isn’t final guidance as to how cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE shared services will work and clearly the payments structure, the business model, the management architecture, the whole operational architecture and so capability and so on and so forth. on, shared services, that are one at the moment would be much more efficient shared between the two banks Q392 Mr Ruffley: Is it fair to say that your than them both having to stand alone. competitors probably take the same view? Stephen Hester: My belief is that while banks can Douglas Flint: I won’t speak for them. and should come in all shapes and sizes, the specifics of the ring-fence while they have the impacts we said, Q393 Mr Ruffley: May I just turn to Mr Hester? The I do not think themselves will lead to a change in ICB places a lot of weight on bail-in debt. Which terms of a total structure. investors are going to be attracted to that kind of debt, in very general terms? Q389 Jesse Norman: It would not be likely that you Stephen Hester: I take a somewhat more sympathetic would want to sell the RBS investment banking view on this subject in favour of the ICB than many business or anything like that? do, perhaps at odds with current market realities but Stephen Hester: I think if we do it would be for be that as it may. reasons other than the ring-fence and that is certainly It seems to me that it ought to be the normal order of not in our plan. Nor, by the way, do I think that there things that if a company goes bust, once the are lots of buyers, either. shareholders have lost their money, the debt holders start losing some money in rising order of seniority. Q390 Mr Ruffley: May I begin, Mr Flint, on the non- That has been difficult to apply in the banking ring-fenced investment end of your business? I was industry because of the particular damage to the puzzled because the ICB said that it would not, in financial system of allowing liquidation of banks and relation to that bank, impose higher equity to risk- overnight administration not being well developed. So weighted asset ratios on the grounds that it would the whole point of the resolution, and an essential damage international competitiveness, but then it went complement of that is bail-in legislation, is to do this. on to say that it would require more primary loss- absorbing capital. Is that not a radical inconsistency? Q394 Mr Ruffley: I understand the concept, but who Douglas Flint: Because we are a G7 global in the real world is going to be attracted? systemically important bank I think they are saying Stephen Hester: Personally, I believe that in the that we should attempt to centre everything we do fullness of time investors in bank credit will consider through the UK in any event, and we certainly would it just as normal that they should lose money once the not disagree with that. I think the non-ring-fenced shareholders run out of money as they do when they bank will be demonstrably and—if these proposals invest in any other credit. But I quite appreciate that in current very stressed moments and with most really are going to carry the benefit that they intend— investors feeling that governments are inherently quite explicitly, standing on its own two feet in hostile towards their interests if they are investors in relation to its capital and its funding and its loss- banks, particularly in the UK, that it may be some absorbing capacity. years before investors are persuaded of that case and that case can be made worse to the extent that there Q391 Mr Ruffley: What I am driving at is the non- are protected classes of creditors above them. So of ring-fenced bank; the ICB was conceding that if it course one of the ICB proposals is to protect all imposed a higher equity to risk-weighted asset ratio depositors, which then leaves a certain category of on you it would impact adversely on your debt investor more isolated than they might be in international competitiveness so it decided not to do another company; and there are pros and cons of that. Yet for loss absorption it does want to impose doing that. So I think in current market circumstances higher requirements on your non-ring-fenced bank. there is a wall of denial on this subject, but that said What is going on there? Have you asked them about I think we ought to aim for a position where this is that? just normality; if you invest in banks as a debt holder Douglas Flint: The bail-in proposals in Europe are you are treated the same as if you invest in any other not yet finalised nor indeed the bail-in proposals company as a debt holder. internationally and they may have been in some way anticipating where theirs might go. My personal view Q395 Mr Ruffley: May I put the same question to is that the UK should not have a specific loss Mr Flint, except to say that of course there are no absorbing capability for the non-ring-fenced bank in voting rights for holders of this debt? One of the the sense that it should be explicitly you are on your virtues, say the ICB, of holding that kind of debt is it own rather than saying we are going to ensure that will enable them to impose disciplines on the bank, there is a certain framework because again that seems but if they do not have any voting rights it is not going to me to create a nexus between the UK regulatory to be that attractive. Just to repeat the question: what architecture and the Treasury and what was designed kind of investor do you think might come across, hove to be separated from the ring-fenced banks. If the non- into view, and start showing an appetite for that kind ring-fenced bank is explicitly designed to be “you are bail-inable debt? on your own and you make your own judgement on Douglas Flint: The same investor that you see with risk and you lend accordingly” then it should be subordinated debt. I think one of the deficiencies of demonstrably stand alone with the capital market the past crisis has been that subordinated debt that did providers making their own judgements on that not respond in the way that it was expected to or cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Stephen Hester and Douglas Flint CBE designed to do. I am entirely with Stephen in the sense Q398 Mr Ruffley: Where is the higher adequacy that the bail-in debt should reflect the risk that the going to be provided? creditor is being asked to take and the pricing should Douglas Flint: The essence of banks’ stability, and reflect that and clearly the discipline comes from the indeed the ability to fund growth and take risk, is the valuation by the debt provider on the business model flow of capital not the stock. An awful lot of attention and the degree of capital and so on and so forth and has been given to the stock of capital, but the real how much they are prepared to risk. I think a separate strength of a financial system is its flow. Does the but really important issue is it is a very different issue system generate a flow of capital that enables those between that debt should bail-in, which I think is an that have been providing it to be remunerated absolute given, and then what will define the category appropriate for that capital; for there to be sufficient is the circumstances of when it will bail-in. Is it on left over to fund growth and there be sufficient on top resolution when the businesses fail and you are trying of that for a cushion for unexpected risk? So the flow to find the least-cost way of winding the business is far more important than the stock and today the down or is there a trigger that can be enforced by a majority of banks in the world are not meeting their regulator or whatever and what are the criteria to cost of capital, which is why they trade at a significant judge it? That makes a very different consideration. discount to book value. As long as that continues I Then the final and really important point for policy think the ability to generate capital is going to be very framework, which is where the ICB went differently constrained. I think that the flow of capital should be from where the Financial Stability Board and the a primary focus. Basel Committee have gone, was to suggest that there should be a minimum threshold of bail-in debt; that is Q399 Andrea Leadsom: Again, it is impossible to the 7% and the top of the 10%. Those other bodies let the opportunity pass. Mr Flint, you were saying have said it should be sufficient and that should be a earlier that it is the loss-absorbing capacity that is the dialogue between the regulator and the institution, biggest consideration for your bank in whether to stay again depending on all the unique characteristics. The located in London or not. Are you discounting danger of there being a defined amount, particularly altogether the prospect of a financial transactions tax when the bail-inable debt can be as short in duration coming from the EU, or are you including that in as just over a year, is that you potentially create a your calculation? trigger in markets that are very difficult from a Douglas Flint: We certainly never discount anything funding perspective that banks breach their required that has been put forward. I think there have been quantum of bail-in debts and you get a spiral effect of very strong statements made by this Government, and you now can’t pay dividends, you can’t pay indeed by many governments in Europe—which we performance payments—that probably wouldn’t would absolutely embrace—that the financial happen anyway—but more importantly you are going transactions tax is not an attractive thing at all. I don’t to make a real signal to the market as to whether they think it is effective; I don’t think it works. I think it want to fund you. Whether the trigger impact of would be very disadvantageous for Europe in the having a defined threshold is an attractive policy broadest sense of the economy. So, yes, we are not perspective, I really would question, in fact I would assuming in our calculations that we are responding say it is not. to there being a financial transactions tax.
Q396 Mr Ruffley: I understand. Given the state of Q400 Andrea Leadsom: So if there were to be a the markets, what is the ability of your bank to raise financial transactions tax, would that tip you in favour additional capital to meet the high capital adequacy of relocating your headquarters? Firstly, if there were proposals in the ICB? a financial transactions tax that included the UK, and Douglas Flint: We already have on a Basel II basis secondly if it excluded the UK but was limited to the core equity well in excess of requirements, and we Eurozone? believe we will generate organically our Basel III Douglas Flint: I should think the financial requirement in equity. We have, in fact, just last week transactions tax would be less to do with where the raised a substantial amount of long-term debt; so I headquarters was but activity was done through think we have been privileged to be one of the few Europe; so it would have a significant impact on what issuers that has been able to access the market for activity was done through Europe. I think it is not long-term debt in the last several weeks. The total necessarily impactful of where our headquarters is. market issuance has been very modest. In terms of equity we do not need to go to the market Q401 Andrea Leadsom: So it would be as bad to be for equity. I think that in a world where the vast imposed within the Eurozone as within the Eurozone majority of banks in Europe and in America are and the UK? trading substantially less than book value and the Douglas Flint: Yes. uncertainty over the regulatory environment as well as the economic environment with the added Q402 Andrea Leadsom: Mr Hester, would you complexities of Europe, I think it is a very difficult comment on that? market for anybody to issue equity into. Stephen Hester: I think that with all taxation it is seldom a free lunch, I think it is a legitimate job of Q397 Mr Ruffley: Do you think that is a flaw in the politicians to decide what taxes they want but to ICB proposal? understand what the consequences are. Clearly if that Douglas Flint: A flaw because? tax was levied there would be some consequences cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Ev 70 Treasury Committee: Evidence
23 November 2011 Stephen Hester and Douglas Flint CBE both in terms of who bore it—passing it on to people system that would simply improve things but would who have pensions and so on and so forth—and in not solve the issue of sticky accounts, that it would be terms of reduced market activity and liquidity. better to move to full account portability? Whether those are right or wrong choices I think is Chair: I realise that is quite a big question. I would a matter of political philosophy as opposed to some not like to— technocratic answer. Clearly, it is not going to Andrea Leadsom: You said only one. influence whether we are headquartered in Edinburgh Chair: But we would like a quick answer. or not. Stephen Hester: The quick answer is I am no technologist. I do not see how that would solve the Q403 Andrea Leadsom: May I just lead you slightly issue of people having to have multiple accounts and ask if you agree that it would have an adverse across Europe because they have to do business across impact on savers, investors, pension funds and so on? several legal entities where today they do not. So, I Stephen Hester: I believe that it would be passed on do not think it would solve that issue. However, I, if to users of the relevant markets. Obviously there are you like, I am instinctively sympathetic towards the many users of relevant markets but ultimately it cause of portability and it certainly is something I comes down to saving. As I say, I am trying to stay out of the controversy on these issues of tax. It is have no philosophical objection to. To me, these are legitimate to debate where you want to raise tax. You practical and technology issues as to where the bounds just have to understand that there is a consequence of benefit versus cost lies. to it. Andrea Leadsom: Thanks.
Q404 Andrea Leadsom: Would you agree that one Q407 Chair: Mr Hester, what steps have you taken of the consequences could be for the euro area to lose to protect the most vulnerable people affected by your a significant volume of transactions? Would it be the decisions on ATM machines? natural reaction of banks to put those transactions Stephen Hester: I think what you are referring to is in outside the euro area? relation to ATM access to basic bank account holders. Stephen Hester: Clearly if you have a tax like that Chair: Yes. and don’t do it globally, then there are all sorts of Stephen Hester: And so what we have done is, of dangers in terms of distortion of markets and course, to start with we have the biggest ATM network movement of activity. We shouldn’t be too precious in the whole country that is accessible to basic bank about it because obviously we have stamp duty, share account holders. Secondly, we have just signed up to taxes, here in the UK and I think sometimes people distribute product through the Post Office which is a are a little too precious on this being an extraordinary loss-making thing for us to do but obviously extends idea that has no merit whatsoever but nevertheless by whatever the number of Post Offices is nowadays, very clearly what it does is it has the influence of the access. And thirdly, we either have or are in the passing on costs, often to pension funds ultimately and process of communicating with basic bank account to savers, and of moving activity to places where that holders who may be in an area or a remote location tax is not present. that is served by neither of those two options within a reasonable distance, and our intent would be to make Q405 Chair: We are almost done with the first session. It has taken rather longer than anticipated but what I would call exceptions to policies in respect to we do apologise; we are going to have to ask you to people who, in a legitimate way, are just simply not stay on a little longer. We will adjourn now for 15 close enough to one or the other of those sources. minutes and resume. The Committee suspended for 15 minutes for a Q408 Chair: Have you published the cost saving? Division in the House. Stephen Hester: No.
Q406 Andrea Leadsom: I think it was you, Mr Q409 Chair: Would you be prepared to undertake to Hester, who talked about the plumbing in a bank and do so? how the ring-fence was actually going to complicate Stephen Hester: I am not very sympathetic to doing things because of sort codes and so on. So, turning to so, so I would certainly take it under advisement and the subject of switching, the ICB proposes the reply to you but I think that— Payments Council sorts out a redirection service that Chair: You will understand this is a matter of is going to cost up to about £800 million. Would it considerable public interest. You are, effectively, a not solve, bearing in mind the ring fencing idea is a10-year aspiration, the complexity of having two sort publicly owned bank and you are taking a decision codes and so on to move to a full account portability with respect to a policy that is closely related to situation making the investment in a new shared social policy. infrastructure and creating a new unique identifier for Stephen Hester: Yes and, of course, one of the each bank account that you would not then have philosophical issues— problems of inside and outside the ring-fence and, of Chair: I would not normally ask a private firm to course, from a customer choice and efficiency point of disclose what you might consider to be commercially view, it would mean that consumers, small businesses confidential information. could switch banks far more easily? Do you not agree Stephen Hester: Let me take it away and see if we that rather than spending £800 million now on a think we can do something that is helpful to you. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Treasury Committee: Evidence Ev 71
23 November 2011 Stephen Hester and Douglas Flint CBE
Q410 Chair: But you are not considering reversing what we do by an important number of people, and that decision in the light of the concerns being that seems to me to be for a considerable period of expressed about it? time yet. Of course, it is the fact that more and more Stephen Hester: That’s right. of us are doing business online and using telephones and so on. Q411 Chair: Do you think that the reductions in ATM access for basic bank account holders will have Q415 Chair: Have you got a chequebook? general implications for free banking services? Stephen Hester: I do have a chequebook Stephen Hester: Well, you know, there are some Chair: What about you, Mr Flint? conflicting pressures in financial services. There are a Stephen Hester: And I use it, I use it less than I did whole series of people and regulators who dislike before. cross subsidy and would like every product and every Douglas Flint: Yes, I do. customer to stand on their own and not be subsidised Stephen Hester: But nevertheless, and certainly for by other customers or other products, and so there is the foreseeable future, it seems to me that if enough that stream and then there are other people such as people are going to want cheques, that is the thing you, just now, who would like us to cross subsidise. that we should provide and that is our intention. Of course, each person has their own view. Chair: I have not said that, Mr Hester. Q416 Chair: What about the cheque guarantee card? Stephen Hester: No, well that was my impression Stephen Hester: I am afraid I do not have a briefed from your question. position on that. Chair: What I have done is try to extract the logic of Chair: Well, perhaps you would like to come back on your stream. a briefed position and once you have been briefed on Stephen Hester: But there are lots of people who it, perhaps it will be influenced by what Mr Flint has would like us to cross subsidise. There is often not to say on the same subject. much agreement among those people on who should Douglas Flint: There is no question the chip and PIN be the beneficiary of the cross subsidy, and who and the debit card have been very beneficial for should pay for it just as importantly. So these are customers and for retailers. There are increasingly few things that we struggle with all the time because retailers now who accept cheques even with a clearly the business of banking does involve elements guarantee card; that is the reason why it is no longer of more than one service being provided to different really used. I mean, the retailers do not like it, whereas groups of people. I would say generally the direction the debit card with a PIN is a much more secure and that we are trying to go is to improve transparency, a much more effective guarantee of a transaction. So such that people have better knowledge of what they I think technology has enabled customers to be better are buying when they buy it, and on an on-going basis, served and better secured and retailers too, which is so the decisions can be as well informed as possible why they have moved that way. and to avoid, if you like, trying to have one group of customers artificially subsidise another but inevitably, Q417 Chair: When one sees reports about the state in our kind of business, these are not perfect lines that of the commercial retail banking market, one has the one can draw. strong impression that the banking sector is still pretty dysfunctional; that is that normal banking conditions Q412 Chair: I understand. Mr Flint, are you have not resumed for a whole variety of reasons and committed to the continued provision of banking that in the absence of that, it is going to be extremely services including unrestricted access to other banks’ difficult—if not impossible—to secure a sustained ATMs for all your account holders? recovery. Do you both agree with that analysis? Mr Douglas Flint: That is our position at the moment, Hester? yes. Stephen Hester: Would you mind being a little clearer on what you mean by dysfunctional so that I can Q413 Chair: When I used to work in the Treasury answer your point properly? and we were actively examining a change in tax and Chair: One can describe dysfunctionality in a raft of we were asked about it, we would say, “We’re not ways, one of which we have discussed today, which considering it at the moment”. I am just wondering is SME lending, another is the inter-bank market, the whether you would like to go a bit further than that? very distorted bond market, the difficulty of the cost Douglas Flint: I have never had the privilege of of funds for banks. We can carry on with a long list working in the Treasury, so that was not the disguise of unusual characteristics in financial intermediation. of my reply. I think we look at the entire service Stephen Hester: So, I guess it seems to me that of proposition that we produce for the customers right course we will be in unusual times, number one, for across the spectrum from basic bank account all the so long as the envelope of rules in which the industry way up to Premier and beyond and seek to be does business is changing and until those changes are competitive in the marketplace, I think that is the embedded and, secondly, while conditions in guiding principle. international and domestic economic terms are themselves unusual. So your guess is probably as Q414 Chair: Do you both remain committed to good as mine as to how long those two things will keeping cheques? Mr Hester? extend. All of that said, you know, we service every Stephen Hester: I think that we should keep cheques day 40 million customers. for so long as they are viewed as an important bit of Chair: Yes, I am just trying— cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Ev 72 Treasury Committee: Evidence
23 November 2011 Stephen Hester and Douglas Flint CBE
Stephen Hester: Those 40 million customers are Stephen Hester: Well, obviously if there are doing business with us in the way they always have. customers there is only one-way traffic but any action another bank takes, and so on. Q418 Chair: My question though is just very straightforward. It is whether you share that Q421 Teresa Pearce: But you would get payment for description of the current condition. people who weren’t your customers who came to Stephen Hester: I think, I think there are many things your ATMs? that are unusual and even distressed about current Stephen Hester: If they do, yes that is right. market conditions and unusual about the amount of Teresa Pearce: Right, thank you. change going through the banking system but I also Stephen Hester: And that being of course part of think that we have 40 million customers who are those economics is why we are able to maintain the doing the usual things with us all day every day and largest network in the country of ATMs. being serviced and that is our job to give them— Teresa Pearce: Sorry, I just wanted to understand. Chair: I think in the course of the afternoon we have Stephen Hester: But certainly, if I may say, we would picked up that point, Mr Hester, we really have. Mr be very happy to engage with you directly in your Flint? constituency MP capacity on the provision of ATMs Douglas Flint: I think we are in very dangerous times and so on in your area. in terms of the visibility of what happens next, so I share your concern. I think on a micro level what Q422 Teresa Pearce: Thank you. I realise you have Stephen says is right. On a macro level, the industry been here a very long time, but I want briefly to ask is faced with the changing regulatory framework, the you about cheques. I completely agree that not many application of the whole macro prudential regulation people go into a shop now and pay by cheque, and it around the world, possible changes to taxation, the is not welcome if you try to, but there is one area whole uncertainty of what is happening in the where cheques are used quite a lot and that is in Eurozone and, within that, the transmission charities. mechanism that the banking system represents in Stephen Hester: Yes. terms of being able to provide a sustainable supply of Teresa Pearce: I visited a local charity. Over 60% of finance adequately capitalised to promote growth, to donations come by cheque and I ask you to consider promote risk absorption and to do so within a that—that you look not just at the retail sector but at competitive landscape. That is an extraordinarily other areas where cheques are actually widely used, complicated backdrop to capitalise the system within, because it would affect them quite badly. because those who provide the capital have got very Douglas Flint: I know. We are looking very actively little visibility as to the structure of the industry, its at that and, indeed, I think we were the first and many regulation and its return profile. So I think we are in have joined us now, and although it is mostly for particularly unusual times, which is why one can see smaller donations, we allow people to pay through increasing concentration of activity back into national ATMs. So when there is a natural disaster or markets and a significant de-leveraging. something, we open the ATMs to people who are making small payments through that, but I agree that Q419 Teresa Pearce: I have three very short the charitable sector is one that is particularly questions. The first is on ATMs and my constituency, vulnerable to cheques and we are thinking very Thamesmead. Thamesmead has 50,000 people and not carefully about that. Cheques are continuing, but that a single bank, so this is very relevant to them and they is a principal focus for the cheques, yes. are likely to be basic account holders. When Chair: Thank you very much for coming in for us somebody who is not one of your customers makes a this afternoon. I am sorry this section has been rather cash withdrawal from one of your ATMs, you get a longer than planned and interrupted, but what you payment? Is that right? So if somebody who is one of have given us is extremely valuable for our inquiry your bank account holders draws money from an into these considerations. ATM that is not one of yours, you have to make a Douglas Flint: Thank you very much. payment, but then doesn’t that work the other way Teresa Pearce: Thank you. round? Stephen Hester: Yes.
Q420 Teresa Pearce: So when you have costed how much this is going to cost, are you taking into account what you get as well as what you pay? cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05
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Examination of Witnesses
Witnesses: Ana Botín, Chief Executive, Santander UK, Tim Tookey, Interim Group Chief Executive, Lloyds TSB, gave evidence.
Q423 Chair: Let us begin. Ms Botín, you have said keeping an eye on these issues. What discussions have that the cost of the ICB proposals will be significant the board, or have you, had with UKFI about this? for your customers, so you presumably disagreed with Tim Tookey: Well, I am not quite sure over which what Robert Jenkins—the newly appointed member period you are referring to that share price data but I of the Financial Policy Committee—said as reported am sure it is correct. in the Financial Times today and with his remarks that Chair: Since the announcement of António Horta- have been published. He has more or less said that Osório’s leave of absence. view, and I quote, is, “Intellectually dishonest and Tim Tookey: Okay. Thank you for clarifying that. potentially damaging”. Is there anything you would What I do know is that in the second week of like to say in response to his allegation? November our share price actually outperformed Ana Botín: First, I would like to say we are absolutely banks and I shared that data with our board only last supportive of the overall goals of the ICB papers and week. I think that outperformance was a recognition proposal in terms of making banks less likely to need of the progress that we are continuing to make in the taxpayers’ support and we strongly believe that no business in reducing the amount of risk that is in our bank should be too big to fail. But having said that, balance sheet. We continue to operate with a very we do believe that the ICB proposals will not help satisfactory capital and funding position. The business lending and potentially could have significant continues to make good progress with our core consequences on the availability of lending to certain business performing very nicely and continuing to be companies, certain services and, in general, be an profitable in the third quarter of this year. additional cost on the economy. Q427 Chair: The average, excluding Lloyds, is 15%. Q424 Chair: Well, is that agreeing with him or For Lloyds it was 22.5%. disagreeing with him? Tim Tookey: I am sure your figures are correct, sir. Ana Botín: I believe that lending will be less Chair: Well, I hope so. I have not checked them all available, other things being equal, if the proposals myself but I can provide you with them but my get implemented in the strictest sense. It is also true question to you about was UKFI. that there is flexibility introduced in the report, so we Tim Tookey: I have not had specific discussions with are confident that that would be taken into UKFI about our recent share price performance? consideration. Chair: So he is wrong. Q428 Chair: What about your Chairman? Ana Botín: Yes. Tim Tookey: I cannot speak for our Chairman and whether he has had any of those discussions. Q425 Chair: Could I ask you, Mr Tookey, about the share price, which seems to have fallen quite a lot? Q429 Chair: But you have, indeed, raised that with What proportion of that do you think is attributable to him? management issues? Tim Tookey: With our Chairman? Tim Tookey: Good afternoon, Chairman, members of the Committee. I think it is very hard to say, actually, Q430 Chair: Yes, you have not asked your Chairman or attribute any element of the share price reduction whether there have been any discussions with the to some of the management issues in Lloyds at the Government about this through UKFI? Have UKFI moment. I think there are a number of factors that are been involved in this in any way is the question I am affecting the whole banking sector, and is affecting asking you? price to book that is a common measure for the Tim Tookey: I have not specifically asked our appropriateness or otherwise of a bank’s share price. Chairman whether he has discussed our share price Clearly, the issues around the UK economy—concerns with UKFI and members of the Treasury, but of over that—are at the forefront of investors’ minds. course we are in regular contact with both UKFI and When they look at Lloyds, we are a UK retail and the Treasury about some of the management issues commercial bank. This is where the vast majority of within Lloyds and, of course, we made sure that there our business is and, therefore, our health is dependent was appropriate and regular contact as these issues upon that of the UK. Clearly, there are other issues in were emerging both with UKFI and the Treasury to Europe as well as regulatory uncertainty. So, make that our principal shareholder work was duly Chairman, a variety of issues are impacting on our informed and we got our announcements to market as share price at the moment. quickly as we reasonably could.
Q426 Chair: I have the figures for the main five Q431 Chair: Okay. I will ask this question slightly banks that show that, broadly speaking, they have differently. Has the leave of absence and its fallen by 8% less on average, taken as an average, consequences of António Horta-Osório from Lloyds than Lloyds suggesting that there is an 8% fall been discussed with UKFI by Lloyds? attributable to this management issue. The reason I Tim Tookey: Yes, it has. ask is that you are partly government-owned and, as an organisation, responsible to its shareholders for Q432 Chair: On how many occasions? cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Ev 74 Treasury Committee: Evidence
23 November 2011 Anna Botín and Tim Tookey
Tim Tookey: On several occasions but I would not Q438 Mr Mudie: £11.7, that is lovely. Now, your necessarily claim to have been present or involved in figure for next year in the same Financial Times is all of those discussions, but I would say on several supposed to be £12 billion? occasions. Tim Tookey: Yes, that is right. We have today announced a target, a gross lending figure to the very Q433 Chair: And are they playing an information important SME sector of £12 billion next year and we role or a role that you would describe as have also said that we would like to maintain a net shareholder-activist? positive growth in our lending to SMEs, which would Tim Tookey: I would not describe it as shareholder- be a continued strong performance that we are activist. I would say they are supportive of the actions managing to achieve this year. that the board is taking to ensure that we have adequate management control over our business every Q439 Mr Mudie: Now the other figure we would day and they wish to be kept informed and we are like from you is your gross lending as a bank. keeping them informed and this mirrors the Tim Tookey: £32 billion in the first nine months of discussions that we have had with many of our largest the year. shareholders as the owner of our business and it is very important for us, as a board, to demonstrate that Q440 Mr Mudie: What was it in 2010? That would we are in control of the business day-to-day and that give us a better idea of your total. is exactly what we are doing. That is why I was Tim Tookey: The £32 billion was all of our corporates referring to our third quarter results releases that I and SME figures. I do not have to hand the equivalent think gave the market a lot of comfort about the figure for 2010 but I would happily provide that figure momentum of the business and we were very pleased to you afterwards. to outperform other banks in the second week of November in terms of share price. Q441 Mr Mudie: So you could give us your 2010 lending figure and your 2010 SME figure? Q434 Mr Mudie: A number of members of the Tim Tookey: Yes, I could provide that to you. Committee have raised the question of lending to SMEs. What is your target figure under the 2011 Q442 Mr Mudie: Do you have a rough proportion? agreement on Project Merlin? Tim Tookey: I know that our SME figure this year Tim Tookey: We have never actually disclosed the is higher than that from last year. I cannot recall the overall target for ourselves within Merlin. corporate figure for last year, I apologise. Mr Mudie: That is why I am asking. Tim Tookey: But I would like to give you some idea Q443 Mr Mudie: Yes. Now, your trade union boss, of the shape of it. I call her, Angela Knight, may have just done you a Mr Mudie: I just want the amount of it. disservice by having a survey of a million SMEs and there are the figures—I have put them on the record Q435 Mr Mudie: With the last two witnesses it was before so I will not bore you with them—but the two like pulling teeth. They have agreed to write and tell key figures is in the last three months one in six us. I think that was part of the problem, they did not applicants for an overdraft have been turned down and know. You have signed an agreement with the one in three, one in three rather than one in six, who Government, there are five of you, £76 billion. What have put in for a loan in the last three months, have is your share? If you do not know your share, that been turned down. Out of the million, 250,000 have would be alarming? said they have because of the bank’s terms and their processes—have given up the ghost. Now, it strikes Tim Tookey: I do know our share. the Committee that Project Merlin is more in spirit than in actual practice. Q436 Mr Mudie: You know your share? What is Tim Tookey: I can assure you that Project Merlin, your share? certainly within Lloyds, is very real indeed. We have Tim Tookey: Our share of that for SME lending is just diverted significant additional resource to the SME under £12 billion for this year. We are on track to sector in the current year and we have materially meet that with £9.6 billion having been lent in the first increased our level of activity supporting businesses. nine months of this year. If I may, I will just give you some further statistics Mr Mudie: Good. that the Committee might find useful. Tim Tookey: I am very pleased to say that is actually By the end of this year, we will have held over 700 net growth in our lending position in what the latest specific events out across the country for SMEs, Bank of England reports show was actually a explaining the services that Lloyds can provide and declining market. providing generic financial information and financial advice, perhaps in inverted commas would be Q437 Mr Mudie: That was a great step forward for appropriate, to SMEs. That has led to us supporting mankind and bankers but you were still how much in the first nine months of this year just over 95,000 below that £12 billion? You said it is a figure below SME start-ups that brings the total we have done since £12 billion. What is it then? It is in the Financial the start of 2010 to a little bit over 200,000. Times this morning as rumoured to be £11 billion. This is not something we do from London. This is Tim Tookey: No, it is £11.7 billion which is why I something we do out across the whole regions. The have described it as just less than £12 billion. SMEs are, as we all appreciate, right at the heart of cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
Treasury Committee: Evidence Ev 75
23 November 2011 Anna Botín and Tim Tookey the UK economy and, therefore, we provide the banks should not be saved by the taxpayer and any support locally through our SME centres. measures that go in that direction are very welcome. We believe that the additional measures proposed by Q444 Mr Mudie: Wonderful. Now I do not need to the ICB need to be carefully evaluated to make sure take you through the same pulling of teeth. Could you that additional strength is provided to banks. just supply the Committee—because I know Obviously, there are two broad areas. One is Santander has a good record and a good history of increasing capital and changing the depositor this—with the same figures we have asked of Lloyds hierarchy and the other one is, of course, the ring- and we will leave it at that? fence. Ana Botín: Yes. We have already publicly disclosed Depending on how this gets implemented, it could our figures under Project Merlin. We are on target to mean—as I have said before—lending is more meet those figures. expensive and less available to small companies and Mr Mudie: Yes. to consumers. In addition, regarding the ICB’s Ana Botín: For SMEs, our target for this year is £4 recommendation on additional capital, Santander UK, billion. We are on track and, as of September, have as an example, went through the crisis with a 6Ð7% lent £3.5 billion. These are gross figures. Our net core capital. As of today, we have 11.4% core tier 1 lending to SMEs in the £12 months ended 30 capital. Going forward, our intention is to work in a September was plus £1.7 billion. The bigger number, range of 9% to 10% core capital. The ICB would the number for larger corporate was £6.7 billion total require us to have significantly more than that. gross lending and we are on target for that also as of On the other hand, regarding the ring fencing, though September. So the actual gross lending increase this we are a very pure retail commercial bank, we do year will be plus 25%. have an SME and a corporate bank where we provide Additionally, we have added 2,500 new SME important services that would be hindered if the ICB customers to our network and opened over 100,000 recommendations get applied in a very strict way. So new SME accounts over the last 12 months which is we do think that we need to evaluate the benefit versus a significant increase over the previous year and we the cost of these recommendations. We have provided have supported 90,000 businesses, including start-ups written opinion on this. and new companies, over 2010 and the first half of 2011. Q447 Mr McFadden: Do you think it would have been possible to get the taxpayer off the hook of Q445 Mr Mudie: I really should not have asked that insuring the banks without something like the ICB question, should I? The one thing that you have left recommendations? out though is we were after a proportion of your Ana Botín: I think that is a very interesting question. overall lending. If you would supply us with that. Some of the institutions that had more problems were Ana Botín: Yes. actually very narrow business model banks. Santander Mr Mudie: And you might get home at an early hour Group once described our model as a narrow bank in if you just agree to write to us, yes? the broadest sense. So we do deal with all kinds of Ana Botín: We are still a small player in the SME customers. Santander UK, as you know, is a and corporate arena, as you can tell from the numbers geographical subsidiary lending only to UK I gave you. Our total commercial balance sheet as of businesses and UK individuals and we believe that today is £205 billion of which about £165 billion is offering these individuals and companies a broad mortgages. Our total lending to UK corporate and range of services makes our business model more busineses is £25 billion. As you know, our UK stable, i.e. less likely to have a problem and need heritage is as a building society, so our corporate bank Government support, and is also a very important is basically a small business from Alliance & service to the economy and to our customers. Leicester that we have continued to grow. We have So being able to offer all kind of services, we believe, added 70 new relationship managers to our SME is very important and we have again written this in business. We have a total of 270 as of today and we our submission. For example, allowing SMEs to get are planning to add another 70 in 2012 and another services from us for risk management, this is one of 70 in 2013. That is in addition to the branches that we the most important points we have made in terms of are acquiring from Royal Bank of Scotland. So we are the potential impact of the ring fencing. I can investing very heavily in that business and I have elaborate on that and give you some examples. stated since I arrived that our intention is that Santander UK become the SME bank of choice in Q448 Mr McFadden: You are an international bank Britain. with operations in a number of countries. When you Mr Mudie: Very good. Thank you. look at the world post the ICB recommendations in the UK, does that make you think the UK is a less Q446 Mr McFadden: The ICB recommendations— attractive place to do business? I want to ask each of you this, I will begin with you, Ana Botín: I would like to start by saying we have Ms Botín—were intended to relieve the taxpayer of invested close to £15 billion in this country. Santander the hazard of insuring the banking system and we Group increased capital in Santander UK by £4.5 have seen the consequences of all that. Do you think billion last year, among other reasons, to continue to the recommendations meet that aim? invest in our SME business. Ana Botín: We are broadly supportive, as I said Mr McFadden: That is the past. I am asking about before, of that objective, so we strongly believe that the future. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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Ana Botín: So we are here to stay. This is a very Q450 Mr McFadden: You are a less internationally attractive market for us and we believe we can add focused bank than Santander. Again, looking at the value and have a positive influence on competition world, we assume that the ICB recommendations have and become, you know, an even more successful been implemented. Does that make the UK a less entity. attractive place to be headquartered or, indeed, to add However, it is true that over the last 12 months, and new teams to manage new streams of business in the going forward, our returns on equity will be future? significantly lowered. I mention that our core capital Tim Tookey: Lloyds is a UK retail and commercial has gone from 6Ð7% to actually 11% and we are bank, so there is no question about us changing where working with capital of 9Ð10% for the cycle. We we are headquartered. The UK is where our business believe that is the right amount and we have actually is and where our heart lies and that is where we will been ahead of regulators in terms of the increase in stay. our core capital, even though we did very well during In terms of international competitors, I think it the crisis with a lower amount, but obviously this is a depends to a degree on what happens with regulatory lower return. reform and some of the discussions happening in other So, what is significant about the ICB is that this cost territories. Clearly, the ICB report and other regulatory comes on top of significant additional capital, changes in the UK have the possibility of introducing additional liquidity and additional regulatory requirements being imposed on banks. I think the a much tougher regime in the UK than in other question we need to ask ourselves is if we want banks European jurisdictions, so that may make it more to access private capital, we are competing with other attractive for some UK people to take borrowings or banks in other countries to raise that capital and also place deposits with foreign institutions. I think we with other industries. So, I think this is an important need to be careful and considered in how we question. Obviously, the more capital you hold, the implement the ICB’s recommendations. That is an less lending can be made available, other things important part of the consultation process, but we being equal. must not lose sight of the fact that the ICB’s Again, we are supportive of having stronger banks and recommendations are a thorough, well-balanced and we are all stronger overall in the UK. We have become well-thought through set of proposals that now need stronger over the last few years. The question is, will to be worked through in some detail so that we do, in more capital make us stronger and, at what additional fact, create the objectives that they quite rightly set cost to lending and to the creation of jobs in the end. out to achieve and that we support.
Q449 Mr McFadden: Mr Tookey, do you think the Q451 Mr McFadden: Do you feel you have to say ICB does the job in terms of getting the taxpayer off that because of the ire that would be attracted for any the hook? bank to say we think these rules are too much? Tim Tookey: Honestly, I am not sure we will ever Tim Tookey: No, I do not feel constrained by that know the answer to that but what I do know is that type of premise at all. I actually believe that the ICB’s this report furthers the debate and provides a much recommendations are an important step forward in greater degree of distance between the likelihood of creating a UK environment that will be more that being required than was the case in the past. financially stable and I do not think it is right that I agree with many of Ana’s comments completely banks should be put into a position where they should around some of the ICB’s measures, and I think I need taxpayers’ support. I think the ICB’s proposals would put them into how it builds on the four pillars take us a very long way—if not all the way—and I that are necessary to increase financial stability in the am not sure we will ever know if they get all the future and make the chance of taxpayer support ever way to achieving that, so I support that as a matter been needed significantly more remote. of principle. Those four pillars are the increasing levels—so that is quantity and quality—of capital, that is certainly Q452 Chair: Mr Tookey, when we had our previous something the ICB talks about; the increasing liquidity two witnesses before us, we asked them if they would requirements for banks operating in the UK; better levels of supervision and regulatory supervision, in supply us with their best estimate of the total cost of particular, that existed pre-crisis and then, of course, Vickers to them, as an institution, on the basis of a importantly recovery and resolution. There the ring number of assumptions about the way it would be fencing is a very important part, alongside other implemented, which is still required—a reasonable measures, that the banks are working on with the range of assumptions. Would you undertake to do that various authorities such as Living Wills, for example. for us as well? So I think if we work on those four pillars as being Tim Tookey: We have not done any analysis ourselves necessary to support greater levels of financial on what the cost impact on Lloyds would be of the stability in the future, then the ICB’s report is very ICB proposals. I think it is very difficult to separate valuable. But I do share some of Ana’s concerns that those proposals from the overall impact of increasing if any one of those pillars is pushed too far, then the levels of liquidity and capital and regulation cost/benefit balance could get out of kilter. So I do ourselves, so we have not done any of that work have some concerns about the report and how it be ourselves, so I am unable to share anything. used, and how it be used if it was implemented in its Chair: We are asking if you would be prepared to completely pure form. prepare something for us. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Anna Botín and Tim Tookey
Tim Tookey: It is something that we could consider do it at all. When your bank first went down this route but it is not something I have on the stocks at the with Lloyds TSB, did you consider any other ways of moment. soaking up that cost maybe for basic bank holders? In the letter there are some things you have listed that Q453 Chair: Would you be prepared to supply the you now do, which I think are really helpful, like the same? text back to people to tell them their balance. Ana Botín: We are working on the numbers also. We Tim Tookey: Yes. are working for the next couple of years with a much Teresa Pearce: That is a really useful thing to do. It lower return on equity already as a result of increased stops them having to go and check their balance. So capital, liquidity and other requirements. As I is that something that you are going to extend to the mentioned before, we have been planning to work Bank of Scotland and Halifax as well? Is that good with 9Ð10% core capital over the next few years, and practice that you have done there, are you going to going to core capital ratio of 10% minimum would roll it out across all three banks and also did you probably force us to hold a ratio of 11% or 12% which consider other ways of restricting the costs of basic would represent additional cost. These are the kind of bank accounts rather than restricting ATMs? numbers we are working on. The non-ring-fenced side Tim Tookey: Thank you for the question. I am glad would need a much higher capital. Our total capital you recognised the text back that we found requirements in the RRFB may even increase to the particularly popular with customers not just of our new minimum of 17% (including the bail-in capital). basic bank account but all of our bank accounts have There will be costs and we are trying to work on the that facility. That is one of the examples of where we numbers and trying to show that for our business actually reinvested some of the savings that we would model, there are many other issues that should be obtain by the restriction of where those ATM cards taken into account. We have a very low risk balance would be used. We are reinvesting in providing better sheet and only 0.4% of our balance sheet is outside products to even those basic bank account customers. the UK. All of the rest is mortgages and SME and And, of course, even with the restrictions that are corporate loans in this country. being put in place and our different heritages have We would be one of the most affected in terms of different approaches because, of course, until very the additional capital because we are not a CIFI as recently we had to operate on multiple platforms. We Santander UK. Basel 3 would allow us a minimum have only, in September, been able to start having all core capital requirement of 9% but the ICB of our accounts running on the same platform. So we requirements may see us require a 11Ð12% minimum have had different reasons for that. Basic bank core capital; the numbers are significant. accounts are an important part of our customer service provision, we opened about 230 basic bank accounts Q454 Chair: I am sure you both understand why we last year, so we are and we remain the largest provider are asking this question. We are in the business of of basic bank accounts in the UK. trying to protect the taxpayer from the implicit subsidy in the banking system and clearly a cost is Q456 Teresa Pearce: Could I just ask you, one of attached to doing that and it is a reasonable question the things that is listed in here is that you can use the to want to know roughly what that cost is going to be Internet and they can call up. from those most affected. Without that information it Tim Tookey: Yes. is very difficult for policymakers to make a considered Teresa Pearce: When the people call either the judgement about whether the proposals are the right Halifax, Bank of Scotland or Lloyds, are the numbers ones to start with. I recognise the difficulty of landline numbers, or are they 0845 numbers? calculation but I expect we will persist and I will be Tim Tookey: I am afraid I do not have the answer to very grateful if you would be prepared to go away that very specific question. and think carefully about how you can present that Teresa Pearce: I just raise it because people who are calculation to us. likely to have basic bank accounts are likely to have Tim Tookey: Absolutely. We will take that away, pay-as-you-go mobiles and 0845 numbers are very Chairman. We are actually providing some expensive for them. information already to the Treasury team who are Tim Tookey: I understand your question. I am very looking at the overall cost benefit analysis of this. So sorry, I do not have the answer we need to that. we are providing some information to them for their Teresa Pearce: Maybe you can take that back and workings. So, some of that work is already underway. find out. Tim Tookey: Yes, certainly. Q455 Teresa Pearce: Thank you. Good afternoon. Tim Tookey: Good afternoon. Q457 Teresa Pearce: Your bank company does allow Teresa Pearce: I just want to talk about some people with basic bank accounts to withdraw money consumer issues, mainly ATMs and use of cheques. from any ATM. Is that something you are going to Your bank, Mr Tookey, wrote a very useful letter to continue doing or reduce it at all? the Chair of this Committee just about how you now Ana Botín: We have no plans to change that. charge for withdrawals—you do not charge, you restrict basic bank accounts from withdrawals to some Q458 Teresa Pearce: Thank you. One of the ATMs—and we have an interesting model here concerns that people have in the restriction of people because the Lloyds TSB did this in 2006 and the Bank using certain ATMs is the fact that this at the moment of Scotland is just doing it now and Halifax did not is for basic bank account holders and their concern is cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Anna Botín and Tim Tookey that this may be the thin end of the wedge and it might businesses like to use and, therefore, as long as that is be rolled out to everybody in time. Has there been any the case, we will continue. As a sector, I think that feasibility done on that? Are there any more thoughts has been decided. at all? Teresa Pearce: Okay. Tim Tookey: No, that is absolutely not in our thoughts Tim Tookey: And I agree. at all. Even for those basic bank account customers Teresa Pearce: You agree. Good. I am very pleased. who are not subject to these restrictions, 96% of our Thank you. existing basic customer account base reside within a one-mile radius of either one of the ATMs that they Q462 Chair: If Santander can afford to provide can use or the Post Office that is available to all of access to all ATMs for basic bank customers, why our customers. But I can give you further evidence of can’t Lloyds afford it? the fact that we have no intention of restricting further Tim Tookey: I do not think it is a question that can be because actually now that we have completed the narrowed up in terms of affording it. What we have integration of the retail platforms that arise in HBOS, done is reinvested some of the savings that we have we are actually planning to extend the ATM access made from the restrictions in actually providing for all of our branded basic bank accounts to all of the product enhancements that are not normally available ATMs that sit within all of the brands within Lloyds to basic account holders, such as the text back facility Banking Group. that was previously mentioned. I think it is also So that means that a Lloyds TSB customer would be important to recognise that each basic bank account able to access their cash free of charge not just from that we open we know will be loss making and we Lloyds TSB and the Post Office ATMs as today, but balance our commitment to provide basic bank also from Halifax and Bank of Scotland branded ones. account access to customers. We are the largest We are actually extending the reach of those provider of such and we opened 230,000-odd such customers, something we could not do until we had accounts last year and we balanced that commitment completed the systems’ integration that, as I said, was with a need to make a return for our shareholders, but done in September and we are now starting to work we have no intention of restricting the availability of on those plans that I would expect to be completed basic bank accounts or ceasing to provide them. during next year. Q463 Chair: Do you publish that cost? Q459 Teresa Pearce. Okay. Just to clarify that, so Tim Tookey: No, I do not believe we do. I do not that decision has actually been made now? believe we have published it, no. Tim Tookey: Yes, it has. Chair: I am getting signals from behind you that are rather different.1 Q460 Teresa Pearce: That’s good. Thank you. Just Chair: I would be very grateful if you would give us to move on to the issue of cheques. There was a lot the current value of that and the current value of of concern, lots of pensioners’ groups wrote to me providing it to all holders as Santander does. about the abolition of cheques and recently there was Tim Tookey: We can certainly look into that. As we quite a strong lobby about it and—as we have heard have done in the past, then of course. from previous people here—many people do not use Chair: Thank you very much. chequebooks any more and many shops will not take cheques, but there is one area where cheques are used Q464 Mark Garnier: Thank you. In previous in the majority of cases and that is with charities and evidence sessions, Sir John Vickers described donations. It is a concern to me that—and looking at Moody’s downgrade of 12 banks, including your two, the future of cheques—we are looking at the retail as a result of the Commission’s report as entirely sector and we are not actually looking at everything. benign. Do you agree with that? There is a very large charity in my area, it is a hospice, Ana Botín: So, well the downgrades are— and I think 65% of their donations are made by Mark Garnier: The Moody’s credit rating cheques, and that is something that concerns me going downgrade. forward, if cheques are going to have a short shelf Ana Botín: Right. We were actually on a standalone life, what will happen there. Have you spoken to the basis upgraded by Moody’s recently but we were then charity sector at all about this? Are either of your downgraded by them and another agency because of banks— the perceived lesser systemic support for all UK Ana Botín: Well, I think the issue of cheques is now banks. agreed that it is now going to be extended, so we— Mark Garnier: Exactly right. Teresa Pearce: For now. Ana Botín: Right. Ana Botín: In our case, many of our customers use cheques. Charities and actually small businesses still Q465 Mark Garnier: Sir John Vickers described use cheques a lot and so that debate has ended and that as entirely benign. Do you think that is a rash cheques will continue. way of describing it? Ana Botín: This is a question of degree. I mean it Q461 Teresa Pearce: So are you saying you think does have an effect. You know, there are many that cheques still have a long-term future? institutions that invest according to ratings, so it does Ana Botín: I do not know what you mean by long- have an effect. I think the overall situation in the term. I think, for now, yes. For the foreseeable future 1 An adviser to the witness confirmed that Lloyds have it is clear that it is something that people use, published such costs in the past. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Anna Botín and Tim Tookey world, mostly driven by Europe at this point, together 6Ð7% core capital, that was fine for us during the with the downgrades does have an effect on crisis, so making banks safer after a certain level of investors’ decisions. capital, is not only about capital. It is other issues that make banks get into problems. We have recognised Q466 Mark Garnier: So are you are talking about that we need more capital. The world has changed and equity investors or are you talking about people who so we have increased our own targets to 9Ð10%. We have had to lend you money? are already at high levels of capital. The bail-inable Ana Botín: Mostly, I would say mostly— debt is an additional significant cost. The depositor hierarchy issue is very important for the UK, because Q467 Mark Garnier: So your cost of funds has gone we import capital especially from the US, so if it up as a result of this? happens, and we do not believe it is necessary, but if Ana Botín: It has gone up significantly over the last it does it should happen throughout the global 12 months. financial markets. Then there is the issue of the ring-fence, which is Q468 Mark Garnier: So John Vickers, saying that important. Essentially, you know, we do not believe this downgrade was a result of his proposals being ring fencing makes banks safer per se. However, we benign, is just wrong? understand it is going to happen, we need to consider Ana Botín: I do not know if “benign” is the right the effect on our customers and the economy and we word but there is an effect. have, in our submission, explained how we should think about the services, especially that SMEs Q469 Mark Garnier: There is an effect. What would throughout the country require. you say? I would like to give an example of the company I Tim Tookey: I would agree. There is an effect. I would visited recently in Castle Donington, near Derby, also agree with Ana. It is very hard to differentiate called Norton Motorcycles. This is a company that is that element of the general move in the cost of debt three years old (even though the brand is an iconic finance to banks over the last 12 months. It is very British brand) that Santander has supported. We were difficult to be discreet and say one particular move the bank that allowed them to be in business. It cost a certain amount, but there certainly was a cost exports 80% of its production. A lot of that is to the element. US, which means they have currency exposures, this company requires risk management; they do not hedge Q470 Mark Garnier: So there is a cost element. You their foreign exchange risk, their margins get to levels just cannot work out what it is? where they would probably not be viable. So, very Tim Tookey: Correct. small companies, and this is not hundreds either, it is probably more like thousands of small companies Q471 Mark Garnier: Following on from the require these services. In our case, if we were not able Chairman’s questions about the costs of the figures, to provide these services, we would have to buy it we have a little agreement about this—£4.4 to £7 from someone else. What we are saying is we need to billion costs that ICB had decided it is going to cost have this service in the ring-fence, and therefore we on a per annum basis. Goldman Sachs has come up should be allowed to have some amount of market with £9.6 billion. Our previous two witnesses have risk. Norton Motorcycles has nuts and bolts and pieces said nobody can really tell. HSBC told us that actually as inventory. Our inventory is having some kind of just the cost of having to issue all these bail-inable risk, mostly interest rate and foreign exchange risk bonds and then the cost of them reinvesting that in inside the bank. What we are proposing is that that be something else, when they just simply do not need to, limited and that there be a cap on that market risk, is going to cost them up to $3 billion a year. We are and that it be related to servicing our customers. This now looking at quite substantial costs coming in and is important because it would change our business that is compared with an implicit guarantee from the model. It is not allowed under Vickers’ proposals. Government that again has various different sides. But there comes a point when you look at the Q472 Mark Garnier: You must feel very sore about implementation of ICB as being greater than the the fact that you presumably did not get affected by implicit subsidy from the Government. Do you think the crisis because you were lending sensibly and you we are barking up the wrong tree? Ana? were behaving very well, oddly enough as was Lloyds Ana Botín: First, I want to reiterate we are absolutely until they were persuaded to take on HBOS. You must aligned with the objectives of the Vickers report and feel very sore that you were doing a very good job, the ICB. survived through the crisis, presumably had all your Having said that, this comes on top of many other liquidity as well as capital, and now you are being increased demands on the industry and so one has to asked to come in and effectively pay the penalty that add up all of these. At the margin the ICB everybody else’s misjudgement has resulted in. recommendations, if implemented according to the Ana Botín: It is not really about us; it is about our stricter interpretation, would have significant costs on customers. Again, if our customers do not do well we us and our customers, so, even though the flexibility will not do well. What we are supporting is that we that is introduced in the report is very encouraging, think about the services that our customers need there is on the one hand the capital, leverage, bail- throughout the country. We already have 40 regional inable debt issues that are very significant. Again, I business centres and we are serving hundreds of want to reiterate the point that we have gone from thousands of small companies and businesses that cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Anna Botín and Tim Tookey need these kind of services that if we go to a very sorts of other things, which is the primary raison strict interpretation of the ring-fence would have to be d’être for having a ring-fenced bank, so you have offered by somebody else. Having the proximity and those key core services available during periods of the reach to these small companies is important—I stress. Having a stable deposit base is very important. gave you an example of a three-year-old company; Ana made reference a moment ago to bail-in and to there are many more like that. It is an important issue depositor preference. I particularly am concerned because, again, if one takes a strict interpretation of about some of the aspects of depositor preference in the ring-fence this would be outside so we would have here and what that does to the wholesale unsecured to also change our business model. funding markets because those are important funding sources, even for the activities that happen within a Q473 Mark Garnier: I am going to come back to ring-fenced bank. We need to be very careful in the the ring-fence in a minute, if that is all right. Mr implementation of this that we don’t preclude the ring- Tookey, getting back to this cost business, given the fenced bank from having access to such sources. fact the implicit guarantee is by all the taxpayers, and generally speaking all the taxpayers in this country are Q475 Mark Garnier: Do you think there is potential customers of the big five banks, do you think that that these proposals could be an end to free retail these increased costs, as a result of Vickers, are banking, such as it is? potentially a waste of time when it is going to be the Tim Tookey: Gosh, that is a big step forward. I am same people paying the extra costs to the banks, not quite sure I can join the dots that quickly. I think through extra charges on their personal bank accounts what they will do is, through the other measures that or whatever, as opposed to through the implicit are in the ICB’s report—and I am not sure I mean guarantee? ring-fencing here—increase levels of competition Tim Tookey: I think that is a very tough question to within the banking sector and I think that would act find a simple answer for but, generally speaking, if as a considerable force against. there is a sensible cost associated with creating a much more stable financial world into the future, Q476 Mark Garnier: So you think they will increase which means we are less likely to see the volatility levels of competition? that we have seen in recent years and less likely to Tim Tookey: I think they will increase competition see substantial calls unexpected on the taxpayer, then through the switching and transparency mechanisms a reasonable cost is worth that. I also recognise that that are proposed within the ICB. That is why I said I the ICB did not have, in the time available to them, am not quite sure it is a ring-fencing point but the enough time to do a full cost benefit analysis and that other aspects of the report will certainly increase is why we are providing—as I said to the Chairman a levels of competition in what is already a few moments ago—information for the Treasury. I competitive market. share Ana’s concerns over some aspects of what may be unintended consequences of the current proposals Q477 Mark Garnier: It is not very competitive, is of the ICB, if they were enacted in the exact form as it? There are only really five banks. It is not like written in the current report. I think it would be a great America with 8,000 banks. shame if some of these things were not developed Tim Tookey: I find the UK banking market a very through the consultation process and addressed in a competitive place in which to operate, but I also way that meant the objectives of the ICB report are welcome the aspects of the report that will increase still delivered but in a way, through consultation into levels of competition and we support those. legislation, that means that the services that retail and commercial banks, like—if I may say so with a Q478 Mark Garnier: I have to say I think you are competitor—we both operate in the UK, providing probably unique that you think that it is a very really critical services to ordinary customers up and competitive banking market. Most people agree it is down the country every day. very uncompetitive. Tim Tookey: I think I am differentiating between Q474 Mark Garnier: Just turning to the ring-fence concentrated and competitive. I know that in many of and the potential trapped pools of liquidity within the the marketplaces and the markets within which we ring-fenced bank, one or two people—the CBI, for operate within the UK we regard it as very example—who have submitted evidence to us have competitive, yes. suggested that you could end up with trapped pools of liquidity. Mr Tookey, if you go first, do you think that Q479 Mark Garnier: Gosh, that is breaking news. is a legitimate worry? Ana Botín, do you feel the ring-fence could result in Tim Tookey: I think there are some worries about liquidity pools? some liquidity issues within the ring-fenced bank. I Ana Botín: Again, I go back to the issue of flexibility. am not sure I am completely there on some of the I believe the economy benefits from different kinds of discussion points around trapped liquidity, but I think business models. One of our concerns with the ring- it is very important that the ring-fenced banks are able fence is that you are actually trying to change the to attract enough quality and stable deposits and structure of the banking sector and it is difficult to funding from various sources in order to continue foresee all the consequences. So it depends how you during future periods of financial stress to be able to break up the ring-fence versus the non-ring-fence provide lending to the economy. That is one of the businesses. Sometimes the consumers have more debt, critical services, along with payment systems and all other times it is the SMEs and corporate; right now cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG05 Source: /MILES/PKU/INPUT/017688/017688_o005_db_Treasury 23-11-11 CORRECTED.xml
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23 November 2011 Anna Botín and Tim Tookey we are at the highest point, I think for 30 or 40 years, to offer simple and transparent products that add value in terms of the amount of liquidity on balance sheets to consumers. So we have launched a fee-paying of corporate companies, whereas the consumers have credit card, which we are doing very well with. It high levels of debts. You want to keep this flexibility. gives you cash back on petrol and supermarket and That is our job, the main function that banks do, to retail purchases and we are finding that consumers assign liquidity, take depositors’ money and lend it like the card. It is a fee-paying card but it gives you where it is needed. So I think having that flexibility is cash back. I think we need to find a way of providing very important. value to consumers and banking is definitely one of Tim Tookey: Only you lose that with the ring-fencing. the areas. Ana Botín: To a certain degree. Obviously you lose Chair: We only touched on quite a large number of some of that, yes, because you are going to have very important issues this afternoon. If either of you separate— think that any of the Vickers or the Basel proposals— bail-in, capital, liquidity or whatever—are Q480 Mark Garnier: Is it fair to say that implies inappropriate, it is extremely important that you speak extra costs on the retail— up now, not privately but publicly as part of the public Ana Botín: Yes, absolutely. We are going to have a debate about what we are going to do in response to higher cost as it is written now, both in the retail ring- these ideas, in writing if you feel that you have not fence and a much higher cost on the non-ring-fenced, put your points across this afternoon. Please don’t so one of our objectives is that we should be able to complain later, after the implementation begins, provide the SMEs with some of the services they need because I don’t think there will be much interest from within the ring-fence because otherwise the cost is Parliament about that. going to be much higher. Thank you very much for coming in this afternoon. I am very sorry that you were kept waiting, first Q481 Mark Garnier: So, an end to free banking? because the initial session was a bit longer than Ana Botín: We believe—and we have recently intended and then, of course, because we were launched examples of this—that what is important is interrupted by a vote. Thank you again. cobber Pack: U PL: COE1 [SE] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 82 Treasury Committee: Evidence
Wednesday 14 December 2011
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Mr Pat McFadden Mark Garnier Mr George Mudie Stewart Hosie Jesse Norman Andrea Leadsom Teresa Pearce Mr Andrew Love Mr David Ruffley John Mann John Thurso ______
Examination of Witness
Witness: Peter Sands, Group Chief Executive, Standard Chartered Bank, gave evidence.
