House of Commons Treasury Committee

Appointments of Michael Cohrs and Alastair Clark to the interim Financial Policy Committee

Fourteenth Report of Session 2010–12

Volume II Oral and written evidence

Ordered by the House of Commons to be printed 7 June 2011

HC 1125–II Published on 12 September 2011 by authority of the House of Commons London: The Stationery Office Limited £7.50

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) Tom Blenkinsop MP (Labour, Middlesbrough South and East Cleveland) John Cryer MP (Labour, Leyton and Wanstead) Michael Fallon MP (Conservative, Sevenoaks) 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) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)

Mr Chuka Umunna MP (Labour, Streatham) was also a member of the Committee during the inquiry.

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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 5768; the Committee’s email address is [email protected].

Witnesses

Tuesday 7 June 2011 Page

Michael Cohrs, External member of the interim Financial Policy Committee Ev 1

Alastair Clark CBE, External member of the interim Financial Policy Committee Ev 11

List of printed written evidence

Page

1 Michael Cohrs: Response to Treasury Committee Questionnaire Ev 24 2 Michael Cohrs: Curriculum Vitae Ev 25 3 Alastair Clark CBE: Response to Treasury Committee Questionnaire Ev 26 4 Alastair Clark CBE: Curriculum Vitae Ev 27

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Oral evidence

Taken before the Treasury Committee on Tuesday 7 June 2011

Members present: Mr Andrew Tyrie (Chair)

Michael Fallon Mr George Mudie Mark Garnier Jesse Norman Stewart Hosie Mr David Ruffley Andrea Leadsom John Thurso ______

Examination of Witness

Witness: Michael Cohrs, External Member of the Interim Financial Policy Committee, gave evidence.

Q1 Chair: Thank you very much for coming to see want to ask questions that are deeply personal, but I us this morning, Mr Cohrs, and thank you very much do think it is of relevance that we have some feeling for volunteering for this job. Could I begin by asking for the proportion of your total wealth bound up in you about your role, which you have rightly and Deutsche Bank and I wonder whether you could give helpfully covered in your written notes to us, on the us some indication? European Advisory Board of Deutsche Bank. What Michael Cohrs: It is a very fair question. These two does that role entail and what is discussed at those topics were the first two topics that I discussed with meetings that might be of relevance to the job that the people who approached me for this role, because you are being considered for now? I do think that there is both a perception, and the Michael Cohrs: The Advisory Board is a group of possibility, of a conflict between my shareholding and mostly industrialists—I think I am the first banker to these two roles. The proportion of my total wealth that be put on the group—who meet twice a year for about is still tied up in Deutsche Bank shares is less than three hours each time and they discuss topics. At the 10%, so it is not a very meaningful figure. What I last meeting a review of the new Deutsche Bank have agreed with the Governor is that I have disclosed headquarters was given to the industrialists. The these holdings. These holdings are not vested. industrialists talk about a bit about conditions they are Whenever my holdings in the bank vest I have seeing in the marketplace. It is not an executive body traditionally sold them, but I am happy to say that within the bank, and it is probably slightly misleading quite some years ago Deutsche Bank changed its to say it is an advisory group because, in fact, no remuneration structure to hold