Q482 Chair: We aim to run this session for just Q484 Michael Fallon: The other report since then under an hour. We are very grateful to you for coming has been the FSA’s report into the failure of RBS, in in. You have given very clear views in the past on this which it suggested that the regulator should have subject, and in your response to the interim ICB report another power to block acquisitions. What is your you said that, given how much regulation had already reaction to that? changed since the crisis, there was an acute danger of Peter Sands: I must admit, I thought they did have an what you called regulatory overkill. Now that the final effective power to block acquisitions. My report is out, is that something you are still understanding was that any acquisition that was likely concerned about? to breach threshold conditions, they had the power to Peter Sands: Yes. But if I may start by saying that intervene. Certainly, that was the understanding on which we have been operating on. In my judgment, actually we are broadly supportive of much of the they could have and should have intervened on the overall regulatory agenda: so, the core principles of RBS acquisition of ABN. But I would have no what is being implemented through Basel III in terms problem with there being a more explicit power of of banks having to hold more and better-quality intervention or scrutiny or whatever on major capital, in terms of having a more structured approach acquisitions. to liquidity regulation, all the work being done on resolution and recovery, so that failing firms may exit Q485 Michael Fallon: I have not seen that suggested without calling upon taxpayers, and the whole arena elsewhere. You are saying they had a power which of macroprudential regulation. These are all things they simply failed to use? that we are very supportive of, but I am concerned Peter Sands: I have to confess, I have only had the that the sheer avalanche of different regulatory chance to skip through the fat report you have in front initiatives at various levels—national, European, FSB of you, Michael. But I think there is a comment in and Basel—adds up to an outcome which may not there about the fact that they did consider whether or strike the right balance between things that make the not the threshold conditions were in danger of being financial system safer and also enable the financial breached and they came to the view that they were system to play its role in supporting economic growth not. But if they had come to the view that they were in the real economy. That is partly about the metrics in danger of being breached, they would have had the that banks are going to be held to, but it is partly also power to intervene in some way. But, I may have just the sheer complexity of having so many different misunderstood it. I confess I was reading that at speed. overlapping initiatives, which brings with it a risk of unintended consequences because it is very difficult Q486 Michael Fallon: The other suggestion that for any one set of supervisors to see through the Lord Turner makes is that bank executives, the complex mix of changes that are being implemented. directors themselves, should be held liable, strictly liable, if their firm fails. What is your reaction to that one? Q483 Chair: If you are not sure what is going on, Peter Sands: It is clearly appropriate that directors of we can be confident the regulators will not be, so what a bank that has failed should be held accountable for you are telling us is quite bad news. their actions. In terms of what the precise mechanism Peter Sands: I think it is. There is real danger in the is by which you do that, I think we need to think sheer quantum and complexity of regulatory change, through that quite carefully, so that we do not have partly because people can’t see through the any unintended consequences. unintended consequences, and there are contradictions between different bits of the agenda, and partly also, Q487 Michael Fallon: What is your reaction to this because both supervisors and bank management teams report, overall? are spending so much time working out how to Peter Sands: Well, obviously, it is a pretty terrible navigate all this regulatory change, there is a risk of story, both in terms of appalling decisions and them taking the eye off the ball about what is really judgment on the part of the management team and going on in the global economy. board of RBS, but also some real shortcomings in cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Peter Sands terms of the supervision of the bank. I suppose the loss-absorbing capital, it seemed to us unnecessary to observation, when I reflect—and I confess I have only do so to come up with requirements of specific levels skipped through it pretty quickly—is that it reinforces in advance of what the FSB and the Basel Committee the importance of good governance and good are doing on an international basis. supervision. There is a slight tendency to think that all the problems around financial services can be Q490 Chair: “Flawed in maths and logic”— solved by, in a sense, throwing more rules at the presumably you set all that out in detail to them in problem; either rules about the way boards work or writing? rules that supervisors then have to supervise against Peter Sands: Yes. or implement. What comes out of the report, just from a quick read, Q491 Chair: Have you published that as well; made is that fundamentally you still require boards to do their job properly and you require supervisors to do that publicly available? their jobs properly. I would argue that, had they Peter Sands: I think we argued— wanted to, the FSA could have stopped the ABN deal. That is clearly not the only issue that led to the failure Q492 Chair: Could you do so? of RBS, but it was one of the critical items. Peter Sands: Yes. If I have not done so, I could check whether— Q488 Chair: You are making the point that whatever the legal position is, in practice, they could have Q493 Chair: Could you take a look and make it exercised influence to obstruct it or prevent it? available to the Committee? I think we ought to see Peter Sands: Yes. that. Peter Sands: Fine, yes. Q489 Chair: You said that this body of regulation that is pouring out is highly complex and runs the risk Q494 Mr Love: Your Finance Director suggested of unintended consequences. Do those proposals and that you are now looking closely at the whole issue of the ICB final report make it more or less likely that whether you should be domiciled in London. After Standard Chartered will remain headquartered in the what you have just said to us now about the UK? relationship on regulation, the ICB report and Peter Sands: Let me step back a bit and say what our taxation, is it not inevitable that you will be moving preference would be. Our preference would be to stay soon? here in the UK. We see great virtues to London as Peter Sands: I don’t think it is inevitable at all. As I headquarters of an international bank. It also has the said, our preference is to stay in the UK. However, great advantage of it is where we are, and moving the we do get asked by our investors why it is that we are domicile of the bank is a complicated distraction. I here and what we are thinking about it. Therefore, as would prefer to be focused on our clients and a Board we have an obligation to consider what our customers and on creating value for our shareholders. options are and to understand the trade-offs. We do get asked a lot about our domicile and why we stay in the UK, and increasingly get asked by our Q495 Mr Love: investors, because there are costs to being a UK- What I have heard so far, you are domiciled institution. suggesting—and I think we would have some The considerations: one of them is what is sometimes sympathy—that you would be more adversely known as super-equivalence, the degree to which the affected by the bank levy than perhaps any other FSA’s regulations are in addition and incrementally major bank, certainly one based in London. You have expensive relative to, say, the Basel III standards; a criticised the ICB report, we have just heard. You are second is the bank levy. The aspect of the ICB’s talking about the volume of regulation that is coming proposals that would cause us most concern in this out from London and at a European level. Where are respect is not so much the ring-fencing, because we the countervailing reasons why you should stay? It don’t have a UK retail business to be ring-fenced, but seems to me your headquarters in London is an the proposals around the primary loss-absorbing accident of history. We understand that means you capital, which we think would cost us. would be reluctant to leave, but all the arguments you We also think it is flawed in both maths and logic: have put so far seem to suggest the strength of the maths because we think the determination of the argument to leave is growing and that that is likely percentage numbers they are looking for is not really to prevail. borne out by the evidence they present, and logic Peter Sands: Well, I think that the strength of the because the ICB had earlier taken the stance that it argument has grown, unfortunately, and things like the did not want to make the non-ring-fenced part of UK- recently announced increase in the bank levy are not domiciled banks disadvantaged in international helpful to us from that respect, particularly because competition. But the primary loss-absorbing capital we are growing our balance sheet; we are growing the proposals, which are proposed for the group as a amount we are lending to businesses around the whole, would do exactly that. They are essentially world. But I do not want to come across as being too front-running the evolution of proposals at the level negative. London has great virtues. It is still the of the Financial Stability Board and the Basel world’s leading international financial centre. It is an Committee. So, while we are supportive of bail-in obvious place from which to run an international capital, and I am not against the concept of primary bank. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 84 Treasury Committee: Evidence
14 December 2011 Peter Sands
Q496 Mr Love: I understand but that seems rather is complicated stuff, but it is very important. It is ephemeral. Could I put it another way: is the problem something where the industry absolutely agrees, that you can’t find another alternative place to people like me absolutely agree, we need to put in headquarter your business? You seem relaxed about it, sustained effort, because it is important that we have so it is not a question of, “We want to be in London”; a regime, a framework, which allows banks to fail in it is rather, “We are in London. We don’t know where an orderly fashion without creating systemic stress else we could go.” and without calls on the taxpayer. Peter Sands: That would not be the case. We understand what our options are and actually we Q500 Mark Garnier: Let me put the question a would be welcomed, or so we understand, in various slightly different way. Do you think these proposals— parts of the world. Many countries would see a bank again, including the international ones—get the with our footprint across the fastest-growing markets British taxpayer off the hook in terms of having to in the world as being an asset. bail out a failing bank? Peter Sands: I would say the thing that most gets Q497 Mr Love: Let me go on. It has been suggested them off the hook is the stuff that I have been your largest single shareholder is the sovereign wealth describing, which is primarily driven at the fund of Singapore. You mentioned earlier on about the international level. If I look at the specific proposals role that shareholders have in putting pressure on you, of the ICB, the problem I have with the ring-fencing asking the board questions, and indeed investors as proposal—and I am making this comment from the well. Are any pressures being put on you to move to perspective of an institution that has nothing to ring- the Far East, and what do you think the possibilities fence—from my observation about it, is that it are the Singapore sovereign wealth fund might take probably makes resolution easier of the ring-fenced over Standard Chartered and move it to a more element, but it actually makes the probability of appropriate location? failure greater of the ring-fenced element. It is a less Peter Sands: I can’t comment on the desires or diversified entity, there is less ability to port liquidity intentions of our largest shareholder. I am afraid that and capital and so less institutional resilience and you would have to talk to them to get their views. All some considerable cost, so I am not sure that proposal I would say is that we get asked about our intentions achieves as much as the ICB suggests. on domicile—how we are thinking about it, and why it makes sense to stay in the UK—in almost every Q501 Mark Garnier: That is very helpful, thank single investor meeting, including with all our UK you. Obviously, you have made your comments about investors, and 40% of our shareholders are based here how the ring-fencing affects you, but you also say you in the UK. think that the loss-absorbing capital is flawed for a number of different reasons. Do you think there would Q498 Mr Love: Does that mean that eventually the have been a better or different way of trying to pressure will tell, and the detailed work you have done achieve the same objectives without having to go on deciding whether to stay will inevitably come to through ring-fencing and this need to have capital? suggest that you should leave? Peter Sands: I should clarify. I do not have any Peter Sands: I don’t think there is anything inevitable problem at all with bail-in debt, which is essentially about it. As I say, we don’t have plans to leave. We what the notion is behind primary loss-absorbing have done the analysis and we continue to keep it capital. In fact, we have been very supportive of the under review. We understand what our options are but idea of having that as part of the capital structure of our preference remains to stay here in UK. banks. My objection is more that the ICB is proposing Chair: Well, we have heard that. a set of levels that we should hold, in advance of an international agenda to do exactly the same thing. It Q499 Mark Garnier: The ICB tell us that, combined strikes me that we might as well do it in line with with the international initiatives coming through, their the rest of the international reform programme. So the proposals solve the notorious “too important to fail” underlying concept of bail-in debt, which is captured problem. Do you agree? by the notion of primary loss-absorbing capital, is Peter Sands: I am afraid to say not really, because I perfectly sensible. think the answer to the “too big to fail” problem, you can disaggregate it into how do you stop things Q502 Mark Garnier: You don’t necessarily think failing, and then how do you deal with the there is a better way of doing it, including the ring- consequences of failure? The fundamental best way to fencing? stop things failing are the basics of having more and Peter Sands: Can I step back and give you a sense better capital and better liquidity—and that is of where I thought the big missed opportunity of the enshrined mainly in Basel III—and better corporate ICB was? governance and better supervision in the way we were Mark Garnier: Yes, absolutely. talking about in the context of the FSA report. In Peter Sands: To my mind the big opportunity—and I terms of dealing with the consequences of failure, I made my opinions very clear to John Vickers and the think there is still work to be done, but the core of rest of the ICB—was this was also an opportunity not that is all in the agenda driven by the FSB, the just to add things to the regulatory agenda but to give Financial Stability Board, around resolution and it a greater degree of coherence and to point out some recovery, crisis management groups, harmonisation of of the areas where we appear to have duplication or resolution regimes across jurisdictions and so on. That contradiction. I am still of the view that that was a cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Peter Sands missed opportunity, because actually all the ICB did precision to that, but it is a substantial drag upon our was add more stuff. We run a risk of having so much economics. stuff going on that we miss the wood for the trees. Mark Garnier: That is very helpful. Thank you. Q507 Mr Ruffley: A final question. The report talks about international competitiveness, but was written at Q503 Mr Ruffley: You spoke about competitiveness. a time I think where there wasn’t too much cognisance Looking ahead, could you tell us how you will given to what an FTT—financial transaction tax— measure the damage to your competitiveness as an might do to UK banks. As a result of the Prime international bank, as a result of these ICB proposals Minister’s decision to veto the EU treaty last being implemented, ahead of other countries and weekend, there is a possibility that the 17-plus, and other banks? maybe some others, might attempt to go for a financial Peter Sands: Ultimately, the measure is going to be in transaction tax if Britain stays out of it. The our success in delivering sustained growth and value Chancellor—quite rightly, in my view—said we will creation for our shareholders, and being able to serve be kept out of an FTT, but are there any ways in which our clients and customers. We have delivered that could adversely impact on a bank like yourself consistently. We have delivered eight years in headquartered in the UK? succession of record income and profits, so we have Peter Sands: We certainly welcome the Chancellor’s grown our profits, grown our customer lending all stance on a financial transaction tax, because for through the crisis. We are on track for our ninth year Europe, either the EU or the eurozone, to try and of record income, record profits. Our challenge is implement a financial transaction tax without the rest going to be we operate in international markets where of the world doing so would make it extremely many of our competitors are not going to face things difficult for an organisation like us, where 90% of our like the 17% to 20% primary loss-absorbing capital business is outside Europe. In terms of a eurozone calculation, or they will not be facing the bank levy only one, we find it quite difficult to work out what that we have, which is effectively imposed on our the impact of that would be on us, because the devil liabilities internationally. So the question is: how is in the detail of how they determine the scope of it. much does that undermine our ability to compete? From our perspective, the thing that I am most concerned about coming out of the summit last week Q504 Mr Ruffley: Those things are quite a hit to is the fact that, once again, the eurozone has not you, as you have outlined in some detail. Over and produced a credible answer to how the challenges of above the ICB, have Government Ministers been the eurozone are going to be dealt with and what the made aware of this? You are a very significant growth agenda is going to be. Although we have international bank and yet these proposals seem a negligible direct exposure to the eurozone, and none story of hits to your competitiveness. at all in terms of sovereign exposure to the more Peter Sands: We do make clear our concerns, and I troubled countries, I don’t think anybody in the world have done so with various Ministers in various fora. can be complacent about the consequences of the We also appreciate the realities of the situation, in the eurozone continuing to face the kind of turmoil and sense of there is a clear need to reinforce the difficulties that it is facing now. regulatory framework in banking and there is a clear Chair: We had better move on now. concern to protect the taxpayer, and there is also acute need to improve the UK’s fiscal position. Q508 John Mann: Is there anything coming out of the European Union or the European Commission— Q505 Mr Ruffley: I think we all agree on that, but and you mention the financial transaction tax, but are have you done any work on getting to a figure as to there any other specific proposals that you have what the cost of these proposals could potentially be concerns about? for your bank? I know that is a very difficult piece of Peter Sands: There are quite a lot of proposals work and you have to make lots of assumptions, but coming out of Europe at the moment. The one I do have you tried to quantify the cost to Standard think this Committee might want to take a look at— Chartered of all these proposals when they come into and I realise you have a fairly daunting agenda of effect, the cumulative effect? Has a piece of work different topics to look at—is the most recent thing been done by your office? coming out on crisis management. That is not to say Peter Sands: Yes. We are continually updating our we are against consistent approaches to resolution and analysis of the costs. recovery, because we think to have consistent approaches is the answer, but we think there are some Q506 Mr Ruffley: Do you have a ballpark figure aspects of that, particularly some aspects that seem for that? biased against entities outside the EU that we find Peter Sands: If you include the bank levy, which this very troubling, given how much of our business and year will cost us something in the region of $190 how much of the UK’s international financial services million—I apologise to the Committee, because we business is outside the EU. That is clearly an report in dollars, and my natural frame of reference is important piece of legislation coming of Europe and to talk in dollars—if you add the other sorts of things would merit quite close scrutiny. that are coming in, which are in a sense super- equivalent to what we would face if we were just held Q509 John Mann: That is one. I am not suggesting to, say, Basel III, it is pretty easy to get a number you spend the rest of the hearing listing the others, north of $500 million a year. There is no particular but approximately how many other specific proposals, cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Peter Sands which are on the table at the moment from the Committee, so that, rather than having countries take European Commission, do you have concerns about? various views on particular levels, or particular Peter Sands: I would find it difficult. There is a lot of aspects of regulation, as far as possible this was done material. But let me not be entirely negative. There at a global level, not just at an EU level. Because are some aspects of the proposals coming out of the every time you have things done, either at a national EU that we think are superior to some of the things or regional level, it creates complexity, it undermines coming out of the FSA, so it is not that everything out transparency, it creates room for regulatory arbitrage of Brussels is necessarily a bad idea. I would reiterate and it actually makes it both more costly and less the biggest issue is the fact that, on any one topic, we effective as a regulatory framework. are facing sometimes multiple proposals within the UK, other proposals coming out of the EU, some Q512 Mr McFadden: I would like to ask you about coming out of the FSB and Basel, and then we operate the investment climate here in the UK. Obviously it in 70 countries, and most of those have their own is important to our economic growth. Standard variance as well. I could spend more than a couple of Chartered plays an important role in financing some hours trying to explain exactly how capital regulation inward investment into the UK, for example, Tata works, and it is not the most coherent of topics. Motors, Jaguar Land Rover, which in a very welcome move is establishing a new engine plant in the West Q510 John Mann: I am trying to get at two separate Midlands—a very important investment. At the aspects here. One is the level of importance to you as current time, how attractive is the UK for investors an institution of things coming out of the European from countries, such as India and China, looking to Commission. But I suppose an easier way to put it is invest in Europe? how important we as a Committee should be Peter Sands: I think the UK, in a very tough global regarding that in terms of the many priorities that environment, has the potential to position itself very there are. How important is the stuff not coming out attractively as a place for investment for big of this country but out of the European Commission, companies and wealth funds, and so on, from the fast- in terms of your operation as a bank? growing markets of Asia. Indeed, one thing we think Peter Sands: It is very important because, although is very important is that the UK growth agenda take it goes through a process of refinement and change, full account of what is going on in the world, and ultimately the capital requirements, directives and so what is going on in the world is that growth is shifting on, end up being the things that gets translated into east. We need to put more and more focus, both in FSA regulation that we then have to operate by. As I terms of where British companies should be exporting say, some of the European stuff is very sensible and a to, trading with and where investment should be lot of it is fundamentally just trying to translate into coming from—and it is not just India and China— legislation things that have already been agreed at they are the biggest markets—but it is also places like Basel III. One of the things that I am often South-East Asia, Indonesia and so on. We do think uncomfortable with is that there is an inward-looking that we at Standard Chartered can play a very EU focus on some of it, which is quite difficult to constructive role in that. reconcile for us, given that we are a business that is growing and focused on the fast-growing markets of You mentioned Tata as an example. We have a very Asia, Africa and the Middle East. long-standing, deep relationship with them. We helped them with the Jaguar Land Rover investment. We are working with Chinese companies that are also looking Q511 John Mann: I have one more question. You are making specific representations to the Treasury, at investments. We are also working with UK for example, on specific European Commission companies that are trading with and investing regulations that you regard as either good or elsewhere. So, for example, we are working with the problematic, it would be quite useful for us to know likes of Diageo all over, in places like East Africa, in what they are and what your detailed view is. That China and so on. We see one of the ways that we can would be useful if you sent that through. make a contribution to the UK economy is helping But my final question: I listened to the Prime Minister facilitate that two-way flow of trade and investment, in relation to the decision of Government last week. and helping the UK economy get better and stronger He was selling that very much on the basis that he growth by repositioning towards the faster-growing wanted to go beyond what the EU was doing, and parts of the world. setting aside the financial transactions tax, which he was very specific about, but with the rest he wanted Q513 Mr McFadden: Can I ask you about the other to go further. He wanted higher requirements on direction then. Statistics show that, at least up until capital, for example. Do you see that as a benefit or a last Friday, more than half of the UK’s trade in goods problem in terms of if we in this country decide to go went to the European Union, but only 2% goes to to a higher level of regulation and conditions than that China. Given your experience in these markets—and of the EU, as the Prime Minister was suggesting we UK Governments of both colours have been might? producing reports for years on the importance of India Peter Sands: I run a bank across 70 or so different and China as markets and globalisation, and so on— markets. I have to say—and I realise this is perhaps why do you think our import penetration into these an unrealistic aspiration—if I had my wish, it would markets or our ability to export goods has not be that the effort was focused on getting agreement at achieved a bigger share of the market than it has so the FSB, the Financial Stability Board, and the Basel far? cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Peter Sands
Peter Sands: It is a very good question and to do it figure underestimates the total, and my understanding justice would probably take a little longer than I have. is even the analysts who researched it only analysed One of the problems with China is that companies are the costs for the four big UK banks. They did not intimidated by China, and it takes them a little time include the costs for the likes of us, so you could to get over the barriers of language, of a very different argue that even some of those figures might be quite business environment. What you tend to find with conservative. But by the nature of the analysis, this is China is that you have some British companies that not a precise science, because you are estimating what are extremely successful and know China very well. credit spreads will be for instruments that do not yet We are one of them. We are the oldest foreign bank exist and so on. in China. HSBC is another. There is a range, but it is a relatively small number of British companies that Q516 Stewart Hosie: What they did say was that the are very knowledgeable and most companies have not most significant chunk of the costs, whatever it ends got over that threshold. That is one of the areas where up being, was the removal of the implicit taxpayer I would like to think we could help, and we have made subsidy, including, for example, access to the Special various suggestions about how we can help, Liquidity Fund that all banks and international particularly, smaller companies understand China institutions have. Was that an issue for your bank? Did better and engage with it more effectively. you have access to those funds here? Would that be It is a different set of issues with India. You don’t an issue at all? have the barriers of language. One of the roles I play Peter Sands: We never use the Special Liquidity is I co-chair with Ratan Tata the UK-India CEO Scheme. Indeed, we did not take any equity; we did Forum, where we have a bunch of CEOs from both not use the Credit Guarantee Scheme. We did not use countries looking at ways in which we can increase any of these things. the economic and business linkage. We have a range of ideas that we are developing to present to both Q517 Stewart Hosie: That is interesting because you Prime Ministers when they next meet. We are also did say your biggest concern was the frontloading of trying to work with SMEs, and we have worked with, the primary losses of the capital in advance of the FSB say, Lloyds Bank in this country, because we don’t and Basel III decisions more generally, and you said have a footprint here. We have done a number of that the total cost, including the levy, would be north workshops for SMEs in different parts of the country of £500 million. about how to do business in India. So there are ways Peter Sands: Dollars. of doing it but you can’t fix it quickly or overnight. Stewart Hosie: Dollars, sorry. Yes, I did write down dollars. Yes, $500 million. What will that mean, in Q514 Mr McFadden: You talked about barriers but, terms of volume of business, in terms of the cost to for example, if you look at Germany they have had a clients and customers? What would that additional very successful export record in recent years. What cost base to the bank mean? are they doing that we are not doing? Peter Sands: Ultimately, you want banks to be Peter Sands: There is a range of different things. For profitable because by being profitable they generate one thing, Germany has been more effective, not just retained earnings and by generating retained earnings in China but more generally around the world, in they build their capital base and they can lend from exporting its manufacturing prowess, and Germany that capital base. The crude proxy is that if you think has managed to make “made in Germany” in terms of, say, a 10% core tier 1 ratio, so a 10% synonymous with being well-engineered and so the core equity ratio, every $100 million or £100 million brand of German engineering is extremely effective. equates to a $1 billion or £1 billion in terms of risk- A lot of Asian businesses underestimate quite how weighted assets, which would equate to a bit more good British businesses are. So, for example, one of than that in terms of lending capacity. So it is the things we have been doing through the UK-India important to have banks that are profitable and CEO Forum is to try and build awareness of the depth generate strong retained earnings, because that is how of skills in areas like advanced manufacturing that we they are able to continue to support their customers. have in the UK. In some ways, we are a case example of this. We date Mr McFadden: Can I just ask one more? the beginning of the crisis from the middle of 2007. Chair: Sorry, we will have to move on now. I We were already nervous but that is when we saw apologise for that. things really beginning to deteriorate. Between the middle of 2007 and the middle of 2011, Q515 Stewart Hosie: The ICB told us that the cost we have grown our lending to our customers and to the banking sector of the proposals would be in clients by 75%. We have grown our profits by 80% the £4 billion to £7 billion range, and Goldman Sachs over that period, and those two things are not a suggests it will be higher, somewhere just short of coincidence; they go hand in hand. By being £10 billion. Do you have a figure as to the cost of profitable, we have been able to stand by and support implementing those proposals on the sector as a our clients. That is also while maintaining what some whole? analysts describe as a rather boring business model, in Peter Sands: I don’t have an aggregate figure. We the sense that we are incredibly conservative about would not be the best people to ask because we don’t what risks we take. If you look at our liquidity have an entity that is going to be ring-fenced, and for position, we are one of the most liquid banks in the many of the banks that is the primary driver of costs. world. If you look at our capital position, we are I can tell you that my judgment would be that the ICB already at the Basel III standard. So by having a cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 88 Treasury Committee: Evidence
14 December 2011 Peter Sands conservative business model, by being very consistent and third order consequences of these things. But am in our approach to customers, but by continuing to I sympathetic with the basic view that directors should be a profitable entity, we can support our customers be held to account if they preside over a failure of an and clients. institution that causes the broader economy and society huge costs? Absolutely; I agree. Q518 Stewart Hosie: Indeed, you can, so I will ask Jesse Norman: I think we are trying to deter people the question a slightly different way. In vulgar terms, from becoming directors of failed banks. if this is going to cost $500 million a year, we are Peter Sands: Yes, and that is good. talking about a shortfall of around $5 billion in lending each year, mainly on the back of increased Q521 Jesse Norman: The Chief Executive of the capital requirements and the levy, not in relation RBS had no, what I would call, banking experience at directly, other than the front loading of the primary all. He had had six years in senior positions in banks losses on the capital, to anything else that Vickers in a managerial role. I am not sure he had ever have come forward with. actually lent a penny to any institution. Do you think Peter Sands: It is back-of-the-envelope maths, but it the regulators ought to permit people to hold senior is that sort of thing. Our ability to grow and our ability positions in banks who have no banking experience? to compete will be constrained by the cost of these Peter Sands: You need to be quite careful, and I things. The two consequences of that are: one, we can confess that I would be a rather interesting example do less in terms of lending for our clients and from that point of view because I came into Standard customers; and two, we can deliver less value for our Chartered as Finance Director, not having had a career shareholders, and 40% of our shareholders are here in in banking. I had had a career in consulting where the UK. most of my clients were banks. I am only one example, but one needs to be a little careful about Q519 Jesse Norman: First, an observation: there is making it a box-ticking exercise. I do think that one something slightly odd about saying that your model has to be very thoughtful about who gets to be in is so successful because it is so conservative and yet positions of responsibility, and so I am sympathetic to regulatory attempts to improve the conservativeness the whole concept of the process around SIFs. of other people’s business models is somehow going Jesse Norman: Scrutinised, as it were. to make them less competitive. You have been Peter Sands: Yes, I am sympathetic to that. How it is competitive because you have run a high-liquid and executed could be streamlined and made more high-capital institution at a time when others have effective, but the concept of it is a good idea. failed in the job of being a boring bank, which is what we want banks to be. We want them to be boring. I Q522 Jesse Norman: I am grateful. Final question, have no time, so if you don’t mind I won’t ask for a if I may. Should the FSA have stopped the Lloyds- comment on that, but I hope you agree. HBOS merger, which after all was worse in many To return to the RBS for a second, it was a bank that ways, in that it took place a year after the banking grew its assets by four times in six or seven years. It crisis had started, at a time when HBOS’ own made 24 acquisitions in five years. It was allowed to valuation had plummeted, at a time when the banks pursue a contested bid for a bank whose assets it had been in conversation for precisely two weeks plainly did not understand in an enormously complex before they struck a deal? It seems to me that is an transaction. Would you not agree this is a catastrophic absolutely cast-iron example of a case where the FSA failure of supervision? should have been screaming, “Stop, stop, this should Peter Sands: It was not a good moment for not go ahead. Proper due diligence should take place. supervision. I would find it hard to disagree with Proper examination should take place”. your statement. Chair: Do not take that as a leading question, if you do not want to. Q520 Jesse Norman: I am grateful for that. Do you Peter Sands: It is a really good question and it is one think the directors of such an institution should be that deserves scrutiny. That deal was clearly a mistake banned from holding jobs in the financial industry from a whole number of different perspectives. If I thereafter? could just respond very quickly to your first point, Peter Sands: I don’t know that I am in a position to— which is why is it that a bank that runs on a Jesse Norman: By the way, I don’t just mean conservative business model is threatened by a whole directors but also senior managers; those directly set of regulations designed to make the rest of the involved, either with formal Government industry more conservative, which is a way of responsibilities or with operational responsibilities, paraphrasing what you said. should they be prevented from holding positions if Jesse Norman: It is much better than I used. they presided over a bank failure? Peter Sands: The problem here is that the sheer Peter Sands: I clearly think people should be held to multiplicity of things that are going on lead to account. But, as I said earlier, I do think one needs to unintended consequences. So, for example, trade be quite careful in thinking through the mechanisms finance—and we are now the largest trade finance and how that works because otherwise you might end bank in the world—is absolutely crucial to the world up with consequences that you do not want, such as economy, is actually a very safe business, but because discouraging talented people from becoming directors of an unintended interplay of different regulatory of banks. Also, it leads to behaviours in stress initiatives it has ended up attracting a degree of situations; you just need to think through the second incremental regulatory burden that I do not think any cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Peter Sands of the regulators would have said was necessary in the entry into the UK retail market, including SMEs, less first place. rather than more likely, because it makes it a less attractive proposition. Ultimately, if you are running a Q523 Chair: So if the conservatism was imposed public company you have to be convinced that you straightforwardly, you would be happy? can generate value for your shareholders by entering Peter Sands: Yes. Can I make one other comment on a new market and I am not at all convinced that these that, which is that we need to be very careful not to proposals are going to foster greater competition. move to what I would describe as a high-bar, low- buffer environment, in which banks appear to be very Q526 John Thurso: What action do you think would resilient but all you have done is you have set their foster competition? point of failure at a higher level. It is a sort of glass Peter Sands: I might have to come back to you with jaw phenomenon, and I think we are in a little bit of a more considered response to that, if I may. I am a danger of moving in that direction. afraid to say that, given that our focus is on the markets of Asia, Africa and the Middle East, I simply Q524 John Thurso: One very quick follow-up on have not spent a lot of time worrying about the that. Is it not the case that prudence, which is what competitive dynamics of the UK retail market. you are talking about, is a culture and it is very John Thurso: I would be very grateful if you did difficult to write a set of rules to make people prudent? want to come back to us because I think one of the Therefore, the danger we face is we write shed-loads biggest challenges that we face is how do we get real of rules but we do not end up with boards that have competition, so that our SMEs and individual prudence and a proper calculation of risk. entrepreneurs do get funded? I will have to leave it Peter Sands: I could not agree with you more. there, Chair. Chair: Yes. Also, it would be helpful if you could set Q525 John Thurso: Thank you. Can I turn to out in a little more detail what is wrong with the competition. You do not have a retail operation in the Vickers proposals on retail banking, which you have UK, so in a way you are a very good person who is alluded to. That was a pretty comprehensive independent to ask this question of. At the moment expression of concern you gave. We are very grateful there appears to be almost no competition, particularly to you for coming to give evidence today. It has been for SMEs, in the high street. What should we be doing full of interesting material for our inquiry and thank to get that competition, and is there anything in you very much indeed. Vickers that will deliver it? Peter Sands: Thank you, Chairman. Peter Sands: I am afraid to say that the ICB’s proposals are, if anything, likely to make competitive
Examination of Witnesses
Witnesses: Bob Diamond, Chief Executive, Barclays PLC, and Antony Jenkins, Chief Executive, Retail and Business Banking, Barclays PLC, gave evidence.
Q527 Chair: Thank you very much for coming to Bob Diamond: I think the latter. As we discussed in give evidence to us this afternoon once again, now we January, my view has not changed on that. have the final report in front of us. You will no doubt have also seen the press reports and some of the Q529 Chair: Then you said you thought it was important remarks made by Lord Turner in his report something that the shareholders should decide. on the failure of RBS, and in the foreword he suggests Bob Diamond: Ultimately all of those things are that “Parliament should consider making senior bank decisions for the shareholders, of course. executives personally liable”, put personally at risk, unlike non-bank companies, for the risks they take. Q530 Chair: To be frank, I wasn’t quite sure where Do you agree? you stood last January, because when I asked you Bob Diamond: We touched on this, Chairman, in whether your behaviour would change in any way if January. I think corporate law would suggest your shirt was on the line you said, “No, not at all”. So otherwise and I would not suggest a change. On the what is to be lost by doing it? You might say “What is other hand, as Chief Executive of a financial to be gained?” but what is to be lost? institution and a director, I do feel immensely on the Bob Diamond: It is a complicated issue, but of course hook for behaviour and for delivering the results that it has to do with, would financial institutions be our customers, our employees, and our— investable, what would the shareholder reaction be, and things like that. In terms of feeling responsible, I Q528 Chair: He is talking about a financial hook, is don’t think that there would be any change to that. he not, Mr Diamond? He is talking about putting your shirt on the line, which is a discussion we had a year Q531 Chair: So you also disagree with Andy ago, and your colleagues’ shirts. Do you think that is Haldane in the Wincott lecture when he said that something we should consider carefully, or do you limited liability was creating perverse incentives in think it will damage banking? banking? cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 90 Treasury Committee: Evidence
14 December 2011 Bob Diamond and Antony Jenkins
Bob Diamond: I don’t recall that specific quote, but I individual performance, competitive pressures and the would agree with what I have said if it is the same overall financial condition of the bank. subject. Q536 Jesse Norman: That is miles away from an Q532 Chair: Also you presumably disagree with the answer to my question, which is whether or not there ABI when they said that too much is being paid to should be some kind of restraint or ban on employees and not enough to shareholders? distributions, in particular bonus distributions, if the Bob Diamond: You are picking out specific things. capital of a bank came under pressure. Why don’t we open it up? So, of the capital funds to be allocated Q533 Chair: I am picking out the same thing among between dividends and bonuses this year that we are different people’s remarks. coming into, what percentage will go to the dividends, Bob Diamond: I meet with the ABI on a fairly regular Mr Diamond, and what percentage will go to bonuses? basis. I certainly meet with individuals in institutions Bob Diamond: Let me try to get to the question you in compensation discussions. feel did not get answered first. I will say, I was looking forward to a discussion on the Independent Q534 Chair: But you are disagreeing with them is Commission, and the implementation, but we are right the point. on to the same issues we ended with last time, which Bob Diamond: That is just a soundbite. That I do find disappointing but I am going to answer them soundbite does not sound right to me but I don’t recall as directly as I can. the specific quote. Jesse, your question on what happens to bonuses Chair: We might come back to this in a minute. broadly in a difficult time for banks I think is a fair one. When a number of us were in front of the House Q535 Jesse Norman: Mr Jenkins, when we last met of Lords we talked about what happens if a bank is in with you I was exploring the logic of the allocation of resolution; so, for example, let us say a bank was the 2011 bonus pool as between the commercial bank below its minimum capital requirements, then it is and the investment bank. It seemed to me, from what absolutely in the province of the regulators to make you were saying—and I do not think there was decisions around issues just as you were speaking to. enormous disagreement—that it was something of the Equally now in the UK we are moving forward with order of 6% to 8% of the total pool went on the the FPC guidance, which is coming to us around—it commercial banking side and the remainder went on is a dangerous time. There is a lot of risk in Europe. the investment banking side. Since there is roughly If we are in certain levels of capital, can we put an the same number of employees on each side, therefore eye more towards preservation of capital than maybe there is a substantial difference in where they come we would have otherwise, which is something that has out. been clear in terms of recommendation from the FPC? So the question really then is—and I suppose it is So certainly Barclays, and I am sure every other bank, more one for you, Mr Diamond—if the credit is in discussions with our regulator—the FSA—about conditions got worse at the moment, and if the bank’s what that means, given our results, given our capital own capital came under more pressure or its ability to and those issues. fund itself came under more pressure, would there be So I think those are both true. Then, as Antony said, a case then for some kind of bank-wide or industry- this is the kind of year where we are looking at a very wide restraint on bonuses, in order to protect the difficult environment for banking and a very difficult capital position of the bank and therefore the position environment around compensation, where it is pretty of the shareholders? clear that compensation levels will be reduced for Antony Jenkins: As we explained when we were here those factors as well. It somewhat depends on whether last time, the process of setting compensation in a bank has crossed that line into resolution how Barclays is very rigorous from the board and the official those rules are, but hopefully that helps. remuneration committee. The determinants of the size of the bonus pool is based on business performance Q537 Jesse Norman: Preservation of capital goes but there are also determinants on individual directly to the issue of the Independent Commission decisions, which are based on competitive market on Banking, and that is obviously one of the things pressures for any given individual’s talents and, as you that has been sitting in their minds. Mr Diamond, can raised, different types of people working in the bank you tell me a little bit about how you assess the and will be subject to different compensation viability of your business lines, as between what you structures. might call the investment banking side and the All of those decisions are reviewed by the board and commercial banking side. I imagine it is on return on also discussed with and reviewed with the FSA, in investment, return on capital employed, those kinds of terms of the implications on capital as well as the assessments in part. Is that right? implications on the balance of, do we have a rigorous Bob Diamond: It has done many, many things, Jesse, methodology? We do have a very rigorous and I know you have worked in the investment methodology at Barclays. Bob is very involved with banking part of the business before, as have I. First of that. I am also very involved with that. I have to go all, within that business there is a business model that and make my case at our remuneration committee for is financial in terms of returns, but one of the things all of the decisions that we take on compensation. So that we find interesting with our business model is a the answer to your question is that there is a very lot of the things that our customers and clients require robust process. The balance is business performance, from us, whether it is risk management, foreign cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
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14 December 2011 Bob Diamond and Antony Jenkins exchange, hedging, raising equity, the types of things Bob Diamond: I think they make generalisations on that we do in the corporate and investment banking all banks. area have not changed at all since— Q543 Chair: Have you seen this letter? Q538 Jesse Norman: The question I am trying to get Bob Diamond: I certainly have. to is, why you would want to continue to own the commercial bank in this country if it is not as Q544 Chair: Okay, you have read these one and a profitable as other uses of capital, in particular post- half pages. With or without the soundbite, do you ICB implementation? Why would you want to agree with it? continue to own the commercial bank in the UK? Why Bob Diamond: I don’t think it is question of agree or own retail branches? disagree. There are areas in the letter that I support Chair: Yes, what is the answer? and there are areas in the letter that I do not support. Bob Diamond: You are saying commercial banking? Jesse Norman: Particularly the retail bank. Why Q545 Chair: Do you support this section of the would you want to own that? letter? Bob Diamond: Why would we want to own the Bob Diamond: I think our process around retail bank? remuneration and compensation is supported by our Jesse Norman: Yes. Because it is likely to be low- shareholders— producing in terms of returns compared to other parts. Bob Diamond: I am happy to give a compliment Q546 Chair: You would agree it is quite difficult to where a compliment is needed because the guy on my get straight answers to a reasonably straight question, left runs a fantastic UK retail bank. We are not perfect, wouldn’t you? If you had an employee in front of but the business continues to improve. I get excited you— when I walk in to the branches in Cambridge, for Bob Diamond: Chairman, it is very difficult to say example, where I was recently, where we have taken whether I agree with the letter in its entirety. two or three small branches in an area very close and have one larger one with much better facilities. Q547 Chair: I have not asked you that; I have asked Chair: I think we have the message that you want to you if you agree with this paragraph. own a commercial bank. Bob Diamond: Apologies. Bob Diamond: Absolutely. Q548 Chair: Okay, let me just try one more question. Q539 Chair: I have heard that. Can I take you back There have been recent reports that Lloyds intend to to this ABI letter that you described as a soundbite. do a clawback of a considerable proportion of Eric What that letter says is that “Too much value is being Daniels’ bonus on the back of PPI mis-selling. Given delivered to employees in contrast to dividends paid to that Barclays was forced to set aside £1 billion earlier shareholders. The reduction in employee payout ratios this year to cover PPI compensation, do you have any needs to be achieved by reducing individual intention to do that with your bonus or other senior members’ bonuses? remuneration payouts to highly paid employees. This Bob Diamond: Let me make some comments on how year is the time to make these changes”. It could not we are treating PPI, and then ask Antony to make a have been clearer, and this is in a letter addressed to few comments as well. the chairman of your remuneration committee. I don’t During our remuneration process we will be think it is a soundbite, but you are disagreeing with it, discussing with our remuneration committee the I take it. impact of the PPI provision, which, for avoidance of Bob Diamond: Chairman, I am sorry, I was referring doubt, was £1 billion. It is expensive. It is something to the sentence you gave as a soundbite, not the report. that both and Antony and I are not happy about. Most I apologise if that was said poorly on my behalf. We importantly, we need to accelerate the payments that spend time with all of our shareholders. have been in the queue as quickly as we can.
Q540 Chair: You have told us that, but I am asking Q549 Chair: I am just asking you a very specific whether you agree with it or not. question about the remuneration and the response to it. Bob Diamond: What I agree with is that our Bob Diamond: We are taking into account in our principles are pay for performance, and the businesses that impact in our remuneration. performance should be adjusted for risk— Q550 Chair: The answer is you are considering it? Q541 Chair: It is a very fair and direct question. I Bob Diamond: Yes. am just asking you whether you disagree with the Chair: That is what I wanted to know. Thank you ABI’s letter that came to your chairman. very much. Bob Diamond: What I would say is I can’t comment on the whole letter based on that paragraph but in Q551 Michael Fallon: If we turn to the bank levy, terms of that— when Bill Winters from the ICB appeared in front of us he said if the Vickers recommendation succeeded Q542 Chair: But you have read this letter, surely. It in removing the implicit subsidy then there would be is only two pages. It has had extensive public a case for removing the bank levy itself. Do you agree coverage. You have seen this letter, haven’t you? with that? cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 92 Treasury Committee: Evidence
14 December 2011 Bob Diamond and Antony Jenkins
Bob Diamond: Yes, I do. clearly be to be domiciled, to be headquartered in the UK. Q552 Michael Fallon: You do. Do you think then it is reasonable if the credit rating agencies start Q556 Mark Garnier: You don’t see any chance of factoring in some reduction in the implicit subsidy that changing, given what you know now about all the that Government ought to take that into account in regulatory changes coming through, the ICB and all framing the bank levy? the rest of it? Bob Diamond: I think they can be connected or Bob Diamond: Correct. But as we have talked here separate. The banks in the UK, if there was an implicit before, there are some challenges in terms of super- subsidy, it is there no longer for the UK banks in terms equivalence, there are some challenges in terms of of their funding, which was one of the goals of the making sure we don’t move too far on safe and sound Independent Commission. We have heard from the versus helping drive the economy. I think we will rating agencies that they use different notches for UK- overcome all those challenges but, as an example, I based banks and for non-UK-based banks. But the can’t be sure what the final report on the Independent bank levy creates an unlevel playing field, so that Commission is but I think I know pretty well and, when Antony, running his retail business in Africa, is based on that, we think this is the right place for us. lending to a customer he pays a bank levy on that, where a bank in the United States or a bank in Q557 Mark Garnier: We have a guidance statement Germany would not. So the biggest issue I have with on Monday, as you know. How close are you to the bank levy is the creation of an unlevel playing changing your mind? field, so there is a disadvantage to being a UK-based Bob Diamond: I don’t mean to hesitate at all. We have institution versus a Santander or a US bank or a been in the United Kingdom for 320 years, this is European-based bank. where we want to be and this is where we intend to be. Q553 Michael Fallon: Have you made Q558 Mark Garnier: representations along those lines to the Treasury? When we took evidence on the ICB from the economist, John Kay, he suggested that Bob Diamond: Yes. a possible consequence of the ICB is that Barclays may split itself up and allow parts of Capital to Q554 Michael Fallon: Have you had any reaction relocate offshore. Again, if you were sitting in a board to that? meeting, what would you recommend your fellow Bob Diamond: Certainly, there was a reaction in the directors do with regard to Barclays Capital and its discussion. There wasn’t a change in the bank levy. domicile? Michael Fallon: Thank you. Bob Diamond: They could have their headquarters Bob Diamond: If I could say one more thing, anywhere they want. The three logical areas I suppose Michael, one of the concerns for us is that for other would be somewhere in Asia, London or New York, banks operating in the UK, within the UK everyone but that would not change our primary regulator being is on a level playing field, but outside the UK it only the FSA, so it is almost a non-issue. We have almost applies to the UK-based banks. as many people in Barclays Capital today in New York as we have in London. It kind of has multiple Q555 Mark Garnier: You have been here four headquarters but none of that changes at all the fact times, and I think most times you have come we have that our primary regulator is the UK, and that is the asked you about your intention of relocating out of driving force. the UK. When you came before the House of Lords Economic Affairs Committee you were absolutely categoric that there is absolutely no intention to Q559 Mr Ruffley: Mr Diamond, the ICB proposals, change that; that you have been in the United what will they do to the competitiveness of your Kingdom for 300 years. However, you then put in investment bank, Bar Cap, relative to other foreign quite a big caveat, which is, “Having said that, I am, competitors; disadvantage them or make no like everybody else here, challenged by our board and difference? our shareholders through our normal planning process Bob Diamond: It is not a positive, it is a negative, to consider all aspects of that, as you would imagine”. and we think we can manage it and, as I have said, If you were sitting in front of your board, what would ring-fencing was not what we recommended. It you be advising them to do with regard to maintaining certainly would not have been our first choice. From the domicile in the UK? everything we know now, and there are still more Bob Diamond: The difficulty in what you are pointing details to come, but what we would expect to be the to comes to one can never say never because we don’t implementation we can live with it and we are going know all the facts, but on the things that we know— to do the implementation when we know the— Mark Garnier: If you had a board meeting— Bob Diamond: The things that we know today, this is Q560 Mr Ruffley: Have you made an attempt to our home and there are some challenges to being a quantify what the possible cost might be? There are a Chief Executive of a UK-based bank that are not lot of assumptions we have to make, but is there a representative. But if you bring all of the pieces in, ballpark figure that you have in your mind for the the strength of the economy, the independent fiscal extra cost to Bar Cap of these proposals, when they and monetary policies, my recommendation would are implemented in full? cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Treasury Committee: Evidence Ev 93
14 December 2011 Bob Diamond and Antony Jenkins
Bob Diamond: I haven’t thought of it quite that way. would have severe consequences for the industry, as I have a long answer and a short answer, and I know people generally agree. the Chairman wants the short answer. Chair: Put the long answer in writing, if you would. Q566 Mr Ruffley: Work on the assumption that the Bob Diamond: We have seen the estimates of £4 Chancellor has vetoed that and work on the basis that billion to £7 billion for the industry. If there are four Britain is not a part of the FTT, but is there any way large banks that will assume most of those then if you that this levy could be implemented in such a way that divide by four we think that is probably in the it would damage your business? ballpark, so we think it is probably north of £1 billion, Antony Jenkins: Frankly, it is still unclear as to how but to get to £2 billion we are not sure yet. That is it would be implemented and the details of what legal primarily the funding, the liquidity charges, and the entity structure it would apply to. capital charges that come with it. There are others things that we have talked about in terms of the cost Q567 Mr Ruffley: He must be making some of regulation, but that is a good approximation of what assumptions—worst-case scenario. Have you not we think the impact on Barclays will be of the done that? Independent Commission. Bob Diamond: Yes. If we did business with a German insurer that is subject to, I would still say that this is Q561 Mr Ruffley: That is an annual figure? having a bigger impact on the real economy than it Bob Diamond: Yes. The majority of that will be felt would have on individual banks. in Barclays Capital but not all of it. I don’t think they have broken it out by business, but it would certainly be the majority in the corporate and investment Q568 Stewart Hosie: Bob, the European banking business. Commission wants to implement maximum harmonisation in European financial regulation, and Q562 Mr Ruffley: My second and final question self-evidently that might inhibit the implementation of relates to the EU. Bearing in mind the Prime some of the ICB proposals. On balance, would you Minister’s decision last weekend to veto treaty prefer to see this maximum harmonisation within change, this could well have implications for financial Europe, or the UK have the ability to offer the services in the single market or our financial service protections to the sector that are implicit in Vickers’ industry position in a single market. Do you have any recommendations, or do you prefer option B? thoughts as to how this might play out or, more Bob Diamond: I have never thought of it quite that particularly, what assumptions are Barclays making way. You know, from things I have said previously, I about the aftermath of Mr Cameron’s decision to veto think we can accomplish the things necessary for the treaty? safety and soundness without going as far as a ring- Bob Diamond: Unsurprisingly, both Antony and I fence. Unsurprisingly, if we had complete would say that the issue is not about financial services. harmonisation, I still believe I would put as a very The issue is about the eurozone, the 17— high priority the same goals and aspirations that the ICB have in terms of creating a more safe and sound Q563 Mr Ruffley: I don’t want to career on from financial system. As you know, from past times, we that. We all understand that the euro is a big issue, but believe that through operational subsidiarisation we I want to stick to the UK’s financial service sector can accomplish the same thing, that if there were a position as a result of the decisions made by Her problem, a bank could be allowed to fail without Majesty’s Government last weekend. creating harm to depositors and without bringing in Bob Diamond: I will ask Antony to speak, but the taxpayer money. I don’t know if you have a different focus of decisions has been on getting the eurozone view. It is hard to answer the exact question but I safe and sound as a financial system. I don’t think we think it could be accomplished both ways. know enough to know what the impact— Antony Jenkins: We have done an enormous amount of work on operational subsidiarisation. We think it is Q564 Mr Ruffley: I will just be more specific, Mr extremely important that banks are able to resolve Diamond. If there were to be a financial transaction over the proverbial weekend. We think that will afford tax implemented in the eurozone, would that have any the protection, both to the systems in this country but impact on your business? also to the other parts of society. The impact of the Bob Diamond: Yes, I think it would be a negative— European framework on this is far from clear, and one Mr Ruffley: Even though Britain is outside? of the reasons why these conversations are always Bob Diamond: It is not as much my business or even complex is because we have many different streams the UK, it is our pension funds, our insurance of activity progressing at slightly different paces that companies. It would have a very broad-ranging and all need to be brought together. So for us, one of the negative impact on the real economy. That is the real questions on our mind, for example, is, “How does issue with the financial transactions tax. your ring-fence work with your operational subsidiarity, work with your holding company, what Q565 Mr Ruffley: Anything you would like to add? is the relationship in terms of operational and capital Antony Jenkins: As Bob said, it is still early to see and funding?” All of those things will have profound what the implications are for the industry. Clearly, if impacts on the capacity that we are able to provide to a financial transaction tax were applied in London that the economy, as well as on costs. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 94 Treasury Committee: Evidence
14 December 2011 Bob Diamond and Antony Jenkins
Q569 Stewart Hosie: Let me ask you about the ring- Q574 John Mann: I just have two questions of you. fencing; more accurately, what Goldman Sachs said You have already raised concerns on two aspects of about Vickers in relation to super-equivalence, which regulation emanating from Brussels and the European is represented by the ICB proposals and the bank levy. Commission. I would be interested to know if there Goldman Sachs said that that could structurally are other specific proposals coming from the disadvantage UK banks, particularly outside the ring- Commission that you have concerns about, and fence. You have already mentioned the impact of the perhaps you could elaborate, or if it is too much detail levy being detrimental. Is there anything else inside then perhaps send us a note of precisely what areas the Vickers proposals that could structurally coming from Brussels you have specific concerns disadvantage UK banks outside the ring-fence? about, in terms of the UK’s competitive position. Antony Jenkins: Of course the issue inside the ring- Bob Diamond: We will do that. I will give you a fence is that you are basically trapping parts of the headline now. We work very closely with the people capital of the organisation, and so you minimise the from the Government in Brussels to keep them abreast benefits of the universal banking model, which has of those types of issues as well through public policy. traditionally resulted in lower funding costs for Broadly speaking, the two big initiatives are the universal banks. That has the potential to impact our ability to do business cost-effectively, and as Bob has implementation of Basel III—it is commonly referred said there is a cost to that. We are in the process of to as CRD 4—and all the issues around crisis continually reviewing an estimate of that cost. It is in management. I don’t know if you want to add to that, the range that he referenced of one to two. but that captures the majority of the—
Q570 Stewart Hosie: So it is the trapping of the Q575 John Mann: It would be useful to get the capital, in that sense, which offers the biggest detail of where you think there are problems, so that structural disadvantage, then? we are aware of them, and whether there is anything Antony Jenkins: Plus, the other associated issues of you can raise. subordination and the relationship of all of that to the Bob Diamond: I am happy to send to the Committee capital structure of the organisation, which is what some of the briefing materials we have given to the— wholesale investors will look at when they think about the pricing of debt specifically. Q576 John Mann: That would be very helpful. The second question: you have been quoted as using some Q571 Stewart Hosie: Finally on that point, fairly fruity language in recent times about some of Commissioner Barnier has just announced he wants to your people. I wondered, considering that you have set up an expert commission to study the mandatory consistently pointed out that the major problems that separation of investment banking from retail banking. we have had in recent years have not emanated from Have you had any input into that? Have you spoken your bank, what your honest assessment is about the to the European Commission? Do you have a view on quality of the regulators that we have in the UK? the way that that might go and how it might be Bob Diamond: That certainly puts me on the spot. different from what has been proposed by Vickers? The quality level has improved, I would say. The Bob Diamond: You know we have a view on that. worry I have—and this is something that I have said to our regulators as well—is that we are all trying to Q572 Stewart Hosie: Have you told Commissioner balance making the financial system safer and sounder Barnier what your view is? but also driving jobs and economic growth, and I still Bob Diamond: I have not talked to Commissioner worry that the regulators are in a position where the Barnier and I am not aware of any specific meetings focus is much more on safe and sound, which is more we have had, but we are very engaged through our office in Brussels and our public policy on that. capital, more capital, more capital, less risk, less risk, less risk, and the impact that has on the real economy. I have had these open discussions, certainly with Q573 Stewart Hosie: A final question on that. Should he decide he wants to do this, through the EU Hector and his team, so I am not saying anything that or through the FSB, would it make sense for the I have not said in those meetings, but I look for more proposals that he has to be mirrored by the ICB’s balance because you have heard me speak publicly proposals rather than having two different ring-fence on this. options coming from two different directions, which With the challenges that the United Kingdom faces in strikes me as a huge concern for banks that work terms of cutting the deficit, which is critical so that throughout Europe? we maintain that AAA credit rating, we don’t have a Bob Diamond: You know I am a big believer in funding issue as Spain or Italy has, and we have the keeping the regulatory framework as consistent ability to borrow on the financial markets. If we have among the G20, the large economies, as possible. The to cut public spending—I believe the Prime Minister Independent Commission ring-fence is a move away and the Chancellor are doing the right thing—then from that, in and of itself. This would be another. So, growth is going to have to come from the private by things I have said in the past, you know I would sector. That means the banks and the private sector be opposed to that. I think creating an unlevel playing are going to have to be investing, and confident and field is quite dangerous. certain and acting. So I do worry that we lean too far Chair: We have just heard similar evidence from on “cut your risk, increase your capital”, with too little Standard Chartered on that very point. recognition of the impact of that on the real economy. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Treasury Committee: Evidence Ev 95
14 December 2011 Bob Diamond and Antony Jenkins
Q577 Mr Love: Can I ask you how you reconcile the by this and so we have discussed with our theme of your BBC Today lecture about being a good remuneration committee how to deal with that issue, citizen, with the fact that last year you were paid a and that is an ongoing set of discussions. In terms of total remuneration that was 340-odd times the median pay for performance and in terms of recognition that income in this country? there should be no payment for failure, that is Bob Diamond: The focus on citizenship, Mr Love, is absolutely on our radar screens and, as Bob has very important and it is about doing a much better job mentioned, our focus now is to make sure that the of banks expressing to the communities in which we customers get their redress as quickly as possible. work, and the communities we serve, what we do to help create jobs and help create economic growth. As Q580 Mr Love: Perhaps we could ask that you a chief executive, the thing that is most important for submit something to us about how that discussion will me in that regard is to help bring back confidence be reflected in the remuneration of senior executives that there are good jobs available, that there are good in the organisation. opportunities available, that there are good Can I move on; there is a report widely in the press opportunities to invest, and that is what we are that the major banks are lobbying very hard in relation working very hard to do. It is also about giving back to regulation generally but to the ICB report in to the communities, and I shall ask Antony to say a particular. Has Barclays been lobbying Government few words. I find it remarkable the things that the on either of those interests? people at Barclays do in their own time to give back Bob Diamond: I appreciate you asking the question. to the communities in which they work, whether it is I resent in some ways the accusations of lobbying. spaces for sports or the things that we are doing with They are usually used in a negative way. I and my the schools in the UK and in Africa. entire team have been available for the Independent Antony Jenkins: We have definitely broadened out Commission, for the FSA, for anyone that has wanted our definition of citizenship because, as Bob has to talk to us, and we have been encouraged to give referred to, we do many very good things in the our views and I think it is important that we give our communities where we do business. But we views. We have not done any lobbying, and I will tell increasingly think of it as the way in which we do you why. Strong banks want strong regulation. There business across our customers, for our colleagues, for is nothing that would fit Barclays better than having a society at large, and being much more critical about strong regulatory environment seen as an advantage some of the decisions that we take along the way of in the United Kingdom. doing that. The banks who were not a burden on the taxpayer, HSBC, Standard Chartered, Barclays, all three of us Q578 Mr Love: We are limited in time so I will stop as Chief Executives said in the House of Lords, when you at that point. I want to ask both of you, in a sense, we were asked to testify there, very, very clearly that don’t you think that the public, your customers, are it was a big burden on us that banks did fail in the right to be cynical, when they are asked to and are United Kingdom. We recognise that the average making sacrifices at the present time and there does person on the street does not differentiate between not seem to be any recognition of that from the which bank was successful and which bank was bad. remuneration committee that you say does such a They just know that there was a banking crisis and good job. Mr Diamond? they blame us all. So, we recognise that the best thing Bob Diamond: We work very hard to balance being we can do is have a strong, tough regulatory responsible, and listening to the messages coming environment, and we want that. from our regulators and the messages coming from the public, with being competitive. We are trying to Q581 Mr Love: It has also been suggested that the balance that, and I think you will see that that is very, banks have argued that if they were to introduce this very much how we approach this period. We are very new regulation that will lead to a reduction in lending early in the process this year. to the real economy. Is that an issue that you have taken up? Q579 Mr Love: Let me ask Mr Jenkins, Barclays has Bob Diamond: I have discussed it and I will ask accepted full responsibility for the PPI debacle that Antony to speak on it too. Just a minute ago I was the Chairman asked about earlier on. If you were to talking about you do have to find a balance. We can be accountable, should somebody be held responsible take capital levels so high that banks can't lend and, within the organisation and, as a minimum, should obviously, you will get safe but you will not have that be reflected in the remuneration? Since we are an economy. suggesting that your remuneration should recognise Chair: Yes, we are coming on to exactly that good practice, surely it has to recognise bad practice? question, and I will bring in George Mudie. Antony Jenkins: Yes, as a point of principle I agree with you completely. We have talked about this with Q582 Mr Mudie: I want to follow up on John the board of Barclays and with the remuneration Mann’s question and your answer. I do not think there committee of Barclays. The PPI problem dates back is a mainstream political party in the country that does to the start of the last decade, 2000. The people who not realise the need to cut back on public expenditure. were leading the business at that time and who had It is the pace and the damage, and you see from the accountability for this have left the organisation. opening statement that to go faster sometimes means Having said that, we still recognise that our you are standing still. I wonder if you think that; give shareholders and customers have been disadvantaged that some thought, because I wonder if you share my cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 96 Treasury Committee: Evidence
14 December 2011 Bob Diamond and Antony Jenkins fears that the regulators are panicking a bit and going Q584 Mr Mudie: Mr Diamond, let me just ask you, too fast, in terms of expecting you to build up capital the latest fiscal financial stability report from the Bank when there is an obvious need in the economy for of England showed it was the smallest sector, 25% of investment. If they were a bit more aware of the wider lending going to small- and medium-sized enterprises. circumstances, the collateral damage this race to Unless we grow that we can't rebalance the economy. pressurise you to build up your capital is causing in Bob Diamond: Yes, I agree. terms of your lending, couldn’t we all relax a wee bit and get our priorities right? What would you say Q585 Mr Mudie: For obvious reasons, you put in to that? your speech that small businesses, small start-ups, a Bob Diamond: I would agree with you. fair number of them are prone to fail. The figures that Mr Mudie: Very good. That is the first time, I think. we have seen with Merlin, the figures that we have In fact, miracles happen, don’t they? seen for decades from the mainstream banks, do you Bob Diamond: Let’s mark the date and time. think it is time the British Government—not any British Government—started to look at a different Q583 Mr Mudie: I will. I want to take you on to conduit to get money in, along the German model, for your BBC lecture, which gladdened my heart but am example, but a different way of getting money in. For I too romantic as a Scot to be taken in by your fine obvious reasons, I sometimes sympathise with you, words? You made the point about the need for because it is not the most profitable exercise in your investment in medium-term business to grow the economy, and you spelled it out. You said you were enterprise, so are we just knocking our heads against committed, and your people were committed. The a brick wall saying you should do more of that, is it figures that were given to us by the Bank of England going against the grain and should we be looking to within the last month indicate that Project Merlin is have some form of different transmission method? not working. It may be working in the terms you Antony Jenkins: If I might add to that, concisely I negotiated, but it is not working. Less net lending is hope. Firstly, lending to small businesses is not a happening and the Governor was worried about it. I peripheral activity for us or something we are not am not saying it in terms of trying to attack you or interested in. It is hugely important to us. We have anything, but what can we believe about this business managers who work with customers in local commitment? I know the circumstances out there, the communities every day. We approve 85% of loans. We pressure on you to build up capital, but do you mean have opened over 100,000 new small business that there will be increased net lending to small and accounts this year. So firstly, it is very important to medium enterprises? That you are changing the Barclays as a line of business. culture of the bank to see that sector, not as a minority Secondly, we have a demand problem. If you look at sector but a larger sector in your borrowers? the SME segment, SMEs are building cash on their Bob Diamond: I will give you a couple of facts and balance sheets, they are paying down debt, they are then I am going to ask Antony to bring them to life. not taking on more debt, and they are cautious on This is a good question and I appreciate it, because employment, for all the reasons we know. SMEs are there are stories that are trying to create the news rational, logical; they open up the paper; they see instead of report the news. So let me give you the eurozone, fiscal retrenching and all of that. facts, and I would say that everyone on this The third point you made is an important one and that Committee, if you would like to come in and verify is, do we have the right mechanisms or conduits for these, sit with us and see how we approve loans and the right types of financing for these businesses? verify everything I say, please do, but here are the Oftentimes what these businesses need is not debt or facts. Net lending to businesses in this economy is revolving credit facilities; what they need is more down about 10% this year as reported by the Bank of equity, and getting that equity to small businesses is England. Our net lending is up 2.5%. There is a 12.5% something that we are looking at. difference between the average in the UK and We have just kicked off a piece of work inside Barclays, and that is because Antony and I and a lot Barclays, in partnership with the Work Foundation, of us have said to ourselves that this is critically to look at how we as an organisation are supporting important. We made a commitment to the Prime innovation, and we are doing an audit right now to Minister and the Chancellor but we said another thing, look at that and to see whether there are ways that we this is a great business. This is Barclays. What we can act differently to tackle this very important do is we support business in the United Kingdom, in countries in Africa and in other places. We have question of, how do you get more equity and different clinics where thousands of people have come. We types of products and structures into small and have set up specialty funds. medium enterprises? That is the German model and One of the things that is important for the Treasury we don’t have that in the UK and we need a solution Select Committee to understand is when the crisis hit to that. I don’t think the solution entirely rests with in 2007 those banks that were headquartered outside the Government. We need private-sector initiatives the UK pretty much pulled their lending out of the and we are committed to looking at that and reporting market, and the burden fell to the UK-based on that. institutions, and we do believe in citizenship, we do Chair: That is an interesting reply. believe it is convincing our clients that we are Mr McFadden: I am going to ask you about the working in their best interests, and we have a big speech as well. spread between— Bob Diamond: I worked very long on that. cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Treasury Committee: Evidence Ev 97
14 December 2011 Bob Diamond and Antony Jenkins
Q586 Mr McFadden: It was reported, almost as an that using ATMs is important to customers who are act of contrition, you used language like being a good marginalised because— citizen, focusing on jobs and growth, rebuilding trust. Mr McFadden: We will come on to ATMs— People would say “Amen” to all of that. I just want to Antony Jenkins: Maybe I can head that one off at the ask you very honestly—you know my old boss Peter pass. The issue is, do I go and use an ATM where I Mandelson described you as “The unacceptable face have to pay a charge down the road or do I get on a of capitalism”, and this is a very different tone—is it bus and go to a bank where I can use an ATM? We fair to read this as a change of mind on your part, in heard loud and clear, “You’ve got to give us access to terms of a previous tone of defiance about questions all the channels”. So we are not going to impose about reward and so on? charges for using non-Barclays ATMs. That came loud Bob Diamond: I have been asked that question before. and clear through the research. In terms of Peter Mandelson, that was a rather The other thing that people said to us was, “We want political statement at the time. He and I have since to feel in control”, so what we have done is we have met, and he has come in and spent many hours with taken away the charge that we made for texting people us to learn more about what we do in our corporate their balances and we are giving that to people free. and investment banking business to help customers So, we are giving them free texts with a £15 buffer and clients. So I think he would see a lot of value on the account, and only then if they go overdrawn or added. The part of what he said that bothered me the if that— most was he said all we do is shuffle papers, and we clearly have a strong value-add to our customers and Q588 Mr McFadden: More than £15? clients. Antony Jenkins: More than £15, then the charges kick Mr McFadden: What I am trying to explore is have in. But when we gave a series of choices and product you changed your mind about— features not only to customers but to consumer Bob Diamond: I don’t think I have changed my mind, groups, they said that this was the right way forward, but I think I am more sensitive and I have learned a and the reason why I am so passionate about this is lot in the last three years. As I said in the speech, it because we believe in this as something that we have shook me when people did not believe that banks to support. We are very committed to this product and could be good citizens, not only were they not good to making it work. For example, we are the only citizens but that they couldn’t be, and so we spent a organisation—one of two actually—that provide this to undischarged bankrupts, people who are trying to lot of time on it. It is not a change as much as it is an rehabilitate their finances, and as I mentioned before evolution, but I do think it is important that we all we will not be imposing ATM charges on customers. learn from the environment that we are operating in. Q589 Mr McFadden: Just to clarify, you can Q587 Mr McFadden: Let me ask you about a couple guarantee that—unlike Lloyds and RBS who have of examples then in terms of the bank’s policies. You been before us recently—that you will not plan to have recently made a change on overdraft charges on impose charges on the basic, but that you will basic bank accounts, which could see people being guarantee that there will not be charges on basic bank charged not £8 a day but £24 a day if they go into account holders using non-Barclays ATMs? unauthorised debt with you. That is more in some Antony Jenkins: Correct. ways than the payday lending companies that have Chair: One last very quick question. been criticised a lot in the media recently. These are people on the very margins of financial stability. Q590 Mr McFadden: Therefore are you saying this Surely, you agree we want them banking with a £24 per day charge is the price that other customers reputable High Street bank, like Barclays or one of have to pay for that guarantee? the other High Street banks. How is it being a good Antony Jenkins: Firstly, to characterise it as a £24-a- citizen to take customers of yours, constituents of day charge is incorrect. It is a maximum of £24 a day, ours, on the very margins of financial stability and hit assuming you have three unpaid items; and secondly, them with a charge of £24 a day for what might be we are saying we have changed the product quite small amounts of debt? configuration slightly to better meet our customers’ Antony Jenkins: I am very pleased that you have needs, because customers told us what they wanted raised this because I view our activities in this space was to get a text that says, “You’ve got £100 in your as a good example of citizenship. We are the biggest account, you’ve got £50 in your account, you’ve got provider of basic bank accounts in the United £25 in your account”, because that is what gives them Kingdom. We are generally recognised as the most the sense of control. We are told by customers and inclusive bank in the UK of the big banks. I was in consumer groups that this is by far the best product in Tower Hamlets recently with one of the third sector the UK and we are committed to continuing to make organisations talking about this very issue. it the best product in the UK, and we will periodically From time to time we do change product features. On review all of the product feature functionality, the basic bank account we did a lot of research with including the one you have referenced, to make sure our customers and with consumer groups on this that it stays the best product in the UK. product and what came back to us were two things. One was information and the second was access. Q591 John Thurso: I want to go back to discussing Access was about, “I want to be able to go into a SME finance, and particularly the area of competition, branch. I want to be able to use any ATM”. We know but first can I have a quick question on compensation? cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Ev 98 Treasury Committee: Evidence
14 December 2011 Bob Diamond and Antony Jenkins
I have recently read research done in America that winning business from major companies need said that in 1991 or 1992 the average top executive in working capital, the primary requirement of an the big banks in America was paid around $2 million, overdraft, and they are having their overdrafts or thereabouts, and it is now up to about $20 million compressed by their current lenders, who find it and that exactly correlates to return on earnings, impossible to get out and find any other competitor which is the measure of success that is used, so it is who will lend to them. It would appear that there is no surprise. no competition in some parts of the country—that all Bob Diamond: Return on equity. of the providers have taken the same decision on the same matrices, and so companies, which can and Q592 John Thurso: Sorry, return on equity, should be expanding and have new business, are not absolutely. Thank you. The thesis that was put being financed. That goes to George’s question about forward was this skews earnings and that if it was the failure of some of the Merlin participants, though measured against return on assets their compensation clearly not Barclays. What can we do to put would have gone up to approximately $3.5 million. competition into the High Street for SMEs? Do you believe that the measures that have been used Antony Jenkins: Part of this is what Bob referred to. for compensation across the banking industry If you go back to 2006, 2007, not only were the worldwide are skewed in favour of the executive and domestic banks having more capacity because they against the interests of shareholders, because of the had to carry less capital and had more leverage, but measures that are used to judge success? also there were many foreign banks participating in Bob Diamond: It is complicated, but I can help give this market, which created capacity and of course some views in that regard. I do not recognise or downward. support the data. I think it has been presented in a way John Thurso: I know that one, absolutely right. that fits the story, but the point is return on equity Antony Jenkins: So, part of this is a consequence of versus return on assets, and I understand what you the issues that we have discussed here, in terms of mean. regulation and the impact of that. In the part of the If I start with return on equity, we have done an awful country that you are referring to, which I must admit lot of research, as you can imagine. Since our bank is I don’t know and we don’t have a presence, I can valued below our book value we are concerned about understand that that problem would be exacerbated— bank valuations, and for our strategy day we did an awful lot of work on this. The financial measure that Q594 John Thurso: Let me put it to you that 80% is most correlated with bank valuations is return on of the bank presence in my part of the world are equity. That is why I would have liked to have had a nationalised or part-nationalised banks who are, it is longer discussion with the Chairman about the report alleged, extremely short of capital, and therefore they from ABI, because the ABI themselves know that the cannot lend because they have to hang on to their single most important financial metric—if you could capital. You are a strong bank with more capital and pick only one, and no one every wants to pick one— you can lend. Is that not part of the problem? that is most consistent with high valuations of banks Bob Diamond: It sounds like we should get some is high return on equity. It is very important to our coverage people up there. shareholders. Antony Jenkins: Yes. On the other hand, we recognise that there has to be John Thurso: I am trying to persuade you to open a a balance in these things and so all of our long-term branch in Thurso and Wick or Tay or Inverness. plans we have evolved over the last four or five years Chair: Also, Chichester at the same time. are now consistent whether it is in retail banking or corporate investment banking, so that their major Q595 John Thurso: It is quite true there are an awful financial measure—we don’t use only one—is a return lot of small businesses out there who are having their on risk-weighted assets. We agree that there should credit reduced or not supplied when they have good be a blend in compensation and we are more heavily businesses and I am failing to understand why this is. weighted now to return on risk-weighted assets. Chair: We are quite pressed for time, so if you could I would just add in that the risk weight on the assets be concise. is important as well. It should not be return on assets Antony Jenkins: So very shortly, obviously there are un-risk-weighted. It should be a risk-weighted pockets of the country where we don’t do business measure. But there is some food for thought. and we periodically review that, we will take a look at that. But again, Bob’s point is we have increased Q593 John Thurso: Thank you. I suspect it is our lending and we have increased it because we have something we will come back to in due course. Can I booked new customers, we have gained customers turn to SME financing and whoever thinks is best go from the banks that are pulling out of the business. for it. Based on my experience in my part of the world, which is at the far north, which means there is Q596 Andrea Leadsom: Just coming on to the bit of no Barclays—there isn’t a Barclays' branch—I think the ICB report that deals with competition, do you you have an operation just starting in Inverness, but think that it is a good proposal for this Payments you don’t register in anything that I deal with. I have Council group that is going to help switching through about 10 cases, and I am involved with a small fund to its conclusion? through the Nuclear Decommissioning Agency that is Antony Jenkins: I do think it is a good proposal and, lending money to companies, where the banks are not, as we have discussed in the past, some of the on purpose to help them. But businesses that are alternatives are very expensive to deliver and have the cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG06 Source: /MILES/PKU/INPUT/017688/017688_o006_db_HC 1534 - vi - SC and Barclays - CORRECTED.xml
Treasury Committee: Evidence Ev 99
14 December 2011 Bob Diamond and Antony Jenkins consequence of potentially derailing significant solution for the customer, and I will tell you why. innovation in financial services for several years. The Firstly, if we have a seven-working-day window for industry solution, which the ICB endorses in their transferring the account I think that is analogous to report, is a very good step forward. It is complex to moving your mobile phone number, speaking as deliver operationally because you have not just the someone who has done it recently, but importantly I banks but also the direct-debiters that all have to be also think if we go down the route of true account brought together, but it is a good plan. There are good number portability the cost is going to be enormous. milestones along the way that will hold everybody The £2 billion number feels low to me. But equally, accountable, and it is deliverable in the timeframe that more importantly, it is going to tie up the industry has been laid out. So, I do think it will be helpful, in and all of our technology development resources for terms of giving consumers certainty around the ability several years to deliver that. It is not something that to migrate their accounts. is going to be easy to be done in parallel with the ICB recommendations at all, and I worry that that is going Q597 Andrea Leadsom: So, you are fully committed to suck out innovation from the industry and doing to it? things for customers that really matter, like improving Antony Jenkins: Absolutely. To be perfectly honest how they make payments and bringing new products with you, we were one of the organisations that were and services to the market. pushing this very hard because we thought it was the right solution to the problem and we have been Q600 Andrea Leadsom: Just to press back slightly, driving this hard in all the industry bodies. what the Payments Council is proposing is not account portability. You will have to change your Q598 Andrea Leadsom: Mr Diamond, can I just ask account number. You will have to move all your you, because I know we have done this before, would standing orders, whereas account portability is just you agree that there is a case for full account that, you take your number with you. So, if I logged portability purely from the perspective of taking away on to iTunes, I don’t have to change my bank account the stickiness of accounts, because there is still number. I think that is a key point because that is residual reluctance on the part of consumers to change obviously a major reason for stickiness. Secondly, the bank accounts? Would you agree that account fact that if you created full account portability, would portability would change that reluctance? you accept it would make it easier for new entrants? Bob Diamond: Are you happy for— Then just a third point is, it does not have to be the Andrea Leadsom: I am asking you because banks tied up doing this technology; for example, it obviously to achieve full account portability it would could be a third party provider, almost through PFIs. require going far beyond what the ICB have proposed. Antony Jenkins: To work backwards from that, it Bob Diamond: Andrea, we believe that the easier it can't be a third-party provider because we would have is for customers to switch banks the better it is going to change all of our systems to accommodate to be for Barclays, simply stated. What we are trying whatever we are connecting into, so that is that point. to evaluate is, what is the cost benefit of getting In terms of consumers, we know that consumers run them there? multiple bank accounts and often they do it on a try- before-you-buy type of basis, so the fact that there is Q599 Andrea Leadsom: We talked very loosely, and not full account number portability I don’t think is a certainly with VocaLink previously, about a cost of real issue for consumers. We can increase more around £2 billion versus around £600 million for a lubrication into the system through this proposal. It is payment service that ensures your payments go a very good proposal for consumers and, as Bob says, through and your standing orders get transferred and we like it because we think we will benefit from it so on, versus a system that you could potentially at Barclays. introduce at the same time as the retail ring-fence that Chair: We are very grateful to you for giving could enable people, rather like mobile phones, to be evidence today. You challenged the data at one point able to switch bank accounts today and again on John Thurso’s question earlier, saying you did not tomorrow and again the next day. From a purely recognise the data with respect to ROE and ROA. consumer point of view, would you agree that that This is the return on equity and the return on assets. would enable new entrants to come to the market very This was derived from Andy Haldane’s speech. It easily, to simply get their licence and plug and play, would be extremely valuable to have Barclays’ they don’t have to go to another bank to act as agency- response to that. I think the whole Committee would clearer and so on? like to see that. Antony Jenkins: No, I don’t think that we agree that Thank you very much for coming to give evidence. It the proposed solution is going to be a superior has been extremely helpful for our inquiry. cobber Pack: U PL: COE1 [SE] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
Ev 100 Treasury Committee: Evidence
Wednesday 11 January 2012
Members present: Mr Andrew Tyrie (Chair)
Michael Fallon Pat McFadden Mark Garnier Mr George Mudie Stewart Hosie Jesse Norman Andrea Leadsom Teresa Pearce Mr Andy Love Mr David Ruffley John Mann John Thurso ______
Examination of Witnesses
Witnesses: Rt Hon George Osborne MP, Chancellor of the Exchequer, and Tom Scholar, Second Permanent Secretary, HM Treasury, gave evidence.
Q601 Chair: Chancellor, thank you very much for Q603 Chair: I am going to have one last go. It may coming to see us this afternoon. We had originally not be one last go, there may be more to come, but I intended to have a hearing concentrating entirely on just want to be clear. I realise that you don’t want to the Vickers report, but given the events that have breach a precedent that might cause problems taken place in Europe since you were last here the subsequently for your colleagues, Chancellor. On the Committee think there is merit in taking a look at that other hand— issue as well. We intend to begin with that and then George Osborne: For my successors. move on to the ICB, as there is some overlap as I am Chair: It is very good of you to think so kindly of sure you are aware. your successors as well, but I do think it is reasonable Can I begin by asking you about the explanatory note for us to know—that is the British Parliament to that has surfaced on the web, which purports to be know—whether there is anything in this document part of the UK’s negotiating position? First of all, that is not an exact representation of the could you tell us whether this is a genuine document? Government’s position. George Osborne: First of all, Happy New Year, and George Osborne: Hopefully, we don’t get too hung second, I should introduce Tom Scholar who is the up on precedent and the like. Second Permanent Secretary in the Treasury and has Chair: I think knowing what it is, we can start a particular responsibility for financial services issues. asking questions— I think there is a standard practice—or so I have been George Osborne: The point I would like to make is told, because I have not been asked this question that there were several weeks of discussions with before in my job for the last 18 months—that various member states and the European Commission Ministers do not confirm the authenticity of about that Council. Various pieces of paper were documents or, indeed, publish documents that are used circulated, both from us and from other member in international negotiations. So I think I should states. adhere to that long established precedent. However, I Chair: So this might have been one? think you can take it from this explanatory note that I George Osborne: am pretty familiar with the kinds of things in it. This might have been one. Chair: I think that is very helpful. Okay, but on the subject— Q602 Chair: I think it would be helpful to know. Since this has done the rounds everywhere and is George Osborne: What I am saying is I don’t think being discussed among European Parliamentarians, you should take this as the only document or for example, as if it is a genuine note, and they appear necessarily the final position. This might well have to have been told that it is by other countries’ been one. negotiating teams, it would be helpful if we could have confirmation that this is an accurate document— Q604 Chair: On the supposition that it might have this is a genuine document. been one, did it come from No. 10, the Treasury or George Osborne: I think what I can say is that the the Foreign Office? issues discussed here, the issues around the voting George Osborne: It was across Government an agreed procedure for handing powers to European advisory negotiating strategy. Obviously, when it comes to agencies; the issues around the voting powers on European Councils, the Treasury and the Foreign financial levies; the freedom that member states have Office are deeply engaged with No. 10 and, indeed, it to erect their own financial stability regimes, all of is a coalition with the Deputy Prime Minister’s office these things are issues that we have been concerned in the kind of work that we commission. As I say, about, including in public, that we have sought looking at this document I genuinely can’t tell you the assurances on and, as I say, I don’t propose to publish exact authorship of it, but— all the documents that were used in international negotiations in the run up to the European Council, Q605 Chair: Okay. How long did other countries’ but I think you can take it from this document that negotiating teams have to examine these issues, the these were the sorts of issues we were interested in. exact issues spelt out here, the detail? cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
Treasury Committee: Evidence Ev 101
11 January 2012 Rt Hon George Osborne MP and Tom Scholar
George Osborne: I will tell you a number of things. Q610 Chair: You will understand that, bearing in First of all, all of the things that are mentioned here mind this is in the hands of Parliamentarians all over are concerns that the UK has that are familiar to Europe with them being told by their opposite fellow member states. For example, one of them we numbers that this is the British negotiating position, I are currently engaged in a very public legal action am asking the Chancellor of the Exchequer whether it with the European Central Bank about, so there is no is the British negotiating position, whether you guys secret about that. As I say, I think it is not appropriate wrote it and, to be frank, you are hedging your bets. for me— George Osborne: I am saying, I wouldn’t say that this—I don’t think you can just take one piece of Q606 Chair: Can I just be clear, Chancellor? I am paper in isolation. I think— not trying to elicit secrets. I am trying to establish whether—I might do in a subsequent question, but at Q611 Chair: That is fine. I think that is very the moment what I am trying to do is establish reasonable, that this is only a small part of it. Would whether these are in fact, in substance, the views of you be prepared to give us, on an exceptional basis, the Government and, if so, then I would like some the rest of this document so that we can consider it in a more balanced fashion? further explanation about what they mean, but if they George Osborne: I will reflect on the long are not the views of the Government then I will ask established precedent. different questions. George Osborne: These reflect issues that we have Q612 Chair: And come back to us with a view on concerns about when it comes to European regulation that. of financial services, not just on our own behalf but George Osborne: And come back to you, of course. on behalf of all member states. We have discussed these issues on a number of occasions, often in public, Q613 Chair: in the ECOFIN Council in front of all the other Can I ask a question about the substance? If you look at what this document actually Finance Ministers. In the build-up to the European says, it is talking about the safeguards, a list of Council there was a lot of UK diplomatic activity. The safeguards that the UK is seeking. Can you explain Prime Minister travelled to Berlin. He travelled to exactly what the risk was to the UK that you were Paris. I spoke to a number of Finance Ministers, the seeking to mitigate by obtaining those safeguards? Deputy Prime Minister spoke to a very large number George Osborne: Our concern and interest has been of Prime Ministers, and we expressed our concern that this. We are in favour of a single market in financial if there was going to be a treaty of 27 involving services. I personally think that would be a very good greater economic fiscal integration among the thing for the United Kingdom because the United eurozone that there needed to be certain safeguards. Kingdom is a major exporter to the rest of the EU of Not least because in discussions about making a single financial services, and we want to be able to do that currency work there is often talk about more more efficiently and reach more markets. But we Community regulation of financial services. obviously have a concern that the approach is not overly regulatory in creating that single market, and Q607 Chair: I just want to clarify this point on we also have a concern that, as the location, the process and ask the same question again. This overwhelming or the predominant location of document is in the hands of other countries’ wholesale financial services in Europe, that European negotiating teams, therefore, it can only recently have financial regulation takes into account some of the emanated from the Government. The question that I specific competitive pressures facing wholesale asked you was when did they get it? When did the financial services industries anywhere in the world. So Government issue it to our negotiating team? we want to make sure the legislation is right. We want George Osborne: I honestly don’t know the answer to to make sure that countries with large, wholesale the specific question that if this document is a financial services are able to make sure that the Government document—and let’s assume for the sake legislation is appropriate. of this argument that it is—when this particular piece We also, as it happens—and this was something that of paper was circulated because there were quite a was lost a bit in translation in other member states’ large number of pieces of papers. accounts of what happened—as a home of very large financial services relative to our GDP, want to enact certain things domestically that other countries, Q608 Chair: Could you let the Committee know because they are much smaller financial centres, don’t that? necessarily want to do. George Osborne: I will let the Committee know Chair: We are going to come on to that. whether I am able to let the Committee know that. George Osborne: That, of course, this is what Vickers is all about. So it is not, as has been presented, just Q609 Chair: This is very hard work, Chancellor, about—we were not seeking a UK opt-out from this afternoon. financial services legislation. We were not seeking George Osborne: All international negotiations are, unanimity for the UK in voting on all financial Chairman. services legislation. We want a single market. In some Chair: Yes. This, though, is a domestic negotiation cases we actually want to impose greater regulation we are engaged in here. on financial services than the European Union is George Osborne: Well, I don’t want to— proposing, and we are going to come on and talk cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
Ev 102 Treasury Committee: Evidence
11 January 2012 Rt Hon George Osborne MP and Tom Scholar about Vickers. So I think the way it has been self–evidently, a treaty being negotiated for presented that we were somehow looking for an incorporation in the European Union treaties. opt–out for the City is not accurate. Q618 Mr McFadden: Again, on substance, you were Q614 Mr McFadden: Chancellor, you talked about saying you were in favour of a single market in cross-governmental strategy in the run-up to the financial services, and yet the Government’s position summit. Part of that is the UK’s permanent has sought to move away from QMV to unanimity on representation office in Brussels, which in my some single market financial services matters. Given experience is very good, well plugged in, extremely that we haven’t lost a significant vote on financial well informed and good at building alliances. Can you services and that QMV helps to advance single market tell us how involved were UKRep in the formulation measures, why did we want to move away from that of and lobbying for the UK Government’s position? and introduce more national vetoes in this area? George Osborne: The development of the UK’s George Osborne: If you take the first item on this position involved UKRep. It involved the Foreign note, the transfer of powers from national level to EU Office. UKRep of course is part of the Foreign Office, agencies, the negotiation about the creation of the but certainly— supervisory agencies was begun by my predecessor, Alistair Darling, and a great deal of that work had Q615 Mr McFadden: From how far out? been done by the time I became Chancellor and the George Osborne: There were discussions about the UK Government’s position had been set out. Now, of European Council for many weeks in the build-up to course, I reserve the right to change that position and it. It is important to remember the actual proposal, I wouldn’t claim that the deal we did would be which the French and the Germans tabled, was only identical to the deal that my predecessor would have tabled on the Wednesday before the Council, of the done, but I had inherited a commitment that the same week as the Council, so it was quite a fast previous Government had secured in 2009 that there moving situation and the nature of that proposal would not be a transfer of a large number of powers changed over the weeks, building up to the point to these new supervisory agencies. There would be where they finally put forward their suggestion. But one or two things that they would look at the in the weeks building up to it there were many regulation of, like credit rating agencies, and that was meetings, many meetings within Government. There a solid commitment secured in the ECOFIN Council was a lot of paper, there was a paper flow, certainly before I became Chancellor. from where I could see it in when the Treasury, There has been a suggestion from a number of people UKRep was involved in that, as you would expect, in the Commission and elsewhere, that the supervisory because they were there on the ground. agencies should take on responsibility for regulating more areas of financial services. That we feel is Q616 Mr McFadden: So you would say they were contrary to the political agreement reached by the fully informed and involved throughout the process? previous British Government. So, in order to make George Osborne: I felt the machinery of Government sure that an important decision that is handing over a was working well, so I thought that all parts of the new area of supervision to a European supervisory Government were coming together to try and body—taking that decision should be one that the formulate a negotiating position for the Council, and whole Council is happy with. As it happens—and this you will have had experience at high levels of comes to the end of your question—I think in the Government of this, Mr McFadden. You will know directives that I have negotiated, whether on hedge that when it comes to European negotiations this funds or short selling, and there is currently a involves the centre of Government, the Foreign negotiation on a directive on derivatives, I think we Office, the Treasury, the Prime Minister, the Cabinet are securing UK interests, directive by directive, with Office, and the European Secretariat of the Cabinet some hard negotiation, and what we have been Office, the Deputy Prime Minister’s office, UKRep, seeking, if there was going to be an EU treaty change and so on. Lots of people are involved in this but I in the area of economic and fiscal policy, is some felt it was a process that did quite well. things that we think would be good additional things to have, particularly if there is going to be an EU Q617 Mr McFadden: On the substance the Deputy treaty in this area. But that does not mean we are Prime Minister has said, and I quote, “‘Veto’ suggests not confident that we can negotiate well in Britain’s something was stopped. Nothing was stopped”. Do interests going forward. you agree with the Deputy Prime Minister? George Osborne: I don’t want to get into a very Q619 Mr McFadden: Just to understand this, adversarial discussion about all of this. What I would leaving aside what might come in the future, on what say is that—certainly, as I understood it—the position is there at the moment, is it the UK Government’s going into the Council was understood by everyone position that some things, which are there at the and agreed by everyone within Government, and moment, which are decided by QMV should in future when it comes to what happened in the Council—I be decided by unanimity in the financial services area? don’t know whether you would describe it as a veto It is quite important for us to understand this. Is it or not—there is not a treaty at 27 because Britain did part of the UK Government’s negotiating position that not want a treaty at 27. There is clearly a treaty at that happens? something less than 27; 26, 25, 24. Ultimately we George Osborne: One of the things we were don’t know at this stage. But there is not, requesting, if there was going to be a European Union cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
Treasury Committee: Evidence Ev 103
11 January 2012 Rt Hon George Osborne MP and Tom Scholar treaty on economic and fiscal integration—and of this struck us as a good moment to seek a broader course there is not going to be—that there were safeguard that said these things couldn’t be transferred additional safeguards for— without every member state’s consent. Obviously, Mr McFadden: What about now? there is not going to be a treaty so we are now going George Osborne: Well, of course there is not going to carry on with the strategy we have been pursuing to be an EU treaty. Changing the voting mechanism of a directive by directive negotiation. for the transfer of powers would require an EU treaty and there is not going to be one. Q623 Chair: In the view of the UK Government, would that safeguard have constituted a restriction of Q620 Chair: Perhaps the question is whether part of existing QMV competencies? the negotiating position of the UK Government was George Osborne: We think it would have been an to claw back some aspects of policy currently decided affirmation in the treaty of the political agreement under QMV and bring them back in the ambit of negotiated by the last Government. unanimity. George Osborne: We were seeking, if there was going Q624 Chair: In your view, was the agreement to be a treaty at the level of 27—a European Union negotiated by the last Government one that clawed treaty—as part of that European Union treaty back any aspect under QMV? safeguards to protect, as we saw it, the proper George Osborne: I don’t think it’s a question of regulation of the financial services and if we had clawing back. Obviously I didn’t— achieved those safeguards we could have signed the Chair: You have defended it— treaty. Now there is not going to be a treaty of 27. George Osborne: If you want to know exactly what happened at the time of the ECOFIN Council you Q621 Chair: That hasn’t answered Pat’s question. would have to get my predecessor, but my Pat’s question is: there is an existing corpus of single understanding of it is that there was an agreement that market regulation covered by QMV. Was it part of we could create these supervisory agencies but the the Government’s negotiating position—as is implied, areas that they would be regulating would be limited incidentally, by item 1 on this list—that some aspects to the agreement at the time—2009. I don’t think there that are apparently covered by QMV of single market is any secret that some people in Europe would like legislation pertaining to financial services should to see more areas handed over. This often comes up henceforth be dealt with by unanimity? when we discuss individual directives. What a treaty George Osborne: We were seeking safeguards to change would have achieved would have been that we ensure that areas of financial regulation could not be wouldn’t have to negotiate it directive by directive. transferred to European supervisory agencies without But we are not having a treaty change so we will the consent of all member states, but to achieve that carrying on negotiating directive by directive, but requires a treaty change. Of course, the alternative is certainly I am confident we can achieve what is in to argue directive by directive. That is where we are Britain’s interests in these negotiations on the now, of course, and have been. But if there is going individual directives, and I would say that I think the to be a treaty—you can only do these things with a evidence of the last 18 months is that we have been treaty. Now, at the moment no one to my knowledge able to achieve that. is proposing a new EU treaty, and I am certainly not going to set out here— Q625 Mr Love: The consequence of the Government Chair: No, I am not asking you to set it out. strategy in this area, according to the business George Osborne:—what the Government’s community and, indeed, the City of London, is dismay negotiating strategy would be if someone did propose that we may have lost influence at a European level a new treaty. and since financial regulatory activism is on the rise Chair: We are asking you whether some aspects of in Europe that signals difficult negotiations in the current policy—it was the Government’s intention to future. How do you respond to that? claw back from QMV to unanimity. George Osborne: Well, I don’t accept that. I don’t George Osborne: We were seeking safeguards if there accept that characterisation of City or business was going to be a treaty. If there wasn’t going to be a opinion. I think there has been plenty of publicly treaty obviously we can’t get safeguards because they expressed City and business opinion that has require treaty change. welcomed what the Prime Minister did. I think the Prime Minister has made it very clear, as have other Q622 Chair: Were you safeguarding putative future members of the Government, that it was not the first legislation from possible QMV treatment only or were outcome we wanted from the December Council. We you, in addition, seeking safeguards for existing would have preferred a treaty at 27 with the legislation currently treated under QMV? safeguards that Britain were seeking. We didn’t get George Osborne: As I say, directive by directive, we those safeguards. There is no treaty at 27. But we are have been making an argument that the British confident that we can negotiate Britain’s interests, and, Government’s consent to the creation of these indeed, we would argue the broader interests of the European supervisory agencies was based on the European economy, directive by directive on premise that only a very limited number of areas financial services. would be supervised. Directive by directive there has If you take the negotiations on the hedge fund been a proposal to bring areas into the area of directive, there is an industry that is very largely supervision. If there was going to be a treaty change located in the UK when it comes to—if you are cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
Ev 104 Treasury Committee: Evidence
11 January 2012 Rt Hon George Osborne MP and Tom Scholar talking about the European Union. I think the directive George Osborne: Can I, first of all, just reject this we have been able to get into good shape, through notion that we are not engaging in Europe. This week tough negotiation. There was no vote on it, so alone I have met the European Commissioner, one of unanimous consent to that directive. As people know, Europe’s Foreign Ministers and one of Europe’s we are currently involved in important negotiations on Finance Ministers. That is in the space of two or three the directive on derivatives. A huge proportion of this days. So that is just this week. On— industry takes place in the UK, when you talk about the European Union, and I am confident we can get a Q628 Mr Love: But you would accept that the good outcome not just for the UK but for the whole interpretation of many European countries of the European economy. Government’s strategy has been negative? Whether that is a misperception or not we have some ground Q626 Mr Love: You mentioned one of the to make up. consequences of Government strategy is we are back George Osborne: I think out there among many to directive by directive. Later on in this session you member states—certainly people I have spoken to will be made aware—I am sure you are already since 9 December—there is actually quite a lot of aware—for example, that Mr Barnier has set up of an sympathy that Britain was seeking some reasonable expert commission to look at the separation of safeguards if there was going to be a treaty at 27. For investment from retail banking. There is this proposal all sorts of reasons that didn’t happen on the night and that euro denominated derivatives, the clearing house, many people would have preferred the outcome of should be based in a euro area country. You will know that summit, including the British Government, to about maximum harmonisation. These are all possible have been a treaty at 27 with the safeguards that we negative consequences that will be made more were seeking. difficult because of the way we have handled the issue If you want me to come on to the IMF, look, I am up to now. Aren’t you concerned that our voice at a absolutely clear and I have said this publicly, I have European level will be muted because of what has said it in Parliament throughout the backend of last happened? year, that Britain is prepared to consider additional George Osborne: No, I don’t accept that at all. First resources for the IMF. I started saying that last of all—and we may well come on to talk about this— summer. We are founding members of the IMF; we I think it is a good thing that the European are part of the permanent—we have a single seat on Commission and the European Parliament are the board, and indeed it was British economist who interested in the Vickers report and what we have first came up with the idea of an IMF. So we are done. I think that shows intellectual thought absolutely enthusiastic supporters of a well funded leadership in Europe, and if other countries want to IMF, and we are prepared to make—as we have done follow our example all well and good. in the recent past—additional contributions to the IMF alongside other shareholders across the world. If there When it comes to the location policy, I think this is is a case to be made for additional IMF resources we something that is very significant, very concerning to should hear it from the IMF; if it is a good case then the UK. This is the requirement that certain businesses ourselves and other countries, like Japan, like have to be located in a eurozone country rather than a Australia and the like, will look at that, I am sure non–eurozone EU country, and that location policy we favourably, and be able to make a contribution. What think is fundamentally contradictory to the single we objected to was in a sense a unilateral decision by market. That is why we are taking the European the eurozone to make a contribution to the IMF, and Central Bank to court and that is obviously a step we the assumption—even though it was a eurozone didn’t take lightly. So we are very prepared to fight statement on the night, not one that Britain had signed hard for the interests—I would argue in this case—of up to—that Britain was going to be part of that. So the single market. We are prepared to fight hard for we want to have discussions with our G20 colleagues the interests of properly regulated financial services. I outside of Europe. Mexico now has the chair. There don’t think this is defending UK interests, defending is a meeting of the so–called deputies, the senior the City, this is defending Europe as a home of officials, in Mexico later this month. There is a internationally competitive wholesale financial meeting of Finance Ministers in Mexico next month, services. I would be happy to see Europe do more of and if there is a good case from the IMF for additional this business but I am also absolutely clear that contributions then of course Britain will listen very London should be the pre–eminent centre of it. carefully to their case and with our partners consider the case very seriously. Q627 Mr Love: The Deputy Prime Minister said, not long after the events that we are talking about, that Q629 Mr Love: We heard announced today that they Britain had to engage with Europe and be on the front have revised down third quarter growth in the euro foot rather than the back foot. One of the ways in level to 0.1%. I think there is a widespread which we could do that at this present time is to expectation that they will be inrecession probably engage with a request from the IMF for additional now. Things are becoming more difficult. funding. That has been rejected by the Government, Negotiations around about the politics of all of this although I notice that the Prime Minister said only the and overcoming that are likely to be extended. In other day that they were still considering that. What those circumstances, don’t you think it would be a is your current position in relation to IMF funding to signal, as much as anything else—and I accept that help in this matter? the rest of the world should make a contribution—if cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar you were to go into those G20 negotiations in a considering. But I absolutely want Britain to make positive frame of mind supporting Europe? That sure that it is a supporter of the IMF and make sure would go a long way to re–establish our euro that, if needed, the IMF has the resources required to credentials. do the job. George Osborne: To my knowledge, I was the first Finance Minister in the world to suggest additional Q633 Mr Love: Are you prepared to go back to IMF resources last September at the IMF annual Parliament to achieve that? meeting. So I am always willing to listen to a well George Osborne: My attitude is, first of all, I am very argued case from the IMF for additional resources. happy to at any point explain this to Parliament and However, and this was clear in the Cannes summit as talk to Parliament about it, as I have done I think well where this was the main issue for discussion and openly over the backend of last year. If I felt it was ultimately agreement was not reached in the Cannes right to offer something more than the current G20 summit, we want to do that with our other parliamentary limit provides for then, of course, by partners in the IMF of course. Britain acting alone is definition that would not be my decision it would be not going to achieve the kind of increase in resources Parliament’s decision. We are all Members of the IMF will be talking about in these circumstances. Parliament. You have to act alongside other shareholders, like Let’s hear what the IMF proposal is first; second, let China, like Japan, like Australia, and so forth. We us hear what the G20 response is going to be and we want to make sure that that money was going into the will be active participants in that discussion; and third, general resources of the IMF and we want to make if we actually need specific parliamentary approval for sure—as was clear at Cannes—that it is not a it then we will seek it. substitute for the eurozone also taking the action it needs to take to deal with stability in its own currency. Q634 Michael Fallon: Could we turn to the issue of maximum harmonisation, super–equivalence, and Q630 Mr Love: That does not suggest for a moment perhaps work our way back towards Vickers and the that you were acting in the way that would be ICB? The Governor told the Joint Committee on the interpreted at a European level as being a good Bill that he can, “think of no logical or economic European. We have influence with all of these reason why you would want to have maximum countries. I accept that politically it may be impossible harmonisation, other than a theology of convergence in America for very similar reasons to why it is for the sake of it”. Do you agree with the Governor difficult here, but it would be a signal, as much as there? anything else, if we were to go out and speak to the George Osborne: I agree with him that I don’t think Australians, the Canadians, the Chinese, the Japanese there should be maximum harmonisation. I think it is and say, “This would be a good thing and we want to important that individual countries are able to erect on make a contribution but we also want you to make top of minimum standards—and of course the Basel a contribution”. requirements are the internationally agreed minimum George Osborne: This is absolutely something that standards—we are able to construct a regime on top has been discussed for the last six months in of that that is appropriate to our national international meetings, both bilateral and multilateral. circumstances. Our banking system is 500% of our It has been discussed and people had hoped it would GDP, and that is different from some other member be a centre point to the Cannes summit but it didn’t states in the European Union, and I think it is turn out that way. So I don’t think there is any secret appropriate for us to therefore have a specific national it is being discussed. As I say, Britain is willing to regime to protect British taxpayers while at the same make a contribution if there is a well argued case put time being a home of globally competitive banks. forward by the IMF and other G20 countries agree We are not alone in this argument. The Swedish with us that it is a well argued case and want to make Finance Minister has been leading the charge on this; a contribution. the Spanish Government—at least the previous Spanish Government, there has been a change of Q631 Chair: Would our share of any contribution be Government—the previous Spanish Government has based on our quota share, that is 4.5% or whatever it also been very concerned about this. So both people is, or will the Government consider proposals that inside the euro and outside the euro have been could mean that we, with other European countries, concerned about this. The IMF have raised concerns. give a disproportionate share? The Financial Stability Board have raised concerns. In George Osborne: I think we would want to see what other words, quite a lot of people raised concerns. The other non–European G20 countries were doing, and I Commissioner to be fair to him, Commissioner would want to act in concert with them if the Barnier, has said that he thinks that the proposals he situation— is developing will allow something like a Vickers regime to operate and that is not going to be a Q632 Chair: You are not closing the door to problem. We have to see what the legislation looks something that requires more of European than like. We haven’t got a final text. We have to see what non–European contribution— the legislation looks like to make sure that those George Osborne: The most recent— assurances are correct. Chair:—compared to their quota share? George Osborne: I want to see, one, what the IMF Q635 Michael Fallon: In your response to the ICB request is; second, what the other G20 countries are report you said you are working with the Commission cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar to make sure we have sufficient flexibility to Q638 John Mann: Happy New Year to you, implement Vickers. Can you give us any update on Chancellor. that? What would happen if you can’t rid us of the George Osborne: I hope you received my Christmas maximum harmonisation provision, for example? card. George Osborne: I am confident we can achieve what John Mann: I did get your Christmas card. Thank we want to achieve, and there was a rather you very much. It still takes pride of place. encouraging quote from the European Commission, George Osborne: Good. I received yours as well. which I will pass on, saying specifically on Vickers Thank you. that they thought that the European legislation would John Mann: On the question of QMV and unanimity, enable us to do what Vickers had recommended. your body language looked rather uncomfortable when you were asked questions on that. Exactly how Q636 Michael Fallon: The Commissioner has also many Commission proposals are you dealing with at said, at the end of November, he is setting up his own the moment, both those that are with the European commission to look at whether separation could be Parliament and those that have been announced and mandatory right across Europe. If the Commissioner are at the pre–European Parliament stage but are ends up mandating full separation where does that available to you? How many different ones that leave the Vickers proposals? impact on the financial services sector in Britain? George Osborne: First of all, the Commission can’t George Osborne: I think about half a dozen. There is mandate anything, it would require the agreement of the derivatives directive; there is the capital the Council and if they were to propose something we requirements directive on banking; there is an didn’t think was in our interests or, indeed, the empirical insurance directive we are discussing at the interests of others then we would oppose it, and we moment; there is a proposal going forward on credit rating agencies, not so directly relevant to the City— would see what came out at the end of that process. we don’t have very large UK credit rating. I can think But I am actually rather encouraged. When we set up of about six or so. Vickers, and I don’t know whether you want to come on and talk about Vickers, one of the arguments used Q639 John Mann: See this is what concerns me, against us at the time was, “Oh we are doing all these Chancellor, that you are not on the ball when it comes things in Britain and no one else in the world is going to European legislation because, in fact, there are 18 to do it”, and I think it is rather encouraging that, currently. That is not the five that you have already actually, other people in Europe, including the adopted from Europe, Chancellor. There are another European Commission, are very interested in this, 18 currently on your desk, nine that are with the what I think is an excellent piece of work. European Parliament and nine that are coming, most of them in draft form already. So 18 different ones. Q637 Michael Fallon: Are you concerned about the Now, aside from the fact of whether your attention is long–term trend to super-equivalence and its effect on sufficiently engaged on what is coming from Brussels, competitiveness of UK financial services? of those in how many of them have you managed to George Osborne: What, within the UK? claw back at the summit powers that would give you Michael Fallon: Yes. a veto where there wasn’t one previously? George Osborne: It is very important that we get the George Osborne: As I say, there are about six that I balance right. I have called this the British dilemma. can think of that are before the European Council, Britain is a home of globally competitive financial either in draft or in what is called the trilogues, the services. In many league tables we come out as the discussion between the Council, the Parliament and pre–eminent centre of wholesale financial services in the Commission. In all of those, of course there is a the entire world and, indeed, in a recent survey we tough negotiation, as you would expect, but I am again came number one in the world as the place to confident we can secure Britain’s interests. When it do financial services. Of course, we have to stay comes to—as you put it—clawing back powers, what competitive, and what I sought to do is, where we are primarily talking about here—to come back to necessary, introduce domestic regulation—I am our earlier conversation—is the ceding of new proposing that with Vickers—that protects the UK responsibilities to the European supervisory agencies. taxpayer from the consequences of being a home of It is about getting the regulation right and making sure globally successful banks and the like, while at the that there is appropriate national discretion and, same time I hope doing it in a way that doesn’t make indeed, that there is a single market. When it comes us a less competitive place to do business. Vickers to derivatives, for example, one of the things we have affects 15% of the financial services activity that takes been absolutely keen on making sure is that the G20 place in the City of London. It affects primarily UK agreement on derivatives is implemented and that retail banking. Indeed, I think one of the good things there is a single market in derivatives. about Vickers is that he is not trying to be overly super-equivalent on investment banking regulation, Q640 John Mann: I will write to you reminding you because he recognises that is best done internationally. of the 12 that you weren’t aware of. I put some So I think you can get that balance right and you questions down to assist in ensuring that we are at the should only be super-equivalent where you think it is heart of those negotiations. I would like to move if I absolutely essential to our national and economic may on to Vickers, and whether you think that the interest. Vickers report, when implemented, would have had cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar any impact on the precise situation with Lehman back looking at Vickers that implementation of those Brothers or Northern Rock? proposals will mean finally that we have resolved the George Osborne: Yes, I think it would have done. British dilemma? Obviously, Lehman Brothers was an American bank. George Osborne: I think we will have gone a long I think with Northern Rock it is clear that with Vickers way to solving the dilemma of how we can be the it would almost certainly have been a ring-fenced home of globally successful universal banks, and at bank, given its scale, and it would have, therefore, the same time protecting the British taxpayer should been required to hold much higher, much more capital something happen to those banks. I would say there and much more bail-inable debt. It would have had are broader issues of Britain as a home of financial higher equity requirements, higher bail-inable debt. In services, not just banking, which other bits of other words, it would have been a much greater buffer legislation and things we are doing I think help to have been eaten through before the taxpayer would address, but specifically Vickers addresses this British have had to step in. So I think Northern Rock is dilemma. We want Britain to be a location of big, actually a classic example of where the Vickers global, universal banks that are successfully proposals would have helped. When people talk about competing around the world. They are a very the Vickers proposals, the first thing they reach for is important source of jobs and wealth for our country, the ring-fencing of retail from investment banking and but also as we saw obviously with RBS—arguably people say, “Northern Rock didn’t have an investment the largest universal bank in the world—when it goes banking arm”. But a very important and substantial wrong we have to have more tools to protect the part of the Vickers report is about additional capital British taxpayer. requirements, additional requirements for equity, additional requirements for bail-inable debt, and those Q644 Mr McFadden: You talk about re–balancing. things would have helped make sure that the taxpayer In your budgets you have talked about helping was not as exposed as it was when Northern Rock manufacturing and so on. Is it a policy aim of went bust. Government that financial services be a smaller proportion of GDP in the future than it has been in Q641 John Mann: We agree, Chancellor, that it is the past? essential that in a situation, such as Northern Rock, George Osborne: I would like to see that happen, but there needs to be additional protection from creditors. I would like to see it happen by growing the GDP, by You criticised Fred Goodwin’s knighthood. What is growing the cake not by reallocating the slice within the moral and ethical difference between Fred the cake, if that makes sense. In other words, yes, I Goodwin and Paul Ruddock? want financial services to grow but I also want George Osborne: I am not going to get into a manufacturing and other industries to grow and discussion of individuals, except to point out that Fred succeed, so it is not by doing down financial services, Goodwin was knighted by the previous Government it is by making sure that other industries get the for his services to the banking industry and, as I attention. I am sure in your previous job, Mr understand it—it was something that never came McFadden, you had direct experience of this, and it is across my desk—Paul Ruddock was knighted for his a truth that the banking industry has had a more direct services as Chairman of the V&A and other things he access to Government to address its concerns than has done for charity. perhaps other industries have had, and I just want to address that. I am always happy to address concerns Q642 John Mann: My final question. Vickers in that financial services have, but I also want to address essence—I think it is reasonable to summarise it—is the concerns that other industries have as well. regulating banks rather than bankers and their behaviour. Can you confirm that you will not be Q645 Mark Garnier: Chancellor, can I talk about intervening when RBS bosses get huge bonuses in the the costs of the ICB. There are a number of estimates near future? that go round. John Vickers talks about £4–7 billion George Osborne: I certainly expect to have many as the cost of implementing this. The Government conversations with the RBS management about the talks of it as £3.5–8 billion, but actually in the bonuses that they may or may not wish to pay. Of Goldman Sachs report they talk about £9.6 billion. course my hands are tied on bonus arrangements Add on all the other various bits of regulations coming agreed by the previous Government, and we have through, in terms of what is coming from Europe, and been reading about those recently, but when it comes you are actually looking at a cost of compliance of to the new bonus arrangements you can be assured something in the region of £20 billion a year. Do you that this Chancellor will be taking a keen interest. think this is good value for money? Chair: There will be other opportunities to come back George Osborne: Yes, I do think it is good value for to that subject. It is something that the Committee money because, of course, you haven’t given me a net may well want to take a closer look at shortly. figure there. You have given me the costs not the Pat McFadden has a further question on the ICB. benefits. The benefits are that Britain and the British taxpayer is better protected from the costs of financial Q643 Mr McFadden: Just coming back to the ICB, failure. The Goldman Sachs’ analysis, I know it is Chancellor. A couple of minutes ago you referred to larger than the British Government’s analysis but it is the British dilemma, the very size of a financial roughly in the same ballpark. Why we came up with services industry and the dangers that creates with the a different number from Goldman Sachs is because I taxpayer when it goes wrong. Do you feel standing think they did a top down analysis, whereas we went cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar and sought confidential information from each bank company. That was a very unenviable choice but it and did a bottom up analysis of the costs. Indeed, was a choice he faced that night. I want to make sure, some other market observers have actually come up whether it is me or my successors, they have more with estimates much closer to the one we had. Indeed, choices available to them. There are ways of resolving one market analyst had costs of £4.1 million for large but complex banks in a way that protects the reforms. But these are the costs to the banking taxpayer and protects vital banking services. If you industry, I stress, and quite a significant element of don’t have any other options to deal with a banking that cost—and I think John Vickers made this point crisis or a banking failure, then it is an explicit when he was here—is the removal of the implicit guarantee because no Chancellor of the Exchequer is taxpayer subsidy for banking. That is a good thing. going to shut down the cash machines across the We should all be welcoming that we are dealing with country the next day. an implicit subsidy, and where there are direct costs— and there are direct costs in IT systems, legal fees, Q647 Mark Garnier: That is a very fair comment. and the like, as well as the potential issues for the cost My last question. Douglas Flint, when he has come of funding. When there are those costs I think you before us, has talked about the fact that for HSBC need to put them alongside the benefits that Britain who have a deposit to advance ratio below 100% they gets from having a better regulated banking system feel very aggrieved by the fact that they will have to where British taxpayers are better protected. raise potentially $55 billion worth of these bail-inable bonds, which they would argue is unnecessary given Q646 Mark Garnier: Broadly speaking I agree with the fact that they run a very conservative loan book. all that, but you raise the implicit guarantee and I Their estimate is it is going to cost some $3.5 billion think it is quite an interesting point because the a year in interest rate spread alone between what they implicit guarantee has been estimated variously deem as unnecessary bail-inable bonds and where they between about £10 billion and £40 billion, depending would have to deposit that money, which would be in on which report you look at, but it is an implied UK gilts. The philosophical point for them is of guarantee. Vickers potentially has an actual cost of a course ultimately they will have to make a decision as number of billions of pounds and, in fact, also in the to whether or not they want to stay in the UK. There Government report you look at an estimate of a drop are some elements of Vickers that are pretty draconian in tax receipts to do with this between £300–650 and some people will be having a careful think about million. I think my question here is slightly whether they want to stay in the UK. What would you philosophical, but given the fact that there is an actual say to Douglas Flint if he was to come along and ask cost brought about by ICB that will have to ultimately this question of you? either be paid for by the drop in tax receipts or George Osborne: I have had this question directly through increased costs to consumers, that actual cost from Douglas Flint. The point I would make is that, is that a better thing than the implied guarantee that first of all, I think it is in the interests of all British comes from the Government, given the fact that when banks, including HSBC, that there is a well regulated we saw the bailout ultimately there is a potential that financial system, and I think London, the UK—not we could actually make money out of bailing out just London, I should say Edinburgh, Birmingham, given the fact that there is a possibility—who knows Manchester, Bournemouth, all the banking sector, what the possibility is—that we might see those share these are all very good places to do business. When prices going up to a position where we are now in you think of the other financial centres in which you profit? might locate a large universal bank, whether you are George Osborne: I would say a number of things. looking at the United States with Dodd-Frank, First of all, that I don’t accept that the only way for whether you are looking at the eurozone and the the banks to absorb these costs is to increase the cost prospect of a financial transaction tax, if you are of lending at all. There is an estimate of the potential looking at Asia and some of the political issues in impact on lending of 20 basis points, or 10 to 20 basis Asia, I think the UK is a fantastic place to locate a points in Vickers. That is quite small with all the other universal bank and those banks have an interest in a pressures on cost of funding. But of course they can well regulated banking system. actually reduce—shock, horror—their remuneration HSBC has a particular model of banking. It is of packages, that might be another way of absorbing course one of the great success stories of the last three these costs. As I say, I think they will benefit, their or four years. It is a bank that didn’t get into trouble, shareholders will benefit and the value of the company partly because of its very large depositor base. Now will increase when people see it is actually a better we have recognised that large universal banks that can regulated, more secure investment. So that is the first provide us, i.e. the regulators, with assurance that thing I would say. should they get into trouble the UK taxpayers aren’t The second observation I would make is—I call it an standing behind their Hong Kong operations or their implicit guarantee, it was pretty explicit in recent Shanghai operations, providing they can provide that times, and the reason it was explicit is that my assurance then we won’t apply the bail-inable predecessor had no other option. He had no tools requirements to their entire global assets. So that is available to him when RBS couldn’t secure funding where we have deviated from Vickers, but we did it in the wholesale markets. He faced a situation where having spoken to him, and he gave an interview he did not have resolution tools, he had no way of yesterday in a French magazine where he, I noticed, protecting RBS’ essential banking services across the was very happy to go along with what we have United Kingdom without bailing out the whole proposed, precisely because there is a key test here, cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar which is the regulator has to be satisfied that the are SME and personal deposits and personal and SME British taxpayer is secure. If you come to the original overdrafts. There are certain things that definitely objective of all this, Britain is the home of successful should not be in the ring-fence, which are investment global banks, while at the same time protecting the banking activities and market trading and the like, but British taxpayer. If the regulator is assured that the then it is up to individual banks to decide whether global operations of a global bank can be—the British things like large corporate lending should be inside taxpayer won’t have to stand by them in order to the ring-fence or not. I think that is a reflection of maintain essential banking services to Britain, then all the fact that, bluntly, Britain’s banks all have different well and good, and that is why we have made the structures and so there may be better appropriate adjustment in the Government’s proposals published solutions for appropriate banks. before Christmas. Q651 John Thurso: Because, as you rightly say, Q648 Chair: Just to be clear on that point, it is a big Vickers’ recommendations were quite strict in that ask of a regulator to know whether a bank’s global they did define what should not be in it and they did operations are secure, is it not? define what must be in it and there was a gap between George Osborne: The question the regulator, I think, the two that could be discretionary. From the would be asking itself would be if this bank was in Government’s consultation paper it seemed to be trouble, do they have a resolution plan for their wider than that. What you are saying is you accept the overseas operations that ensures that the British Vickers proposals, which are a certain number of taxpayer is secure? Of course, a bank like HSBC things that were legislated to be in, some which were would have ring-fenced its UK retail banking definitely out, and it is the gap that will be at the activities and so there will be an option of maintaining discretion of the regulator and the banks, not the essential banking services and it is easier to resolve totality? that. So the regulator will want to satisfy themselves George Osborne: Yes, so there are, as I say, certain that is the case, that we would not be liable for things that definitely have to be in the ring-fence, overseas liabilities. certain things definitely can’t be in the ring-fence. There is a middle ground that may or may not be. Of Q649 Chair: But you would agree you are adding a course, it is correct to say that it is not just the lot of discretion into the system by doing it? decision of the bank, the individual bank, it also has George Osborne: What I have tried to do throughout to be approved by the regulators who approve the these changes, not just with Vickers but also when it structure of banks. I am speaking for John Vickers comes to the financial services legislation that we are here, but I think he has sensibly taken the decision not about to introduce in Parliament, is give more to come up with a rigid definition of the ring-fence, discretion to regulators to make these sorts of but to make sure that wherever you draw your ring- judgement calls here. fence that it is a high fence, so flexible in its location, high in its fence-like qualities. Q650 John Thurso: You mentioned the ring-fence and discretion for regulators. As I understand it, the Q652 John Thurso: Can I go on from that? We, the Government’s current intention is not to prescribe taxpayer and the Government on our behalf, have 83% what will be and what will not be in detailed terms in of one universal bank in RBS, which is of course the the ring-fence, but have a set of objectives and universal bank that kicked it all off and got it most principles and leave it to the regulators and the spectacularly wrong. Is there any merit in proceeding bankers to kind of work it out. Is that really the right now to simply turn that into its component parts and way to go about constructing a robust ring-fence? have a couple of retail banks called RBS and NatWest George Osborne: First of all, John Vickers and his and an investment bank that can be flogged off to committee thinks it is and we are following their somebody rather than continuing to pretend it is a advice in this respect. If you come back to the original universal bank of some merit? purpose of Vickers, when I came to office, there was George Osborne: I have had many discussions on the an argument raging among the people who had done future of RBS and I am conscious that we must not our job previously, the chair of the regulators, the act as a shadow director and the like, but I certainly Governor of our central Bank, and indeed many have been clear in my view that I thought RBS should parliamentarians, about how best to learn the lesson scale down its global investment banking activities, of the crisis. We established an expert committee. We that it should become a much more UK and Europe- have John Vickers, who I think everyone accepts has focused retail bank, where the investment banking it done a very, very good job, with a committee that does primarily supports its retail clients and offers includes people with retail banking experience, them products and the like. Now, that is the strategy investment banking experience, and indeed, consumer that RBS is pursuing and that RBS has announced champions. They came up with a unanimous report. It before Christmas, and so it is not claiming to be or has been, as far as I can see, unanimously welcomed aspiring to be that vast universal bank it was four or across the political spectrum, so they have done a so years ago, and that I think is a sensible decision for really good job. Now, they reckon they specifically it to take, one that I think will increase the value of looked at the point that you make about whether they the bank rather than diminish over time. should prescribe exactly what should be in the ring- Let’s be clear, I know Mr Garnier asked me this, the fence. They have said it is better to say that certain idea that was quite current at the time—I can things should be or must be in a ring-fence, so those remember I was the Shadow Chancellor following cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar these things quite closely—there was a lot said at that Q654 Chair: Do you think a good deal of the capital time about how we were going to make a killing out of RBS has been absorbed on the investment side at of RBS, fantastic deal for the British taxpayer, we the expense of retail? were buying in at the bottom of the market, “Gosh, George Osborne: Well, I just think it is quite a who wouldn’t want to do a deal like this?” We are capital-hungry bank because of its structure. many tens of billions of pounds underwater on our Chair: You were just using that phrase, so I was investment, if you can put it like that, in RBS. I think just— that is frankly a reflection of some of the problems George Osborne: No, I think— that RBS has had. But I am happy with the strategy. Chair:—asking you whether you think there is a factor of cross-subsidisation between investment and Q653 John Thurso: What you raise is, of course, the retail banking in RBS. question of what is value for the taxpayer, and there George Osborne: I just think it has been quite a is the simple value you referred to of you bought it capital-hungry bank because of its structure and some for X and sold it for Y and the difference is a profit. of the activities its investment banking arm is engaged But there is also perhaps the greater social value of in. Lots of investment banks are, this is true of any decoupling the investment bank operation and having of them. two retail banks operating on our high streets that Chair: I am just trying to clarify whether you think simply cannot shift its capital into investment banking this state-owned bank is cross-subsidising its because it is not there, which will do far more to investment activities with its retail deposits. liberate lending to SMEs than virtually any other George Osborne: It is not of course wholly state- action. Is that not something that the Government owned, but it is shrinking its investment bank from should consider as delivering a form of value to the where it was four years ago. This is not something taxpayer that could have a great deal of merit? that can be done overnight, but it is shrinking its George Osborne: I very much agree with the premise investment bank, it is reducing some of its capital- hungry activities. I think one of the consequences of of your question, which is that we are not just any old this will be a good deal for the British consumer. investor in the banking system. We have a broader Chair: You are falling back on the same phrases, but responsibility, as I have a broader responsibility, the that is fine, I know where you are coming from. House of Commons has a broader responsibility for the health of the British economy and the welfare of Q655 Mr Mudie: Just to keep going, Chancellor, do the British people. So my predecessor wasn’t you envisage the retail ring-fenced bank being able to investing in RBS, he was buying RBS shares in order pass retail bank deposits over to the investment arm? to save the British economy, and that was his George Osborne: The deposits of individuals and judgement at the time. So when it comes to the small businesses have to stay in the ring-fence, and disposal of RBS, and indeed other shareholdings, we one of the things we are consulting on is the financial of course have to have a regard for value for money. relationship between the ring-fenced bank and the rest That is very important, and indeed, is an accounting of the bank, but we are clear the ring-fenced part has officer judgement made by my Permanent Secretary to be financially independent as well as legally that makes sure that is absolutely taken into account independent. and we have to be compliant with EU state aid rules, Mr Mudie: So there is a greater chance? That should which is also a very important consideration. But I be good news for small businesses and small, have been keen also to make sure there is more medium-sized businesses, because they are in the competition out there on the high street. Now, retail side and they are able to get first go at the funds Northern Rock is a good example. There the very that come in the retail side instead of it being shipped clear independent advice that we received from the over to the investment arm, and that is what we want Treasury was that this thing was continuing to lose to see happen, surely? value as a Government shareholding, so the sooner we George Osborne: I think the proposal is good for sold it the better. But I also frankly wanted to get it small businesses, and very explicitly small business out there on the high street, a new bank with a clean deposits were included as something that had to be in balance sheet that could go and lend. I don’t want to the ring-fence. get involved in the detail of the negotiations Lloyds is having with the Co-op, but they have chosen the Co- Q656 Mr Mudie: I am sorry, I was watching the op as their primary partner for discussing the sale of clock because we are short of time. John Mann asked 600 branches to the Co-op. I think it would be good you a question and the Chairman indicated we were to have a new competitor out there on the high street, going to do an inquiry on it, so I don’t want to go into an expanding competitor. salaries or other things, but I am very interested in When it comes to the Royal Bank of Scotland, I think hearing the Prime Minister’s speech on shareholding the Royal Bank of Scotland focusing on its UK and powers, and I have been disappointed with the last its European business is a good thing for British Government and up until now with the present customers, and indeed, by shrinking the size of the Government how they have acted as shareholders, for investment bank dramatically so that they are example, with RBS. Now, I read in the papers you primarily servicing their retail customers, they are have just passed it off as a proposal that emerged. I getting out of some of the capital-hungry things, top know I am asking this at a hard time, but what was end, by which I mean of the investment banking scale, the arrangement between you and UKFI in respect of i.e. the very market-trading operations required. that decision to lower the investment capital or the cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar investment activity? It clearly seems to have upset Bank of England, through the Financial Policy people in the bank, and therefore although it should Committee that we have created, issued saying that be applauded, do you not take ownership of it? banks should not be paying out bonuses if they have George Osborne: I know this will sound like—I will capital, that they should be using that money to build enter a caveat, which is I have to be careful that I up. That advice should be heeded and the Financial don’t act as a shadow director. There are private Services Authority is currently going bank by bank to owners of shares in RBS. However, I was very clear see whether they are compliant with that warning. about what I thought was in the Government’s interests as a very large shareholder, and I was happy Q661 Mr Mudie: With RBS in mind, if have you that the management agreed that RBS needed to move successfully achieved them pulling back on the to a much smaller investment bank. investment arm we might expect the chief executive of that bank, that his remuneration to be more in the Q657 Mr Mudie: Did UKFI, to your knowledge, Captain Mainwaring area rather than the chief have any part in that initiative? executive of Goldman Sachs, wouldn’t we? George Osborne: The UKFI were involved— George Osborne: The scaling down of the investment Mr Mudie: They are the assured shareholder, the banking activities is just starting to take place. Mr official legal shareholder. Hester’s contract is something that was negotiated by George Osborne: Absolutely. Although I see the my predecessor or under the previous Government— management of— Mr Mudie: No, but did they, to your knowledge—I Q662 Mr Mudie: Chancellor, can I just ask you am not asking about your involvement now. I am something? I said to the Chair I was finished, but I saying, to your knowledge, did they have any part in was a trade union official for 20 years, maybe even the initiative to get the RBS to come out of the extent 30, and the number of times employers changed the of their operation in investment by the bank? contracts of my members, I can’t tell you how often, George Osborne: Yes, they were extensively involved and it was simply done by issuing another contract in discussions with the RBS, but they had also and the alternative was, “If you don’t like that discussions with me as well. contract, you go. Now we will see you in court”. Why, when you get into a senior position, do the contracts Q658 Mr Mudie: No, that is good. Have they, to become something that cannot be changed? your knowledge, been as active as that in the past two George Osborne: But some of the stories we have years in terms of remuneration? been reading recently have been about, in effect, George Osborne: I think they are pretty active in money that was awarded three years ago, two or three remuneration. They have secured in the last couple of years ago, in the form of shares and those shares are bonus rounds that there are no cash bonuses of more now vested, so I don’t think we would have the power than £2,000 in RBS and Lloyds. Ultimately it is a to sort of seize that money. That was money in shares. decision for the bank and its board but I think UKFI, Mr Mudie: You don’t think, have you checked it and indeed the Government Ministers, have been legally? pretty clear about what they think is appropriate. George Osborne: I am pretty certain.
Q659 Mr Mudie: The last two, is that 2010/11 and Q663 Teresa Pearce: As I see it the commission is 2011/12? looking to remove risk from the taxpayer and to get a George Osborne: It is the beginning of—yes. better service for the customer, and you have touched Mr Mudie: For example, the one we are coming to, on competition and mentioned budget money, the Co- the same as the last year in terms of— op and the high street looking different. How do you George Osborne: No, sorry, it is not. It is the see the safeguards on capital requirements for newer beginning of last year—it was the last time we had entrants to the banking industry, smaller banks the bonus round. I proposed it as Shadow Chancellor maybe? How do you sort of balance that safeguard two years ago, although I was only Shadow with not being a barrier to new entrants? What would Chancellor. I helped secure it last year. We are now you like to see in the banking industry? Would you having our discussions about this. like to see new, smaller banks? George Osborne: I would like to see new, smaller Q660 Mr Mudie: I am sure your fingerprints are banks. I think you raise a very good question and, over what is going to happen in the next few months. I frankly, it is a policy dilemma. Obviously we have to do not mean that in a bad way. You take ownership— make sure that people who have a banking licence, George Osborne: You might not. who are offering products to customers, are fit people Mr Mudie: Well, okay. But can we expect the present to be doing that, and are able to protect their bank settlements to have been part of the discussion from failure, and the bank doesn’t fail, it has sufficient between the management of the bank and the capital and the like. Since the financial crisis we are shareholders working in conjunction with yourself, asking banks for more capital, not just here but quite sensibly, and that will be reflected in the elsewhere in the world, so that makes it more onerous outcome? to establish a bank than would have been the case in, George Osborne: I am clear that given the fact this say, 2005/2006. Now, I think that is sort of inevitable, has not been a particularly successful year for banking given what happened, but that said, for appropriate we would expect to see bonuses lower this year than people, fit and proper people who come forward, who last year and I am also clear of the advice that the do have the resources, I want that process of getting cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar a banking licence to be as quick and as that. When it comes to a level playing field, I think straightforward as possible. I have had many a level playing field is important when it comes to conversations with the FSA, it is their responsibility, international regulation of financial services, but I that that should be a straightforward process if people think you have to allow individual jurisdictions like fulfil the criteria. the UK, where they have very large banking industries, to do specific things nationally to protect Q664 Teresa Pearce: So you don’t want to go from their taxpayers, and that is what Vickers proposes. too big to fail to too small to start? George Osborne: Yes, but one of the things where we Q666 Andrea Leadsom: Happy New Year, have explicitly departed from the Vickers report—and Chancellor. we are consulting on this so this is something we are George Osborne: Happy New Year. genuinely seeking an opinion on—is in Vickers’ Andrea Leadsom: Thank you. I am still concerned, I interim report he suggested a de minimis that small have raised this with you before, that the second bit, banks would be exempted from his regulations. In his the kind of the afterthought of the Vickers proposals, final report, he said all banks should be included. those around competition, are still not really enough. What we have said is we should consider Vickers’ There is a huge amount being done to make sure that interim recommendation of a de minimis exemption banks are not too big to fail, and if they do fail, they for small banks and I think, without wanting to pre- can be resolved, but not really enough being done to empt your work, it would be extremely interesting to ensure that the barriers to entry have been removed. get a Treasury Select Committee’s view on whether to Teresa Pearce has raised that point with you already, have a de minimis exemption for small banks that but it does seem to me, having taken some private Vickers said in his interim report, but not his final meetings with the likes of Virgin Money, who as you report. know launched their new bank yesterday, which is great news for the consumer, and also with Metro Q665 Teresa Pearce: Thank you. Just one more Bank, who all agree there is a big issue of IT in question. It is about this issue of if you regulate the banking, and that these huge legacy systems of the banks too much they will all move abroad, which you banks, the need to go to an agency clearer and so on touched on, and I don’t know if I understood correctly, as a new start-up is a massive barrier to entry. I just but you seemed to be saying you didn’t think that was wonder if you could talk again about why you feel it a realistic thing because it is not just regulation that is adequate to support the proposal that the Payments makes people move abroad. What keeps people in this Council simply give you a gold plated switching country is the fact that they do know they have the service, rather than moving to a new shared stability, they understand what is going to happen, infrastructure for banking where any new entrant there has been consultation, there is a good workforce could come in and plug in and play any day of the and all those other factors. However, I just wonder to week. what extent you have had to modify the proposals in George Osborne: Well, first of all, I accept there is a the face of the Government’s concerns that banks may genuine dilemma, as I was just explaining, between relocate. Have there been modifications because of making sure you have people who can come in and that? be proper people to do banking and have enough George Osborne: No. We have listened to specific capital to do banking, and at the same time, not having representations about the structures of certain banking an overly-high hurdle to getting on to the high street groups and whether we can take account of that, and and being a competitive bank. I think the success story we discussed that earlier, for example, in regard to of Metro Bank, HandelsBank, hopefully Virgin HSBC. But I made sure that the proposal we put Money, are all good examples of out there there is forward achieves the same objective, which is some diversity happening, choice happening and new protecting the British taxpayer. As I say, I know John entrants growing. Vickers, I think certainly publicly—I am not aware When it comes to the very specific question you have of him saying anything privately to the contrary—has about account portability, first of all, Vickers looked welcomed the proposals we have put forward. I think at this and he came to the conclusion that the cost these proposals make Britain the best regulated, not would outweigh the benefits. That ultimately the cost the most over-regulated, the best regulated centre for of changing the banking IT systems of the entire a universal bank and I think when you look at the British banking system or all British banks so that you realistic alternatives for those banks, I think we have could take your account number and your sort code a very good story to tell. into any bank outweighed the benefit. He thought it Teresa Pearce: So do you agree that what business was much more expensive than, for example, taking wants is certainty and a level playing field? your mobile phone number with you. For example, George Osborne: Yes, I think they would certainly sort codes currently are very branch specific, so if you like certainty, and what I have tried to do is move as keep your sort code that changes the nature of the sort quickly as possible, while getting the detail right, to a code. So he came to the view that the switching option place where we all, as different political parties, agree he proposed, that within seven days you would have that this is a sensible way forward, given what in effect a guarantee provided by the industry that you happened in Britain in 2007, 2008. I won’t speak for can switch your current account, the numbers would my opposite number, Mr Balls, but I think we have change but all the direct debits and the like would broadly reached a political consensus, and I think the follow without you having to contact all the individual Vickers process has been really good at delivering companies that you have a direct debit with, he cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar thought that was a better value for money option. look at directives on the way through before we kind Now, what we have done is—and as I said in the of get presented with a fait accompli at the end? House of Commons, this is partly due to the work that George Osborne: I think I will leave this for Mr Tyrie you have done in drawing my attention to this—we to discuss with Mr Cash. I won’t intrude into this have said that if this does not deliver what we hope, fraught area. I think in terms of the scrutiny specific then we will look very seriously at account portability, directive, I certainly would hope, and indeed you have so that was not in the Vickers report, it is something interviewed Commissioner Barnier— we put into the consultation document. Andrea Leadsom: Reluctantly on his part. George Osborne: He tells me how much he enjoyed Q667 Andrea Leadsom: Can I just press back a bit appearing before you, but I would say that this on this, because I did speak to John Vickers just European legislation is very important to the UK and before his interim report came out, and it didn’t appear we certainly should have people taking a good look to me that there had been a great analysis of a new at it. shared infrastructure system. In fact, it more appeared Andrea Leadsom: Thank you. to me—I don’t want to put words into his mouth, and Chair: We asked him some fairly straightforward obviously the conversation was off the record—more questions and to some of them, I regret to say, we are that it was in the sort of “too hard” bucket, that it still really awaiting full answers, but maybe we will wasn’t worth going there, and we have certainly taken have another go. evidence from chief executives in banks who said, “Too hard, too expensive” and so on. But I have also Q669 Mr Ruffley: Chancellor, how many new met with some IT companies who have said, “Banking entrants to the retail banking market have there been is about IT and if you had a single customer view, in the last 20 years? you would reduce fraud, you would reduce errors for George Osborne: I don’t know. customers, you would be able to give a far better customer service, you would be able to have a far Q670 Mr Ruffley: You do not think there is seriously clearer tariff”. What other industry is there where they inadequate levels of competition in retail banking? call it free credit banking? Well, of course it is not George Osborne: I do think there are, absolutely. free, and we took evidence from banks on the amount of money they make from our credit balances, so it is Q671 Mr Ruffley: You have talked about Northern a completely opaque industry, and that is down to the Rock and you have talked about a deal that the Co-op legacy systems. So if you ask them from an IT might be doing, but why do you think it is that the big perspective, they will say even without the huge four banks’ market share in the PCA market has been benefit of account portability that vastly improves the pretty constant over the last decade or so? What is competition, you have enormous benefits to the banks your personal assessment of that? themselves and to customer service by ensuring that George Osborne: I think it is because it is a business you sort out IT legacy systems once and for all. where—we were just having a discussion about IT— George Osborne: You make a powerful argument. I scale gives you an advantage, where there is a huge set up the John Vickers committee and I made sure consumer resistance to switching accounts. I think it is less than 5% of people switch their accounts. We that there was a consumer champion on it. You say are trying to make that easier for people. It is quite you don’t feel they did enough work on this. I think difficult for a new entrant to get knowledge of, for there is a substantial section in his report on example, a small business’ banking relationship with competition, on switching current accounts, but we are another firm, that small business is extremely nervous in consultation on this, so we have published a about moving and breaking that relationship to try and document, we have not produced the final version of create a new one. So there are a lot of barriers to entry. this at all. So I think if you want to make your I think the other truth is that if you look at what has arguments, and there are others who put their happened in recent years, the big new challengers arguments, let us absolutely hear them. But at the were some of the biggest casualties of the banking moment the evidence that I have seen and the advice crisis, HBOS and Northern Rock. HBOS in I have received and so on has been that this would be commercial lending particularly, but also personal prohibitively expensive because of the change it lending, and Northern Rock in mortgages were the big would require to the IT that stands behind every bank challenger, they were the big entrants. Of course they account in the country. were running, as we now know, big risks to be the big new entrants and they were trying to break into the Q668 Andrea Leadsom: Yes. One last question on a monopoly of the big four, as you put it. Although I slightly different matter, just referring back to what would just draw your attention to, I think, Santander Pat McFadden was saying about scrutiny, and the UK has been a powerful new entrant on the high amount of scrutiny directive by directive that you street, and Nationwide has made a very welcome need to do in EU financial services matters. Is there, recent announcement that it is going to be getting into do you think, a role for a committee like the Treasury the small business lending business. Select Committee in looking more early at directives as they come through? Obviously the EU Scrutiny Q672 Mr Ruffley: Do you think there is enough Committee itself does a great job, but they are competition in the SME banking market? inundated. Do you think there is a potential role to George Osborne: Again, I don’t think there is and we have some of the expert Select Committees start to are trying to increase it. cobber Pack: U PL: COE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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Q673 Mr Ruffley: What were the ICB proposals you Cruickshank, who first argued for this around 2000, have endorsed and want to enact? What do those and he suggested that the Treasury had objections, that proposals look like to enhance SME banking they basically put the kibosh on the idea, and he competition? regrets, ten years on, that this has not been done. Is George Osborne: I think, for example, insisting that there a piece of work you could make available to when it came to the divestment of Lloyds branches this Committee that your officials have put together that we should consider that creating a powerful new explaining why the costs would outweigh the benefits? challenger, I think that is a helpful recommendation As my colleague, Andrea Leadsom, has said, some in that respect, and as I say, I think the way they have people would doubt that the IT costs would be constructed their proposals on the ring-fence makes it prohibitive. Could you make that available to this quite easy for people to engage in small business Committee? lending. It is good news, as I say, that Nationwide are George Osborne: Yes. I think what I will undertake getting engaged in this activity. There have been big to this Committee is that in the conclusion of the casualties in the last four or five years, and some of consultation and the White Paper we produce that we them were the most aggressive lenders to small give very serious treatment to the account portability businesses. The Royal Bank of Scotland remains a proposal. We set out the costs and the benefits, and very, very big player in the small business lending indeed, if the benefits outweigh the costs, we will look business in the UK and that is because it took a vast very favourably at it, but let us hear the evidence and market share in the— see the evidence. What I promise the Committee is that we will give our full consideration. Q674 Mr Ruffley: The question is, Chancellor, can you point to anything in the ICB proposals that you Q678 Chair: That is very helpful. Out there, there is have endorsed that are going to improve and enhance a considerable concern about the squeeze on lending competition in the small business banking market? to small businesses that is taking place, and we George Osborne: As I say, I think the very specific received extensive evidence that the ICB proposals recommendations we have had on competition that the could add to that squeeze. The CBI, for example, said Government should ensure—as a minority that this will add to the cost of banking operations, shareholder, and using what levers it can—that the all of which will have some impact on the cost and divestment of the Lloyds branches that was required availability of lending, and others have referred to by the European Commission went to create a new small business lending. Is this an issue that you have challenger bank or expand a small bank rather than go addressed carefully, and given thought to— to one of the existing banks, I think is a specific George Osborne: Obviously I would be concerned if recommendation. I felt that was going to be the case. It is also something, to be fair, I think the Vickers committee Q675 Mr Ruffley: So you are just hoping that those took seriously. One of the reasons why John Vickers new entities will lend more to small businesses? suggested—we have not discussed today the timetable George Osborne: Well, those branches and that on implementation, but one of the reasons he business is not going to Barclays or HSBC. suggested 2019 as the backstop, particularly on the capital requirements, which is where you might see Q676 Mr Ruffley: Did you ever consider breaking the impact on the cost of credit, one of the reasons he up RBS to create a new challenger bank? has suggested that long implementation date on that George Osborne: Well, obviously on coming to office proposal was, I think, to deal with a reflection of the and in discussions I looked at the Government fact that the current credit conditions across Europe strategy—inherited, from my point of view—towards and the UK and elsewhere in the west are not what RBS and in the last 18 months that strategy has we would like them to be. changed. The management themselves have made proposals that I welcome, so I think you can see in Q679 Chair: One of the points that the banks have what RBS is doing partly what the Government thinks also made to us is that the regulation being put is the right thing to do. through now in order to make banks look safer, Mr Ruffley: So you didn’t consider breaking up particularly on the liquidity side, is itself making it RBS? more difficult for them to lend. How carefully are you George Osborne: I don’t think it is helpful to keeping an eye on that issue, or are you leaving that speculate about individual firms, even ones where the very much at arm’s length to the regulators? Government has a very large shareholding, about all George Osborne: These are judgements for the the options we have ever considered in private, but I regulator, but it is something we take a close interest think people can see in public that RBS is changing in. its strategy, dramatically reducing the scope of its investment banking and I think that partly speaks for Q680 Chair: You have someone monitoring this in itself. the Treasury, have you, and briefing you on it? George Osborne: Yes, absolutely, it is something we Q677 Mr Ruffley: A final question. On Andrea monitor, and of course the concerns the banks have Leadsom’s point about shared infrastructure, and you expressed to you are the concerns the banks have talked about what John Vickers said about the cost, expressed to us. While I say banks generally, there that at this stage the costs would outweigh the benefit. have been one or two specific institutions. I would just We have had evidence in this Committee from Don say that events in the last three or four months have cobber Pack: U PL: COE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG07 Source: /MILES/PKU/INPUT/017688/017688_o007_db_TC 11-01-2012 MER corrected.xml
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11 January 2012 Rt Hon George Osborne MP and Tom Scholar demonstrated that it was quite a good idea to ask some of this Committee that we want to see competition as of these banks to be more liquid and one of the a primary objective in the legislation that you will be reasons why I think UK banking is seen by the world formulating shortly. You will also have heard that we to be well-capitalised and liquid is because the would, on an exceptional basis, like high-level of regulator has made sure that it was, and it has passed transparency with respect to our negotiating position every kind of stress test that has been done at a at the summit. I recognise the difficulties there for European level over the last couple of years. you, but I would be very grateful if you would think Chair: Chancellor, we are very grateful for you giving very carefully about how you can supply that evidence this afternoon, it has been extremely transparency. Thank you very much for coming this interesting. On the competition side, you can tell the afternoon. strength of feeling around the table and the unanimity cobber Pack: U PL: CWE1 [SE] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Written evidence
Written evidence submitted by Lloyds Banking Group Executive Summary Lloyds Banking Group (“the Group”) welcomes this opportunity to provide our first impressions of the Independent Commission on Banking’s (ICB) final report to the Treasury Select Committee (TSC).
Financial Stability We are broadly supportive of the ICB’s recommendations on ring-fencing and also welcome the Commission’s support for making capital buffers truly loss-absorbing. Given the complexity of the issues in the report, however, our comments below are necessarily high-level.
Competition We believe the UK retail banking market is internationally competitive but we also think more can be done to enhance competition and have led the way in putting forward proposals for achieving this. We therefore welcome the ICB’s recommendation that the new seven-day switching process which we proposed and the Payments Council has adopted be implemented swiftly, in tandem with measures to increase transparency and comparability. We believe that the Verde process will lead to the emergence a strong and effective competitor and we believe that the divested bank is well placed to benefit from the opportunities that enhanced switching and transparency will bring. Our view is that the combination of the Verde divestment and the switching and transparency measures will be transformational while it needs to be recognised that they should be given the necessary time to take effect. On this basis a potential review by the Office of Fair Trading (OFT) in 2015 seems appropriate.
1. Financial Stability 1.1 Ring Fencing We support ring fencing key UK banking activities within universal banks as a way to contribute to the objectives of eliminating or significantly reducing subsidies, improving resolvability and safeguarding key economic functions.
Width We welcome the ICB’s recognition of the importance of a wide ring fence for safeguarding the provision of credit to the economy, which is key to minimise the economic consequences of banking crises. As we had argued in our response to the ICB’s Interim Report, even the largest companies that normally have access to capital markets rely on the provision of credit by banks in a crisis, when capital markets become impaired. Furthermore, large companies rely on bank credit facilities and deposits in normal times as well in order to demonstrate the liquidity necessary to achieve the rating required for capital market issuance. We therefore fully support the ICB’s recommendation to allow lending to corporates of all sizes to be included within the ring-fenced bank.
Height In terms of the “height” of the fence, we support the ICB’s recommendation to allow the use of a holding company structure which would continue to allow different activities to be part of a single group. On governance, it must be emphasised that the UK’s main banks are by no means homogeneous and therefore a “one size fits all” model of governance may produce unintended and unwelcome consequences. In the Group’s case, for example, there would be no conflict of interest between the ring-fenced bank and the Group as a whole and therefore no benefit from having separate Boards.
1.2 Capital In conjunction with the ICB’s recommended structural ring-fencing reforms, the enhanced capital requirements recommended in the ICB’s report make UK banks much less likely to require taxpayer support. Ring-fenced banks, in particular, will be exceedingly safe entities, protected from the volatility and interconnectedness of the I-bank.
Loss absorbing capacity of capital We welcome the ICB’s stated intent that the proposed enhancements to capital requirements should be loss absorbing, since loss absorbing capital facilitates the continuity of credit in a downturn. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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The ICB correctly recognises making buffers loss absorbing can be difficult, since in practice loss absorbency depends on the market’s reaction to a bank’s dipping into a buffer. We welcome the ICB’s useful suggestion in this regard, namely that authorities allow buffers to be used in meeting stress test requirements. We also welcome the ICB’s recognition of the need to allow banks some flexibility in implementing proposals to increase loss absorbing capacity (eg equity capital, non-equity capital and bail-in bonds). In particular, we are pleased that the ICB is allowing contingent capital to form part of a bank’s loss-absorbing capacity.
Impact on cost of funding Depositor preference is likely to have a significant impact on the cost of unsecured debt and will thus encourage banks to make greater use of secured funding where possible. It will likely also have an impact on the price and availability of credit to households and businesses. It is unclear what the impact on funding costs and availability will be of requiring that all senior unsecured term debt can be bailed in. A consistent international approach to the structure of bail-in as a concept would help to minimise unintended consequences.
1.3 Resolvability In the event of a crisis it should be possible for failed banks to exit the market in an orderly fashion without jeopardising the provision of key economic functions. This allows the competitive process to function without adversely affecting financial stability and eliminates any potential for moral hazard arising from possible implicit guarantees to a bank. We are fully engaged with the Bank of England and the FSA in developing a credible living will. With regard to the ICB’s recommendation that regulators be allowed to impose an additional 3% capital buffer (a “resolution buffer”), we would note that the potential factors that can be considered in determining the amount of any applicable buffer are vague and allow considerable regulatory discretion and risk of super-equivalence. We would encourage the Government to clarify these factors in primary legislation.
1.4 Transition Period With regard to the length of the transition period for the ICB’s recommendations, we believe that a long transition period for both enhanced capital requirements and structural reform is particularly important so as to avoid potential damage to the economic recovery. As ring fencing also involves significant technological and legal complexities, a long transition period will also be needed to allow banks time to minimise the cost of adjustment. We fully support the ICB’s recommendation to allow banks until 2019 to complete these changes.
2. Competition 2.1 Switching in PCAs and BCAs We believe the UK retail banking market is competitive compared to other international markets. Customers change provider much more frequently in the UK market and often use more than one bank, a market feature more common in the UK than in other markets. However, as we said to the ICB, we also think more can be done to enhance competition. Customers want easy-to-understand products, clear information about charges and benefits so they can compare different providers, and the ability to change provider easily and quickly if they want to. We therefore welcome the ICB’s recommendation that the new seven-day switching process which we proposed and the Payments Council has adopted be implemented swiftly. The Payments Council is now actively working on the implementation of a fully automated, guaranteed system to enable customers to switch current accounts within seven days. Indeed it is working on enhancing existing services during 2012 in time for full implementation of the transformed solution by September 2013. We are confident that the ICB’s deadline of September 2013 will be met—more details can be found at http://www.paymentscouncil.org.uk/media_centre/press_releases/-/ page/1618/. The TSC may be aware that the Payments Council met with HM Treasury (HMT) and agreed that the CEO’s of all Payments Council banks would each write to Mark Hoban by 30 September pledging their commitment to implement the switching solution. We have done this and the letter is attached at Annex 1. This is the right thing to do for customers and good for competition. Customers should be able to understand, compare and switch product providers if they are dissatisfied or indeed a better offer comes on the market—it is that understanding and capability that enhances competition.
2.2 The Need for Strong Regulatory Support for the Switching Solution We outlined to the ICB the need for strong regulatory support for the switching solution. Experience from other industries and countries suggest that strong regulatory support will improve the outcomes delivered by the switching solution. The regulator needs to ensure that all providers are ready to launch the service and cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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prevent implementation moving at the pace of the slowest. The scheme needs to be marketed by a trusted, independent body and the relevant industry regulator (Ofgem and Ofcom) took on this role when switching was introduced in energy and telecoms to make sure customers were aware of the new service. The regulator also needs to survey customers regularly for a period after implementation to make sure there is good customer awareness and that customers who use the service find it easy and hassle-free. We would also support an industry code of practice covering all of the obligations on current account providers and direct debit (DD) originators to make the scheme work effectively. This could cover: — Clear and consistent marketing: rules on displaying and promoting the service. — Free use for customers: banks should not be allowed to charge for the service. — Rules for banks: ensuring that banks don’t limit access to the switching service. — Rules for direct debit originators: appropriate incentives (or penalties) for DD originators to ensure timely updating of their records. — Rules guaranteeing the service for customers: switching to be guaranteed so that customers to not suffer loss if mistakes occur. The Regulator’s role would comprise: — Oversight: is the service being delivered? Progress monitoring of development plans via regular updates; is it working? Performance monitoring of switching via regular management information. — Enforcement: taking a firm line with banks and DD originators who do not deliver. — Continuous evaluation: customer survey prior to implementation and periodically after implementation to enable robust evaluation of costs and benefits. — Oversight: the Regulator should ensure that all banks introduce the service simultaneously. The customer survey work we have done (Quadrangle survey previously provided to the TSC and ICB) indicates a favourable response by consumers to the new switching proposition along with strong indications of potential for increased switching activity; 66% of consumers surveyed say it would make switching easier, 51% say it would make them more likely to switch if they needed to and 64% say it would make the industry more competitive. Customers also said that for the service to work properly it was important that the service was independently regulated.
2.3 Transparency Our view is that in tandem with the measures that have been recommended on switching, transparency needs to be improved in order to allow customers to understand and compare the cost of their current account with the other offerings available. We support the ICB’s recommendation to improve transparency by putting interest forgone on current account statements. While this is not a panacea it is clearly a meaningful first step in the direction of providing improved clarity.
Improving comparison websites is the next step
These websites don’t work as well as in other markets where switching is common. For energy and phones, websites show customers the total cost of different providers based on the customer’s pattern of use and show providers’ customer service ratings alongside price comparisons. Regulators have introduced codes of practice for the comparison websites to make sure they offer independent, reliable and meaningful comparisons. For current accounts, these websites currently only offer customers limited information on the total cost of current accounts with the only available comparators being credit and overdraft rates or the benefits (such as travel insurance) offered by accounts with monthly fees. They don’t allow customers to understand the cost of a current account based on typical patterns of usage. They do not even rank according to best rate/price even within simple these simple categories and accounts at the top of the list often reflect commissions paid to the comparison website. They are also solely price focussed—there is no ability to search by quality and range of service. This is often as important to customers as price when choosing a current account. As we have said to the ICB, the Group is willing to work with the Financial Conduct Authority (FCA), Money Advice Service, Which? and other consumer groups and the switching websites to better develop more “meaningful” Personal Current Account comparison tools and we are talking to these organisations to improve the tools available to customers to make more meaningful comparisons.
2.4 FCA We think that there is a risk that regulatory rules applying in the banking sector may operate as barriers to entry, growth, or competition, and therefore we think that the new FCA should have a duty to have regard to the objective of promoting competition, among other policy considerations, when exercising its functions. We do not consider that the FCA should have concurrent powers with the OFT to enforce general competition law. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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2.5 Verde
We are pleased to note that the ICB has not recommended that Lloyds Banking Group dispose of further branches. Instead it has focused on the emergence of a strong new challenger, by reference to funding and market position in PCAs. We believe that the Verde process will lead to the emergence of such a strong and effective competitor and we believe that the divested bank is well placed to benefit from the opportunities that enhanced switching and transparency will bring. While we understand the ICB’s desire to use market share as a proxy for how competition in the PCA market is working we think that this is looking at the symptom rather than the cause. Our view is that while this market is competitive more can be done and that the best means of stimulating further competition is to focus on robust switching and transparency remedies, which the ICB has recommended in its report and which we are now working to implement. Improved switching and transparency in other markets have demonstrated that these remedies can drive significant results.
The ICB has chosen a number of criteria by reference to which they think the OFT should assess the state of the market in 2015—obviously if the OFT conducts such a review, the conditions of competition will be a matter for it to assess as it thinks fit. Our view is that the combination of the Verde divestment and the switching and transparency measures will be transformational while it needs to be recognised that they should be given the necessary time to take effect. September 2011
Annex 1
CEO LETTER TO HMT PLEDGING OUR COMMITMENT TO SWITCHING SOLUTION cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Written evidence submitted by Nationwide Building Society 1. Nationwide welcomes the opportunity to provide a written submission on the final report of the Independent Commission on Banking (ICB) to the Committee. This short note provides an overview of our initial position on the ICB’s proposals and suggests a number of specific issues that the Committee should raise with Commissioners.
2. Overview of Nationwide’s position on the ICB recommendations 2.1 The financial crisis exposed weaknesses in the global financial system and came at a very high cost. We therefore welcome the work that the ICB has undertaken in developing a reform package to improve stability and competition in UK financial services. 2.2 We support the core proposal of creating a retail ring-fence as an appropriate measure and the recognition that the building society model should be used, in part, in designing the ring-fence is welcome. 2.3 Nationwide has been operating under ring-fence-type conditions for many years and we have shown that ring-fencing and a competitive, growing and secure business are not mutually exclusive. Unlike our plc competitors, we will face minimal restructuring costs. 2.4 Whilst we are broadly supportive of the ICB’s proposals, there are a number of important aspects that the Committee should look to raise with Commissioners and urge the Government to address: — A leverage ratio over and above Basel III is wholly inappropriate for low-risk institutions and could create significant unintended consequences for consumers and the wider economy. — As considerable reforms are made to improve stability and competition, the time is right for building society law to be modernised, enabling societies to compete effectively whilst retaining their fundamental purpose. — We support the ICB’s proposal for depositor preference—but it should apply to all depositors, not just those with less than £85,000. — More competition in retail banking is welcome but costs of enhancing switching should not outweigh consumer benefits—simpler solutions should also be considered.
3. A leverage ratio over and above Basel III is wholly inappropriate for low-risk institutions and could create significant unintended consequences for consumers and the wider economy 3.1 We understand the ICB’s desire to impose higher capital requirements and loss absorbency measures on financial institutions. We were pleased that the final report recognised the current restrictions mutuals have in raising external capital (which we hope will be resolved as the Capital Requirements Directive is finalised) and, therefore, our ability to meet the more stringent requirements set by the ICB. 3.2 The ICB proposes that all ring-fenced banks should maintain a tier one leverage ratio of between 3% and 4.06%, depending on the relative size of their risk-weighted assets to UK GDP. Given Nationwide’s scale, we are likely to be subject to the ratio at 4.06%. 3.3 Whilst we understand the principle behind the measure, the imposition of a leverage ratio—and one significantly higher than set under Basel III—pays no heed to the nature of our business model and the low risk posed by our balance sheet.1 Indeed, we are restricted by statute in our ability to engage in high- risk activity. 3.4 In its current state, the proposal may lead to the unintended consequences of institutions such as Nationwide having to either reduce the scale of low-risk lending and/or increase the proportion of higher risk assets to generate higher returns. This would be contrary to our low-risk approach and affect the safety and security represented by our business model by requiring us to have a higher risk profile on our balance sheet. It may also result in a higher cost of lending to low-risk borrowers and more difficulties in consumers accessing credit. We believe it is more appropriate for leverage to be monitored as part of the supervisory regime, both at individual firm and macro-prudential levels.
4. As considerable reforms are made to improve stability and competition, the time is right for building society law to be modernised, enabling societies to compete effectively whilst retaining their fundamental purpose 4.1 The ring-fence proposed by the ICB is relatively wide and flexible, based upon definitions of “mandated services” that must be ring-fenced (deposit-taking from, and overdraft provision to, individuals and SMEs), a broad range of “permitted activities” that may be inside or outside the ring-fence and “prohibited activities” that must be outside the ring-fence. 1 The overall charge for impairment losses in 2010–11 on loans and advances was down 35% on 2009–10 at just £359 million. The average loan to value (LTV) of new residential lending remains very low at 66%, with the indexed LTV for the whole residential portfolio at 49%. Less than 1.4% of our new residential lending during 2010–11 was written at LTVs in excess of 90%. The proportion of Nationwide originated mortgage accounts three months or more in arrears is 0.68% and is less than a third of the CML industry average of 2.09% (March 2011). cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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4.2 Under the ICB’s proposals, banks will have a significant degree of freedom to determine what goes inside and outside the ring-fence, and to manipulate their balance sheets to optimise capital. Building societies will remain distinct, and rightly so, from ring-fenced banks as they will continue to operate under the enhanced constraints imposed by the Building Societies Act (such as the “nature limits” on the proportion of wholesale funding we are permitted to raise and the requirement that the majority of our assets are secured on residential property). 4.3 At a time when considerable reforms are being made to the banking sector to improve stability and competition, a strong and competitive building society sector should also be a priority so that it is able to effectively challenge the ring-fenced banks on a more even playing field. 4.4 We would therefore urge that, hand in hand with the wider banking reform package, the Building Societies Act is modernised to remove its inherent anachronisms and inappropriate barriers to competition with the banks. This would allow societies greater flexibility and strengthen the competition that mutuals are able to provide (including in commercial markets). 4.5 The changes we seek are largely of a technical nature to give us greater flexibility in our risk management activities and would not alter the fundamental nature of what it is to be a building society (ie an institution focused primarily on retail deposit-taking and residential mortgage lending).2 But they would, in effect, recognise that in the financial services sector of the 21st Century, effective mutual challengers are needed to tackle the dominance of the big banks—both in the consumer and SME markets—leading to enhanced lending capacity and growth prospects across the economy. We would welcome the opportunity to discuss these changes further with Committee members.
5. We support the ICB’s proposal for depositor preference—but it should apply to all depositors, not just those with less than £85,000 5.1 The ICB has recommended that upon insolvency of a deposit-taker and in resolution, all depositors insured by the Financial Services Compensation Scheme (FSCS) should rank ahead of unsecured creditors. Currently, all bank depositors rank pari passu with unsecured creditors, whilst those in building societies are subordinate. 5.2 We fully support a move to depositor preference, ensuring retail depositors are nearer the head of the queue at insolvency. The potential burden on the rest of the industry through the FSCS will also be reduced. 5.3 However, we believe that the ICB should have recommended that all depositors, not just those insured by the FSCS, should receive preferential treatment on insolvency. This would create the best conditions for swift and easy resolution (eg transfer of customer business into a new bank which could trade on) and ensure that two retail depositor classes are not created (the insured and the uninsured), leading to an unnecessary complication. 5.4 If the Government is not minded to take this additional step, given the current position of building society depositors relative to those with banks, it should at least implement the relevant sections of the Butterfill Act (which provides for all depositors to be ranked pari passu with unsecured creditors) simultaneously with the ICB proposals. This will ensure that both insured and uninsured depositors are in the same position (preferred to and pari passu with unsecured creditors respectively) whether they choose to deposit with a bank or a building society.
6. More competition in retail banking is welcome but costs of enhancing switching should not outweigh consumer benefits—simpler solutions should also be considered 6.1 Nationwide is highlighted by the ICB as the primary challenger brand to the big banks in retail financial services and we have consistently advocated greater competition. We fully support the aims of increasing current account switching and enhancing transparency of terms and conditions. 6.2 The ICB’s proposals to improve the switching process—a seven day guarantee and the creation of a redirection system for payments by September 2013—will be costly (estimated to be between £650 million and £850 million) and the timescales challenging. However, we will be working closely with the rest of the industry to take forward this initiative. 6.3 To deliver swift results and improve consumers’ experience and perceptions of the switching process, the ICB could have focused more heavily on those companies acting as Direct Debit originators. Direct Debit originators do not always comply with the rules that state that amendments and cancellations must be actioned within three working days of receipt. We support Payments Council efforts to rectify the problem, and would advocate strong measures in this regard, possibly including extending the Direct Debit guarantee to include 2 For example, they include permissions for building societies to be able to: — Create floating charges which would enable us to settle repo transactions in treasury bills, gilts etc through “Delivery by Value” (DBV), which is the market norm. This would afford societies cheaper funding costs allowing us to be more competitive in the market. — Utilise derivative instruments for other legitimate business purposes, in addition to those risk management transactions that are currently permitted, subject to close supervision by the regulator. This would remove some of the commercial constraints on societies’ activities and lead to cost, and therefore pricing, benefits. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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originators’ keying of amendments, publishing details of poor practice and fining or excluding poor practitioners from the scheme. September 2011
Written evidence submitted by Consumer Focus About Consumer Focus Consumer Focus is the statutory consumer champion for England, Wales, Scotland and (for postal consumers) Northern Ireland. We operate across the whole of the economy, persuading businesses, public services and policy-makers to put consumers at the heart of what they do. Consumer Focus tackles the issues that matter to consumers, and aims to give people a stronger voice. We don’t just draw attention to problems—we work with consumers and with a range of organisations to champion creative solutions that make a difference to consumers’ lives.
Introduction Our goal is the creation of a financial services marketplace where the companies that prosper are the ones that offer products which are good value, simple to understand and trustworthy. We wish to see consumers empowered to switch to the products that most suit them and take advantage of the best offers. There may never be a better time for Government to ensure that in the future the sector meets consumers’ and society’s needs. The Independent Commission on Banking (ICB) report provides a solid platform to ensure the sector is fit for purpose. We believe reforms for improving competition, ensuring real choice and universal provision of financial services are necessary to make the sector fit for purpose in the future. We support the measures to remove barriers to new entrants to a retail banking sector which has seen significant consolidation since 2007. However, a healthy financial services market should not just be a small number of major banks and big building societies. More innovation and diversity is needed including other models such as credit unions, community initiatives and post office banking. We have focussed our comments on the competition aspects of the ICB’s recommendation as this is where we have the most evidence and expertise.
Our Response Improving competition We agree with the ICB that strong interventions are needed in the regulation of banking products beyond the current OFT reforms, which have failed to deliver either consumer protection or an effective market place. In our response we assess ICB proposals to improve competition and consumer outcomes
Switching process We are pleased the ICB has addressed the problems consumers face when switching. The current reforms put in place by the OFT following its 2008 report are not working. Reforms included improving the consumer experience in switching; most notably on ensuring Direct Debit transfers do not incur errors. Bankers’ Automated Clearing Services (BACS) also introduced an originator education strategy to ensure those firms who use Direct Debits have adequate systems in place to amend them. In addition, in December 2009, BACS promised that no consumer would lose out financially because of errors in the switching process from the bank or a Direct Debit originator. As consumers shift payments more and more to Direct Debit, it is vital reforms radically reduce the problems consumers face when switching in order for trust in the process to increase. Unhappily, and demonstrably, this is not the case.
Error rates in switching As the ICB notes, Consumer Focus undertook research with consumers and discovered a far higher rate of problems switching than had previously been found in the 2008 OFT report. Subsequent to the Interim report, new figures provided to the OFT by BACS showed error rates had actually increased from 7.6% to 8.5%. The ICB’s final paper noted that with an 8.5% chance of a Direct Debit being sent to the old account, for an account with “multiple Direct Debits this equates to a substantial chance that at least one of them will go wrong”. It later adds: “there is a 46% chance for a consumer with the average number of Direct Debits that at least one will go to the wrong bank”.3 The ICB explains why the technical data showing a low error rate per individual Direct Debit does not transfer to an improved consumer experience when switching.4 3 ICB Final report, p 219. 4 ICB Final report, p 185. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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It is three years since the OFT report into current accounts and still the error rate for Direct Debits remains stubbornly and consistently high. With consumers relying more and more on automated payment methods, it is right that the ICB’s proposed solutions involve automated transfers to ease of the switching process for consumers. We welcome the announcement by the Payments Council that the redirection service will be in place in 2013. It is important that the redirection service is designed to be in place for 13 months in order to capture every Direct Debit. This is because many customers have annual payments that will need to be successfully transferred. We must ensure that DDs captured by the automated process are updated by the firm or automatically through the process so problems do not resurface at the end of the automated transfer period. The Dutch example shows there is a danger that at the end of the automated period DDs will continue to go to the old account. If this can be implemented then the largest barrier that prevents those who wish to switch current accounts will be removed. We see less evidence for the ICB’s proposals on reducing the time taken to switch to seven working days from the current 18 working days. Our research did not identify consumer dissatisfaction with the time it currently takes to switch.5 We are as of yet unaware the extent to which the estimated costs are to create the infrastructure of the new service as against completing the switch in seven days. Further analysis and analysis of the costs–benefits of the constituent elements would be helpful.
Wider recommendations to improve the switching experience We believe two further alterations to the current switching process not mentioned by the ICB would encourage consumers to switch.
(a) Compensation In the long run the success of persuading more consumers to consider switching will depend on actual consumer experience. Trust in the process would be increased if consumers were confident that if things did go wrong they would be adequately compensated. That would mean that any fears, rational or otherwise, about errors rates would be tempered by the fact that their time and effort in resolving a problem would be adequately compensated. We recommended compensation (as well as restoration of any money lost as is already the status quo) to a consumer who has suffered an error, or if the agreed timelines and performance standards are not adhered to. That would encourage businesses to improve their performance and it would fairly compensate consumers who have had to chase up mistakes.
(b) Consumer information In 2009, the BACS working group established a guide for switching, a consumer website with tools and advice for switching, and template letters for consumers to use. We do not believe these initiatives are adequate. The promotion of switching could be better undertaken than under the current voluntary approach. The “switching service”, is only on the BACS website, which is largely aimed at industry not consumers, so unsurprisingly just 7,000 people looked at the site between September 2009 and September 2010.6 We found many banks’ websites do not refer to this website and nor is the documentation available in branches. The introduction of a new automated switching service offers a timely opportunity for radical improvements in the information provided to consumers to promote and navigate the switching process. We would like to take the opportunity of the automated processes to promote switching more widely than has been the case until now. The switching service information should be more actively promoted to consumers on banks’ consumer-facing websites and prominently in branches. Tools to encourage and support switching, both to and away from banks, need to be accessible and crystal clear with easy-to-read scenarios that consumers can relate to their own circumstances. When the new service is launched the Payments Council should produce an information campaign similar to the “I love Chip and Pin” campaign which went live on Valentine’s day 2006. Consumers will soon get an annual summary of charges and interest. That is intended to alert them to the cost of their account and potentially make them consider switching. We welcome that reform but its potential to encourage switching could be enhanced. We recommend the inclusion of a reminder on the annual summary that consumers have the right to switch. It could include a reference to a website where consumers can compare offers such as on the Moneymadeclear website. 5 Defined by BACS switching guide, and the EBIC code. This includes the when the new account must be operational (10 days) and when all automated payments must occur http://bit.ly/mBkiPt 6 OFT, PCA update, September 2010. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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This proposal has already been recommended and implemented by the Competition Commission following its investigation into the current account market in Northern Ireland.7 It seems appropriate for similar triggers to be available to consumers in Great Britain. This is also becoming best practice across other industries. For example, Ofgem has already introduced this in the energy sector following its Energy Supply Probe.
Consumers’ difficulties in understanding and comparing products As the Final Report makes clear, an improved switching process will only benefit around 12% of Personal Current Account (PCA) customers. It states: “even with the switching reforms half of customers would be no more likely to switch accounts with the new system”8 thus, “this gives cause to be sceptical about claims that the impact of this measure on its own will be transformational for competition or consumer choice”. Thus, it is vital wider reforms are put in place to address complexity. In pure economic terms complexity is an additional cost to consumers, to assess and comprehend the market and to choose a suitable alternative provider. We do not believe the OFT reforms to date to improve transparency adequately resolve this problem. We believe creative thinking is needed to ensure consumers can more easily compare products on offer and identify which account suits them best. For all customers of current accounts (including Basic Bank Account users, customers who suffer unauthorised overdraft charges and those who stay in credit) achieving transparency and comparability is difficult at the moment because an assessment of value very much depends on your own personal circumstances, how much money you have and how you use it. Annual summaries are a welcome addition to enable consumers to see what they are charged. Yet, without consumers being able to easily understand the revised costs from an alternative provider the annual summary and switching service are unlikely to lead to a significant rise in the switching rate. With packaged accounts growing steadily this makes comparison even harder still since there are multiple products to compare. It also makes consumers even less willing to switch because to do so would impact on a range of financial products they currently possess. Thus, price complexity and bundling mean there are clear limits to the potential for reforms to enhance switching.
ICB reforms—how to deliver transparency We agree with the ICB’s efforts to enhance “good” competition and reduce firms’ ability to offer “bad” competition. However, we are concerned that the transparency proposals lack bite and rely too much on recommendations for a future Financial Conduct Authority (FCA). The ICB report is right to identify significant changes to the operation of price comparison sites something we called for in Stick or Twist?. Currently, their use is limited because actual value depends on how each consumer uses their account. Pricing remains too complex for consumers to know which account is best for them. Without price comparison tools that can assess value for the individual and their history, we do not believe there is any hope of price comparison sites playing a strong role in helping consumers choose. The only way to ensure price comparison tools are improved is with the addition of individual usage and account data in unison. It is noteworthy at this juncture to compare what is being done in other sectors. In energy, consumers can “plug in” details of their bill into online price comparison sites to see which tariff is cheapest based on their usage patterns. There are differences that need to be worked through to ensure that industry specific problems are addressed. The largest one being that how consumers accumulate charges can vary enormously in banking, whereas in energy it is simply by usage. Potentially, a better comparison comes from the mobile phone sector. That industry also has complex pricing structures. As a result BillMonitor offer a service that allows consumers to see which tariff best fits their phone usage. Consumers simply have to consent to BillMonitor’s software reading the monthly electronic bill. The software then scans the market based on actual usage of differing services (minutes, peak and off-peak, texts, and mobile internet).9 Each month it generates a list of the best value tariffs for consumers based on actual usage. We believe further work could investigate the viability of such a comparison tool in the PCA market so consumers could base their assessment on which account offers best value based on actual evidence of how they have used their account in the past. There are clear problems that the ICB identifies in making price comparison sites a viable tool for comparison. We are happy to support all reforms proposed by the ICB on enhancing the service provided by price comparison sites. We share its recommendation that the My Data project should work through the difficulties that there will inevitably be in realising this agenda. We also share the ICB’s proposals to ensure 7 Competition Commission, 2007, Personal current account banking services in Northern Ireland market investigation p184. Remedy f) http://bit.ly/c2wAoG 8 ICB, Final report, p 220. 9 www.billmonitor.com cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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banks hand over all required information on pricing in a useable form and include representative costs for differing consumer subsets. Yet, we caution the committee the reforms to switching and price comparison sites will only achieve marginal returns due to the nature of the PCA market. Free in-credit banking means consumers do not consider switching since to them the account is “free” and where the alternative on the market, packaged bank accounts constitute complex bundling. These accounts are likely to further reduce consumers’ ability to compare, assess and switch. We discuss this further below.
Incorporate interest foregone in any annual summary
We agree with this proposal as historically it has been an important factor in assessing the costs consumers face from banking. The arguments in favour of this proposal in paragraph 8.72 are reasonable and appropriate. To make this work will require additional information from the banks such as average daily balances. The ICB report suggests the future FCA should undertake consumer research on how to present that information. It adds that the additional information should be on bank statements from January 2013. As the Financial Services Bill has not even entered parliament, one wonders whether the FCA will be ready to take this forward. The OFT is better placed to meet the end date as part of its work programme on the PCA market.
Complexity and tariff numbers
We agree the number of tariffs has grown too large. Preventing complexity is not simply about removing toxicity from products but is also about allowing consumers to understand and gain maximum value from the market place. Competition, as it currently operates in financial services, tends towards an increasing number of very similar products and this applies across all products in financial services. For example, the HM Treasury paper on Simple products has identified growing proliferation in the number of savings products.
Consumers are unable to make informed choices about what best suits them and they believe the complexity is there to catch them out. All this means consumers are turned off from engaging in the marketplace. Thus, we support the ICB recommendation that the future FCA should work on standardisation. There are two distinct ways in which standardisation proposals can be moved forward: 1. Vanilla products: There are various work streams looking at a vanilla product type, and how to make that successful. HM Treasury are looking at how to deliver “simple products”, the Financial Services Consumer Panel are developing proposals on “straight forward outcome products” and the Association of British Insurers have developed some product minimum standards in the insurance industry. A recent Social Marketing Foundation paper on trust in financial services recommended the Government should also create a “trusted product” kite-mark scheme to improve the quality of financial products, against which all other products must be compared.10 As the ICB recommends, the future FCA should take forward these proposals to develop workable and effective products that consumers can trust on current accounts with at most two or three useful and easily comparable variables. We also firmly agree with the ICB that the new regulator should be able to challenge unarranged overdraft charges, not just on the transparency of the charges but also on the fairness. 2. The future FCA’s powers: In our response to the draft Financial Services Bill we called for an explicit recognition in the legislation for the future regulator to provide a distinct and lesser regulatory regime for products produced under a vanilla or standardised product model. We hope such an approach should reduce costs and uncertainty for firms looking to develop such products and ensure regulatory resources are focused less on products designed to be safe and secure than other complex products more likely to lead to consumer detriment.
Transparency on non-price information
We believe the best way to compare non-price aspects is greater comparability and transparency about complaint handling by firms as a proxy for customer service. Complaints data is the best guide available to assess firms’ commitment to treating customers fairly, in terms of the amount of complaints, the uphold rate and and similar statistics from cases that reach the Ombudsman service.
Currently, the Ombudsman service and the FSA produce aggregated complaints data twice a year. Much more can be done to make this data useful, from more nuanced complaint categories, to complaints in relation to market share and finally by better presentation of the data through clear graphics. Consumer Focus already aids consumer comprehension by producing comparative tables on the largest banking brands that produce the vast majority of complaints. 10 http://bit.ly/rjS6Mn cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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This data can be further enhanced, helped with changes to the publication of data, and more widely disseminated. We believe the Money Advice Service, through its Moneymadeclear website, should lead on this work. Each of the banks should have to carry comparative tables on its website, provide such information to consumers thinking of switching and also in brochures as part of switching information in store.
Impact of free in-credit banking model on reforms
Although we welcome the ICB’s proposals to improve transparency and enhance the switching process there is a limit to the impact this will have on the market for current accounts. We believe this is largely to do with the free in-credit pricing model. When consumers are charged based on future unpredictable usage, evidence from the OFT shows consumers do not assess the charges in a rational way needed to ascertain and choose based on a rational appraisal of value.11
Furthermore, as the charges are both behaviourally dependent and deeply complex, it is difficult even if you know your past annual charges to know which account will be appropriate for you in the future. Evidence shows product complexity leads to a lack of trust in financial products.12
Our report on switching found three quarters of consumers had never even thought about switching their bank accounts in the last two years.13 The ICB is right to note the problems of “demand side weaknesses” are even more pronounced in the PCA market than in any other financial services industry.
We believe improvements in transparency and comparability, and ultimately switching, can only occur with radical prescription over the pricing mechanisms available to banks to ensure unfair and manipulative pricing strategies do not undermine efforts to improve competition. Without changes to pricing to make costs transparent the effective discipline of market forces cannot apply, leading to detrimental outcomes for consumers, market inefficiencies and productive losses.
Thus, while we welcome the recommendations on transparency they must surely comprise elements in a wider strategy to ensure charges and revenue in the PCA market are clear, upfront, comparable and transparent. Without a clear iteration of the need for clear and transparent charges there is a danger that banks may migrate charges onto ever more novel ancillary aspects of products, furthering complexity and opacity but in new ways.
While a logical solution would be to charge consumers up-front fees for the bank accounts—either via a transaction charge or flat rate—no bank dares to be the first to charge as they risk losing market share to rivals who decide to hold out longer. The free in-credit model of banking seems unsustainable and Consumer Focus is not in principle opposed to charging for bank accounts. However any move from the free in-credit model should be accompanied by a clampdown on unfair ancillary charges and a move to more transparent charging. Clear up-front charging would allow for much easier comparison and may promote a competitive market in current accounts. However there will be many losers not least among those consumers on low incomes who are able to stay in credit.
Effects on low income consumers
It is clear moving forward banks are likely to offer lower income consumers continually descending levels of service as banks seek to limit costs. For example RBS and Lloyds have restricted the access their basic bank account holders have to their money via the Link system. There are two reasons for this: greater inelasticity of demand from low income consumers; and firms offering attractive deals to richer consumers as part of a “cross selling” strategy. The dynamic of market competition (supplier profit incentives and consumer choice) simply does not apply to ensure banking products meet lower income consumers’ needs.
Consumer Focus evidence on current accounts and cash ISAs shows it is the minority—those in higher social categories—who switch more and are more likely to switch when these deals come to an end.14 Stick or twist found the social grades D or E have switched less and thought about switching current accounts less than other consumers.
Efforts to increase switching therefore are likely to disproportionately benefit higher income social groups who may be more likely to engage in a more transparent market. Lower-income groups are less engaged and are likely to remain so.
Secondly, firms are less concerned about providing products that meet low income consumers needs as they are less profitable. Many commentators have noted the PCA is increasingly seen as a gateway product for the banks through which they can promote other products such as savings, investment and mortgage products.15 Consequently, many banks are offering attractive teaser deals but for those with high monthly balances. 11 OFT, Price Framing, 2010, OFT Personal Current Account: A Market Study 2008, and follow up report 2009. 12 HM Treasury provides ample evidence of this in their recent paper on simple products 13 Consumer Focus, Stick or twist, p 31. 14 Research in switching in Stick or Twist, October 2010, research in Cash ISAs, February 2011. 15 For example Mintel, Retail Banking overview, November 2010. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Consequently, market reforms offered by the Vickers report, although welcome, are insufficient for low- income consumers as they may simply encourage an even greater cross subsidy from those customers not interested in switching to those who are tempted with introductory offers.16 More needs to be done to help those lower income consumers neglected by banks, who do not see them as profitable enough to provide with appropriate products. Bank accounts are essential services and policy-makers need to think about those at the bottom for whom enhanced market competition will do little to reach. September 2011
Written evidence submitted by the Association of Corporate Treasurers Executive Summary 1. The ACT is pleased to see that the ICB has tried to be practical and well balanced in its proposals in the Final Report. We accept that there are benefits for the UK in attempting to avoid, or reduce the risk or impact from, financial crises even when set against the ongoing costs of structural reform that have to be borne. 2. The ICB has set out principles, but precise wording of consequent primary and secondary legislation and subsequent rule-making must be seen before full implications for banks and for their business customers, with their individual contingencies, can be fully evaluated. 3. The requirements for increased capital for banks may however reveal a serious problem over shortage in the supply of equity and need for non financial companies themselves to raise more equity. An extended implementation period could help here. 4. The capital proposals from the ICB, taken together with re-regulation measures in progress driven by the G20 agenda risk reducing the availability of bank funding for business. We are sympathetic to the views of US regulators that the effect on the real economy of the G20 motivated changes cannot be accurately estimated.17 Large companies can have access alternative markets not available to smaller companies. It is important that any structural changes to the UK banking system be accompanied by significant and practical measures to encourage the flow of finance to both SMEs (small and medium enterprises) and mid-sized companies. 5. The proposed design of the ring fence generally can achieve the separation required but retain sufficient flexibility to prevent undue distortions and inefficiencies in the market. The flexibility is to be welcomed. 6. There are, however, some very significant changes proposed, not least in operational terms for the banks affected. It is important to resolve the reforms to be introduced with due speed (allowing time for detailed consultation) so as to remove the destabilising effects of uncertainty. An extended period for implementation is desirable so that all parties, banks and business customers, can adapt. This task should not be underestimated.
The Association of Corporate Treasurers (ACT) 7. The ACT is a professional body for those working in corporate treasury, risk and corporate finance, providing the widest scope of benchmark treasury qualifications. Our 4,200 members and 2,400 students work widely in companies of all sizes through industry, commerce and professional service firms. Our members working in non financial services companies are typically responsible for their company’s dealings with the banks and financial markets.
General 8. The ACT regards the ICB Final Report as pragmatic and, seemingly, balanced. Whilst the changes and challenges for the affected banks are hugely significant we believe that the implications for customers, large and small, and their day to day banking needs, will not be so material. Nonetheless it will be beneficial to resolve any uncertainty quickly by taking clear decisions and progressing the legislation as soon as possible and then allowing for a much longer period for an orderly implementation. 9. At present there are many new elements of financial regulation in train, driven often by the international agenda. The ICB recommendations propose relatively small changes in the context of these other regulatory changes for banks and markets following the financial crisis. Taken together the regulatory changes in prospect are very significant and inevitably complex. 16 A recent report from the SMF made this point clearly. http://bit.ly/rjS6Mn 17 (i) The Financial Times of 8 June 2011 reports that Jamie Dimon of JPMorgan Chase asked Ben Bernanke if anyone had “bothered to study the cumulative effect of all these things?” To his great credit Bernanke replied with some candour: “I can’t pretend that anybody really has... We don’t really have the quantitative tools to do that”. (ii) John Walsh, Acting Comptroller of the Currency commented to a dinner in London, 21 June 2011: “I want to urge due caution regarding the cumulative effects of all the contemplated changes”. ... “In considering whether we’re getting all this right, I am reminded of the saying: “In theory, there is no difference between theory and practice. In practice, there is”. We don’t know how all of these new approaches will work in practice, how they may interact with one another, and what their cumulative impact will be”. (http://www.occ.treas.gov/news-issuances/speeches/2011/pub-speech-2011–78.pdf). cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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10. We are at an early stage in considering all the implications of the Vickers report and of the international G20 inspired re-regulation generally. It may be that as the details are resolved for particular elements, further particular difficulties and unexpected interactions will become apparent. It will be necessary for legislators and regulators to be prepared to make appropriate amendments and adjustments.
Capital 11. The ICB recommends a requirement for up to10% equity capital for large ring-fenced banks which is very similar to the 9.5% level required under Basel III/CRD IV for systemically important banks. There is then a requirement to bring the loss absorbing capital up to a cumulative amount between 17% and 20% of risk weighted assets. Without wishing to specify a precise level we recognise that an additional buffer is required to diminish the likelihood of bank failure if subject to significant shocks. Reducing the occurrence of financial crises carries with it a significant benefit to business and the economy. Theoretically there should be a price and rate of return which is sufficient to generate a demand for this sort of bail-in bond or similar capital, but we remain doubtful about the market’s capacity and willingness to provide this capital in sufficient volumes. 12. A quantitative impact study by the Basel Committee on Banking Supervision shows banks worldwide would need additional capital of €175 billion to reach a core capital ratio of 4.5% proposed under Basel III and €600 billion for the 7% requirement (euro area bank equity issuance has been $20 to 50 billion annually since 2005). 13. If there is indeed a shortage of capital, the banks can instead achieve their target ratios by shedding assets, in other words by reducing the extent of their lending. 14. Our members working in business are normally responsible for the funding of their companies. If the banks are in the event unwilling or unable to lend, affected companies will have to adjust their own capital structure and will come to depend more on equity or capital markets. 15. Although corporate gearing in the UK has fallen back somewhat in the past year, it is still very high historically. Anecdotally, our members are indicating that they are beginning to plan to reduce gearing—partly to move to a more robust structure able to withstand uncertainty and partly for fear of lack of bank funding or availability of capital markets in the years ahead. We have concerns over the capacity of the markets to provide this new capital for companies and over the cost particularly at a time when the banks themselves will be raising capital and governments probably being more highly indebted themselves. 16. Share capital cannot be raised easily at the exact point of need, but rather it has to be raised when markets are receptive, in advance of need. This timing effect will tend to reduce corporate leverage and increase the requirement for equity even more. This prefunding and generally cautious approach will result in companies operating at gearing levels that may be sub-optimal from the point of view of stakeholders, including shareholders, and society at large. This puts pressure on weighted cost of capital deployed and thus, at the margin, on business activity across the economy. 17. We do hear arguments that if the banks have to hold additional layers of loss absorbing capital this will come at a cost and that with reduced gearing their returns on equity can only be preserved if their lending rates rise significantly. Treasurers accept that pre 2008 the amounts charged for credit and risk were underpriced and that it may be “correct”, in some sense, for prices to have risen. But clearly treasurers and their companies have a very strong interest in keeping the cost of credit down—it ultimately drives the viability of what they can invest in and thus jobs and economic activity generally. 18. We agree that it would be appropriate for less risky banks with more conservative capital structures to deliver a much reduced return on equity. We have seen the Bank of England paper from David Miles and others18 and find persuasive their arguments that with much increased capital the cost of bank funding for their customers might only rise by a modest amount. 19. However, we also think that there might be an expectation that annual bank returns on capital in the mid or high teens seen in recent years might fall in future years generally rather than being restored to more normal levels by the periodic effects of financial crises. As regards large corporate banking, the ICB’s Interim Report noted “It is clear that there is a lack of price transparency in this market and that for some products and services prices are very high. The remuneration levels of employees involved in providing some of these services do not give confidence that competition is working well for customers”.19 So there may be some cushion available there. 20. The ICB report proposes that the 17% cumulative loss absorbency capacity is required in both the retail bank and the non ring-fenced banks. Given that the ring-fenced bank is supposed to be capable of surviving an insolvency of the non ring-fenced side and is recommended to be capitalised accordingly, presumably this is to protect the external banking system as a whole—the same purpose as the Basel III proposals. We are not best placed to judge if the Commission has justified querying the appropriateness of the Basel III proposals for 18 Optimal bank capital by David Miles, Jing Yang and Gilberto Marcheggiano http://www.bankofengland.co.uk/publications/ externalmpcpapers/extmpcpaper0031.pdf. 19 Interim Report of the ICB at 2.82. [The ACT noted the high targets for returns on corporate relationships of banks in the Appendix to its response to the HM Treasury discussion paper on non-bank lending in early 2010. http://www.treasurers.org/hmt/nbl/actresponse, at page 15ff]. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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capital on the non ring-fenced side. If not justified, such a change would weaken the international competitive position of those UK universal banks with retail operations to which the ICB recommendations would apply.
Ring Fence
21. We think that the Commission has done a good job in its recommendations for how a ring fence between retail and wholesale banking should be positioned and function, given that UK resolution proposals for distressed banks already require separability—distinct from separation—into different businesses.
22. The ACT is pleased to see the Commission recommends that large corporate loans and deposits are permitted on both sides of the ring fence. It is also encouraging to see that modified “one-stop” relationships for customers who want both retail and investment banking services would be possible, as would expertise, information and sharing of operational infrastructure across subsidiaries. These were some of the ACT’s key concerns when it engaged with the Commission at the consultation stage and they play an important part in the efficient day-to-day functioning of businesses large and small.
23. Allowing wholesale deposits with the ring-fenced bank provides a welcome flexibility for company treasurers. However the preferred status given to the FSCS insured deposits subordinates those deposits and means that once there are any signs of distress at a ring-fenced bank those deposits, kept short-term in anticipation, will probably be promptly withdrawn en masse, destabilising that bank and causing a lack of liquidity and perhaps triggering failure. Alternatively we expect creditors will seek collateral thus diluting the preference and the position of ordinary non-retail depositors. Since the FSCS is funded by the banking and financial services industry we wonder if this depositor preference is really required.
24. The retail bank is prohibited from taking on exposures to non-bank financial organisations. As a point of detail we would like to clarify when definitions are drafted that this should not apply to non-regulated finance or treasury companies within a non financial services group.
Competition/International Competitiveness
25. With regard to competition in wholesale banking, we note that the Commission does not dwell on this in view of limited responses to its Interim Report. We continue to share the concerns the Commission set out in the Interim Report about this and note that the subject remains for later enquiry. Even for larger companies competition in banking is lacking and this may be reflected in the returns banks have in recent years expected to make on corporate banking.
26. There is a risk that competitiveness of the UK wholesale banking sector may be damaged by the Vickers reforms in that the wholesale banking side would no longer benefit from the efficiencies of scale, the synergies, the valuable retail deposit base and some of the cross selling opportunities, thus setting them at a disadvantage to their overseas rivals. Given the market shares in the UK of the affected banks, there is a material risk that much of the cost of this would be passed on to customers rather than reducing bank returns on capital and staff remuneration costs as discussed in paragraph 19, above.
27. The cost and complications arising from the practical implementation of the ring fence should not be underestimated. There will also be material ongoing costs in terms of lost efficiencies and synergies. We would be concerned if during the transition customer service deteriorates for businesses in the UK.
28. We note too that it would not be difficult for a UK retail bank to provide its UK retail services from a European group company and passport its retail operations back into the UK and avoid the new rules. Anti avoidance provisions may address such a relocation but it is hard to see how that would easily comply with European regulations. There may be perceived competitive advantage for new retail banks coming in from abroad that would not be subject to the new rules in course of time.
Smaller/Mid-Sized Companies
29. Overall we recognise the argument that there is a cost/benefit advantage in moving to a more robust UK banking structure, but we note that the benefit comes with some disadvantages for businesses and their ability to finance themselves. For larger companies any problems over financing can be redressed through raising new capital, borrowing from overseas banks or from accessing non bank sources of funding such as the international bond markets when circumstances allow. Many of these mitigating measures are not readily or at all open to SMEs and mid-sized companies.
30. It is important that any structural changes to the UK banking system consequent on the G20 sponsored changes or the report of the ICB be accompanied by significant and practical measures to encourage the flow of finance to those smaller and mid-sized companies. 4 October 2011 cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Written evidence submitted by Royal Bank of Scotland Group Thank you for inviting us to respond to the Final Report of the Independent Commission on Banking. While we welcome the opportunity to give a preliminary reaction, it will take time for the full implications of the Commission’s recommendations to become clear. These will also be influenced by detailed rulemaking, market developments and customer and competitor actions. I should say at the outset that RBS supports the direction of international banking reform. In that regard we are generally supportive of the ICB’s focus on capital levels and progress towards an effective resolution regime, even though this will be costly for bank shareholders and potentially for their customers and the economy. While we remain convinced that the Commission’s proposals on ring-fencing will not achieve the benefits intended, we recognise the clear determination that they should proceed. RBS set out its arguments in full in its published submission to the ICB, but one point bears repeating: ring- fencing will not create a “safe” ring-fenced bank and a “risky” non-ring-fenced bank. Many aspects of EEA retail and commercial banking permitted within the proposed ring-fence entail considerable risk, while many prohibited activities are routine, low risk services to UK corporates and institutions. In RBS’s case, most of the losses incurred since the onset of the financial crisis have been ordinary commercial banking loan losses, not global markets losses.20 While our view of ring-fencing has not changed, we realise the Government has endorsed the main recommendations of the report. We will therefore work closely with Government and legislators to carry out the reforms arising from the Commission’s report and to assist in the implementation of its recommendations. I hope that in this implementation the Government will be cognisant that the incremental impact on financial stability of the ICB’s final proposals should be measured not against the world of banking regulation as it was in 2007 but against the new regulatory framework that will soon be in place. The Basel III reforms to capital and liquidity are in train. The FSA and Bank of England are working on Recovery and Resolution Plans with each bank. There will soon be a new supervisory architecture as well as international crisis management mechanisms such as bail-in measures to ensure that equity and debt investors, not taxpayers, bear the burden of recapitalising failing banks. It is against this backdrop that the design of a new UK ring-fence should take place. The delicate juncture for the economy and for the international financial markets also needs recognition, as the 1GB’s proposals, even if not implemented for some time, already form part of market and company analysis and decision-making. The ICB’s proposals will entail significant costs not just to the RBS Group but to the UK banking industry and to the UK economy as a whole. You will have seen a wide variety of analysts’ estimates confirming this judgment. This will present a significant challenge to the value of the taxpayer’s holdings in UK banks. In future, in light of regulatory change, it is likely that there will be a lower contribution from the financial sector to the economy than in the past or than would otherwise have been the case. As I said at the outset, RBS supports the direction of international banking reform. We also support the ICB’s recommendations relating to competition in the UK banking market. We think it unlikely, however, that the proposed UK ring-fence will add to financial stability in a cost-effective way. 6 October 2011
Written evidence submitted by Barclays plc 1. Executive Summary 1.1. Publication of the Independent Commission on Banking’s Final Report represents a welcome step towards the regulatory certainty that banks need in order to focus on serving their customers and clients and, thereby, fostering economic growth. 1.2. We support measures aimed at balancing enhanced financial stability with growth. We see resolving “too big to fail” as a key part of that, and we welcome measures to achieve it. 1.3. We remain un-persuaded that a retail ring-fence offers enhancements to financial stability and believe it has, at best, marginal benefits as a resolution tool over and above reforms already in place, underway, or in development, including the improvement and alignment of resolution plans and powers and improvements to loss absorbency requirements for banks at the global level. 1.4. There is understandable, but considerable, ambiguity around how the ring-fence will operate, the impact that it will have on bank costs, and the wider costs to the economy. This uncertainty, arising directly from the Final Report, exacerbates what is already a difficult market environment for banks globally given sovereign and global growth concerns. Clarity must be obtained through the legislative process, and the Treasury should have an explicit objective to minimise the risks of creating unintended consequences as specific rules are designed. 20 The assertion in Box 2.1 of the ICB’s Final Report that most of RBS’s losses arose from its global markets activities is incorrect. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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1.5. By its own admission, the Commission’s recommendations go significantly beyond international regulatory standards; UK based banks therefore will not be operating on a level playing field. We recognise that the Commission has considered this impact and made some efforts to mitigate this, but it has not eliminated it. 1.6. Barclays supports the recommendations to improve competition, particularly enhanced switching for customers, and is participating in the new industry commitment to make improvements by September 2013. 1.7. The approach to implementation must now be practical and pragmatic. If the financial stability recommendations set out by the Commission (including the ring-fence and capital requirements) are pursued, this should happen in a way that minimises the cost to the economy and the impact on the competitiveness of UK banks. 1.8. The timescales for implementation reflect the practical reality of putting in place the legislation that will enable what are complex and far-reaching structural reforms. Attempting to implement those reforms without primary legislation would risk destabilising the sector and undermining the intention of the reforms.
2. Introduction 2.1. Publication of the Final Report represents a welcome step towards the regulatory certainty that banks need in order to focus on serving their customers and clients and fostering economic growth. However, the recommendations constitute significant and far-reaching reforms with a high degree of ambiguity remaining as to final design, implementation, precise impact on bank costs, and the consequences for the wider economy. Further careful consideration of the proposals is therefore required, and we welcome the Treasury Committee’s continued scrutiny of the recommendations to ensure that the correct reforms are implemented in the right way. 2.2. The final recommendations put forward by the Commission are broad and complex. Barclays is still considering those recommendations, and our submission here represents our preliminary views only. This submission first looks at recommendations relating to financial stability, then considers proposals to improve competition, before examining the approach to, and timescales for, implementation.
3. Financial Stability 3.1. Much has changed since the financial crisis both within banks and across the regulatory landscape to make banks safer and to reduce the impact of bank failures. Barclays Core Tier 1 ratio has broadly doubled since 2007 from 4.7% to 11%; our leverage is down by one third, from 33x to 20x; and our liquidity pool (of cash or cash equivalent instruments) has grown from £36bn in 2008 to £145bn. For the industry: capital and liquidity has increased; the term of wholesale funding and the volume of liquid assets have increased materially; risk management and governance arrangements have improved; recovery and resolution plans are under development; deposit insurance arrangements are being strengthened; and, the quality of supervision has been enhanced. 3.2. These changes have significantly enhanced the stability of the UK based banking system. However, each adds to the cost of doing business and therefore to the cost and potential availability of credit to businesses and consumers. This is exemplified by the fact that UK banks average Return on Equity was 7.5% for full year 2010 (excluding RBS for which there is no publicly disclosed Group RoE). Therefore, it is important to continually review the aggregate cost to the economy of the changes placed on the banks. 3.3. Further reform is being implemented or is under consideration. In particular, reforms: — to increase capital further for systemically important institutions; — to align resolution planning activities and powers across borders, and ensure the relevant authorities have powers to impose losses on shareholders and creditors rather than rely on taxpayers; and — to improve the infrastructure supporting key trading markets to make it more resilient. Any incremental, UK specific reforms should be required to demonstrate significant additional benefit over and above the cumulative effect of those reforms at an acceptable cost to the economy. 3.4. Barclays welcomes the Commission’s recognition that the universal banking model offers benefits to financial stability and the wider economy and that, for these reasons, full separation is undesirable. 3.5. However, the Commission argues that there is a strong case for some form of ex-ante structural reform on the basis that it will make it easier to resolve banks that get into trouble and to insulate critical functions of retail banks from external shocks. That is the premise underlying the proposed ring-fence. Barclays does not agree with the Commission’s analysis for the reasons set out below.
Retail Ring-Fence 3.6. The Commission argues for a retail ring-fence on the basis that ex-ante structural separation of this sort would isolate those banking activities where continuous provision of service is vital to certain individual customers who generally have no alternative to their main provider. The Commission argues that ex-ante separation of these activities would ensure that at the point of non-viability of a bank, these activities could more easily be separated and continuity of service ensured without taxpayer support. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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3.7. Regulatory changes introduced since the financial crisis and currently in development21 at a global, regional (EU), and national level have materially decreased the likelihood of a bank failing and the impact of a failure by making them easier to resolve. This includes Resolution and Recovery Planning (so-called RRPs or Living Wills) and so-called bail-in of debt—which significantly adds to the potential loss absorbency of a firm and provides the capital required for an orderly recovery or wind-down of a business. 3.8. Given the international nature of financial markets, it is important for the UK that all banking markets are stable and secure. We therefore welcome moves which will see these reforms implemented at an international level and are actively participating in the dialogues that will produce that outcome. 3.9. We do not believe that a retail ring-fence will materially further enhance the stability of banks. To the contrary, in some cases, such structural separation could have a destabilising effect. In particular, the ring-fence will disrupt the flow of liquidity within a bank, which, at the extreme, could result in a bank failure which would not otherwise have occurred. The disruption to free flows is likely to put an increasing burden on the Bank of England as “Lender of Last Resort” to provide liquidity support during a crisis. Subject to how the design and operation of a ring fence are finalised, the capital flexibility might also be constrained. 3.10. The objectives set out by the Government for the Commission would be best achieved through firms implementing a combination of credible Recovery and Resolution Plans and operational subsidiarisation (see p5) to enable continuity of service, set within the context of a wide and effective resolution regime. We welcome the Commission’s recognition of the importance of such measures but believe they have underestimated the stability benefits that these combined reforms will deliver. 3.11. Implementation of a ring-fence will add to the cost of UK banking operations. Higher funding costs, for example, will have an impact on the cost and availability of lending to customers. The competitiveness of UK wholesale banks will also be affected if one or more of the measures are implemented unilaterally. Therefore, if a ring-fence is to be introduced, it is vital that it is implemented in a way that minimises the cost of implementation and only after careful consideration of such costs and potential benefits. 3.12. The cost of implementation of the ring-fence will depend on the precise detail of the design and operation of the ring-fence. The high level principles for the operation of the ring-fence, articulated in the Commission’s report, lack sufficient detail to enable a full understanding of the practical implications of how the ring-fence will function and so it is not yet possible to confidently model its cost. 3.13. Whilst Barclays preliminary assessment suggests that the flexible approach to the design of the retail ring-fence could help mitigate some of the expense of a ring-fence (flexibility which should be enshrined and protected in legislation), a large number of ambiguities and variables remain that will impact the way in which the ring-fence is ultimately implemented and, therefore, its cost. 3.14. For example, there is currently insufficient detail to reach an informed view on: — The precise nature of third party relationships that must be adhered to between the parent and ring- fence, which will significantly affect banks’ ability to efficiently manage their balance sheet and provide liquidity to the retail ring-fence both in time of crisis and during “business as usual” activity. — The interplay between loss absorbing capital requirements and (as yet undefined) limits on parent and wholesale funding which could effectively establish a prescriptive funding structure for the ring-fence. — The precise definition of EEA customers to be used to construct the ring-fence. — The relationship between the ring-fence and any operational subsidiary(ies) that are set up to ensure that all aspects of the entity are resolvable. — The combined implications of a minimum amount of loss absorbing capacity; bail-in; and depositor preference on the funding basis of the retail ring-fence. 3.15. It is important to note that whilst there is agreement internationally on the need for stronger resolution tools, the UK is alone in considering ring-fencing. 3.16. Barclays disagrees with the notion put forward by the Commission that the increase in funding cost of the unsecured finance in the wholesale division of banks will be due to the removal of so-called “state support” notches provided by some Credit Rating Agencies. Analysis shows that there is no correlation between funding costs and such notches. Rather, funding costs are driven by underlying bank strength expressed by their base ratings—Barclays is able to fund itself more cheaply than many banks which receive more support notches for example. Because these reforms will remove diversification benefits and segregate certain assets and liabilities, it is likely that funding costs will increase because the underlying strength of the business units will be diminished and unsecured creditors to the non-ring-fenced part of the bank will become structurally subordinated. 3.17. Barclays believes that no bank should benefit from a taxpayer guarantee; the aim of these reforms is to enhance financial stability by making banks resolvable, not to enshrine taxpayer support to certain types of banks. If a market perception builds of an explicit guarantee for the retail ring-fence, that will create highly undesirable customer behaviours that, especially in a crisis, could obviate the benefit of the design flexibility 21 For a full list see Barclays Response to the ICB Issues Paper, page 11. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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that the Commission has provided. That will arise because customers may elect to redirect their funds from the non-ring-fence entity to the retail ring-fence in the midst of a crisis in order to benefit from the perceived government guarantee with a resulting impact on the liquidity of the firm.
Operational Subsidiarisation 3.18. The Committee will be aware that Barclays considers operational subsidiarisation (whereby the part of a bank’s infrastructure that is vital to ensure ongoing operation of critical functions is placed into a separately capitalised and insolvency remote subsidiary) to be a vital part of recovery and resolution. Operational subsidiarisation ensures that the critical functions (the same as those defined by the Commission) of a bank are able to continue to operate in the event of a bank becoming non-viable. The imposition of a retail ring- fence does not change our view. Given the importance we attach to it, Barclays remains committed to implementing operational subsidiarisation by 2013. There is significant ambiguity in the Final Report as to how such subsidiaries will interact, and we look forward to obtaining clarity from HM Treasury, as quickly as possible, so that we can continue to execute our resolution planning activities at pace.
Loss Absorbency 3.19. The Commission’s recommendations on loss absorbency go well beyond standards yet to be agreed internationally through Basel III and explicitly anticipate reforms in the EU on crisis management and globally on resolution planning. If these reforms are to be implemented in the UK in advance of those regional and global reform movements, it is vital that UK authorities work closely with the industry to ensure that similar changes are introduced as quickly as possible on an international basis. 3.20. One other area that caused considerable confusion, in the immediate aftermath of the publication of the report, was in the language relating to the Commission’s recommendations on primary loss absorbing capital (or PLAC)—especially its use of the term “bail-in bonds”. Specifically, the recommendation for UK banks to hold a minimum of 17 to 20% PLAC was widely misunderstood. Many compared this to the so- called “Swiss Finish” and assumed the UK was considering the same reforms. However, the ICB recommendations related to their expectations that the international authorities will put in place a so-called statutory bail-in regime under which any wholesale unsecured finance held by banks would be subject to loss in the event that any bank becomes non-viable. In such circumstances, the total loss absorbing capacity of those banks will likely well exceed the recommended minimum PLAC, as the Commission illustrates. 3.21. Barclays agrees with the principle of extending the PLAC to cover unsecured creditors to enhance the ability of a bank to absorb losses. However, there are considerable ambiguities in the Commission’s recommendations relating to the secondary bail-in powers that are to be granted to the resolution authorities. Their recommendations appear largely consistent with Financial Stability Board (FSB) proposals granting resolution authorities primary bail-in power to impose losses on long-term unsecured debt, with secondary power to impose losses on all other unsecured liabilities—if required. However, including certain liabilities into secondary bail-in (eg, uncollateralised derivative positions) might create countercyclical effects prior to the execution of a primary bail-in that put into question the purpose of the bail-in or the feasibility of resolution. The consequence of these recommendations needs significant and careful consideration.
4. Competition 4.1. Barclays fully supports actions to increase competition in the UK banking industry. The switching and transparency initiatives recommended by the Commission are currently being executed by the industry, and as an individual institution we commit to continuing to develop and implement new ways to ensure that our customers’ lives are made much easier. 4.2. Although the Report stops short of recommending an immediate reference to the Competition Commission for a market investigation into retail and SME banking, it does advocate that this should be considered in 2015 if such a reference has not been made by then. We believe this would be an unnecessary step given the findings of the Commission and all of the prior studies of competition that have been conducted on the UK retail market in recent years. 4.3. Further, the Report recommends that the FCA should have a primary duty to promote competition in addition to enhanced competition powers, and that the current proposed statement of objectives should be strengthened to reflect this. The aim seems to be to create an economic regulator. We feel that this would be highly unusual and an unprecedented step in the financial services sector. 4.4. The Commission does not appear to have taken account of the fact that the proposed structural reforms are likely to have a knock-on impact on competition in banking. In particular, the retail ring-fence and associated increase in capital requirements are likely to increase costs for consumers and raise barriers to entry for new competitors as they will effectively represent new fixed costs of entry.
5. Timescales 5.1. Barclays regards the proposed implementation timelines set out by the Commission as pragmatic given the range of steps that must now be taken (including new primary legislation) and the time it will take to cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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complete each. While that timeline may look longer than necessary, these are fundamental reforms to the industry, and we believe the time indicated is necessary to allow careful assessment of the recommendations. Their full and careful consideration will allow a thorough cost benefit analysis to be conducted to ensure that the measures balance the benefits that they bring to financial stability with the cost to the economy.
6. Implementation 6.1. Barclays notes the Government’s stated intention to include elements of the Commission’s recommendations in the forthcoming Financial Services Bill. There is a strong case for including clauses within that Bill that gives the Financial Conduct Authority (FCA) a statutory objective for competition. However, it is important that there is alignment between the FCA’s competition objective and existing powers held by competition authorities such as the Office of Fair Trading (OFT) and Competition Commission. 6.2. Because the UK authorities already have considerable resolution powers granted through the Banking Act of 2009 and the special resolution regime within that, there may be opportunities to refine that existing legislation through the Financial Services Bill to deliver the Commission’s related recommendations. However, the implications of depositor preference require careful consideration because there could be material unintended consequences unless this is designed appropriately, particularly in conjunction with the other reforms. Such a reform will have far reaching (and potentially extraterritorial) consequences on the nature of insolvency law in the UK and customer behaviour, so time should be taken to ensure that legislation is drafted carefully and there is sufficient consultation to ensure that unintended consequences do not undermine the intention of the reforms. 6.3. The significance of the Commission’s recommendations; their potential impact on the UK economy; implications for UK banks’ ability to compete globally; and the ambiguous, under-developed nature of many of the recommendations require a robust and thorough consultation process. 6.4. This should include a rigorous cost benefit analysis on the recommendations ahead of any legislation, explicitly taking into account the range of other reforms already delivered, underway, or under development. 6.5. The Commission’s recommendations have the potential to reshape the banking industry for generations, and it is essential that adequate time is taken to provide a proper statutory footing for those changes and to allow full consideration of their impact on the UK’s fragile economy today and in the years and decades to come.
7. Conclusion 7.1. These represent Barclays initial thoughts. We look forward to working with HM Treasury to clarify the ambiguity in the Commission’s Final Report and to identify a practical and pragmatic approach to achieving the Government’s desired objective with respect to financial stability while preserving the ability of UK banks to compete effectively inside and outside of the UK so that they are able to support fully their customers and clients and, thereby, contribute to economic growth. October 2011
Supplementary written evidence submitted by the Royal Bank of Scotland Group ICB Implementation Costs The Committee asked for details of our cost estimates for the recommendations of the Independent Commission on Banking. There a number of sensitivities surrounding our estimates; namely that the proposals are yet to be fleshed out in detail, market conditions will vary between now and full implementation, plus there is a complex interaction between customer, market and bank decision making that is currently difficult to model with any precision. The illustrations below relate only to RBS, but given we are only one of the banks affected, it illustrates why we estimate the costs of the proposed reforms to be higher than those estimated by the ICB. We estimate22 the costs to fall in the following areas:
1. Additional Capital held by UK Banks This will be in the form of equity capital and costs for a capital structure above equity to meet the PLAC requirements put forward by the ICB. The higher levels of capital proposed are likely to require buffers in excess of the target set in order for banks to operate normally. Furthermore the capital outside the ringfence, while explicitly only subject to Basel requirements, is likely to be significantly higher as a result of the weaker credit profile caused by creating ringfenced entities. The total cost to banks in terms of incremental capital buffers cannot be ascertained at present. Nevertheless by way of illustration for RBS alone, using our current 22 It is not clear at present what the increases in capital and funding may be in future, so it would not be correct to combine the costs outlined above into an overall estimate of the ICB costs to RBS. Applying this methodology may lead to either an underestimation (or possibly depending on the implementation details an overestimation) of the potential costs. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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market implied cost of capital, every additional 10% carries a pre-tax cost to shareholders of some £750 million per annum.
2. Increased costs of market funding We expect the cost of market funding to be higher in the non-ringfenced bank as a result of lower credit ratings than would have applied to a more diversified unitary bank without ringfencing. The cost of this will depend on market conditions at the time and the volume of finance involved. There will also be inefficiencies of trapped liquidity and funding as between the ringfenced entities. Again by way of illustration, a 0·5% increase in funding costs on RBS’s current volume of term wholesale funding would equate to some £500 million per annum.
3. Increased operating costs to implement and operate ring fence The operational costs are hard to estimate until the final details of how the operational setup is to be required are complete. Our estimate is that implementation costs alone may lie in the range £500 million to £1 billion for RBS with ongoing operational costs of some hundreds of millions annually in certain scenarios.
4. Customer impacts In addition to capital, funding and operational costs, we expect there to be customer related costs. There will be customers who do less business with UK banks as a result of ringfencing both reflecting the additional complexities of dealing with banks with ringfenced entities and some of the credit uncertainties that ringfencing creates. This business is likely to migrate to non-UK banks. The quantifying of this impact is currently impossible. We nevertheless expect it to be significant over time. As we have previously stated to the House of Lords Economic Affairs Committee we believe the public policy direction is clear in relation to the implementation of the key recommendations of the ICB report. Therefore, our focus is on preparing the bank to adjust to the new regime and ensuring that the potential impacts on our customers and shareholders associated with operating in the post-implementation environment are fully understood.
Fixed Rate Business Loan The Committee asked for details on the initial take-up of our fixed rate business loan product. For the benefit of the Committee it may help to set out some background to this new product offering. RBS announced on 3 November that for a three month period to February 2012 we are offering a range of fixed rate loans at special introductory discounted rates. These loans can be taken over three, five or 10 years. They have no arrangement fees and no early repayment charges. A business borrowing £75,000—the average small business loan—could save as much as 60% on the cost of the loan over three years. We believe this is the best offer we have ever made for small businesses. Our aim is to encourage our customers to invest in their business as part of our efforts to get behind the economic recovery. To demonstrate this commitment, RBS will need to lend an additional 10% to recover the costs of the initiative. As with the launch of many products, it will take some time before the volumes increase. To date we have received loan applications worth £9 million and loans worth over £2 million have been drawn down. We have recently begun a campaign of external promotion to generate further interest, including a direct mailing to 31,000 customers and 69,000 prospective customers with details of these new rates.
Lending In our Q3 results statement we reported that new lending in the first nine months of 2011 totalled £68.7 billion. These totals lead the industry and substantially exceed RBS’s natural share of customer relationships. Of this figure, new SME lending in the first nine months of the year totalled £30.7 billion (£23.6 billion of new loans and facilities and £7.1 billion of overdraft renewals). This was achieved in spite of demand from SMEs remaining muted, with loan applications during the quarter down 12% from the prior year at 68,000. Our approval rates remain above 85%. The Committee asked for more detail of our SME loan pricing. At our Q3 results presentation we reported that our average price of new SME lending was generally stable, averaging 3.77%. This is an average and there will be customers paying more (and less) than this. Loans at higher rates, tend to be unsecured, fixed- rate lending with no fee attached.
Access to ATMs for Basic Bank Account Customers The Committee asked for details of cost savings made from changes to ATM access for our Basic Account customers. First, we must stress that RBS Group is committed to offering the option of basic bank accounts to our customers who might otherwise struggle to access banking services. Restricting access was a difficult decision for us to take, but we are making a loss on these products which we need to reduce. We currently pay cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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a charge on every transaction, every time someone checks their balance or makes a withdrawal at an ATM run by another company. This costs between 21p and 35p on each occasion.
We currently have over 8,000 cash machines through RBS, NatWest, Tesco and Morrisons making it one of the largest ATM networks in the UK. Our decision was taken with the knowledge that nine out of ten Basic Account holders live within one mile of an RBS ATM or Post Office and so would continue to have widespread convenient free access to cash. Where a concern is raised we are dealing with those customers individually. If a customer advises us that it is more difficult to get access to their cash at one of our ATMs or the Post Office, because they live in a remote rural location or have a disability, we are providing an account that provides full ATM access. We have written to all basic account customers to ask them to get in touch if this applies to them to try to minimise the impact on potentially vulnerable customers.
The Committee may be interested in looking at the various Basic Account products offered by the UK banks. This document from the Money Advice Service from November 2011 demonstrates the different products available: http://moneyadviceservice.org.uk/_assets/downloads/pdfs/your_money/a5_guides/basic_bank_ accounts.pdf
The table on pp 6–7 demonstrates that our competitors have chosen to make their accounts more financially sustainable in a range of ways. For example, some basic bank account holders are prevented from using a branch counter to pay in money or make routine account enquiries. RBS offers our customers full access to bank counter staff. Some banks do not issue debit cards to basic bank account customers. RBS offers a debit card that means our customers have the ability to get cash back at retailers which is popular with them. Some banks charge £25 for unpaid items on their basic accounts, whereas the RBS charge is significantly lower. We believe that even after the changes to ATM access, our basic account is one of the best on the market.
Cheque Guarantee Scheme
The Committee asked for RBS’s position on the future of the Cheque Guarantee Scheme. As the Committee are aware, this scheme has been in decline for some years as customers, both personal customers and retailers, have preferred to use other payment methods, in particular debit cards. From more than one billion guaranteed cheques per annum in the UK in the 1990s the number of guaranteed cheques fell to fewer than 80 million in 2010. RBS therefore supported the Payments Council’s original decision of a managed closure of the Scheme in June this year. We wanted to avoid a scenario where retailers and, potentially other banks, may have withdrawn from the Scheme, resulting in confusion among customers about how it worked and where it applied.
Although we have received very few comments from customers since the closure, we also believe it is right to look at whether customers are experiencing significant problems as a result of the scheme closure. RBS therefore supports the Payments Council’s current research designed to assess how customers are handling payments post-closure and whether there is a case for re-opening the Scheme. The Payments Council’s report and recommendations are expected shortly. Regardless of the results of the Payments Council report, RBS is always ready to assist customers needing guidance on payment methods to find those most appropriate for their needs. 16 December 2012
Letter from Tim Tookey, interim Group Chief Executive, Lloyds Banking Group, to the Chairman of the Committee
I promised to write to you to follow up a few factual points that were raised at the Hearing on 23 November.
You asked for our estimate of the costs to the banks of the ICB’s recommendations. I attach a short note on the costs- which for the four larger banks: Barclays, HSBC, Lloyds and RBS, we estimate to fall in the range of £6–10 billion, with Lloyds’ costs being a small share of that aggregate figure- together with some of the key uncertainties which depend on how the ICB’s recommendations are implemented.
Teresa Pearce asked about the costs of phone banking for basic bank account customers. All basic bank account customers across the Group can call us using Lo-Call 0845 numbers (0845 3000 000 for LTSB, and 0845 850 5525 for Halifax and Bank of Scotland). Standard local rate charges apply from landlines, although the cost will depend on the contract that the customer has with their service provider. For example, calls from BT landlines cost from 1p per minute to 4p per minute, depending on time of day, plus a set up fee of 3p to 12.5p depending on the customer’s calling plan. Halifax and Bank of Scotland Cardcash and Easycash customers can also phone us for free from our branches.
You asked about the cost to Lloyds of providing basic bank accounts. This was £72 million last year. The cost of extending access to all free ATMs to all of the Group’s basic bank account customers would be an additional £7 million a year. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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George Mudie asked about our total business lending and SME lending in 2010. As stated in our 2010 Annual Report, we provided £49 billion of committed gross lending to UK businesses in 2010, of which £11 billion was for SMEs. We remain on target to meet our lending commitments under Project Merlin for 2011 and have announced a target for 2012 of £12 billion to SMEs. 16 December 2011
Supplementary written evidence submitted by Lloyds Banking Group Introduction Lloyds is pleased to submit this response to the TSC on the financial impact of the ICB’s proposals. We would note to start that although the ICB has now published its final report, there remains a great deal of uncertainty on the ultimate shape of the reforms that will be pursued by HMT as well as the economic landscape in which these reforms will be implemented. As these factors become clearer, the comments below may need to be revised.
Social and Private Costs and Benefits From an economy-wide perspective, the financial impact of the ICB’s proposals should include, in addition to the private costs to banks, both the social benefits (in terms of the reduced probability and impact of crisis) and the social costs (in terms of the impact on both long-term and short-term growth rates). While the ICB’s final report estimated the aggregate costs of its reform package, this approach does not allow the incremental costs and benefits of individual reforms to be considered. In the discussion that follows, we therefore highlight the contribution of individual reforms.
Impact on Probability and Impact of Crisis The benefits of the ICB’s proposals derive from their effect in reducing the probability and/or the impact of crisis. Higher capital requirements that are truly loss-absorbing in the sense that they are capable of being used in a crisis, would make banks more resilient to losses and enable them to continue to lend in a downturn. On the other hand, if capital requirements are increased quickly in a crisis (as is currently the case), then they have the potential to deepen or prolong the downturn by encouraging banks to meet these enhanced requirements through de-leveraging. By subordinating them to insured deposits, depositor preference would likely have the effect of making corporate deposits more volatile. If corporate deposits moved to non-UK banks in a crisis period, then banks would be left with a large funding gap that would be particularly difficult to fill at short notice and in volatile conditions. Any bail-in provision, especially one implemented only in the UK, would exacerbate this difficulty by making wholesale funding providers particularly reluctant to lend. The combination of these two reforms would therefore be to deepen or prolong a crisis by triggering rapid de-leveraging or asset sales.
Impact on Recovery Part of the costs of the ICB’s proposals derives from their impact on the economic recovery. As noted in the Chancellor’s autumn statement, the economic recovery in the UK is likely to remain weak for an extended period. This reflects both the scale of de-leveraging and re-balancing that needs to take place and the challenges of doing so in a subdued international economic environment. The availability of credit to the real economy throughout the recovery is crucial to ensuring that re-balancing can take place and that de-leveraging can happen over time, in a way that is least damaging to long-term growth prospects. While the ICB envisioned a transition period extending to 2019, experience from past crises suggests that debt/GDP ratios take a decade to fall to pre-crisis levels and that unemployment remains elevated over the same period.23 In other words, the period during which reforms will need to be implemented is likely to be a period characterised by continued slow growth. Several of the reforms proposed by the ICB have the potential to weaken growth further by raising the cost to banks of extending credit to the real economy. Depositor preference, for example, makes both senior debt and corporate deposits more expensive by subordinating them to insured deposits. Bail-in, if pursued independently from the EU crisis management process, would make senior debt issued by UK banks significantly less attractive than debt issued by non-UK banks, thereby increasing its relative cost.
Financial Impact In the case that reforms have negative effects on economic growth and financial stability, this impact would far outweigh the private cost to banks of implementing the ICB’s reforms, in whatever form they eventually emerge. 23 Reinhart, Carmen and Kenneth Rogoff (2009). “This Time is Different: Eight Centuries of Financial Folly”. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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This is not to suggest that the private costs are trivial; Lloyds estimates that the aggregate annual costs across Lloyds, Barclays, RBS and HSBC would amount to £6–10 billion, of which the vast majority is derived from higher funding costs. Although we anticipate that Lloyds’ costs will be a small share of this aggregate figure, we would encourage the Government to consider carefully the contribution of individual reforms to the pace of recovery and the probability and impact of crisis. 16 December 2011
Supplementary written evidence submitted by Standard Chartered Introduction 1. Following the appearance of Peter Sands, Group Chief Executive Officer of Standard Chartered, before the Treasury Committee (“Committee”) on 14 December 2011, Standard Chartered was asked to provide its views to the Committee on (i) the design of group Primary Loss Absorbing Capacity (“PLAC”) (ii) the Cost Benefit Analysis (“CBA”) conducted by the Independent Commission on Banking (“ICB”) (iii) mechanisms to promote competition in UK retail and SME banking and (iv) details on key European Union (“EU”) regulations that will affect London. As set out in Peter Sands’ evidence to the Committee our overarching concern is that the ICB missed an opportunity to bring some coherence to the vast array of reforms faced by UK banks. 2. This note sets out a detailed response on these issues but for the Committee’s ease our key concerns on each of these issues are set out below:
Group Primary Loss Absorbing Capacity 3. The PLAC recommendations proposed by the ICB and largely accepted by HM Treasury (“HMT”) are flawed in maths and logic for a number of reasons: (a) The data on bank losses used to justify the recommended 17%-20% of PLAC is based on flawed data. (b) Assuming that capital/loss absorbing debt will need to cover a tail risk loss event undermines the principle of capital reserves. Levels should not be set to meet all eventualities, instead other regulatory tools, such as Recovery and Resolution Plans (“RRPs”), central clearing of derivatives and effective supervision should also be considered as part of the mix. (c) There is an inherent contradiction in the ICB’s position that it wants to avoid making non-ring- fenced entities uncompetitive whilst also imposing group PLAC most likely in excess, but definitely in advance, of international agreement. (d) The approach to exempting non-UK liabilities, to address concerns about group PLAC for non-UK activities, continues to pose problems because of the difficulty of pursuing the approach envisaged by HMT and the likely reluctance on the part of regulators to implement such an approach. (e) The incoherence revealed in the ICB’s approach to assessing the costs of PLAC. The ICB expected no cost to for Standard Chartered, whereas we expect a cost of at least several hundred million dollars.
Cost benefit analysis 4. We believe the CBA by the ICB underestimated the costs of its package of reforms and exaggerated the benefits over and above all of the other regulatory reform already underway. Whilst we welcome HMT’s use of bank data to conduct its CBA, some key problems with the initial ICB CBA do not appear to have been addressed, in particular the considerable differences between Basel II and III levels.
Mechanisms to promote competition 5. We support efforts to make the UK market more competitive. However, we believe that on balance the ICB’s proposals, taken together with the other body of UK super-equivalence, will make the UK a less attractive investment proposition for banks looking to enter UK retail and SME banking. In particular we note that: (a) There has been a significant consolidation of banks during/since the crisis and this will make market entry more difficult. (b) Ring-fencing will make the UK market unattractive for entry by major universal banks compared to other markets since banks entering the UK would be required to create a UK retail ring-fence. Whilst we welcome moves by supermarkets, Metro Bank, Virgin Money, Santander and The Co-operative Bank to increase competition in the market we believe that a driver of competition, new bank entry, is less likely as a result of the ICB. We also believe the benefits of these new market entrants will largely accrue to retail customers and SMEs will not see an increase in competition. It is important to remember that the ICB’s recommendations come on top of a vast body of regulatory reforms that have made banks increasingly reject marginal business and focus on their core activities. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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European regulation 6. Standard Chartered has been supportive of efforts to reform the financial services sector. We have been broadly supportive of Basel III but think that it is essential to achieve a consistent and harmonised implementation of key banking regulation. Taken together the reforms at an international, European and UK level represent a chaotic and uncoordinated blizzard of reforms. Whilst individually many of these reforms are likely to have merit their combined and uncoordinated affect at the time of unprecedented market turbulence could lead to significant economic risks. 7. In the following sections each of these issues is considered in more detail.
Group Primary Loss Absorbing Capacity 8. We support the use of bail-in debt at the point that a bank becomes or is expected to become non-viable and after equity holders have borne losses. However, we believe that given the international nature of bank debt markets and the need for effective and consistent cross border resolution, that the UK should seek to adopt a globally consistent approach on bail-in debt. 9. The ICB recommends requiring PLAC both for the retail ring-fenced bank and also at a group level for Global-Systemically Important Banks (“G-SIBs”). 10. We believe policymakers need to give careful consideration to what bail-in debt is for, how it is triggered and the levels of bail-in debt banks are required to hold and must ensure that such targets do not incentivise bad behaviour. Additionally, we believe it is essential for a consistent global application of these standards. 11. In setting the level of bail-in debt that banks should hold it will be important for policymakers to consider that some banks, like Standard Chartered, are significantly deposit funded (A/D ratio of 78.1% in June 2011) and so would be in a different position should recovery or resolution be contemplated. Such banks would also face additional costs in meeting specific debt requirements over and above those with a greater reliance on wholesale funding. A key lesson from the financial crisis was that an over-reliance on wholesale funding can pose significant risks for the financial system when liquidity dries up. It will be important for policymakers to continue to provide incentives for deposit funded banking models which have been shown to be stable throughout the financial crisis. Careful thought also needs to be given to how the design of “buffers”, such as the concept of PLAC developed by the ICB, will actually operate in practice. Banks treat regulatory minimum levels very seriously and additional management buffers are typically held on top of this to be dipped into in times of stress. A regulatory buffer which triggers regulatory intervention (as envisaged by the Financial Services Authority (“FSA”)) is an entirely different concept. 12. We believe that Standard Chartered will not be required to create a retail ring-fence and we are not on the current G-SIB list, however we believe that the application of PLAC at a group level needs to be set as part of an internationally consistent regime. The ICB recommendations essentially envisage a UK-specific regime which would be unilateral and would proceed ahead of international agreement. We believe that this poses significant risks for UK banks which will be competing against other banking groups not subject to such additional funding costs and who might face a regime that differs in the technical detail of the design of the trigger or type of funding that is eligible. Policymakers are already in advanced discussions on the regimes that need to be created. In Europe the European Commission is expected to publish its Crisis Management Directive shortly which will include provisions for bail-in debt. We believe an internationally consistent regime would be in the best interests of both UK financial stability and also of its banks. 13. The PLAC recommendations proposed by the ICB and largely accepted by HM Treasury (“HMT”), are flawed in maths and logic for a number of reasons: (a) Loss data—As we set out in more detail in the next section on the ICB’s CBA (para 19e), the data on bank losses used to justify the recommended 17%-20% of PLAC is based on flawed data. It also is at odds with assessments made by the Basel Committee on Banking Supervision (“BCBS”) which conducted a significant amount of analysis in developing the final recommendations on the capital levels to be applied in Basel III. (b) Tail losses—Assuming that industry wide regulatory capital will need to cover a tail risk loss event undermines the principle of prudential regulation. Anglo Irish Bank, which the ICB notes suffered losses of 39% of Risk Weighted Assets (“RWAs”), would have required minimum capital levels of at least 40%. Such an approach is clearly untenable across the industry and would have negative economic consequences as it would lead to significant deleveraging and reduced credit availability. Therefore, as recognised by the likes of BCBS, capital levels should not be set to meet all eventualities and they should be balanced against the wider economic impact. Instead, capital levels should be seen as part of a much wider suite of regulatory measures that can be used to both reduce the probability of default (“PD”) and the loss given default (“LGD”). (c) Contradiction on competitiveness—There is an inherent contradiction in the ICB’s position that it wants to avoid making non-ring-fenced entities uncompetitive whilst also imposing group PLAC on non-UK operations most likely in excess of, but definitely in advance, of international agreement. We believe the UK government should seek to reach a consistent global standard on the levels of cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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bail-in debt that need to be applied otherwise UK banks will be placed at a significant competitive disadvantage to competitors not domiciled in the UK. (d) Problems with HMT’s solution—In its response to the ICB’s Final Report HMT has attempted to reach a position in which it seeks to maintain group PLAC but to allow banks to be exempt from these requirements where they can show that the failure of non-UK operations would not pose a threat to UK interests. Whilst the principle is welcome in reality we believe that such an approach will be impractical for a number of reasons: (i) Regulators (presumably the Prudential Regulation Authority) are likely to be reluctant to provide such an exemption for firms because they would be required to guarantee against UK disruption even when it would be difficult to do so without knowing the likely parameters of future financial crises. (ii) We have concerns about the HMT approach which implies (para 3.64 of HMT’s response to the ICB published in December) that to adopt such an approach banks would have to develop RRPs in which the resolution of foreign and UK operations would be separate. What is needed is a single RRP which has been agreed by the main regulators. (iii) Such an approach implies implicit government support for those groups that have not managed to secure an exemption from group PLAC requirements. We would prefer to create a regulatory landscape in which no firm is considered to have an implicit guarantee. (e) Costs of bail-in debt—The ICB makes assumptions about the costs of PLAC and also suggested that the market had factored in the cost of bail-in following the passage of the Special Resolution Regime (“SRR”) in the Banking Act 2008. However, we believe the market had not factored in the costs given so much policy uncertainty and because at the time of the creation of the SRR this was largely an emerging policy discussion. As a result we believe the ICB should have given greater thought to the additional funding costs that would arise. We also query the ICB’s assumptions that banks already have sufficient levels of bail-in debt. Both the ICB and HMT appear inconsistent on this point. Whist they state that there should be grandfathering of existing debt to a new bail-in regime they also state that it will be essential for debt to include upfront disclosures about the possibility of bail-in. The ICB secretariat suggested that there would be no incremental costs for any PLAC Standard Chartered may have to issue because we were not considered to have an implicit guarantee and therefore the total costs of our debt would reflect our risks. Whilst we do not believe we have an implicit guarantee from the UK Government, we do however believe that there will be incremental costs for any PLAC we need to hold. 14. It is worth noting that in assessing the costs of the regime proposed by the ICB, banks are likely to have assumed that bail-in debt will be tax deductible. This is a matter that is still being considered by HM Revenue and Customs. Clearly if a decision was taken not to make bail-in debt tax deductible this would mean that the final costs of the ICB would be significantly higher. 15. The ICB also recommended the application of a resolution buffer in addition to the group PLAC requirements. Before implementing these buffers the UK authorities need to give much greater thought to how the increasing number of buffers will work together and what their relationship will be to Pillar 2. In implementing the recommendations we believe HMT needs to consider two important points: (a) The default position should be that where a bank holds an effective RRP then the resolution buffer should not apply. If regulators do not have to set out reasons for applying the resolution buffer then it will simply become an additional capital requirement and will not provide incentives for banks to create effective RRPs. (b) The UK authorities need to be consistent in their views on the level and composition of the buffer. The latest edition of the Bank of England’s Financial Stability Report (“FSR”) recently suggested that the buffer should be greater than 3% and that it could include more equity than envisaged by the ICB. Such changes to the level and composition of the buffer will have significant implications for the costs of the ICB’s recommendations and this needs to be considered. 16. In considering the next steps on implementing the ICB recommendations we believe HMT should give greater consideration to (i) how these reforms fit with the international agenda being pursued to create bail-in regimes and (ii) should consider the market capacity available to meet these extra funding requirements at the same time as the implementation as Basel III, where one estimate suggests a €350bn funding shortfall for 145 international banks.24
Cost Benefit Analysis 17. The ICB was unable to conduct a full CBA in order to understand the costs of its recommendations because of limited resources and time. As a result it conducted a review of existing academic literature and regulatory studies and used research from bank equity analysts to consider the costs. We appreciate the difficulty of conducting such complex CBAs, not least because we have been involved with a number of attempts 24 Boston Consulting Group, A Global View of Regulatory Reform, December 2011. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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to consider the cumulative impact of the reforms, however we have concerns about the final CBA in the ICB’s report. 18. CBAs are generally conducted to consider the best of a range of options and policymakers will normally adopt the policy solution for which the maximum benefit can be achieved for the minimum cost. However, the ICB report failed to present any meaningful alternatives (eg macro-prudential regulation, resolution planning or liquidity regulation) and therefore we have concerns that the final recommendations from the ICB may not be the optimal solution. 19. We accept the need for regulatory reform and significant changes in the practices at many banks. As a profitable, well managed bank financial instability reduces our ability to deliver for our clients and shareholders and therefore we are keen to see reforms that reduce the likelihood of instability. However, it is important to ensure that reforms will not cost more than the benefits they will bring and to reduce the probability of negative economic outcomes. Faced with increased regulatory demands to hold more capital banks essentially have three options (i) to reduce returns for shareholders through reduced dividends (ii) to increase capital levels or (iii) to deleverage essentially reducing lending to the economy. The first two options are difficult because banks face pressures from investors to sustain return on equity, just as investors face pressure to maintain investment returns for their clients. Increasing capital levels becomes difficult and follows an inverse relationship so those with the greatest needs find it most difficult to raise additional capital. As a result there is a significant risk that banks seek to cut costs, sell assets (possibly further reducing the market price of assets) and deleverage. This is a scenario the Institute of International Finance (“IIF”) envisaged in its report on the cumulative impact of regulatory reform25. The Bank of England’s recent FSR26 highlights a growing body of evidence that shows European banks deleveraging as a result of the current regulatory and economic pressures they face. One report from Morgan Stanley, highlighted in the FSR, estimates that European banks will deleverage by over €2tn.27
Methodological problems
20. We believe that the ICB’s CBA had a number of methodological problems, some of which are problems that have been highlighted with other studies from regulators and therefore were simply compounded by the ICB work and others which are specific to the ICB’s work. We consider that there were essentially three problems (i) the approach taken (ii) the benchmark used and (iii) some specifics about the costs attributed to the ICB’s specific recommendations. We consider these in turn: Approach (a) Old and new world costs—We are broadly supportive of the changes that will be introduced with the implementation of Basel III and we support a consistent global implementation of these reforms. In particular we have always been an advocate of liquidity regulation which was an underutilised tool for some regulators. The implementation of Basel III will see banks holding significantly more capital both because the level of capital banks must hold has increased, because the quality of that capital has improved and also because the risk weights used to calculate a banks’ required capital have also been tightened. As a result banks are likely to be holding around five times28 as much capital with the implementation of Basel III as they were under Basel II. This means that any costs based on Basel II calculations will most likely significantly underestimate the costs of a regime on a Basel III basis. The ICB’s CBA provides little clarity on whether the costs are calculated on a Basel II or III basis and our discussions with the ICB secretariat did not provide any further clarity. We can only assume that this key variable is currently unclear. (b) Sources—The CBA in the final ICB report drew heavily on bank equity analyst research however this was flawed for a number of reasons: (i) Equity analysts based their cost assumptions on the Interim Report and the recommendations in the final report went further than the Final Report (eg PLAC, resolution buffer). As a result it is likely that bank equity analysts may have assumed higher costs if they had been calculated on the recommendations from the Final Report. They were also calculated at a time that key components of the new regulatory landscape, most notably the G-SIB regime, had not been agreed. 25 Institute of International Finance, The cumulative impact on the global economy of changes in the financial regulatory framework, September 2011. 26 Bank of England, Financial Stability Report, December 2011. 27 Ibid. 28 Precise figures on the additional capital banks will need to hold will depend on individual bank balance sheets. However the five times increase in minimum capital requirements from Basel II to Basel III is derived as follows: (i) Basel II to Basel III uplift factor derived from cross-industry work as an average from the impact analysis of the six major UK banks (including Santander UK) which showed a 34% uplift [8% Basel II = 10.7% Basel III]. The uplift factor adjusts for the regulatory changes being implemented by Basel III, i.e. more stringent definitions of capital, regulatory deductions largely applied at the equity level and increases in RWA for counterpart credit risk. (ii) Basel III minimum Common Equity Tier 1 capital level (including capital conservation buffer) set at 7%. (iii) Therefore, 7% new Basel III minimum is equivalent to 9.4% compared to the current Basel minimum of 2% core equity capital, i.e. 4.7 times higher and (iv) the regulatory adjustments that are applied currently are applied at the Tier 1 capital level. If they were to be deducted from the 2% core equity capital minimum, then the Basel III minimum would be 6–7% higher than the current minimum. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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(ii) There were considerable uncertainties around the recommendations in the final report and this will have led to considerable cost variants. Equity analysts could not understand the full costs of separation (eg need for changes to payment systems, the creation of new governance arrangements etc). Many of these costs could only be estimated through making assumptions and often only with the use of internal data. (c) Coverage of the CBA—Significantly the ICB also limited its population in the CBA to the costs on the larger UK retail banks29 even though many other banks (smaller UK retail and banks branching into the UK) believe they will have to make significant changes to their business model in order to accommodate the ICB’s recommendations. We are aware that only the larger banks were asked to provide the ICB with balance sheet data that could be used to understand the costs of the recommendations. Benchmark (d) Overestimated costs of crises attributable to banks—In assessing the economic impacts of financial crises some of the official sector assessments have assumed that the GDP figures immediately before the crisis are representative of long-term trend GDP and not artificially inflated as a result of an unsustainable credit boom. As a result the impact of the crisis becomes the difference between the GDP high and the GDP low immediately before and after the crisis. Such assessments will exaggerate the costs of the fall and in turn the contribution of the financial sector to this economic downturn, when in fact the financial sector will often reflect wider economic readjustments. The table below from a publication by the IIF30 highlights the significant difference that occurs when considering the costs from different assessments of “trend” GDP. Measuring the Costs of Financial Crises
Low cost view High cost view
Crisis Crisis B D B D
Old trend
C C New trend
A A
Source: IIF table adapted from BCBS information and IIF staff estimates. Perhaps the greatest economic impact of a financial crisis is not the direct costs incurred by governments but the significant deleveraging that often occurs and the reduction in banks’ lending ability which has an economic impact. These deleveraging pressures can often occur as a result of direct regulatory intervention as regulators seek to increase bank equity levels. Such actions end up contributing to pro-cyclical pressures. For instance, in October the European Banking Authority concluded that as a result of pan-European stress tests that banks would have to increase Core Tier 1 ratios to 9% to build up a temporary capital buffer against sovereign debt exposures. Whilst Standard Chartered already has a Core Tier 1 ratio of 11.9%, considerably higher than the EBA requirements, we have concerns about pro-cyclical policy decisions. (e) Setting PLAC levels—In recommending the total level of PLAC banks should hold the ICB considered historical loss data in banking crises and appears to have decided to set the level of PLAC that needs to be held at a significantly higher level than the BCBS concluded using the same data. The ICB appears to have assumed a level of PLAC that would have addressed tail risks from previous financial crises, even though regulatory actions currently being implemented (Basel III, RRPs, macro- prudential) make the likelihood of such tail risks considerably less likely. There are a number of reasons why it seems inappropriate that the costs of future failures should be attributed in this way: (i) Korean FX crisis—The source the ICB (figure 4.5) uses to derive the scenario for large banking failures is the high point of losses suffered in the Korean FX crisis in 1997 which it believes 29 For example see the comments at para A3.102 in the ICB’s Final Report. 30 Institute of International Finance, The cumulative impact on the global economy of changes in the financial regulatory framework, September 2011. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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sits between 16%-24% of bank Risk Weighted Assets (“RWAs”). This figure is taken from a BCBS report which itself concludes from the same data set that typical historic losses incurred by banks were about 4%-5% of RWAs and that to withstand losses and maintain a reasonable level of lending growth, the capital needed increases from approximately 7% to 12% of RWA. (ii) Basel III—The problems above appear to be compounded by the fact that the ICB failed to take account of the need to convert the Basel II figures into the Basel III equivalents which require the holding of significantly higher quality capital. (iii) Loss data—We indicated to the ICB that we did not recognise the data for the loss figures in (fig 4.4) which suggests Standard Chartered suffered losses (even if rounded to zero % RWAs). (f) Overestimated the benefits attributed to the recommendations—In addition to overestimating the costs of financial crises attributable to banks the ICB’s CBA also overestimated the benefits of its recommendations in reducing the risks of financial crisis. There are a number of issues that need to be considered: (i) Universal banks—Much of the analysis presented by the ICB appears to start from the assumption that universal banks present greater risks than narrow banks. Whilst we acknowledge that some universal banks failed during the financial crisis we believe that failures of risk management, corporate governance, a lack of liquidity and macro-prudential regulation and supervision were predominately the cause of the problems (the Financial Services Authority review of the failure of the Royal Bank of Scotland highlighted many of these issues). The ICB appeared to look at a narrow data set of financial crises and ignored past incidents that contradicted its thesis. For example, it does not examine financial crises involving smaller banks, such as the savings and loans crisis in the United States (“US”) in the 1980s. Research by Barclays Capital31 shows that of the 3,284 banks insured by the Federal Deposit Insurance Corporation and which failed or were subject to assisted takeovers between 1960 and 2009, 93% of those that failed had assets of less than USD1bn. These banks are most likely to be narrow, specialist banks which failed because they had exposure to narrow asset classes, unlike a well managed universal bank which would have exposure to a diverse range of asset classes most likely across a number of geographies. (ii) Implicit subsidy—The ICB’s work is focused on removing any government subsidy. It estimates the funding subsidy received by some banks because of implicit government support is “considerably in excess of £10bn per year currently”.32 Our analysis of Credit Default Swap (“CDS”) spreads before the crisis indicates the concept of state subsidy did little to affect the cost of funding. Market participants thought that the probability of bank failure was incredibly small, not that governments would step in if a bank did fail. By contrast, current CDS spreads indicate that creditors do believe they are at significant risk of loss. Neither data set supports the notion of an embedded support from the taxpayer. In any case, analyses based on ratings suffer from the fact that ratings are a relatively poor guide to actual credit spreads. Indeed, a concern we currently have is that the creation of the G-SIB regime may create the risk of an implicit subsidy as some banks will be clearly identified as too big to fail by regulators. (iii) Incremental benefits—The last two years have seen a significant body of regulatory reforms both designed to reduce the probability of bank default (“PD”) and the losses given fault (“LGD”). Banks in the UK face a range of reforms from the international, EU and UK level. All of these reforms are designed to increase financial stability. The ICB simply assumed that their recommendations would be net positive without actually assessing the extent to which its recommendations would reduce bank PD over and above the reforms already being implemented. It appears that HMT also accepted these assumptions33. Without considering all of the regulatory reforms already underway and the extent to which they reduce PD, we do not see how HMT can make any meaningful assessment of how the ICB recommendations will either reduce costs for the taxpayer or improve financial stability. (iv) Market dynamics—In common with some other studies the ICB CBA focuses on academic assessments that do not necessarily reflect market dynamics. In particular whilst the CBA considers the costs for the market of meeting the PLAC requirements it does not consider the capacity of the market to deliver this at a time that banks will already have significantly increased funding needs as a result of the implementation of Basel III. The virtual drying up of bank debt markets in late 2011 highlights the significant problems the industry is likely to face. In such markets only strong names are able to access funding markets. Recommendations (g) Impact on whole sector—The recommendations from the ICB are so far reaching that they will most likely lead to a wholesale reform of the way in which UK banks are regulated. For instance, the ICB seemed unclear about the impact the final recommendations would have on the FSA’s Pillar 2 regime and significant questions exist about how the FSA’s Solo regime will need to adapt. Equally there was no consideration on what the response by Bank boards would be to higher regulatory minimum 31 Barclays Capital, Break-up or Shake-up?, 11 January 2011. 32 Independent Commission on Banking, Final Report, para A3.53. 33 Para 5.21, HM Treasury, The Government response to the Independent Commission on Banking, December 2011. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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levels and to the amount of buffer that bank management would seek to hold (which would not be costed). As a result much is unclear about the shape of the UK regulatory landscape. However, what is clear is that there will be changes even for those banks not directly affected by the ICB’s recommendations and costs (which the ICB has not considered) will be involved.
CBA conclusions 21. We are supportive of a number of the regulatory reforms already underway and have been a proponent of liquidity and macro-prudential regulation in particular. However, we have growing concerns that the regulatory landscape is becoming increasingly complex and unpredictable and this is likely to be make the identification of problems more difficult and the compliance costs significantly higher. The ICB’s recommendations only added to this complexity and added to the risk that the UK’s increasingly complex regulatory regime will make the UK less competitive without necessarily leading to significant increases in financial stability. 22. We are studying the report released by HMT on 19 December to consider the initial CBA it has produced. We note that the CBA produced by HMT includes a cost estimate of £3.5–8bn per annum for UK banks for the ICB proposals alone.
Mechanisms to Increase Competition 23. Effective competition is most likely to be achieved through new market entrants. Whilst some additional competitive elements may be achieved by UK start ups or existing banks taking a greater share of the market, there could be significant benefits if existing non-UK universal banks were also to come into the UK. However, when banks make such decisions to enter a market they have to think carefully about the margins they will receive when entering a market and in particular the regulatory risks they will be exposed to. As a result of the implementation of the ICB recommendations the UK is likely to look like a less appealing market to enter, especially compared to the vast opportunities available in emerging markets. There are a number of issues the Committee should consider when seeking to increase competition in the UK market: (a) Market consolidation—Some players may be concerned by the extent to which the market has become concentrated especially during/since the crisis. They may see this as a trend that would be difficult to reverse and would threaten their ability to develop in a market. (b) Ring-fencing makes market entry unattractive—Evidence shows that the entry of new banks into a market helps to drive up competition and often creates innovation to the benefit of consumers.34 However, a universal bank considering entering the UK would have to consider the UK against its other options. The UK is a market which faces significant barriers to entry, not only with the need to create a retail ring-fence with the implementation of the ICB recommendations, but also as a result of a significant amount of regulatory uncertainty and super-equivalence (eg bank levy, UK liquidity regime, bank payroll tax). In particular, these concerns are likely to make it more difficult for existing large international universal banks to consider a move to the UK, even though they may have the advantage of having existing infrastructure in place to enter a new market. They may also pose a greater threat to existing market participants than the likes of Santander, Virgin Money and The Co-operative Bank which are also trying to increase their market share. In particular, a new universal bank entering the UK would be able to provide services not only to retail customers but also to SMEs. 24. Since Standard Chartered does not operate a retail business in the UK we have a limited understanding of the retail market in this country. As a result we are not necessarily best placed to offer a detailed analysis of the factors that could be used to improve the competitiveness of UK retail banking. However, in the appendix to this note we have set out some general principles we believe would help to foster greater competition in the UK. We believe a focus for the Committee should be in understanding the extent to which UK regulatory intervention may make the costs of market entry higher and may as a result curtail competition. Clearly where this intervention can be shown to provide clear incremental benefits for financial stability there may be a reason to still apply provisions. However, where new provisions do not provide sufficient incremental benefits over and above other reforms, then the case for implementing the changes will be more marginal.
European Regulation 25. A single market in the EU should be focused on removing barriers and simplifying existing rules to enable everyone in the EU—consumers and businesses—to make the most of the opportunities offered to them by having direct access to 27 countries and 495 million people. Financial markets are crucial to the functioning of modern economies. The more integrated they are, the more efficient the allocation of capital and long-run economic performance will be. 26. We support efforts by the European Commission to harmonise regulation across the EU and more broadly for the EU to develop a consistent international approach. Whilst there will inevitably be elements of the regulations coming from Brussels with which we disagree (for instance the Financial Transaction Tax (“FTT”)) overall we support efforts to develop a more harmonised regulatory system. What is difficult however is operating in a regime in which the UK is in principle committed to a single handbook for financial services 34 World Bank, Foreign Bank Participation in Developing Countries (WP 5398), August 2010. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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regulation but in practice operates a different regime (as in the case of the liquidity regime) or lobbies for a specifically UK approach to implementing international agreements (as in the case of the implementation of Basel III.) 27. Differing implementation of global agreements such as Basel III presents significant challenges, costs and competitive pressure for banks such as Standard Chartered which operates in 70 markets. However, we are also concerned by the risks that such an approach will create an overly complex situation in which it is difficult for banks and supervisors alike to understand the risks to which banks are exposed and will present some banks with an opportunity for regulatory arbitrage. As a bank that has consistently pursued a conservative risk strategy we support consistent implementation and clear regulatory regimes. 28. The Committee indicated that it would like to understand the key pieces of European legislation that are currently of interest to Standard Chartered. There are two major Directives (on Capital Requirements and Crisis Management) that we would highlight. There are a considerable number of other Directives and Regulations being proposed: European Market Infrastructure Regulation (“EMIR”), Markets in Financial Instruments Directive (“MiFID2”) and Market Abuse Directive (“MAD”), which will have most impact on investment banks with a different business model to Standard Chartered.
Capital Requirements Directive (CRD) 4 29. We support the full, timely and consistent implementation of Basel III internationally, including across the EU via CRD4. We also support a single rulebook for uniform oversight of banks. 30. As the Committee is aware, in December 2010 BCBS released the Basel III rules text, which will set higher levels of capital requirements and introduce a new global liquidity framework. The BCBS members agreed to implement Basel III from 1 January 2013, according to the transitional and phase-in arrangements developed by the BCBS. 31. However, it is clear from the text in the CRD4 proposal that there are differences between what is proposed for the EU and what was agreed in Basel III on capital and liquidity.
Capital 32. The transitional arrangements for regulatory adjustments and grandfathering of capital instruments in CRD4 clearly allow scope for a more “super-equivalent” implementation of Basel III by EU member states at the discretion of national regulators. CRD4 also grants significant powers to the European Commission (upon the recommendation or opinion of the European Systemic Risk Board) to change the prudential requirements after the legislation comes into force. There is also a lack of clarity, eg on point of non-viability and the definition of bail-in debt. The approach to recognition of regulatory capital issued by subsidiaries at the group level in CRD4 also differs from the approach in Basel III.
Liquidity 33. This is an area where the UK has introduced an interim regime that is inconsistent with Basel III. As a result the costs of liquidity provision for banks domiciled in the UK are significantly higher than their international peers but it also means that UK banks have to follow one regime whilst preparing to implement a significantly different one. We also do not think that the UK regime is the most prudent as it is very narrowly drawn. The UK regime includes a narrower set of eligible assets for the liquid asset buffer than those set out in Basel III. In particular it excludes some of the most highly rated and more liquid assets from Asian markets. 34. Similar to the capital issues, the CRD4 rules for liquidity are less detailed than in Basel III, leaving significant scope for interpretation by national regulators. This could lead to inconsistencies across EU member states, eg around areas such as the definition of operating accounts and correspondent banking and to what type of account liquidity constraints of correspondent banking is intended to apply.
Trade Finance 35. Whilst we welcome the broad thrust of Basel III, there are some unintended consequences for low risk activities caught within the new rules on top of existing ones. One example of this is trade finance which banks undertake to facilitate global trade flows and which therefore plays an important role in fostering global economic growth. In CRD4, the EU has a real opportunity to influence the BCBS in its approach to trade finance. BCBS has made some changes to make capital rules less punitive for trade finance however we believe more action could be taken without compromising financial stability. Our internal estimate is that the changes recently made by BCBS probably address less than 1/10th of the discrepancy between the true cost of trade and the cost as determined by regulation. 36. In particular we believe that the capital rules need to be more reflective of the risks posed by trade finance since exposures are diverse; small in value; short-term; self-liquidating (having an identifiable source of repayment); transactional in nature; and, due to the diverse nature of trade finance exposures, they have a very low correlation. Evidence from a survey35 conducted by the International Chamber of Commerce (“ICC”) 35 International Chamber of Commerce (September 2010), Report on findings of ICC-ADB Register on Trade & Finance. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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and the Asian Development Bank (“ADB”), shows that in a five year period (including the period during the financial crisis), out of the 5.2 million trade finance transactions registered and analysed, only a very low percentage encountered default (fewer than 500 defaults among 2.8 million transactions). In these rare occasions, loss recoveries were high; recovery rates averaged 60% for all product types. 37. The EU should be looking to take a lead here by developing a regime that recognises the low default rates for trade finance and the importance it holds in helping to facilitate economic growth. Without more appropriate and risk-based capital proposals, finance available to support trade will become more expensive and less accessible. Bank trade finance makes an important contribution to global trade flows and in turn economic development relies on trade.
Crisis Management
38. The Commission has consulted on a new EU framework for crisis management in the financial sector but the text of the proposal is in draft still and is expected to be released in the coming months after significant delay. The Directive will seek to create a pan-European resolution regime to allow banks to fail without recourse to tax payer funding. We agree with aims of the Directive and believe that the creation of cross-border resolution regime is an essential tool in reducing risks to financial stability. 39. Under the original RRP pilot scheme for the FSA, Standard Chartered completed several detailed submissions covering both recovery and resolution planning, the latter referring to preparation of a detailed “resolution pack” that would help the UK authorities to write a resolution plan for the firm. As such, Standard Chartered has material experience of recovery and resolution planning in practice. The concept of RRPs is crucial and needs much more focus and thought by industry and policymakers.
40. Recovery planning requires firms to go beyond existing contingency planning to contemplate management actions that would be taken under extreme stress. It requires a firm to set out a robust, but crucially judgment-based approach to when recovery actions would start to be considered. Standard Chartered believes this is a valuable exercise for the industry to go through and also one that shows clearly the differential strength of Standard Chartered’s balance sheet. Standard Chartered has developed a clear framework for escalating the active consideration of these actions, based on business judgment and a forward looking view of Standard Chartered’s balance sheet and the external environment. In summary, Standard Chartered’s experience so far has confirmed the opinion that recovery planning must be flexible and that recovery must be firm lead.
41. In contrast to this view, the Commission may force firms to structure their recovery planning more rigidly and introduce new restrictions on intra-group funding which could make it more difficult for banks to survive short periods of instability. Furthermore, it may create new regulatory powers for early intervention that in practice would make recovery more challenging.
42. Standard Chartered has analysed the resolvability of business lines, branches and legal entities under the FSA’s pilot program. This has been a useful exercise and confirmed Standard Chartered’s opinions about the Group’s low systemic risk and inherent resolvability. Standard Chartered recognises that there is a significant challenge for regulators in developing resolution plans for institutions, as they will need to clarify their resolution aims, view of systemic risk and understand firms’ business and operating models. Following the creation of a plan, regulators will need to coordinate internationally to set out Institution Specific Cross Border Co-operation Agreements (“ISCBCA”) to prepare for its international implementation. In summary, experience of resolution planning so far shows that the most important issue is ensuring that regulatory authorities are required to actively engage with firms, clarify their own views of systemic risk and draft an effective, targeted plan within a reasonable timescale.
43. We are concerned that European Commission may propose sweeping regulatory powers to facilitate the use of resolution tools. While we can understand the regulatory perspective that these may be helpful in some cases, their existence is likely to be of concern to the funding markets, particularly as firms move toward the last stages of recovery and funding markets continue to face many challenges.
44. We would strongly disagree with the need for significant new regulatory powers to implement ex-ante structural change or business restrictions as was one suggestion put forward in the Commission’s consultation. In the short-term, such powers would imply that there is one, correct business model that the regulators can impose, when this is not the case. In the medium to long-term, this would damage competition and stability as it could potentially lead to a number of firms operating in the same way. Resolvability itself is a purely theoretical concept and many measures that might be considered to improve it would have the effect of reducing firms’ resilience, which would itself increase systemic risk. Instead, the focus of regulation should be put on the initial and most important steps of the process, requiring real engagement between regulators and firms, and impelling regulatory authorities to clarify and define their view of systemic risk and produce a resolution plan within a reasonable time scale.
45. Finally, we would also strongly disagree with any proposals to set up an ex-ante resolution fund. This would drain credit from the European economy at the time of great stress and perversely create greater moral hazard. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Financial Transaction Tax (“FTT”) 46. We support HM Government’s position that any FTT would have to be applied globally. 47. Following a consultation last September the European Commission issued a proposal for a Council Directive on a common system of FTT throughout the EU. The main features of the proposed Directive are that the FTT would apply to all financial transactions where at least one party is established in an EU member state and a financial institution is also party to the transaction. The effective date is 1 January 2014. 48. An FTT would result in increased costs for users of transactions and instruments subject to the tax, and therefore have an adverse economic impact. The Commission’s Impact Assessment suggests significant negative economic effects as a result of the implementation of an FTT and suggests that the revenue raised from the tax would be less than the negative economic consequences that are likely to follow from the implementation of the tax. 49. An FTT would disadvantage EU firms with non-EU operations because they would compete at a disadvantage to competitors in other markets, and there would still be an undesirable effect of creating additional costs for developing economies. 50. The financial impact of the Directive on Standard Chartered would appear to be significant, given the likely scope of the tax. Work is required to establish a reasonable estimate of the financial impact but there would be significant implications for systems to ensure compliance and payment on a daily basis plus monthly returns. Because transaction chains in financial services can be long (for instance, the transaction chain for a pension company purchasing equities for a personal pension) and because the tax would apply to every transaction in this chain, the costs are much higher than would initially appear to be the case. As a result of the way the tax has been designed analogies with the UK’s stamp duty regime are therefore misleading.
Creating an effective European regulatory regime 51. In considering the European regulatory reform we believe the committee should pay particular attention to the implementation of CRD4 and the UK government’s approach to implementing this and the Crisis Management Directive in addition to MiFID2 and EMIR.
APPENDIX ENCOURAGING COMPETITION IN THE RETAIL MARKET 1. Standard Chartered’s Consumer Banking business (“CB”), which includes retail banking as well as SME banking and Private Banking, has a presence in 44 countries and serves over 13 million customers. The business operates more than 1,500 retail branches, 6,000 ATMs and offers online banking in 30 countries. At the end of June 2011, CB’s outstanding loans portfolio stood at over USD125bn (84% secured or partially secured), of which 16% was attributable to SMEs. Since the start of the financial crisis in mid-2007 Standard Chartered has increased customer lending across both CB and our Wholesale Bank by 75% (USD115bn), of which SME lending is up 62% and mortgage lending is up 47%. 2. While Standard Chartered does not have a mass retail banking or SME banking business in the UK, we hope that by drawing on our experience across multiple markets that we can provide an independent and useful perspective on this topic. In a large number of the markets in which our CB operates we are not one of the largest four banks and therefore we support measures which level the playing field. 3. Our evidence sets out four mechanisms to promote competition in UK retail and SME banking. In setting out these views we highlight that some forms of competition can have a detrimental impact on the sector’s financial stability whilst equally some stability-oriented regulations can be barriers to market entry. Therefore, it is essential that policymakers create a regulatory framework that sets to strike this balance.
Customer Focused Innovations that are Well-Regulated 4. While basic banking products may have, in some ways, become homogenised, customer focused innovations around delivery of products and services remain critical means by which a bank can differentiate itself and gain market share. Universal banks are in a better position to deliver a range of products and services for their clients. 5. It is important for regulators to strike the right balance between effective product regulation and allowing banks the opportunity to innovate to meet customer needs. Customer focused innovations pursued by Standard Chartered that have supported its growth across multiple markets include extended branch banking hours, shorter turnaround times for a variety of services (eg loan approvals, issuing of credit cards and new relationship account opening), improved online and mobile banking functionality, total relationship reward points (ie earning points not only on credit card spend but also on loan, deposit and wealth management account balances), customer service guarantees (on turnaround times for credit card and personal loan applications), and bundling of products and services to address multiple customer needs. The CB’s bundles do not preclude customers from taking up single products, but reward them for consolidating their banking relationships with Standard Chartered. The savings from a lower cost to service these relationships are passed back to customers and/or cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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invested in strengthening the franchise. Customers that sign up to some bundles pay reduced (or no) fees and get better interest rates and enjoy a higher rate on reward points. Customers that have salary accounts with Standard Chartered enjoy lower interest rates on personal loans and credit cards because we know that loan impairment rates for these customers are lower than for those who do not have their salary account with us. While banks can take the lead in developing customer focused innovations, regulators need to be supportive of, and permit, these innovations (eg extending banking hours or granting reward points for all products). 6. Regulators should ensure that market share is increased through the provision of higher customer service and not lower risk standards. Therefore, working with the industry regulators have a key role to play in establishing clear standards on management of risk in retail banking. For example, it is important to differentiate customer focused innovation from risk taking innovation such as Northern Rock’s 125% loan-to-value mortgage that enabled the bank to gain market share but also subjected it to unacceptable levels of risk. Regulators need to set clear parameters for risk taking to avoid banks taking unacceptable risks. For instance, we would welcome steps being taken by the Bank of England’s Financial Policy Committee to set clear loan-to-value ratios as part of its work on macro-prudential regulation. Such steps have worked effectively in many of the markets in which we operate in reducing the growth of asset bubbles and in reducing the risks of bank impairment. 7. To support SMEs, specifically during the financial crisis, governments in many of Standard Chartered’s markets (eg Singapore, Hong Kong and Taiwan) put in place credit guarantee schemes. Such schemes need to be available to all banks in order to ensure a level playing field.
Technologies that Reduce Barriers to Entry 8. The increasing move of retail and SME customers towards online banking will, in time, reduce the importance of the branch network, an enormous fixed cost in banking and a significant barrier to entry. India’s ICICI bank has made a successful entry into the UK retail banking market by pursuing a largely direct banking model. ICICI Bank UK’s retail customer account balances stood at over USD4bn in March 2011 and it was named “Best Online Savings Provider” by MoneyFacts. In markets where it is permitted by regulators (eg Singapore and Hong Kong) Standard Chartered allows customers to apply for credit cards online. Standard Chartered’s commercial banking online banking platform, Straight2Bank, has a SME version specifically for SMEs and this forms a key part of our proposition that has helped it win SME customers away from larger domestic competitors. 9. Mobile banking has reduced the cost to serve customers and hence reduced the barrier to entry. In Kenya, M-PESA, an SMS based mobile wallet offered by the mobile network operator Safaricom, has over 14m customers or 50% of the adult population (although the total balance of all M-PESA accounts is estimated to be less than 0.2% of banking deposits). M-PESA allows customers to transfer money to other users or make withdrawals from and deposit into their M-PESA accounts through a nationwide network of nearly 28,000 agents. In May 2010, Safaricom partnered with Kenya’s Equity Bank to offer M-PESA customers the option to open an interest bearing account, M-KESHO, with Equity Bank. Customers can use their mobile phones to transfer funds between their M-PESA and M-KESHO accounts or to apply for micro-credit or micro-insurance from Equity Bank. 10. Governments play a role in supporting technological innovation by being clear and pragmatic about (i) the types and volumes of banking activity that can be conducted through non-branch channels (eg online, via ATMs, through mobile banking, or through an agent network), and (ii) what security standards need to be. In the same way that banks undertake CBAs in deciding where to make technology investments, governments should balance the intended benefit of a regulation against the potentially substantial technology costs the sector will need to incur in order to comply with regulations. 11. Governments can back initiatives to standardise technology and protocols and to invest in shared infrastructure that allows customers to bank with smaller players without seeing a marked reduction in transactional convenience. For example, the Korean government set up and invested in a consortium (with credit card issuers, banks and telecom companies) to roll-out Near Field Communication point of sale infrastructure for mobile payments.
Practices and Policies to make Switching Banks Easier 12. For individuals to be able to switch their main bank account they need to not only go through the hassle of updating automatic direct debit authorisations but also have their employers be willing to credit their salary to an account at a bank of their choice. Standard Chartered’s experience is that some markets, such as Indonesia, are “employer-led” whereby the employer determines the bank where salaries are credited. In China, corporations are only allowed to maintain one “Basic Account” which essentially limits them to a single partner bank for their employee banking account. These practices adversely impact competition as employers will tend to favour banks with high market share. 13. Another key consideration for switching is the ease with which bank accounts can be opened. In some markets, eg in India and China, regulators require in-person (and in some cases in-branch) account opening. This limits the ability of players with small branch networks to acquire new customers. While in other markets, eg the US, customers can open an account entirely online with one or two documents having to be mailed in. We are aware that in the UK it is possible to open some bank accounts without going into a branch. Such steps cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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are to be welcomed and policymakers and regulators should ensure that without compromising anti-fraud and money laundering requirements, that it is possible to provide as many services as possible without the need for the presentation of physical information.
Improving Information Transparency and Customer Education
14. The UK authorities need to continue to educate consumers on the real cost of banking products (eg pay- day lenders) and the benefits of finding better deals. Financial literacy is being championed by several governments (eg www.mymoney.gov) and non-governmental organisations globally. Several websites (in the US and other markets) allow consumers to compare banking offers or to easily solicit multiple quotes for mortgages. These sites increase competition and empower customers.
15. Standard Chartered believes that banks also have a key role to play in helping customers develop the skills they need to better access banking services. The Business Call to Action (“BCtA”) is an initiative led by the United Nations that encourages business to use their core skills to help meet the Millennium Development Goals. In 2008, Standard Chartered joined the BCtA and Peter Sands announced Standard Chartered’s commitment to provide business training to SMEs in order to help them grow their business and contribute to local economic development. Standard Chartered partnered with the International Finance Corporation to pilot training programmes in Pakistan (2009) and Kenya (2010). This pilot evolved into a partnership with PriceWaterhouseCoopers to deliver training to SMEs in three countries in Africa (Ghana, Nigeria and Zambia).
16. The Singaporean government established an enterprise development agency, SPRING, to work with partners to help enterprises in financing, capability and management development, technology and innovation and accessing new markets. Although the needs in developed and emerging markets will differ considerably there is a role to be played by banks in all markets in helping customers better understand banking products. The British Bankers’ Association work on the Better Business Finance Taskforce includes many initiatives such as the creation of mentors for SMEs which play a vital role.
17. Competition can potentially be enhanced by requiring banks to be explicit about pricing. For example, banks in Taiwan are required to publish interest rates. Credit card issuers in the US have to follow a specific format for communicating pricing and other key terms and conditions to customers. We are aware that some of these pricing transparency measures have been adopted in the UK both through UK-led initiatives and also because of changes to EU law. We welcome steps to continue price transparency in retail banking and believe that policymakers must find ways of continuing to drive this transparency.
A Highly Fragmented Market could Diminish Financial Stability
18. Governments need to guard against the potential detrimental impact on financial stability of having a large number of banks in the market, many of which could be small. In markets such as Taiwan, an overbanked market drives down industry profitability and increases the potential that banks will fail during times of economic stress, with the collective impact being just as devastating as the failure of larger but fewer institutions. However pre-emptive actions taken by governments are important, which is why there have not been any outright bank failures in Taiwan, despite several periods of severe economic stress. The banking crises experienced by Indonesia and Thailand during the Asian Financial Crisis (1997–99) were exacerbated by the presence of too many small and medium sized banks with tenuous profitability and poor governance and supervision.
New Stability-Oriented Regulation could be an Additional Barrier to Entry
19. Some mechanisms to increase sector stability—capital increases and the need to erect complex operational or balance sheet ring-fences between parts of the business—could be barriers to entry as new players may not have the economies of scale to profitably pursue business in the UK or may elect to purse higher returns in other markets.
20. We suggest that an assessment of the competitive intensity of the retail and SME banking markets should be made on a product by product basis as it likely varies materially between products. Efforts to increase (or reduce) competition can then be targeted and prioritised on those products which have sub-optimal levels of competition. Equally important is that any product specific efforts to change the competitive environment should not result in an overall sub-optimal outcome for customers. For example, where customers are prevented from consolidating their banking relationships with an institution of their choice and enjoying the benefits that this would afford them. 9 January 2012 cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Supplementary written evidence submitted by Barclays During the evidence session on 14 December there were three requests for information: — Further detail on the cost of the Independent Commission on Banking (ICB) recommendations; — Thoughts on return on equity (RoE) versus return on assets (RoA) relating to compensation in the context of Andy Haldane’s speech on 24 October; and — EU regulatory priorities.
1. ICB Costs As Bob Diamond said during the session, we believe that the £4–7 billion per annum estimation made by the ICB is broadly right based on what we currently know from the ICB recommendations and the Government’s response. This number was also generally endorsed in the Government’s December 2011 response to the ICB Report which stated that “...the aggregate private costs to UK banks...will fall in the range £3.5bn-£8bn per annum” and the Government agreed that the great majority of the costs are likely to fall on the larger banks. As the Committee will be aware, the Government is due to publish a White Paper in the Spring which is likely to include further detail. We will need sight of detailed legislative proposals before we can confirm a more specific estimate of the cost of implementation. However, it is fair to say that even seemingly minor changes to implementation decisions could have a significant impact on the eventual cost, which can be illustrated through examples: — The most significant cost of the ICB’s recommendations will arise due to changes in the cost of raising funding in the wholesale market, both inside and out of the ring-fence. The cost of raising market funding will change for banks for two reasons: removal of any perceived implicit government guarantee and the subordination of claims of wholesale creditors due to the ring fence structure. The ICB and Government are of the view that the change will relate solely to the removal of the implicit guarantee, but this has largely already occurred due to the changes in credit ratings that agencies have already put in place. The change due to subordination, however, has not specifically occurred because the ICB recommendations contain flexibility and ambiguities around the restrictions that could be put in place and the market needs certainty on those before it can price the impact. Some decisions around the actual design will be left to legislation, and we have been working with HM Treasury to help them consider how this should look. Some detail may be left to the discretion of regulators post legislation. More generally, though, funding costs are determined by the market. Precisely how the market interprets the implications of the structural changes required by eventual legislation and regulatory rules is difficult to predict. — Another issue concerns the operational infrastructure. The level at which common infrastructure— such as branches and ATMs—can be shared in and out of the ring-fence is, as yet, uncertain but could have a significant impact not only on cost, but also on customer service. For example, could we reach a situation where some businesses will have to change their relationship manager? We simply do not know. — Another example is the impact of changing the legal entity in which UK staff are employed. Depending on precisely how this is done, very costly implications on VAT and pensions could arise. Again, we simply do not know what will be required here. Some of the reforms enacted since the financial crisis will come with costs but will clearly also benefit the economy by making the system more stable or more easily resolvable. Higher capital, RRPs, creating a bail- in regime and operational subsidiarisation are good examples of such reforms. As we have already made clear to the Committee, we remain unconvinced that the added benefits that a ring-fence will bring to the system are sufficient to offset the significant cost that this reform could (subject to further detailed decisions) have on the economy. More importantly, the costs of unintended consequences from implementing such significant reforms on a unilateral basis cannot, by definition, be predicted. We are committed to continuing to assist HM Treasury in identifying potential negative consequences and calling for clarity where there remains ambiguity. Given the complexity of the potential changes needed to implement, as well as the complexity of the legislation needed to enact them, it may take many months or years before we have a clear understanding of what the costs will be to Barclays and the implications for the wider economy. We feel we have a responsibility to continue to shape the final designs to ensure they achieve the appropriate balance between future stability of the system and the ability of the sector to adequately support a growing economy.
2. Mr Haldane’s Recommendations on Compensation The chairman also asked for views on Mr Haldane’s speech on 24 October where he discussed return on equity (RoE) and return on assets (RoA). Barclays approach to compensation is consistent with Mr Haldane’s recommendations. As Bob Diamond mentioned during the session on 14 December, we use return on risk weighted assets (RoRWA) as a key performance measure for management. RoRWA as a metric is even more closely aligned to the risk across the balance sheet than RoA. As a measure, it incentivises a reduction in leverage and a move away from riskier assets. This can easily be observed by comparing the historical loss rates (as a proportion of assets) of UK banks (who adopted the more sophisticated Basel 2 risk weights several cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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years ago) and US (who remain on Basel 1 and are generally governed by leverage ratios). The US loss rates are materially higher because the less risk-sensitive risk weights used within the Basel 1 regime incentivise them to take on—with the same capital consequences—higher returning, but more risky assets. We recognise that there are some who wish to disparage the risk weights put in place by the Basel Committee, but if that is an issue, it is best addressed by fixing the risk weights, not reverting to a regime that ignores the fundamental differences in risk tendency across asset classes. Further to this, Barclays has also ensured that compensation is linked to the existence and duration of risk through deferred incentives with clawback features, long term incentive plans, and a high ratio of rewards paid in equity. In 2010 Barclays used a contingent capital plan. This links compensation to the stability of the bank, and reinforces it.
Return on Equity RoE remains an important performance metric for Barclays because it is an important metric for our owners. That said, an organisation of the scale and diversity of Barclays should not—and we do not—rely on any single metric when balancing the short, medium, and long term needs of investors. Our priority is to ensure sustainable returns for our shareholders. It is absolutely in our interests—and the interests of all of our stakeholders—to encourage long-term returns as targeted by many of our largest investors. In difficult market conditions, we have remained profitable, strengthened our capital position, and invested the gains from efficiency savings in future business growth. These are measures which will disproportionately benefit long-term investors. Hopefully it is clear that Barclays has been taking action to create returns for our shareholders, serve our customers and clients well, reward our staff for success (but not failure) and support our communities in a way that is both stable and sustainable for the long term.
3. European Commission Financial Services Proposals There are over 20 significant separate, and interlocking, proposals covering banking, securities, investment funds, retail financial services, payment services, and financial market infrastructures which in some capacity have an impact on Barclays business. It is important to note that Barclays supports the Commission’s intention to ensure that the financial services sector is well regulated and Barclays, as a strong bank, wants strong regulation. That said we are concerned about the cumulative impact of these proposals and their potentially limiting effect on banks’ ability to support economic growth. It is also essential that there is a level playing field for the global financial services industry. The international nature of markets and firms is at odds with regional or domestic regulatory divergence on reforms. The best way to ensure safer and sounder markets is to strive for international consistency in regulation which takes into account the growing needs of companies to operate cross-border and to obtain financial services on the same basis.
Main Financial Services European Commission proposals (a) Crisis Management and Resolution Framework The European Commission is expected to publish a proposed Crisis Management and Resolution Directive by February 2012. This has been expected since July 2011. The Directive is envisaged to apply to credit institutions and investment firms plus financial and mixed- holding companies. It will set out requirements for the development of recovery and resolution plans and their assessment by competent authorities, such as the FSA. Competent authorities are likely to gain significant new powers to require changes to businesses, should resolution authorities hold concerns over resolvability. Also, competent authorities are envisaged to have new powers including the power to appoint a “special manager” to exercise the powers of management, including raising capital or reorganising the business structure. There are also likely to be provisions on “bail-in” measures. There is considerable potential overlap with the UK Government’s Independent Commission on Banking proposals and we welcome Government’s commitment to ensuring consistency between the UK and EU proposals, particularly on “bail-in”. Barclays fully supports the creation of an EU Crisis Management Framework as the means of addressing the “Too Big To Fail” issue. We have argued that the Framework needs to be clear and transparent, but also simple.
(b) Capital Requirements Directive (CRDIV) Barclays broadly welcomed the Commission’s proposals on CRD IV, adopted on 20 July 2011, which is the EU’s vehicle for implementing Basel III. We strongly agreed with the principle that prudential capital standards cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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for the banking sector should be raised and, prior to publication, Barclays had already increased its capital ratios (doubled to 11% from pre crisis), thereby providing a substantial capital buffer against the risk of further stress, whilst also lowering our leverage by a third since 2007 and improving our liquidity position significantly (multiplying it by 8 from £19bn pre crisis to £160bn in Q3 2011).
We do have concerns though that the varied non-EU efforts to implement Basel III could lead to significant fragmentation of the global regulatory environment. The different timings of EU and US actions in particular will lead to significant variations in the prudential rules for banks in the respective territories and could encourage markets, consumers and practices to shift from one jurisdiction to another.
There are also aspects of CRD IV which potentially conflict with G20 principles. For example, its stipulation that banks should be encouraged to clear derivatives through a central clearing house/counterparty. This is a principle Barclays fully supports, however aspects of the draft legislation conflict with that principle. The current Basel III text introduces increased capital requirements for exposure to centrally cleared counterparties (CCPs). This impacts both cleared over the counter (OTC) trades and exchange traded futures and options. Whilst the text may encourage banks to clear derivatives through a qualifying central counterparty, it has the opposite effect for a bank to act as the clearing member for any of its clients’ trades.
With an aggressive implementation timeline of 1 January 2013 this aspect of CRD IV could initially lead to less centrally cleared trades in the EU, which would lead to an unlevel playing field with other jurisdictions, especially the US. This underlines the importance of transatlantic co-operation on Basel III implementation and synchronised implementation timetables.
There is also the challenge of differing regulatory regimes adapting to supplementary capital requirements such as the EBA’s decision to move to temporary 9% Core Tier 1 Capital as part of the recent stress test. Whilst a disjointed EU and US approach is in itself a significant concern, it also seems there is little co- ordination on actions, such as that of the EBA, which supersede the requirements as they stand.
Furthermore, there are elements of CRD IV which have an impact on other important reform initiatives. These include corporate governance, remuneration, G-SIFIs and crisis management. The complex interplay between capital requirements and these issues demonstrates the need for a co-ordinated approach.
(c) Markets in Financial Instruments Directive
The European Commission published on 20 October 2011 its proposals to revise the current Market in Financial Instrument Directive (MiFID 2) and implement a new Markets in Financial Instruments Regulation (MiFIR).
The current MiFID framework (MiFID 1) has brought significant positive changes since it was implemented. Maintaining European investors’ choice and protecting and ensuring safe, well-functioning and transparent European capital markets are key elements of Europe’s competitiveness, and MiFID stands at the heart of achieving this.
We recognise and strongly agree with the aims of the Commission of strengthening the current framework where weaknesses have been highlighted, in particular, as a result of the financial crisis. However, in doing so, it is important to safeguard the benefits that MiFID 1 has delivered.
MiFID 2/MiFIR will significantly expand the scope of the current legislation to a broader range of market participants, activities and financial instruments. It is imperative that the proposals seek to address a clear market failure, as imposing regulation in the absence of a market failure or without a clear consideration of its impact may have unintended consequences that ultimately damage the European financial markets to the detriment of end users.
Whilst we are generally supportive of harmonisation across the European single market, we would be concerned if the MiFID 2/MiFIR proposals resulted in a worse outcome for end users of financial markets. For example, the UK has historically had an open approach to allowing access to third country firms, provided such access takes place within a sound regulatory framework. We would be concerned if the proposed pan- European regime governing third country access does not build upon arrangements that currently work well or is used in a protectionist manner.
The timetable set out by European policy makers to implement MiFID 2/MiFID is extremely ambitious given the broad scope of the proposals and its crossover with other European legislative proposals, as well as regulatory change taking place in other major financial centres. It is imperative that policy makers take sufficient time to ensure the robustness of the proposed changes, in addition to allowing ESMA sufficient time to craft appropriate and well calibrated rules. 14 January 2012 cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Written evidence submitted by the Campaign for Community Banking Services (CCBS) Executive Summary The ICB declined (8.44) to make any recommendations in the area of branch network access, specifically on neutral shared branches and improvements to IBAAs (inter-bank agency agreements) , recommended by the Treasury Committee to the Commission for consideration as potential solutions to an important barrier to entry and competition in the retail banking market. This submission examines ICB’s flawed and incomplete analysis of IBAAs, neutral shared branches and post office access upon which its “no action” decision was made and suggests there is now an urgent need for government to consider not only the competition problem with regard to branch networks, but also the issue of escalating branch closures in the social contexts of community sustainability, financial inclusion and carbon reduction. We also comment upon ICB’s weak stance on creation of a strong challenger to the established banks, putting too much emphasis on a combination of the “Verde” assortment and the NAB subsidiaries which would result in at least 50% of its branches being in Scotland and the North of England and five cultures to unify whilst being expected to take on the incumbent banks.
Introduction 1. CCBS is a coalition of 20 national charities, consumer and small business organisations which share concerns about the decline in local access to, and choice in, banking services particularly the closure of local bank branches and the impact of this on community sustainability, financial exclusion and carbon emissions. We assist local communities in campaigning against closures and promote viable alternatives including neutral shared branches and inter-bank agency agreements. This submission is made against a background of a 44% reduction in bank branches since 1990 resulting in 1,000 communities being left without banking access and a further 1,000 with only one bank and therefore no competitive choice for branch dependent individuals and small businesses. The attached bar chart reveals an escalating return to significant closure programmes by the big banks which is continuing in 2011 with an emphasis on the categories identified above. 2. This submission deals exclusively with the Competition aspects of the ICB Final Report and in particular addresses the considerable shortcomings of paragraph 8.44 in which the Commission attempted to justify its decision not to make any recommendations in the area of improvements to inter-bank agency agreements (IBAAs) and neutral shared branches, the absence of which represent important barriers to entry and inter-bank competition. Recognising this, the Treasury Committee had recommended (Competition & Choice in Retail Banking, April 2011) that the ICB consider these solutions within its competition remit. 3. However it should be said that realistic assessment of alternatives to branch access needs to go beyond the benefits to competition, and to the SME sector, and recognise the direct and indirect advantages for vulnerable individuals, community sustainability and carbon reduction, all government priorities. The Treasury Committee has experience of a similar failing as it recommended, in 1996, that the Financial Exclusion Taskforce explore shared branching which it failed to do because of its narrow focus on just the financial inclusion benefits.
Treasury Committee Recommendation 1. In its report Competition & Choice in Retail Banking published 2 April 2011, the Committee, having received evidence from several sources, dealt with the need for branch networks as a “barrier to access” in paragraphs 137–139 and specifically recommended, Recommendation 19: “That the ICB considers solutions such as an improved Inter Bank Agency Agreement and neutral shared branches as part of its remit to promote competition in banking”. 2. On 4 April 2011 CCBS wrote to Sir John Vickers with considerable detail in support of the Treasury Committee’s recommendation and offered more. This offer was not taken up. 3. As the Committee’s recommendation was directed specifically at the ICB, the Government’s response of 12 July 2011 did not comment.
Government’s Position 1. Since the Election CCBS has corresponded, unsuccessfully, with BIS,C&LGandDEFRA all of whom passed the matter to Treasury without comment. 2. Treasury acknowledged in its replies: “The government believes that it is important to ensure that people can access the banking services they need easily and conveniently” and “understands the importance to local communities of having access to appropriate financial services” cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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but made it clear that the matter was for the ICB to consider. Regrettably the ICB failed to do so properly.
ICB Reports 1. At its own request the ICB was provided initially with the comprehensive evidence on these matters which CCBS had provided to the OFT’s review of Barriers to Entry in Retail Banking but, in its report of 4 November 2010, the OFT commented (page 150): “From the evidence received, this (shared banking facilities) was not a route either existing incumbents or potential entrants expressed interest in as they were reluctant to share space with rivals and dilute their own customer experience” This displays an astonishing absence of challenge on the part of the OFT as the shared branching model, on which they have been repeatedly briefed, is a neutral space operated by outsourcers. The major banks have been briefed on this over many years and new entrants need to understand what could be available to them and how it could meet their needs. CCBS has briefed most new entrants since. The OFT, and the ICB, were made aware of our criticism on 5 November 2010. 2. In its Interim Report the ICB, not having had time to consider the Treasury Committee’s recommendations, acknowledged the need of new entrants to have access to cash (and cheque) handling services and that the Post Office network was not the complete answer. Accordingly it sought responses in its consultation to the question: “How could small banks’ ability to offer a national network of cash handling services be improved?” 3. CCBS and others responded, calling for improvements to IBAAs and a shared branching trial, and ICB, in its published summary of responses acknowledged: “There was concern raised about bank branch closures. Respondents suggested that the Post Office might be able to play a fuller role in providing banking services, while others wanted to see more shared banking services. 4. In its Final Report the ICB displayed an astonishing absence of understanding of the well documented shortcomings of IBAAs, the intrinsic neutrality of shared branching and the infrastructure and funding problems of post offices in concluding, at 8.44: “The Commission does not see a clear case for making recommendations in this area”. 5. The operation, cost and level of awareness of IBAAs has been the subject of criticism since the Cruikshank report of 2000 and the Competition Commission’s efforts to achieve provision on “fair, reasonable and non- discriminatory terms” in 2002 were successfully thwarted by the big banks which have consistently failed to honour their commitments to improve a service which can facilitate competition between them and with new entrants. ICB, however, concluded: “The Inter bank agency agreements that already exist offer an adequate mechanism for these services to be provided by large banks to small banks where required”. 6. The definition of neutral shared branching used by CCBS in its submissions to the OFT, the Treasury Committee and ICB is as follows: Basic counter and related services, to agreed operating standards, delivered by third party provider(s) on behalf of participating banks through a variety of delivery channels—retail/social enterprise franchises, mobile vehicles, community banks and banking centres—as appropriate to each community and locality. The model, which uses existing common technology, can replace existing branches and make it cost-effective to establish an “open to all” banking presence in new communities, free from the perceived competitive disadvantages of IBAAs and post offices. Why then did ICB not challenge the mistaken concern of smaller banks that their customers would be targeted by advertising in this neutral environment, especially as the chief executive of one of them, Aldermore, had written in the Daily Mail 25–4-2011 “Small banks should be allowed, for a sensible price, to use the infrastructure of the big banks. This would allow small businesses to deposit money into their chosen bank anywhere throughout the country. This would act as a real spur to competition.” 7. The ICB puts its faith in “additional planned investment by the Post Office” to put right substantial infrastructure deficiencies of space, security and staffing that, alongside the inherent sales conflict, currently prevent post office outlets providing banking agency services to 90% of the country’s five million small businesses. The small business sector is the heaviest user of bank branch counters. Since the shortcomings in post office provision identified by ICB in its Interim Report, there has been no indication that massive government funding is available to improve the post office network to a point where it could handle business banking given that it struggles now to provide consistent quality of service when it is available to less than 10% of the sector.
Conclusion 1. There is little doubt that the subject of neutral shared branching and improvements to inter-bank agency agreements has not received from the ICB the full consideration expected of it when the Treasury Committee made its recommendation on 2 April. 2. Renewed and escalating branch closure activity by the established banks, and the urgent need for new competitors to enter the market with comparable access facilities, demands urgent and thorough consideration cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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by government of all the alternatives available and options for imposing action upon the established banks. The social impacts should also be taken into account.
Other Matters Given the ICB’s confirmation that a strong challenger is required in the retail banking market, it is relevant that a combination of NAB’s UK subsidiaries with the mandated Lloyds’ disposals would result in at least 50% of the new bank’s branches being in Scotland and the North of England; a geographical imbalance that would seriously diminish the competitive strength nationally. The new bank would also face the difficulties of unifying five separate bank cultures whilst being expected to challenge the established banks competitively. September 2011
BIG 4 BANKS NET BRANCH CLOSURES (excluding branch mergers) 2000 - 2010 350 325 300 275 250 225 200 175 150 125 100 75 50 25 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: BBA Annual Abstract of Statistics 2011 and CCBS research Campaign for Community Banking Services
Source: BBA Annual Abstract of Statistics 2011 and CCBS research Campaign for Community Banking Services
Written evidence submitted by The Finance and Leasing Association (FLA) Introduction 1. The Finance and Leasing Association (FLA) is the leading trade association for the consumer credit, motor finance, and asset finance sectors. Our members include banks and building societies and their subsidiaries, the finance arms of leading retailers and manufacturing companies, and a range of independent firms. 2. In 2010, FLA members provided £70 billion of new finance to UK businesses and households. £50 billion of this was in the form of consumer credit, including 30% of all unsecured lending in the UK, made available via credit and store cards, unsecured loans, store credit, second charge mortgages, and funding for half of all private new car sales. The remaining £20 billion was provided to private and public sector businesses via leasing and hire purchase. This represented around a quarter of UK fixed capital investment (other than property) during the year, including support for 750,000 small and medium-sized enterprises. 3. We consider the ICB was right to recognise that consumer credit is provided by a wide variety of lenders, including many non-banks. It would not have been sensible to restrict consumer credit provision to ring-fenced banks. Maintaining a healthy and diverse population of lenders—both banks and non-banks—for consumers and SMEs will be an important objective for the Government in its parallel consideration of a new regulatory regime for consumer credit. 4. Similarly, the ICB was also right to allow ring-fenced banks to lend to businesses on a secured basis to avoid limiting competition and choice in the market. It is vital, however, that such lending includes not only loans secured on business assets or the personal assets of directors, but also asset finance where security comes from the bank’s ownership of the asset that is being financed. Realised losses on asset finance are typically very low (less than 1% of outstanding finance) so there should be no problem over allowing ring-fenced banks to lend in this way. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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5. Lending to small business could suffer as a consequence of the proposed prohibition on ring-fenced banks’ lending to non-bank financial businesses (p 235 of the report). It is essential not to cut off the supply of finance from ring-fenced banks to the many non-bank business and consumer finance companies. Such lending clearly has no impact whatsoever on the exposure of the ring-fenced banks to global financial markets. 6. Measures that go further than the Basel III requirements accentuate the need for attention to the detail of the impending changes to the capital requirements regime. In particular, we are concerned that the security provided by the asset in asset finance should be properly recognised. The draft changes to the Capital Requirements Directive introduce a new requirement for the value of the asset to be based on a “publicly available” source. Depending on how this requirement is interpreted, there could be a problem here, as many assets are quite specialist. It is critical that sufficient regulatory attention and resource is invested now, to get these details right for all the types of loans that ring-fenced banks will offer. 7. We would be happy to give further evidence to the Treasury Committee on any of the issues we have raised. 23 September 2011
Written evidence submitted by Unite the Union This response is submitted by Unite the Union. Unite is the UK’s largest trade union with 1.5 million members across the private and public sectors. The union’s members work in a range of industries including financial services, manufacturing, print, media, construction, transport, local government, education, health and not for profit sectors. Unite is the largest trade union in the finance sector representing some 150,000 workers in all grades and all occupations, not only in the major English and Scottish banks, but also in investment banks, the Bank of England, insurance companies, building societies, finance houses and business services companies.
Executive Summary Due to the short response timescale, this response will focus on the issue of remuneration and the effect the financial crisis has had on workers in the finance sector. — Unite has expressed disappointment at the outcome of the ICB final report and, in particular, some key omissions, including calling for a change to remuneration and reward systems, as well as recommending changes to the culture and behaviour in the boardroom that encourages greed. Unite believes that this is a lost opportunity for a new order of socially useful and ethically robust banking. — Unite is also concerned that additional costs will be introduced affecting customers through increased charges, and that the workforce, through a reduction in jobs, will suffer as the banking sector seeks to claw back additional costs that will be incurred as a result of creating the firewall between retail and investment banking across the industry.
Introduction 1. Unite is disappointed that there has been little acknowledgement of the effect the crisis has had on those employed in the banking industry. It is estimated that around 150,000 finance sector jobs have been lost since the beginning of the crisis as a result of acquisitions, mergers, and, ultimately, financial and corporate mismanagement. This has led to an increase in the pace and intensity of work, rising stress levels and lower morale among the workforce, which when combined with concerns over job security, adds further pressures to an already intense working environment. 2. Unite is further concerned that the drive to increase profits to compensate for the eventual costs associated with ring-fencing will be paid for by the workforce through lower pay, further job losses and pressures to increase sales targets; and on to customers through increased charges and higher interest rates on borrowing and lower interest rates on savings. 3. The ICB were in a position to recommend fundamental changes to the way banks are run. Ultimately this requires a cultural and behavioural shift. However, the ICB pulled back from recommending a move towards a more ethical and socially responsible banking system, instead focused on ring-fencing against the existing risk driven behaviours which pervade the industry. Unite sees this as a fundamental failure in the report.
Remuneration 4. The ICB failed to tackle the issues associated with the remuneration systems which operate within the banking sector. Unite has made representations to the ICB and others36 that there must be an assessment of the role of remuneration and reward and the part it played in the banking crisis and how this must be reformed in order to limit the risk of such a crisis taking place in the future. 36 Unite responses to HM Treasury, FSA, Treasury Select Committee between 2008 and 2011. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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5. Many of the reward packages within the finance sector link pay and performance, with the majority linked to sales. The stress placed upon workers in the industry to reach personal and peer group targets is recognised as a significant contributory factor leading to behaviour which may lead to inappropriate selling taking place as well as higher levels of sickness absence and an increase in the number of workers involved in the disciplinary process on grounds of performance. 6. Unite is disappointed that the ICB has also failed to address the link between target based reward systems and the increase in complaints to the Financial Ombudsman Service (FOS), a significant number of which are due to inappropriate sales including Personal Protection Insurance (PPI).37 7. The ICB was tasked in its Terms of Reference with “ensuring that the needs of banks’ customers and clients are efficiently served”.38 The reward system should therefore have been considered if this statement is to be addressed. All aspects of remuneration systems must be transparent, accountable, and fair and open to independent scrutiny. They should not be sales driven. 8. The Which? Future of Banking report published in 2010 agrees. It stated that: “There should be no commission or bonuses received for selling products.”39 9. According to the Which? report sales based remuneration systems should be replaced by reward schemes which focus on customer satisfaction, fair treatment and resolution of customer complaints. 10. Unite believes that the adoption of an ethics based culture within the boardroom and filtered down through the company would have improved customer confidence, raised morale among the workforce and improved existing negative perceptions of the industry.
Culture and Behaviour 11. Unite is disappointed that the ICB failed to recommend a socially useful banking business model which incorporates a moral and ethical dimension; one which regards good customer service as important as its drive for sales; one that is fair in its treatment of its workforce as well as treating its customers fairly, and one which will serve the needs of society and not just a mechanism for delivering profits at any price. 12. Unite would wish to re-emphasise the points made in our response to the ICB interim report regarding corporate governance. Weak corporate governance has been identified as a key determinant which led to the crisis and yet the existing system of corporate management and company law remains relatively unchanged. The Treasury Committee Ninth Report of the Session 2008–2009 identified that the Board of Directors (Executive and Non-Executive) have a duty to promote the success of the company. The Report went on to refer to a comment by John Varley (Group Chief Executive of Barclays Bank) to the Committee that banks were the “single, biggest contributor” to the crisis. The Report also included a quote from the Pensions and Investment Research Consultancy (PIRC) who recognised that the Board approved the “business strategies and products that caused such damage…” and they urged the committee to consider the role of the boards.40 Indeed the previous Chancellor, Alistair Darling, in his evidence to the Committee stated that the board of directors was an “area which we overlook at our peril.” The ICB has overlooked the role of the Board in this process.41 13. Much of the responsibility for the crisis could be said to lie firmly on the shoulders of the Board of Directors in the banking sector and yet the ICB has decided not to take decisive action to ensure that the boards conduct themselves in a manner which is conducive with good corporate behaviour, social responsibility and which incorporates ethically sound judgements. This could have included tough penalties or legal action which would act as disincentives for risky behaviour. The ICB failed to take a clear stand to encourage a change in corporate culture.
Conclusion 14. The workforce in the banking sector have seen the media portray them, by association, as “greedy bankers”;42 customers have taken their anger for the crisis out on them;43 their employers are making their colleagues redundant44 and regulators and the Financial Ombudsman are scrutinising every aspect of their work. It is little wonder Unite members are feeling battered and bruised and more than a little annoyed. 15. It is therefore disappointing that in the most important review of the banking system in a generation those who will ultimately be responsible for turning around the industry were not given any acknowledgment 37 FOS Annual Report 2010–11. 38 http://www.hm-treasury.gov.uk/d/banking_commission_terms_of_reference.pdf 39 Which? Future of Banking Commission Report 2010 Para 25. 40 http://www.publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/519/519.pdf Para 128 41 http://bankingcommission.independent.gov.uk/interimresponses/ 42 Daily Mail: 15 May 2009, The Sun: 26 April 2010, Sunday Mirror: 13 February 2011. 43 Mail Online: “Bank workers given alarms to deal with public anger”. 28 September 2009. 44 More than 60,000 jobs have been lost within Royal Bank of Scotland and Lloyds Banking Group since 2008. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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for the contribution they make to the industry, or recognition of the pressures placed upon them throughout the upheaval of the past four years. September 2011
Written evidence submitted by the Building Societies Association Executive Summary — The Building Societies Association (BSA) broadly welcomes the proposals made in the Independent Commission on Banking (ICB) Final Report. The structural reforms, together with other reforms that are in train, should reduce the Government subsidy that large complex banking groups have enjoyed, enabling mutual lenders and deposit takers to compete on a more equal basis. — The proposed structural reforms recognise that building societies can be the model for a more sustainable and socially useful retail financial services sector. The principles of risk management that are appropriate within the ring-fence are modelled on legislation which has applied to building societies for a number of decades. As such, ring-fencing should have only a marginal effect on mutuals’ businesses. Principles such as these would have limited some firms’ reliance on short-term wholesale funding which contributed to their failure in the financial crisis. — Furthermore, mutuals are already well capitalised, with Core Tier 1 ratios above the minimum recommended by the ICB. It is sensible that the ICB proposes a sliding scale so that the largest, most complex firms are most affected by the higher capital requirements. — However, the backstop leverage ratio may discriminate against firms such as retail-funded mutual lenders which have high volumes of low risk assets. And requiring debt to be subject to bail-in at such retail-funded firms means that write-downs will be concentrated among a relatively small group of wholesale creditors. These reforms therefore risk having perverse effects on mutuals. — The BSA believes that a case remains to increase the divesture of branches by Lloyds Banking Group, and that financial education to increase financial capability could potentially do more to help to improve consumer outcomes in the current account market than changes to the switching process. — Having a diverse range of providers in terms of size, geography, business model and approach to risk management can help to make the retail financial services sector more stable and increase competition and choice. The Coalition Agreement stated a desire to promote mutuals and foster diversity, and although recognised only implicitly in the ICB report, its recommendations should help to achieve this goal.
Introduction 1. The Building Societies Association (BSA) represents mutual lenders and deposit takers in the UK, including all 48 UK building societies. Mutual lenders and deposit takers have total assets of over £365 billion and, together with their subsidiaries, hold residential mortgages of almost £235 billion, 19% of the total outstanding in the UK. They hold more than £245 billion of retail deposits, accounting for 22% of all such deposits in the UK. They employ approximately 50,000 full and part-time staff and operate through approximately 2,000 branches. 2. As the ICB states, at present, “an expectation of government bail-outs means the price of bank funding does not reflect the risks that banks run” [Paragraph 3.95 of the Independent Commission on Banking (ICB) Final Report]. The proposed structural reforms should help to remedy this, and result in a more stable and competitive market in the future. The BSA believes that, broadly speaking, the proposals made by the ICB are a vote of confidence in the UK building society model, which has provided security and good returns to UK consumers over many years and across the economic cycle.
Retail Ring-Fence 3. The ICB’s proposals for ring-fencing retail activities in its own subsidiary will help to reduce the impact of a bank failing, make it easier for the authorities to resolve a bank, and by doing so, reduce the incentive for banks to take excessive risks as wholesale creditors are more exposed to losses. The retail ring-fence proposed by the ICB insulates the activities (principally depositing, borrowing and transmitting money) that matter to consumers and businesses, services which they could not easily obtain elsewhere. In concert with other regulatory developments, this reform should help to ensure continuity of supply of these services, even when one of these retail financial service providers fails. And structural rules such as the retail ring-fence are likely to be more difficult to erode than regulatory standards. 4. A key reason that the BSA supports the ring-fence idea is that it should help to reduce the Government subsidy to large, complex, systemic banks. The Commission estimates that the value of these subsidies considerably exceed £10 billion a year. By making these complex banks easier to resolve, creditors are less likely to assume that the firm will be supported by the taxpayer if it runs into problems. Such implicit (and explicit) guarantees have meant that large complex banks benefitted from cheaper sources of funding than many mutuals, which has distorted the markets and made it much more difficult for some mutuals to compete. The ring-fence should mean that firms are competing on a fairer basis to provide financial services to cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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households and businesses, and mutual lenders and deposit takers are looking forward to competing on equal terms with other ring-fenced entities.
5. The ring-fence design, as proposed, should have a limited impact on mutual lenders and deposit takers. This is perhaps unsurprising, as mutuals did not cause the financial crisis, and instead are seen as the model for the solution by the ICB. The ICB states: “The precedent in building society legislation appears to provide a particularly good basis for the risk management functions of ring-fenced banks. Building society regulations have operated effectively for a long time. A number of former building societies failed in the crisis or were taken over as a result of poor business models, sometimes associated with their treasury-related activities. However, evidence to the Commission suggested that problems that occurred in the treasury function only did so following the lifting of the relevant restrictions after demutualisation. In principle a ring- fenced bank should be able to undertake its necessary risk management within the building society regulatory framework, although the types of permitted instruments might need some extending given the wider range of services which may be provided by ring-fenced banks.” [Paragraph 3.53]
6. However, while broadly welcoming the ICB’s proposals, we also need to look carefully at a few areas at the margins where there may be one or two respectable activities that are permitted under existing building societies legislation that appear to be ruled out by the ring-fence. For example, a building society must be the head of its corporate group and is prohibited from being a subsidiary of a parent company, so it could not utilise the holding company or operating company models proposed by the ICB. And the principles for the ring-fence state that any entities owned or partly owned by a ring-fenced bank can conduct only permitted activities. Therefore, if a building society conducted any activities not permitted in the ring-fence it would not be able to organise its activities into ring-fenced and non-ring-fenced subsidiaries; it would have to discontinue or divest these prohibited activities.
7. Retail banks do take risks, and the BSA therefore welcomes as one of the principles that the ICB sets out for the retail ring-fence the inclusion of ancillary services such as the use of interest rate derivates to hedge and manage these risks. As the ICB states, “in general, it would be damaging for financial stability to hamper the effective operations of the treasury function” [Paragraph 3.51]. Such ancillary activities are vital to ensure that ring fenced subsidiaries would be able to operate on a standalone basis, thereby making them easier to separate and increasing the credibility that investment banking activities will not be bailed out.
8. Other activities that are central to modern retail banking activities, such as raising wholesale funding and managing liquidity are also permitted within the ring-fence. It is sensible to permit ring-fenced entities to transact with other ring-fenced entities, as well as non-ring-fenced banks, in order to conduct necessary treasury activities. And it is appropriate that the ring-fenced operations should have to meet regulatory requirements in relation to liquidity, capital, etc, on a standalone basis. A key recommendation in this area that many commentators appear to have overlooked, however, is that the ICB proposes that “back-stop limits should be placed on the proportion of a ring-fenced bank’s funding which is permitted to be wholesale funding” [Paragraph 3.57]. When it ran into problems, Northern Rock had obtained over 75% of its funding from wholesale markets. A limit on wholesale funding could have prevented this excessive behaviour. The Building Societies Act limits this to 50% of funding, and the average proportion of wholesale funding at building societies peaked at just under 30% in the run up to the crisis, and is now at just over 25%.
9. It is vital that the ring-fence is effective, and that ring-fenced and non-ring-fenced entities that are legally separate are also separate in substance, so that they are not reliant on the parent company. The principle proposed by the ICB that economic links to the parent group are no more substantial than those with third parties should help to enforce this boundary.
10. Protection must be put in place to ensure that the reforms do not result in such volumes of business flowing to non-ring-fenced entities to such an extent that they themselves become systemically important. It is important that the authorities credibly signal that large, interconnected wholesale and investment banks will be allowed to fail in order for them to be subject to increased monitoring and diligence by creditors and counterparties. In the BSA submission to the ICB’s Interim Report, we called for the Government to impose some sort of statutory commitment on itself not to rescue banks outside the ring-fence. Once it has been given a few years to bed in, the operation of the ring-fence should be reviewed, and this review should assess how much activity is taking place in entities outside the ring-fence, and whether these entities could realistically be allowed to fail.
11. The ICB rightly acknowledges that there need to be important cultural differences between the retail ring-fenced bank and investment banking operations. They propose that a ring-fenced subsidiary should have its own board of directors, the majority of which are independent non-executives, and that there is minimal cross-over between the directors on the group board and that of the ring-fence. This again reflects what has been required of building societies for very many years, and as set out in the FSA Handbook of Rules and Guidance which states that the Chair should not hold an executive position, and that a clear majority of directors on a society’s board should be non-executive.45 45 FSA Handbook: Building Societies Regulatory Guidance, BSOG 1.3.9G. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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12. For large universal banks operating across the ring-fence recovery and resolution plans will be vital to ensure the retail subsidiary can be separated on resolution. However, for small, simple institutions the costs of developing detailed resolution plans are likely to outweigh the benefits, especially as standard insolvency procedures under the UK’s Recovery and Resolution Regime will be sufficient, as was shown to be the case in the resolution of the Dunfermline Building Society in 2009.
Capital and Loss Absorbing Debt 13. Under the ICB’s proposals for ring-fenced firms’ capital requirements, it is sensible that a sliding scale is used so that it is the largest firms, whose failure would have the largest impact, which are affected the most by the proposed minimum capital requirements. Presently, the largest mutual lenders and deposit takers have an average Core Tier 1 capital ratio of 12.7%, well above the ICB (and therefore Basel III) minimum, so the ICB proposal should not have an immediate effect on mutuals. 14. Some of the concerns that we raised in our submission to the ICB in relation to the non-risk adjusted leverage ratio remain unaddressed. The ICB recommends that all ring-fenced banks should maintain a Tier 1 leverage ratio of at least 3%, as in Basel III, and up to 4.06% for larger institutions. However, this requirement could have perverse effects as it discriminates against low risk, high volume business models, such as retail- funded mortgage lenders, potentially hindering these institutions’ ability to lend. 15. In our submission to the ICB’s Interim Report we recognised the value of contingent and bail-in debt for the largest, complex, systemic banks. The ICB’s Final Report recommends that, at resolution, bail-in can be applied to instruments issued by all institutions.46 We believe applying this to all firms risks imposing a disproportionate cost on non-systemic firms, for little benefit in terms of financial stability. In particular, at predominantly retail-funded institutions, bail-in would be concentrated among a small group of wholesale investors, necessitating large write-downs. This may have a perverse effect on these firms’ ability to raise wholesale funding. 16. We support the proposal for retail depositor preference for insured deposits, while also recognising that there could be benefits for consumers if this were extended so that all genuine retail deposits were preferred. We would also reiterate our suggestion to the ICB that any changes to the creditor hierarchy to place insured retail depositors above other creditors should be planned and communicated carefully to avoid distortions and unintended consequences in funding markets, and that the transition to the final position should be swift and apply universally and simultaneously to all firms. Otherwise this change could cause potential disruptions in funding markets if the relative position of creditors in the hierarchy changes at different times for different firms.
Competition 17. The BSA believes that Lloyds Banking Group will retain considerable market power even after the divesture required by the European Commission. We are therefore disappointed that the ICB has decided not to press for an additional divestment of branches, but we accept that the experience with the Verde divesture has shown how difficult it is to realise this sale in current market conditions. 18. The BSA believes the switching process for personal current accounts should be transparent and reliable, and the ICB makes recommendations aimed at improving the process, including redirecting direct debits, and the Payments Council is introducing changes accommodating these recommendations. However, the BSA is not entirely convinced that such reforms will lead to considerable increases in current account switching or consumer benefit. This is because much consumer survey evidence indicates that most consumers are satisfied with their current account. We recommended a full cost benefit analysis to ensure that the reforms would deliver the hoped-for benefits. Efforts to increase financial capability might be more fruitful in increasing consumers’ awareness of the advantages to them of switching accounts. 19. The ICB also recommends the FCA be made a pro-competitive regulator, with a primary duty to promote competition and greater powers to police this. The BSA believes that the FCA should promote competition, including due consideration of the effects of regulations on mutual providers, but that it is not clear why retail banking is special to the extent that the existing designated competition authorities are not sufficient in applying competition and consumer law to the sector. 20. Finally, the ICB does not explicitly recognise in its report the benefits of having a diverse range of providers in financial services markets, except in that the performance of universal banks and investment banks are more closely correlated to the market as a whole than are retail banks, and therefore adding these operations to a retail bank might increase, rather than decrease, systemic risk. The Government, in its Coalition Agreement, stated its desire “to foster diversity and promote mutuals in financial services”. This is something on which the Treasury Committee has previously called the Government to do more to deliver.47 Diversity, for example in ownership structures, is important because firms will then face different incentives and will not all behave in similar ways, and are thus less likely be affected by a system-wide shock in the same way. Diversity therefore 46 This power applies to all instruments, in the first instance, with a term of 12 months or more at issuance, with secondary powers to impose losses on all other unsecured debt. The ICB proposes no grandfathering of existing instruments. 47 Treasury Committee, 2011, Competition And Choice In Retail Banking. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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increases the resilience of the system, as well as benefitting consumers by providing greater competition and choice. 21. We therefore welcome the ICB’s proposed structural reforms in that they should prevent complex, systemic banks from enjoying Government subsidies, enabling other types of provider to compete on an equal basis, and welcome the Commission’s acknowledgement of the value of the mutual and building society sector’s way of doing business in providing sustainable and socially useful retail financial services. September 2011
Written evidence submitted by the Financial Services Consumer Panel
Introduction In our submission to the Independent Commission on Banking48 we set out a number of key consumer outcomes which the banking sector should deliver for consumers. We welcomed the ICB’s interim report,49 particularly the proposals aimed at promoting a market that provided choice and value for money, which we thought went a long way towards meeting these key outcomes. The interim report supported our view that the regulator needed competition powers, as well as an effective toolkit and resources to deliver consumer protection in banking and to ensure access to financial services. The ICB report cannot be considered in isolation, but in the context of wider national and international regulatory change. It is now time to establish whether, along with the new regulatory structure in the UK and international initiatives, the ICB recommendations will deliver what is needed. We are pleased that Members of Treasury Committee have decided to hold an evidence session with the Commissioners and we have set out in this submission the key issues for retail consumers that we believe need to be addressed, and that we would like Committee Members to take into account during their cross-examination of the Commissioners.
Executive Summary The Panel’s engagement with the Independent Commission on Banking has focused on the interests of retail consumers, including small businesses, and the impact of wider reforms and changes such as the split of future regulatory responsibility between the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The Panel is not in a position to undertake a detailed analysis of some aspects of the Commission’s recommendations, such as the economic impact of the ring-fencing proposals, but we have taken the opportunity to set out in this submission the key consumer issues that we would like the Committee to take into consideration in their cross-examination of the Commissioners. These issues fall into three main areas: — Competition—We fully support the Commission’s overall approach to competition issues and we agree that the new FCA should have a specific competition objective. We have also reiterated our recommendation that the FCA should be the lead on competition issues in financial services, including dealing with supercomplaints and referring competition issues to the Office of Fair Trading (OFT)/Competition Commission only when structural changes may be needed. We support recommendations to improve current account switching, and would like some of the detail of the methodology explored further. Consumers will only move their accounts when there is a more diverse range of services and providers on offer, however, and when more meaningful information is provided by banks about the products and services they offer, how they will meet key consumer needs, and how much they cost. We would be interested to learn whether the Commissioners think that the divestiture of Lloyds Banking Group could be dealt with more creatively, using further enhancements or restrictions to ensure increased competition within the retail banking market. We welcome the recommendation that the PRA and OFT should review the application of prudential standards to ensure that they do not present an unnecessary barrier to entry to the banking sector, or an impediment to growth. This is an issue we would like to see debated further. — Protection—We strongly support measures that will ensure the safety of retail deposits and avoid further costs to the taxpayer as a result of bank failures. We do not however have the technical expertise to express an opinion on whether the proposed ring-fencing arrangement would be the most effective way to deliver the necessary degree of safety, and will rely on others to undertake that assessment. We would be interested in learning more about how any ring-fencing or similar arrangement would work for the retail end user, where there could be complexities of detail, such as consumer access to fixed rate mortgages. We agree with the Commission’s recommendations for “insured” depositor preference in the event of bank failure, but would welcome clarification of the position of retail depositors whose accounts would not fall within the scope of the Financial Services Compensation Scheme—such as consumers with aggregate savings with retail banks operating under a single authorisation that exceed the limit of £85,000. 48 At www.fs-cp.org.uk, November 2010. 49 At bankingcommission.independent.gov.uk, April 2011. The Panel’s response is at www.fs-cp.org.uk, July 2011. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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— Timing—We accept that there is a great deal to be debated and agreed before the proposed deadline for change of 2019, although in our view significant progress could be made now on issues such as greater transparency. Nevertheless 2019 is over seven years away and retail consumers and tax-payers remain vulnerable to uncertainty in the financial markets. We would be interested in the views of the Commissioners and of the Committee on any transitional changes that should be put in place ahead of 2019.
Effective Competition and Real Choice Effective competition 1. The reform of the banking industry, alongside regulatory and other changes already underway, must bring effective competition, end unfair charges and drive up standards of service. Bank accounts are an essential part of life and it is vital that consumers get a fair deal from organisations they should be able to trust. A well functioning and competitive market that delivers the right outcomes for consumers will also deliver a sustainable and less risky business for the retail banking industry as a whole. Well-managed, competitive banks operating in a well-regulated sector where banks focus on good ongoing customer service should be an achievable goal.
Choice 2. Part II of the ICB Report covers competition issues. We fully support the Commission’s overall approach—what is important is not competition in the abstract but competition to provide what consumers want. With this in mind, we are encouraged by the Commission’s recommendations to improve current account switching—and we are pleased to see that the Payments Council is already committed to working in this area.50 The Panel has long supported account number portability and we suggest that the Committee might usefully explore whether the alternative suggested by the Commission—an “alias database”—will achieve the same result. Improvements to the switching process are important; however, consumers will be more inclined to switch accounts if there is a service available that is better, cheaper, or both and at present they see little difference between what banks offer.51 3. The Commission’s view is that a substantial enhancement of the Lloyds Bank Group divestiture is the best opportunity to improve the structure of the personal current account market, with the focus on ensuring the emergence of a strong new challenger. Of course this is an important area and the Commission is proposing enhancements to the process, including the transfer of retail deposits along with branches to ensure that a purchaser is able to operate effectively. Further enhancements or restrictions may be necessary to prevent this divestment merely strengthening one of the other major banks and not increasing competition within the retail banking market and we would welcome further debate in this area.
Transparency 4. In order to shop around consumers need access to information about the products and services that are available and how much they cost. We agree with and support the recommendations in the report on improving transparency, although we see no reason why banks and the regulators could not start work on this now. We too would like to see information such as credit interest forgone made available on account statements in a standardised form and we welcome the ICB’s support for improving price comparison tools for personal current accounts. If banks providing retail banking services opt to change their current business models this may well result in the illusion of “free banking” being dispelled. But we see nothing in the ICB recommendations themselves that would inevitably mean that banks could not offer a no-charge-if-in-credit option on a menu of current account services and facilities, if they wished to do so. Consumers may welcome this outcome. 5. Banks’ obligations under the Payment Services Directive52 make it clear that the charges they can impose for payment services must be proportionate to the actual costs relating to that customer. So banks should already have made considerable progress in identifying the cost of particular services to customers and being in a position to justify and disclose that cost in this particular context. We do not think it is much of a leap for banks to start providing far more information to their customers about the price of/charges for operating a bank account and any ancillary products and services that customers might want to use. This could include a summary statement of total charges for each customer. A format similar to the Moneymadeclear tables53 could provide a useful template, to be used alongside best practice/qualitative type guides produced by independent bodies. 6. The Panel also welcomes the work being done by the European Banking Industry Committee to improve transparency of bank charging at EU level, although it believes nevertheless that there is room for further improvement. The Report itself refers to the work of FairBanking54 in this context and we think this approach is worth further consideration. 50 Press release “Payments Council Board endorses plans to make account switching easier” 15 September 2011 at www.paymentscouncil.org.uk 51 Stick or Twist, Consumer Focus, October 2010 at www.consumerfocus.org.uk 52 Regulation 54. 53 At moneyadviceservice.org.uk 54 Fairbanking Foundation at www.fairbanking.org.uk cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Impact of Regulation 7. The role of the new conduct regulator, the FCA, is another key factor in invigorating competition in the banking sector. As we have said during the continuing debate on the future of regulation we believe the FCA should have an objective to promote effective competition that improves consumer outcomes in retail and wholesale markets. Section 1B(4) of the draft Financial Services Bill requires the FCA only to discharge its general functions in a way which promotes competition, when this is compatible with its other objectives. The ICB suggests replacing the “efficiency and choice” objective with a specific “promoting effective competition” objective. The Panel has suggested changing the wording of this objective to “efficiency, access and choice”. We would be interested to learn from the Commissioners how their proposal might encompass these concepts in its single “promoting effective competition” objective. It is not simply a question of the FCA’s statutory powers and duties however. The FCA will need an effective toolkit and the right resources with which to carry out its functions if the right outcomes are to be delivered in practice. 8. The case for the FCA to have concurrent powers, as do other industry regulators, to use its expertise to carry out market investigations, with reference to the Competition Commission only if structural change needs to be considered, is a strong one. The FCA should be the lead on competition issues in financial services and should refer competition issues to the OFT/ Competition Commission when rules cannot be made to solve a problem and structural changes may be needed. It should also deal with supercomplaints regarding banking and other financial services. Support from the Commission and the Committee for this approach would be invaluable. 9. There is reference in the ICB recommendations to barriers to entry to the market and suggests that the new PRA should work with the OFT to review the application of prudential standards to ensure they do not unnecessarily limit the ability of new entrants to grow. We welcome this as an area for further analysis and debate. Obviously we would not wish to see consumers’ interests put at risk by new banks with business models unable to withstand economic pressures in the rush to provide a more diverse market, but we are concerned that the PRA in particular may focus on prudential issues to the detriment of competition. For this reason we believe that as well as working with the OFT, the PRA’s objectives should include an obligation to have regard to the impact of its actions on competition. We also think the FCA and PRA should consider ways of speeding up the authorisation process, while maintaining its robustness. This would take a measure of uncertainty and costly “waiting time” out of the procedure.
Protection 10. One of the most radical proposals in the ICB Report is to require a ring-fence around particular retail business activities.55 This approach has immediate appeal, particularly in the light of recent media coverage of substantial financial losses to one bank apparently caused by a single employee.56 11. We strongly support measures that will ensure the safety of retail deposits and avoid further costs to the taxpayer as a result of bank failures (plus any other benefits to consumers of stability). There has been much discussion of the additional cost of such an arrangement—and there seems to be no doubt that any such move would involve costs to all parties—perhaps with a view to discrediting the proposal. The Panel does not, however, have the technical expertise to evaluate the specific ICB recommendations and we will be relying on others to undertake this work. Nevertheless we believe that it is essential that further measures are taken to protect consumers and tax-payers from future bank collapses. The onus is on the critics of “ring-fencing” to propose an alternative that delivers better protection for retail and small business customers and gets the tax payer off the hook, at lower cost. If the consensus following the Treasury Committee Review and further consultation is that ring-fencing as proposed is the most effective way to deliver the necessary outcomes, we would be happy to support the ICB approach. 12. We believe that the application of the ring-fence principles set out in the ICB Report, whatever the mechanism that is eventually identified, should go a considerable way towards ensuring the right level of consumer protection. But the feasibility of the approach will very much depend on the detail of ring-fenced operations at customer level. Some of this is referred to in the Report, such as where banks wish to offer customers fixed rate mortgages, which would involve the use of a derivative product. This immediately raises questions about the complexities of applying the ICB principles in practice and we are interested in learning more about how any ring-fencing structure might work for the end retail user. 13. We support the ICB’s recommendations for “insured” depositor preference as a further level of consumer protection. This would place most retail depositors ahead of other creditors, such as holders of other forms of bank debt. Importantly, in real terms this would shift the immediate risk currently borne by the Financial Services Compensation Scheme (FSCS) onto market counterparties. This should encourage share and bond holders to take greater responsibility for the behaviour of banks. 14. We are not sure of the position of retail depositors whose accounts fall outside the scope of FSCS cover. This might include, for example, individuals with deposits with more than one bank within a group whose total savings exceed the current protection limit of £85,000. These would not be “insured” deposits as we understand 55 Chapter 3 of the Report. 56 Statement 16 September 2011 at www.fsa.gov.uk, report 18 September at www.bbc.co.uk/news/business cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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the position described in the Report, yet it seems inequitable that they should not enjoy the same retail depositor preference as an individual whose savings total, say, £84,000. This again is an area which will benefit from further clarification and detailed debate.
Timing 15. There are a great many important principles and practicalities to be debated before the ICB’s recommendations, or proposals developed from the recommendations, can be put in place. Nevertheless 2019 is over seven years away, and we are living in an environment dominated by global financial uncertainty. Retail consumers as well as tax-payers continue to be vulnerable. 16. The banking industry is also making other changes and will have to respond to national, European and other international initiatives in future. We would like to see the industry taking the initiative and working alongside consumer groups and the regulators to bring about some of the changes recommended in the Report much more quickly. For example, greater transparency over retail banking services and charges could we think be an area where significant progress could be made in a relatively short time. 17. While we do not have specific proposals on any transitional protections for retail customers, we would be interested to hear the views of the Commissioners on any areas covered in their Report where transitional protection might be necessary, or where there is a significant risk of additional detriment before reforms are put in place. As already indicated we do however think that progress could be made now in areas such as greater information about fees and charges.
Annex ABOUT THE FINANCIAL SERVICES CONSUMER PANEL The Panel is an independent statutory body, set up to represent the interests of consumers in the development of policy for the regulation of financial services. It works to advise and challenge the FSA from the earliest stages of its policy development to ensure they take into account the consumer interest. The Panel also takes a keen interest in broader issues for consumers in financial services where it believes it can help achieve beneficial change/outcomes for consumers. Since the Panel was established in 1998, we believe it has helped deliver significant, positive benefits for consumers. We support the FSA where we believe policies can help consumers and challenge the FSA forcefully when we feel consumers would be disadvantaged. Members of the Panel are recruited through a process of open competition and encompass a broad range of relevant expertise and experience. There are 15 members of the Consumer Panel, including the Chair Adam Phillips and Vice Chair Kay Blair. Current members have experience of consumer advice, campaigning, communications, market research, journalism, the law, financial services industry, financial inclusion, European issues, financial regulation and compliance and later life issues. 30 September 2011
Written evidence submitted by the Institute of Chartered Accountants in England and Wales Introduction 1. We are writing in response to the call for evidence by the Treasury Committee on the final report of the Independent Commission on Banking (ICB). Our submission is concerned with the proposal to create ring- fenced retail banks. ICAEW would be pleased to provide oral evidence on any aspect of its evidence. We also stand ready to provide further technical input to the Committee. 2. The ICB’s ring-fencing proposals are multi-faceted and complex. The evidence below reflects ICAEW’s current understanding of the main issues, but further questions may surface as public debate proceeds.
WhoWeAre 3. ICAEW operates under a Royal Charter, working in the public interest. Its regulation of its members, in particular its responsibilities in respect of auditors, is overseen by the Financial Reporting Council. As a world leading professional accountancy body, we provide leadership and practical support to over 136,000 members in more than 160 countries, working with governments, regulators and industry in order to ensure the highest standards are maintained. We are a founding member of the Global Accounting Alliance with over 775,000 members worldwide. 4. Our members provide financial knowledge and guidance based on the highest technical and ethical standards. They are trained to challenge people and organisations to think and act differently, to provide clarity and rigour, and so help create and sustain prosperity. We ensure these skills are constantly developed, recognised and valued. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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5. ICAEW established a Financial Services Faculty in 2007 to be a world class centre for thought leadership on issues and challenges facing the financial services industry, acting in the public interest and free from vested interests. It draws together professionals from across the financial services industry and from the 25,000 ICAEW members in the sector, including those working for regulated firms, in professional services firms, intermediaries and regulators.
Major Points Ring-fencing
6. Following full consultation with stakeholders, the Government will need to make a high-stakes judgement call in striking a balance between public demand for strong action against the concerns of the banking industry and others about the possible costs and unintended consequences of such action. It is important that Government sets a clear direction and timetable for any further reform. Business confidence requires as much certainty as possible, and any on-going speculation and delay could undermine the economy.
7. ICAEW supports the policy objectives of minimising the likelihood of disruption to the supply of vital banking services to the UK economy, and of limiting perceptions of a government guarantee for bank liabilities.
8. We agree with the ICB that ring-fencing would reduce the likelihood of UK retail business being brought down by problems elsewhere in a banking group. It would in general also make it easier to avoid systemic financial disruption to the UK economy in a crisis, because at least some functions critical to the economy would be in separately-capitalised entities. Furthermore, placing functions vital to the UK economy in ring- fenced entities could make it easier for stakeholders to discern banks’ performance in supporting British business and households.
9. So overall we have sympathy for the ICB’s view that essential UK banking services should be kept separate from the wider, global role of some British banks, and in particular recognise the case for seeking to insulate UK retail deposits from capital market volatility. However, there is a range of practical issues which need to be explored further before concluding that ring-fencing is the appropriate path to take.
Suggested questions for Committee
10. We believe that there are a number of important questions that should be considered by the Committee. We have set these out below, and provide some analysis of them in the section on practical issues. — How do the ICB proposals fit with international developments? — To what extent would the ring-fencing proposals limit the pressures for public sector solvency support to the banking system? — Why does the ICB propose an apparently narrow set of banking services which must be inside the ring-fence? Are there not many more banking services which are essential, and on the ICB’s reasoning should also be inside the ring-fence? — What does the ICB expect the balance sheet position and profitability of ring-fenced banks to be? — How much work did the ICB do on the impact on bank lending, including lending to SMEs, of ring-fencing and the reform programme more generally? — What would be the role of independent boards of UK ring-fenced bank subsidiaries? — Did the ICB consider the implications for transparency of UK ring-fenced banks possibly not meeting the technical criteria for consolidation into the accounts of their wider group?
Practical Issues for Further Consideration International and European developments How do the ICB proposals fit with international developments?
11. In our view the ICB’s proposals need to be considered more explicitly in the context of the global and European financial reform process generally. For example, the current draft of the legal text which would implement Basel III in Europe takes a broadly maximum harmonisation approach to bank capital requirements. That could limit the scope for the UK to impose additional requirements in respect of ring-fenced banks.
12. Another potential constraint is the impact of additional UK requirements on the competitiveness of UK retail banks. There is a risk of ‘passported in’ banks from elsewhere in the European Economic Area gaining market share as a result of less onerous regulatory requirements. At an extreme, this could lead to a repeat of the scenario seen recently with respect to Icelandic banks. This issue was explored in The Turner Review (Box 1 C, page 38). cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Public sector support to banking To what extent would the ring-fencing proposals limit the pressures for public sector solvency support to the banking system? 13. Four aspects of the ICB’s proposals relevant to pressures for public sector solvency support of the banking system may require further consideration. 14. First, in our view, the ICB has looked more at the position of banks taken individually rather than instances where much or all of the banking system as a whole is under stress, either domestically or internationally. It may be more difficult to avoid support if the system generally is in difficulties, because that would typically limit the feasibility of private sector options for bank recovery or resolution. 15. Second, the fact that certain banking functions are deemed essential, and required to be placed inside the ring-fence, could create a strong expectation of back-stop public support for ring-fenced banks. This matters because such banks would face a variety of banking risks—for example risks arising from limited diversification of assets and, on the funding side, any imbalances between the deposits they attract and the size of their loan book. 16. We note that the ICB makes a distinction between essential functions, that need to be maintained, and the creditors of banks supplying these functions who, except for insured depositors, in its view do not need to be kept whole. We believe that in a generalised crisis it may be difficult to maintain such a distinction. We also note that for many years the Building Societies Commission administered a kind of ‘UK retail bank’ regime for the societies, and there were nevertheless several cases in which individual societies got into difficulty. 17. These points suggest that there should be the greatest possible commitment ex ante to treating ring- fenced banks in the same way as all other banks with regard to recovery and resolution. 18. Third, the ICB’s recommendations mean that a range of more or less essential functions may be found outside the ring-fence. That could result in pressures to support non ring-fenced business. We do not agree with the ICB that the only truly essential services are retail and SME deposits and overdrafts. For example, deposits of companies above the SME thresholds (many of which are nonetheless relatively small), key forms of credit creation (notably residential mortgages), and vanilla commercial banking services such as trade finance would all normally be regarded as essential. 19. While we accept that in practice banks may voluntarily put many of the business lines identified immediately above inside the ring-fence, because of the need for retail deposits to be profitably invested, this is an area which requires further analysis. It would seem more consistent with the logic of the ICB’s approach to require all functions essential to the UK economy to be inside the ring-fence. The Treasury Committee may wish to review the list of economic functions of banks set out in the recent FSA paper on Recovery and Resolution Plans (CP11/16, August 2011, page 36) and consider whether the set of activities which must be placed inside the ring-fence should be broader than the ICB advocates.
Why does the ICB propose an apparently narrow set of banking services which must be inside the ring- fence? Are there not many more banking services which are essential, and on the ICB’s reasoning should also be inside the ring-fence? 20. Fourth, continuing contingent public support for non ring-fenced banks may arise from the scale, complexity and cross-border nature of the wholesale capital markets business of major banks. As the Financial Stability Board, Bank of England and the FSA have recently indicated, it is questionable whether, for the foreseeable future, there would be a smooth path to resolution without some kind of public intervention— especially if market conditions were highly stressed. 21. There is a variety of work-streams in train internationally, in Europe and domestically on Recovery and Resolution Plans (RRPs). ICAEW believes that the ICB Commissioners should make clearer why, if robust RRPs were in place, there would still be a case for ring-fencing—in other words, to justify their view that structural change of the kind the ICB advocates is required in order for RRPs to operate effectively. This is partly a question of whether there would still be a case for the ICB’s proposal that large retail banks hold capital in excess of the Basel III minima, and for their proposals on bail-in-able debt that go well beyond what has been agreed globally (if so, there would have to be separately-capitalised entities to which these additional requirements would apply).
Banks’ business models What does the ICB expect the balance sheet position and profitability of ring-fenced banks to be? 22. The ICB report does not explicitly analyse the implications of the regulatory reforms for banks’ business models, and the extent to which the proposals are consistent with a banking system that works for both banks and bank customers. In particular, there is a need to look at what the business position (both profitability and balance sheet) of ring-fenced banks might be—especially the interest margins that might be needed for such cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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banks to be economically viable. This analysis should be done against the backdrop of a range of medium- term macro-economic scenarios, including ones in which economic growth remains subdued for an extended period of years. 23. A key issue is whether the synergies for firms and customers from the universal banking model can be largely retained, as the ICB maintains, in a ring-fenced model where retail and wholesale banking are still in the same group.
How much work did the ICB do on the impact on bank lending, including lending to SMEs, of ring-fencing and the reform programme more generally? 24. There are at present a variety of pressures on banks’ income and return on equity. These include existing domestic and international initiatives to increase capital and liquidity requirements, the implications of fragile economic conditions on the value of their assets, and a strengthening of the regulatory framework for conduct of retail business. In this environment, market appetite to absorb new issuance of bank equity or debt at anything like current levels may well be limited. There is a risk that banks’ reaction to further tightening of prudential requirements will be to restrict lending, and/or widen spreads.
Governance, accounting, insolvency and other legal issues 25. The ICB proposes that a ring-fenced UK retail bank would be legally, economically and operationally separate from the rest of its banking group. It would have an independent board, should publicly report as if it were an independent listed company, and retail depositors should rank ahead of certain other creditors in the event of insolvency. This raises some important governance, accounting and insolvency questions.
What would be the role of independent boards of UK ring-fenced bank subsidiaries? 26. On the assumption that the publicly-issued shares are those in the bank group, the boards of both the ring-fenced and non-ring-fenced parts of a banking group would be reporting to the same shareholders. It is not entirely clear whether the independent boards of UK retail bank subsidiaries would have an additional duty of care in law to anyone else—but if so the UK bank could conceivably come to operate in a way which was inconsistent with the business strategy of its wider group. 27. We are not sure whether UK retail banks boards would need to be “independent” in the manner envisaged. An alternative would be to retain normal corporate governance arrangements, but for additional duties on the directors of ring-fenced banks to be imposed by statute or regulatory rules. Existing company law can require directors of a subsidiary to put the obligations of that entity before the interests of the wider group—for example, limiting dividend distributions to the parent in instances of a pension scheme deficit.
Did the ICB consider the implications for transparency of UK ring-fenced banks possibly not meeting the technical criteria for consolidation into the accounts of their wider group? 28. Regarding accounting, if the retail subsidiary bank was strongly separate in the way the ICB envisages, there could be important technical complications regarding the group accounts—it is not clear that the subsidiary would pass the test of control for accounting consolidation (as set out in International Financial Reporting Standard 10: Consolidated Financial Statements). 29. This means that although it may be widely acknowledged that economically the ring-fenced banks are part of wider banking groups, it might not be possible to reflect this in banks’ group accounts. 30. The proposal to move depositors up the insolvency rankings could have a significant business impact. Insolvency law is a complex area, so any legislation would need careful consideration. It could indeed have the effect of incentivising wholesale markets to pay closer attention to the risks run by banks and strengthen the role of market discipline. However, the effective subordination of wholesale creditors could make it more difficult for banks to obtain market funding whenever confidence is fragile. 31. Alternatively, markets might seek to protect their position by carrying out a higher proportion of transactions with banks on a collateralised basis—in which case there would little impact on market discipline. 32. The ICB report lists legal issues which would need to be addressed in any transition to ring fencing, in the light of legal advice taken by the ICB (paras 5.98–5.99, p150). This list looks formidable, and to facilitate Parliamentary and public consideration the substantive legal advice should be put in the public domain.
Conclusion 33. There is a considerable number of issues regarding design and transition which will require further consideration in order to see whether ring-fencing would make a positive contribution towards the public policy objectives in the ICB’s mandate. 34. The benefits of any form of ring fencing that may be proposed by the Government would need to be carefully compared to the costs. More generally, the need for financial stability and protecting future taxpayers cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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has to be weighed against the needs of businesses and customers to have financial services available at an affordable price, and the important role that financial services play in the UK economy. 35. The ICB has provided extensive analysis. It will take time fully to consider the report and the questions it raises. As the report is debated, some of the issues highlighted above may be resolved, while others may come to light. We would be very happy to assist the Committee further in any aspect of its work in considering the ICB’s proposals. 30 September 2011
Written evidence submitted by the CBI The CBI Perspective 1. The CBI is the UK’s leading business organisation, speaking for some 240,000 businesses that together employ around a third of the private sector workforce. 2. Our contribution to the Independent Banking Commission, and submission to the Treasury Select Committee inquiry, focuses on the “business user” view of the banking system and the impact of potential reforms on business. 3. The CBI’s membership encompasses companies of all sizes and sectors, including banks, so we are uniquely well placed to do this.
Executive Summary 4. Business wants greater stability in the banking sector, but the immediate need is for an unrelenting focus on bank lending to support the economic recovery and growth. 5. The ICB recommendations will add to the cost of banking operations in the UK, all of which will have some impact on the cost and availability of lending to business. 6. Against a backdrop of major reform to the financial sector, the “when” and “how” details for implementing the ICB’s recommendations need careful examination to avoid damage to the economy. 7. Ring-fencing requirements will make bank products more expensive and harder to access for some businesses, and there could be unintended consequences around the stability benefits. 8. Imposing higher capital requirements on UK banks in isolation will make lending to UK businesses more expensive relative to their international competitors. 9. Measures to boost competition in the banking sector are welcome, and will benefit small businesses as well as retail consumers.
Business wants greater stability in the banking sector, but the immediate need is for an unrelenting focus on bank lending to support the economic recovery and growth… 10. UK businesses and the wider economy depend on a strong and stable banking system to conduct everyday business, such as making payments and taking deposits, but also to provide funds for investment and to help manage the risks they encounter in day-to-day trading. Businesses also benefit from a universal banking model so that they can easily access the full range of services they need. 11. The costs of the recent banking crisis have had widespread economic impact, and business wants to see reform in the banking sector. In particular, the CBI favours banks being required to hold more capital to withstand losses, having recovery and resolution plans to resolve crisis situations, and more rigorous regulation to identify and tackle emerging problems. 12. Businesses recognise that some of these reforms come at a cost, but these costs must be proportionate to the benefits they deliver in terms of greater stability and competition in the banking sector. 13. With the economy in a fragile state, and bank lending remaining subdued due to depressed demand and constrained supply for parts of the economy, the immediate focus should be on ensuring banks are in a good position to support the recovery, through lending to businesses and consumers. So we urge the Government not to implement any reforms now that would jeopardise that priority.
The ICB recommendations will add to the cost of banking operations in the UK, all of which will have some impact on the cost and availability of lending to business… 14. The ICB proposals will add to the cost of banking operations in a number of ways, which will have a knock-on impact on the cost and availability of lending to business. We set out the detail of this in the sections on ring-fencing and capital reforms below, but in summary: — The ring-fencing proposals could add to cost in a number of ways: — Through increasing total capital and liquidity requirements on banks, which both restricts and adds to the cost of lending. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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— Making it more expensive, especially for small firms, to access some financial services such as treasury products—including foreign exchange, interest rate and commodity hedging—if those activities sit outside the ring-fence. — By banks passing on the costs of ring-fencing, such as loss of diversified earnings, to end customers including business. — The proposals on additional capital—principally for bank activities inside the ring-fence, although measures on primary loss-absorbing capital will impact on non-ring-fenced activities as well—will lead to an increase in the cost of banking.
Against a backdrop of major reform to the financial sector, the “when” and “how” details for implementing the ICB’s recommendations need careful examination to avoid damage to the economy… 15. The CBI believes it is particularly important that the ICB’s suggested approach on the level of flexibility around its ring-fencing proposals and the timing for when the package of reforms will be introduced are maintained. 16. There is already a major programme of international banking reform underway, and much has already changed since 2008. Measures include much tougher capital and liquidity requirements, better recovery and resolution tools or “living wills”, and a tougher and more intrusive regulatory regime. 17. In the UK, for example, banks’ capital buffers are now broadly double what they were in the run-up to the financial crisis, having increased from 4–6% to 9–11% today. 18. All of these will make the banking system more resilient, but the consequence will be to add cost to banking operations. The capital proposals, in particular, will make lending more challenging. 19. The ICB proposals are a substantial set of measures that go beyond this programme of reforms that has been agreed internationally. Reforms that are unilateral and add to the cost of doing business should not be introduced at this point in the economic cycle. 20. The CBI welcomes the ICB’s proposals for a phased introduction on the majority of its proposals. First, because the economy should be more resilient and better placed to absorb additional costs. And second, because the 2019 deadline is consistent with when other major international reforms, particularly the Basel III capital reforms, are due to be completed.
Ring-fencing requirements will make bank products more expensive and harder to access for some businesses, and there could be unintended consequences around the stability benefits… 21. The costs of imposing a retail ring-fence on banks will result in some bank products and services becoming more expensive and harder to access for businesses. 22. The ring-fence will increase the total capital and liquidity requirements on banks in total, as capital and liquidity will become “trapped” within each silo of the ring-fenced and non-ring-fenced parts of the bank. This will both restrict and add to the cost of lending, which at least in part will inevitably be passed on to customers. 23. There are some specific prohibitions on what can be inside or outside the ring-fence that could have cost and availability implications for business. These include: — The ability of firms to obtain risk management products The ICB proposals specifically prohibit “structuring, arranging or executing derivatives transactions, as agent or principal”. This will make it more costly and harder to obtain for businesses, especially smaller firms, to access some important financial services such as exchange rate hedging and other risk management products. — Restrictions on dealing with non-EEA customers The ICB also proposes that ring-fenced banks will be prohibited from transacting with entities based outside the European Economic Area (EEA). This has a number of consequences for business. As an example, the following scenarios would not be permitted: — A small manufacturing business has an operation in Jersey, and wishes this subsidiary to use the same bank relationship. — A medium-sized retail business has outlets in a number of overseas territories, including a number in the US and Japan, but wishes to maintain a single banking relationship in the UK. 24. There are also a number of potential unintended consequences that the Government should avoid in implementing the ring-fencing proposals, which could undermine the stated objective of delivering greater financial stability. These include: — A ring-fence could result in increased leverage in the system, as a result of a mis-match of eligible assets and liabilities within the ring-fence. — Moral hazard could increase within the ring-fence, leading to riskier lending practices, driven by a perception that deposits held at the ring-fenced bank will be safe. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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25. So the CBI urges the Government to undertake a rigorous cost-benefit analysis of the ICB’s ring-fencing proposals to ensure that the costs to the economy are fully understood, and the benefits stand scrutiny, before moving ahead with implementation.
26. The level of flexibility in the design of the ring-fence proposed by the ICB is a step in the right direction, and will go some way to alleviating our earlier concerns expressed at the time of the ICB’s interim report. For example, the proposed design of the ring-fence will allow banks to transact with businesses of all sizes and help prevent distortions in the corporate banking market. It also recognises and allows for different bank business models, which will help to promote competition.
Imposing higher capital requirements on UK banks in isolation will make lending to UK businesses more expensive relative to their international competitors…
27. Requiring banks to hold more and better quality capital is one of the CBI’s preferred measures to help make the banking system more resilient.
28. International reforms, driven by the Basel III proposals and due to be implemented in Europe through the latest Capital Requirements Directive (CRD IV), will significantly raise the levels of capital banks are required to hold to withstand future shocks.
29. The ICB has recommended a package of capital reforms that go beyond the international consensus. These include requirements for higher levels of capital within the ring-fenced bank, a minimum level of primary loss-absorbing capital at the group level, a higher leverage ratio and new proposal to introduce depositor preference. Depending on how they are interpreted and implemented, the new proposals on primary loss- absorbing capital could be particularly significant.
Notwithstanding the benefits of enhanced financial stability, capital reforms will lead to an increase in cost. This will impact on business in one or both of the following ways: — Imposing higher equity capital requirements, coupled with making debt funding riskier for investors, will increase the overall cost of funds for banks. This will ultimately get passed on to customers. — Banks may look to reduce their levels of lending to stay within the new capital requirements, as raising further capital in the current market environment will be challenging and costly.
30. The CBI’s concern is that if the UK acts in isolation on tougher capital requirements, the cost of lending to UK businesses will increase, putting UK firms at a disadvantage relative to their international competitors.
Measures to boost competition in the banking sector are welcome, and will benefit small businesses as well as retail consumers…
31. Business wants choice and diversity in financial products, so the ICB is right to set out measures to inject greater competition in the banking sector. These include proposals on switching, price transparency and competition objectives for the new Financial Conduct Authority (FCA).
32. From a business perspective, we believe the ICB’s competition proposals will be most relevant to small businesses.
33. The ICB’s proposals to improve switching are welcome and will help to increase competition for small businesses as well as retail consumers. In particular, the CBI supports the recommendation that banks should improve the process for transferring security, which will help businesses that have borrowing relationships with their existing bank. Although little detail on this is provided in the ICB report, we believe this is a critical part of enabling higher levels of account switching for small businesses.
34. The ICB makes a number of proposals in relation to greater price transparency for retail products, including business bank accounts. In general, transparency can help small businesses make informed choices, although we believe that providing data on “foregone interest” will only have a limited impact for many businesses.
35. The CBI also supports strengthening the objectives of the new FCA to ensure that there are strong pro- competitive powers and duties embedded within the new approach to financial regulation. We believe that a markets-based competition approach will deliver better outcomes than the new regulator attempting to impose price controls or acting as an economic regulator. September 2011 cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Written evidence submitted by the British Bankers’ Association Introduction 1. The British Bankers’ Association welcomes the opportunity to provide written evidence to the Treasury Committee in respect of the final report of the Independent Commission on Banking. We represent 220 banks from 60 countries on UK and international banking issues. 2. This submission outlines our views on: — The interrelationship between the ICB’s recommendations for the UK and the international reform programme and the need for a comparative analysis setting out incremental costs and benefits of the additional measures. — The retail ring-fence and its effect in practice on banks of different types and sizes and their ability to meet customer needs. — The combination of the loss-absorbency proposals and depositor preference and whether the proposals overall may combine to have a disproportionately negative effect on long term bank funding. — The need to understand the potential consequences of the proposed introduction of a leverage ratio that may be more constraining than the equivalent measure in Basel III. — The ICB’s assessment that its recommendations would not unduly impact international competitiveness, including its requirement for additional loss absorbing debt to apply to the broader group operations of UK headquartered banks. — The extended timetable proposed for the introduction of resulting measures. 3. A further consideration is that the report does not necessarily weigh up all of the consequences of its proposals. It is possible, for instance, that incremental measures aimed at reducing the impact of failure may have consequences that may be of broader detrimental effect. An example would be the proposed introduction of depositor preference. While this reinforces the need for shareholders and creditors to bear losses in the first instance, if it has an undue bearing on the price and availability of unsecured medium to long term funding then the economic effect may outweigh the benefit. 4. As the ICB’s recommendations have potentially far reaching consequences for individual banks and, the sector generally and for the wider economy, we see a need for HM Treasury to ensure that there is appropriate consultation with a wide range of stakeholders in determining the approach to implementation and a full and thorough cost/benefit analysis of the potential impacts. We stand ready to contribute to these processes. 5. We should add that the ICB report was published less than three weeks before the preparation of this written evidence and that we are still in the process of analysing key aspects in consultation with members. We are pleased to share our initial assessment with the Treasury Committee, but would underline the tentative nature of the views that we are so far able to express.
Aims of Reform 6. The ICB report explains that the international reform agenda—notably the Basel process and European Union initiatives—is making important headway but adds that the ICB considers that this needs to be supported and enhanced by national measures, which the ICB sees as especially important given the position of the UK as an open economy with very large banks extensively engaged in global wholesale and investment banking alongside UK retail banking. It sees part of the challenge for reform to reconcile the UK’s position as an international financial centre with stable banking in the UK. 7. The ICB sees further reform measures as necessary in order to ensure not only greater resilience against future financial crises and removing the risk from banks to the public finances, but also to achieve a banking system that is effective and efficient at providing the basic banking services of safeguarding retail deposits, operating secure payment systems, efficiently channelling savings to productive investments, and managing financial risk. 8. Whether in terms of the proposal for a retail ring-fence or the specific proposals for increased loss- absorbency, however, the report stops short of providing a comparative analysis setting out the benefits and disadvantages of the UK adopting measures that differ considerably from the internationally agreed path built up on the basis of consensus within the G20 and the bodies reporting to it including the Financial Stability Board. This is a shortcoming that will need addressing at a future stage.
The Retail Ring-fence 9. The ICB recommends the introduction of a “ring-fence” between retail banking and investment banking. The retail-ring fence will be required to be a separate legal entity and to meet regulatory requirements for capital, liquidity, funding and large exposures on a standalone basis, with dedicated operational and support services, an arm’s length relationship with the wider group, and an independent board. The ICB allows for some flexibility for banks to choose how much of their corporate banking business they put inside the ring- fence, but not for banks to allow funding to pass through it. The ICB envisages ring-fenced banks being able cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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to provide “one stop” services to their customers through agency agreements between the ring-fenced bank and other parts of the group. 10. The ICB views the retail ring-fence as: — Providing a more proportionate response to the crisis than a total separation of retail and wholesale/investment banking and a means by which many of the benefits of diversification within a universal bank can be maintained. — Offering additional protection to core retail services including greater assurance of being able to implement a resolution plan in the event of financial difficulty being encountered. — Enable banking groups still to service fully the needs of corporate and other clients through the use of “agency agreements” between the retail ring-fenced bank and other parts of the banking group. 11. The retail ring-fence is a vastly different proposition from the recovery and resolution plan initiative currently underway. It puts in place a firewall that reduces the prospect of the retail entity being exposed to untenable losses in the wider group but comes at a cost of increased organisational complexity and some loss of the benefits of diversification. It aims to make banks easier and cheaper to resolve, with vital services maintained, and is in addition to measures intended to strengthen the resilience of the financial system, whether in terms of increased capital and liquidity standards under Basel III, infrastructure changes, closer banking supervision or the planned introduction of a macro-prudential element to regulation under the direction of the new Financial Policy Committee. These are in themselves all highly significant initiatives and will contribute to financial stability to a very substantial degree. 12. A consideration on the cost-side should be that the UK adopting the ring-fence approach will provide a lead to other jurisdictions favouring the application of legal and regulatory requirements on a local basis leading to the trapped pools of capital and liquidity, which in good times must reduce lending capacity and in bad times could arguably reduce the ability of banking groups to respond to financial difficulty. At the very least, it would appear possible that third country supervisors may be inclined to apply ring-fencing measures locally to the operations of UK ring-fenced banks since their interests will be overridden in favour of the UK ring- fenced bank. 13. Other concerns relate to the operability of the retail ring-fence and whether the ICB is right in its belief that a ring-fenced bank will still be able to make available a full range of financial services to customers. This will be dependent upon the way in which a banking group will be able to organise its business in light of the division between mandated, permitted and prohibited activities described in the first three “principles” upon which the retail ring-fence is to stand and needs careful consideration. Further thought also needs to be given to whether there are unforeseen consequences from the fourth and fifth principles respectively setting out the legal and operational expectations upon the retail ring-fence and the expectation that any economic linkage between the ring-fenced bank and the wider corporate group be entirely on a third party basis. This, together with large exposure limitations, may work to unduly constrain the extent to which the “agency agreements” envisaged by the ICB can ensure the provision of a “one stop” service. 14. A further issue may be the appropriateness or otherwise of limiting the ring-fence to services integral to the provision of payments services to customers in the European Economic Areas (EEA) or to intermediation between savers and borrowers within the EEA non-financial sector. Accepting the intention to protect the ring- fence from direct exposure to global financial markets and activity that would significantly complicate its resolution, we would nevertheless question whether the EEA is necessarily the right place to draw the line. The report, as drafted, explicitly allows lending to a UK subsidiary of a non-EEA group, with paragraph 3.44 stating that a ring-fenced bank “could serve companies incorporated within the EEA, or with substantial business in the EEA, provided that the transaction also took place within the EEA and was subject to the law of an EEA member state.” The report equally gives a helpful illustration of what it explicitly views as not permitted, using the example of providing mortgages to American homeowners or a loan to an Australian energy company with no base, or subsidiary, in the EEA. While this would appear to provide a reasonable dividing line care will be needed to ensure the division works as intended in practice. 15. We are also aware of concern amongst smaller banks that flexibility intended to deliver a proportionate approach may require clarification or refinement in order to ensure that they are not unduly impeded from organising their businesses to meet the specialist needs of their customer bases in a reasonable way under the new arrangements. The ICB appears to have made assumptions (for instance in paragraph 3.15) about these providing services mainly inside (or outside) the ring-fence and this may not be the case. The recommendation as currently drawn up may therefore involve disproportionate reorganisation and reporting costs for small banks. The report also suggests, at paragraph 3.85, that “a ring-fenced bank should make, on a solo basis, all disclosures which are required by the regulator of the wider corporate group and/or its other relevant substantial subsidiaries, and those which would be required if the ring-fenced bank were independently listed on the London Stock Exchange”. Our understanding is that one interpretation being given to this is that a ring-fenced bank would need to make full listing disclosures irrespective of whether the parent company was listed. It is difficult to see how this could be viewed as proportionate. 16. Paragraph 3.86 explains that a ring-fenced bank could not be the parent of (or have any equity holdings in) any entity except other ring-fenced banks. While we appreciate that the intention is to place appropriate cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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constraints on the activities that can be undertaken from within the ring-fence we believe that some members may wish to make a case for certain interests to be permitted providing they are not inconsistent with the principles determining the demarcation of the ring-fence. 17. The geographical scope of ring-fenced banks is determined by the requirement that they could only provide services within the EEA. This would mean that they could provide services to individuals within the EEA, whether permanent resident or visitors—an important provision—and as mentioned above serve companies incorporated within the EEA or with substantial business in the EEA, but not serve non-EEA customers from within the retail ring-fence. While the emphasis on the retail ring-fence only providing services to customers within the EEA, or with substantial business in the EEA, on the basis of transactions taking place within the EEA and subject to the law of an EEA member state, this will need working through to ensure it works in practice. 18. Paragraph 3.17 explains that there are a small number of individuals who are better equipped to plan for an interruption to their banking services and therefore do not meet one of the core criteria for what should be viewed as a “mandated service” that can only be provided from within a retail ring-fence. The ICB notes that this may apply in particular to very high net worth private banking customers, for whom exemption could apply if they certify that they understand that their deposit is being placed outside the ring-fenced bank, but cautions that the authorities should place stringent limits on the use of such an exemption to “guard against attempts to use this exemption to conduct general retail banking outside the ring-fenced bank”. While we broadly concur with the objective, the precise dividing line may give rise to issues of a practical nature which need further consideration. 19. A further practical consideration is whether the introduction of the retail ring-fence would impact upon the ability of banking groups to meet future requirements for a Net Stable Funding Ratio (NSFR). The NSFR requires banks to match more of their long term assets with long term funding, cutting across the fundamental role that banks play in society of maturity transformation. It is not clear that investors will have sufficient appetite to provide the long term funding that the NSFR demands given that they will rank behind retail depositors because of depositor preference. If they are prepared to do so it will likely be at an elevated price, impacting the provision of funding by banks to their ring-fenced borrowers.
Loss Absorbency 20. The ICB recommends that: — Large ring-fenced banks holding more than the equivalent of 3% of UK GDP in risk-weighted assets (RWAs) be required to hold at least 10% equity capital and for similar arrangements to apply for medium-sized banks (defines as those with a ratio of RWAs to UK GDP of 1%–3%) on a sliding scale. — All UK headquartered banks and all ring-fenced banks respect the Basel III leverage ratio of 3% (ie putting in place a backstop based on lending being no more than 33 times total assets) and requires this to rise to a little over 4% (or a lending ratio of a little under 25 times) for the larger ring-fenced banks. — Resolution authorities should be given primary powers over a new class of bail-in bonds and secondary powers to impose losses on other unsecured liabilities; FSCS insured depositors be given creditor preference in insolvency and resolution. — UK-headquartered global systemically important banks (G-SIBs) and the larger ring-fenced banks as defined above be required to hold capital and bail-in debt equivalent to 17%; and that the supervisor of UK-headquartered G-SIBS and medium-sized ring-fenced banks as defined above be entitled to require the bank to hold an additional loss-absorbing capacity of up to 3% if they have concerns about the resolvability of the bank. 21. Paragraph 4.47 envisages that if a bank is subject to both a ring-fence buffer and a G-SIB surcharge then it is only the higher of the two which should apply. It is unclear however whether it is also the intention that the ring-fence buffer should provide additional loss absorbing capacity pre-resolution. Under the FSB proposals for the G-SIB surcharge the additional capacity can be called upon but involves agreement on a capital remediation plan to return to compliance over a timeframe to be established by the banking supervisor. Until such time as the plan has been completed and compliance achieved, the G-SIB is subject to the limitations on dividend payout defined by the capital conservation buffer bands and to other arrangements as required by the supervisor. We would underline the importance of the ring-fence buffer working in a similar way. 22. The leverage ratio recommended by the ICB of 4.06% is significantly more constraining than the Basel III 3% ratio. Paragraph 4.57 explains that this results from uplifting the Basel III baseline for the ratio of Tier 1 capital to RWAs from 8.5% to 11.5% to reflect the ICB’s recommendation that the 7% Basel III baseline be increased to 10% for large ring-fenced banks. Box 5.1, on page 149, on the other hand reminds us that the draft Regulation for CRD IV does not as yet contain any firm proposal for introducing a leverage ratio, but instead suggests that firm data and experience be gathered before an effective leverage ratio is introduced as a binding requirement in each jurisdiction. The ICB recommendation therefore gives rise to a need to understand the potential consequence for introducing a ratio that may be more constraining than the equivalent Basel provision. One concern, for instance, is that ratios of this nature discriminate against entities that have larger cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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portfolios of lower risk assets. The business implications of the recommendation must be understood and it is unclear to us whether the ICB had a proper opportunity to look at this other than in terms of what may be the mathematical consequence of a related change. 23. The ICB makes clear that its proposals for a retail ring-fence and increased loss-absorbency should be viewed as a “package” and that without structural change they would be recommending even higher capital requirements. A mirror image of this would be to ask whether the proposals together—the ring-fence which reduces the integration of the universal bank offering, the bail-in proposals and the proposed introduction of depositor preference and other changes in the creditor rankings—combine to make investment in UK ring- fenced banks and non-ring-fenced G-SIBs an unattractive proposition for senior debt holders. We need therefore to work through the different component parts of the package to ensure that each adds more than it removes from the equation. 24. The minutes of the latest meeting of the Monetary Policy Committee explain that one consequence of the recent turbulence has been the virtual closure of corporate bond and bank term funding markets to new issuance and that a consequence of UK banks being unable to access unsecured term funding markets may be a pressure to reduce lending.57 This illustrates the importance of understanding the effect of the proposals on funding markets. Furthermore, it should be recognised that whilst banks have been successful in attracting term funding from wholesale markets it remains to be seen how the appetite for UK bank debt will evolve under a regime which includes explicit bail-in conditions (which may look different to those in other jurisdictions) and against the backdrop of regulatory changes which may alter the appetite and ability of some classes of traditional investors to hold bank debt, not least due to Solvency II, which attaches higher capital charges to medium and longer term funding instruments on the part of insurers. 25. Our initial assessment is that need for depositor preference may add very little to the loss-absorbency recommendations given the increased capital levels and the European initiative expected to result in a measure of pre-funding for deposit protection schemes. While there is a logic to depositor preference, and unsecured debt holders subsuming losses before protected deposits in the event of insolvency (and all deposits in a resolution through the bail-in mechanism), there is a risk that shifting this exposure from the industry generally through the deposit insurance arrangements to unsecured debt holders may result in an undue loss in investor demand for these instruments. These considerations were explored at some length in the recent consultation by the Financial Stability Board on effective resolution. This is an aspect of the ICB’s proposals that we consider needs much closer analysis before decisions are taken on how to proceed. 26. Irrespective of the differences in perspective over whether capital and liquidity standards are better viewed as maximum or minimum in nature, we would see less difference of view over the benefit of the UK ensuring that its approach to bail-in debt fits within the European statutory regime currently under development. Good progress is being made on this, with a draft EU Directive due for publication next month, and we see strong grounds for the UK ensuring that its approach achieves full consistency with the European regime. This would clearly strengthen the prospect of orderly recovery or resolution, enhance cross-border cooperation and in any case is likely to be an EU statutory requirement.
International Competitiveness 27. The specific ring-fence buffer is to apply only to the ring-fenced bank on a solo basis (paragraph 4.45); whereas for UK G-SIBs the requirement for primary loss absorbing capacity of at least 17% of RWAs is to apply to both the group as a whole and to individual UK-domiciled banks within the group (paragraph 4.121). This means that within a UK universal banking group any ring-fenced bank and any (UK) non-ring-fenced- bank would need to meet any requirement to have primary loss absorbing capacity separately. This requires the group as a whole to hold substantially higher loss absorbing debt than envisaged under Basel III. It is difficult to reconcile this to the ICB’s prime objective of protecting core retail banking services. In paragraph 4.40 the ICB explains that in “in order to allow the wholesale/investment banking operations of a UK bank to compete in global markets, they should not be required by regulation to have more equity than that agreed at international level”. It adds, however, that they should have credible resolution plans including the ICB’s requirement for additional loss-absorbing debt. The implication therefore is that the ICB believes that the wholesale/investment banking operations of UK banks can bear the additional loss-absorbing debt requirements without any undue effect on their international competitiveness. This would clearly merit close appraisal. 28. The ICB report (in paragraph A3.104) explains that ring-fenced banks may seek to offset part of the increase in costs associated with the restructuring by charging higher prices to borrowers. It dismisses this however since: a) where there are already alternatives to loans and other services provided by UK banks, such as financing from the capital markets or from non-UK banks, the ability of banks to pass higher costs through would be limited: and b) that while UK banks may react by raising lending spreads, the effect on the total supply of credit to customers would be limited as they switch into substitutes. The report (in paragraph 5.82) concludes that the competitiveness of wholesale/investment banking should not be unduly reduced since the UK banks represent only 15% of the international financial services sector as a whole. 29. We would view these statements as being indicative of the ICB being dismissive of the potential competitive effect on the prospective retail ring-fence banking groups and the potential consequences for their 57 Paragraph 5, Minutes of7&8September MPC meeting. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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customers, whether retail or corporate. The analysis assumes the continued availability of non-UK bank finance and implies that if the price of services from a ring-fenced bank increases significantly then this will not be of significant effect. This appears to be on the premise that the ring-fence will only impact upon domestic retail business and—should the cost of lending from UK retail ring-fenced banks rise—customers can always borrow from non-banks or from (non-ring-fenced) foreign banks. In addition to highlighting the limited scope of the ICB’s recommended approach, this makes the assumption that non-UK bank sources of finance will be available, which as the experience of the financial crisis has shown may not be the case.
Cost-benefit Analysis 30. Given the importance placed on impact analysis by the Basel Committee and other regulatory bodies in determining their requirements it must be imperative that the ICB recommendations be subjected to as rigorous a process. The report makes some attempt at quantification of the effect of removing the implicit government guarantee or indirect “social cost” and places the direct “private cost” of the ICB’s recommendations at £4 billion to £7 billion per year to be borne by a combination of bank shareholders, employees, creditors and/or borrowers. Paragraphs 5.59–5.63 explain that this estimate was put together by the ICB on the basis of estimates of costs put into the public domain by a number of analysts suggesting annual costs of between £2 billion and £10 billion—with an average of £6 billion—and information received by the ICB on a confidential basis. 31. As paragraph 5.59 observes, none of the analyst estimates cost precisely the package of recommendations contained in this report—a notable exception being that they cannot have built in the cost associated with the non-equity loss absorbing capacity recommendations since their scale and nature, and depositor preference, cannot have been predicted. It is therefore clear that in taking forward the proposals the Treasury will need to undertake a more thorough analysis based on the recommendations themselves as opposed to an approximation based on what it was that they were envisaged to be.
Implementation Timetable 32. While the 2019 timeline for the retail ring-fence has been questioned by some, it needs to be appreciated that the organisational, legal and administrative tasks involved in bringing about the ring-fence will be substantial and that implementation will necessarily be preceded by legislation and detailed regulation. We would therefore say that a realistic approach would be to put in place the statutory and regulatory framework in as feasible a time as possible and then to give an extended implementation period. The ICB recognises that introducing the retail ring-fence is likely to involve substantial legal and administrative challenges, including the obtaining of third party consent to the transfer of contracts and the separating out of contracts between the ring-fence and other group entities—but does not view these as insurmountable. 33. The ICB has proposed an extended implementation timeline of 2019 for its loss-absorbency proposals, which coincides with the timetable for the introduction of the higher capital standards agreed under Basel III. While some have described this as too long a period, others have questioned whether it is long enough, recognising that banks need time to build up their capital if further demands upon them are to be met by means other than restricting lending. The additional loss-absorbency proposals may also have a significant effect on the supply and cost of bank funding. The recommendations have serious potential consequences and must require further detailed consideration. It also needs to be borne in mind that the UK is one of the jurisdictions that have committed to introducing a counter-cyclical capital buffer of up to and possibly above 2.5%.
Competition 34. The ICB also made a number of recommendations on competition. First, it wishes to see the LBG divestiture result in the emergence of a “challenger” brand. Second, it wishes to see progress made on account switching and transparency. And third it proposes that the new Financial Conduct Authority be given a statutory objective for competition. It has further recommended that if sufficient progress has not been made on these recommendations by 2015 then the Office of Fair Trading should think about making a market referral to the competition authorities. 35. In most respects, these recommendations are in line with developments in train and so the report can be seen as the ICB setting out with clarity what it wishes to see achieved—and by when. The industry, for example, is working on an initiative for improving accounts switching and the ICB has set a demanding—but by no means unachievable—standard and timetable. On the recommendation that the FCA be given a statutory objective for competition, our main concern would be to ensure that there is clarity in terms of the expectations that this places on the FCA and the way in which this lines up with primary responsibility for competition resting with the competition authorities.
Closing Remarks 36. We would reiterate that we are only at the early stages of our consideration of the ICB report and that we plan to give the issues outlined above further thought over the forthcoming weeks and months. While it is our intention to work with the grain of what the ICB has proposed we cannot rule out the identification of aspects of the proposals that would merit significant reconsideration. cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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37. We would also underline the effect that the proposals will have on the ability of banks to lend into the broader economy and the imperative therefore of any Government proposals building on the ICB’s recommendations to be accompanied by a robust cost/benefit analysis, with consideration given to the need for an extended implementation period if we are not to unduly impede the lending activities of UK ring- fenced banks. 38. We are also not convinced that the ICB gave sufficient consideration of the competitive effect on UK institutions and their diversity and whether this could be to the detriment of their client-base, whether retail or corporate, and therefore the good of the economy. 30 September 2011
Written evidence submitted by the Payments Council Thank you for your letter of 2 November to the Payments Council Chairman, Richard North, in which you ask two questions regarding the implementation of the new account switching service. As I have recently taken up the post of Chief Executive, I hope you do not mind me replying on the Council’s behalf.
Estimate Of £650 Million To £850 Million for the Implementation of the Payments Council Account Switching Service The figure of £650 million to £850 million, quoted in the final report from the Independent Commission on Banking, is for the implementation of the entire new account switching service, of which redirection is just one part. Although we were still in the early stages of developing an analysis of the costs of an account switching service, and were therefore only in a position to provide an order of magnitude estimate, the ICB asked us to provide this early estimate to enable them to perform their own cost benefit analysis of an account switching service. We made it clear that this was an estimate that required further work to refine the costs. That work is ongoing with impact assessments currently taking place to enable more precise costs to be used. We will be in a position to share further detail on costs early next year. We will be able to say most about the costs that relate to the management of the implementation programme and the costs of the changes required to the payment schemes. These will be an important but small proportion of the overall costs. By far the largest proportion of costs will lie with the financial institutions that will participate in the service. Those costs are for each bank to assess and manage and will vary due to the different needs in terms of training staff, re-engineering business processes and adapting IT systems to provide the new account switching service. The Payments Council will provide an estimate of these costs. The overall estimate of £650 million to £850 million was reached using estimates from a number of sources: Payments Council members’ own initial estimated implementation costs were synthesised; indicative costings were sought from infrastructure providers for implementing the new systems and making the required changes to existing systems; and estimates were made of the cost for service users’ (those organisations that make and receive payments through the Bacs Payment Scheme service, eg direct debit originators) use and management of participating in the payment systems. The major cost elements of implementation are expected to be: — individual scheme member costs for internal changes, building of systems and training and communications; — central infrastructure costs for the new messaging service, changes to payment systems and industry-wide testing; — central management costs in establishing the new account switching service governance and management structure; and — service users’ costs for aligning to the new service. Early indications of the one-off cost to service users for implementing the entire new service will be in the order of £160 million to £210 million, across 2012 and 2013. The service user group exceeds 100,000 organisations, from the largest utility companies to the smallest local clubs. The cost per organisation is therefore relatively modest, and the actual cost to each will very much depend on their size. We expect the cost for the smaller organisations to be negligible in relation to the costs they are already paying for use of the payment systems. The industry is clear that it must work to minimise the impact of the implementation costs, particularly on the smaller service users and smaller players in the banking industry. We know that this is also a priority for HM Treasury. cobber Pack: U PL: CWE1 [O] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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Cost Benefit Analysis of the Implementation of the Payments Council Account Switching Service or Full Account Number Portability The payments industry was asked, and agreed, to deliver a much improved current account switching service for customers. We are already fully committed to implementing that account switching service. We expect a strong correlation between increasing awareness of and confidence in an easy-to-use, efficient and reliable account switching service and improving switching rates. We are undertaking independent market research—both quantitative and qualitative—with consumers, small businesses and small charities to investigate their reaction to the new service and to provide a base line for future comparison. We will then be repeating the quantitative research annually to measure the success of the switching service. All of this research will be published. The Payments Council and the British Bankers’ Association, together with the six biggest deposit-takers, have commissioned KPMG to produce an independent report on mass account transfer in the event of a major bank failure. We have asked KPMG to review the feasibility of account number portability as part of that study. The stakeholder owners of this report are the FSCS, the Bank of England, the FSA and the Treasury. KPMG will be reviewing not only the cost of implementing account number portability and the time required for implementation, but also the extent to which retail banking and payment systems infrastructure would need to be restructured. We are keen to understand KPMG’s research and to receive their conclusions. Nevertheless, we do believe that the benefit of increased competition, which is the major driver of the portability concept, will more straightforwardly be provided by our work on account switching; customers will be provided with the same outcome in a shorter timescale. We also anticipate that the account switching model will bring this benefit at a significantly lower cost and with less disruption and implementation risks than full account number portability. I hope that this information answers your questions. Adrian Kamellard Chief Executive 18 November 2011
Written evidence submitted by C. Hoare and Co. I am writing as chairman of C. Hoare & Co to support the recent letter sent to you by Philip Mallinckrodt, Group Head of Private Banking at Schroders Plc, about the potential impact on smaller banks of the recommendations made in the Commission’s report on Banking. We agree with their concerns about the unforeseen consequences which these may have. The business model of C. Hoare & Co. is similar to that outlined by Schroders, and includes many of the same activities of deposit-taking, payment, lending, foreign exchange, custody, holistic financial advice, and investment management. We have a strongly capitalised and highly liquid banking book, with a balance sheet standing at approximately £2 billion, and believe that C. Hoare & Co. poses no systemic risk. On the contrary, we feel strongly that our unusual family ownership structure, based on unlimited liability for our seven family directors/shareholders, provides an excellent deterrent to excessive risk taking. This conservative approach has served our customers well for over three centuries. The reduction in the risk profile of firms within the ring fence sits at the heart of the Commission’s recommendations, and we support this fully. However, we share many of the concerns outlined in the letter from Schroders about the approach proposed by the Commission to achieve these aims. In particular, the report says that: “... the impact of ring-fencing on small banks would be minimal—the vast majority of small banks would be unaffected by the ring-fence because they conduct only services which would be permitted within ring-fenced banks...”—paragraph 3.15, p38 ICB Report September 2011 We disagree with this. The impact of ring fencing on smaller banks may seem minimal compared with the impact on global Systemically Important Financial Institutions. However, the burden imposed on smaller banks of the proposed ring fencing will be disproportionately far greater than the Commission may have appreciated. It would be wholly unworkable for many smaller institutions to have one ring-fenced operation and a separate operation for customers who are outside that ring fence. Smaller banks would have no option but to cease providing services to the latter, which would be damaging to consumers and competition alike. We believe that only the largest institutions (which benefit from economies of scale and resourcing) will be able to run two separate business models, one within the ring fence and one outside. There are a number of further aspects which we would like to highlight. First, we do not understand the logic of proposing that activities involving non-EEA customers should sit outside the proposed ring fence. London is an attractive financial centre for internationally active individuals. It is not unusual for smaller banks to provide services in the UK to individuals outside the EEA, such as cobber Pack: U PL: CWE1 [E] Processed: [09-11-2012 15:03] Job: 017688 Unit: PG08
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residents of the Crown Dependencies of Jersey and Guernsey. The location of consumers seems to concern the Commission but it is not clear why these activities require a ring-fenced operation. The service provided to them does not differ from the service provided to customers within the EEA. There is no increased risk to the institution in providing these services to non-EEA customers. Second, the provision of investment services highlighted in Figure 3.6 (p54 of the ICB report) shows certain activities as being prohibited from within a ring fenced institution. It would mean that smaller banks such as ourselves would be unable to provide certain investment services to their customers. For instance we would be prohibited from purchasing investments such as mutual funds even where we were acting as agent or riskless principal. There is no case for placing this prohibition on institutions which, in providing these services, are neither acting in a trading capacity nor running a trading book. We have taken a strategic decision not to create our own investment products, but we would be prohibited from even offering the mutual funds of other non- ring-fenced firms. Again, it is not clear why services should be placed outside a ring-fenced operation if their provision does not increase the risk profile of the institution in question. Finally, we agree with the Commission’s view that any exemption provided for High Net Worth (HNW) individuals to place assets outside the ring-fence should have stringent limits placed on its use. Our concern stems from the possibility that a non-ring fenced firm could be set up specifically to service the highly attractive HNW sector. We can envisage a scenario where HNW individuals are attracted to a non-ring fenced firm due to the services and products being provided, even though these services and products may not be in their best interests and the consumer would not benefit from appropriate regulatory protection. We question whether this is desirable and whether the reduction of regulatory protection could be justified. In short, we believe that the Commission has made a number of recommendations which, if implemented, will result in smaller banks withdrawing certain services either completely or from certain customers based on factors such as their location. Smaller banks provide a whole range of services to customers based both here in the UK and abroad. The vast majority do not pose any level of systemic risk and in general have provided consumers with valuable alternatives to the “Big 5” High Street banking institutions. Surely the aim should be to nurture the competition provided by small banks, not dismiss it as minimal and stamp it out? While we support the general aims of the Commission, we remain concerned about the potential unforeseen negative impact on smaller institutions and on competition. Lord Wilson of Dinton Chairman
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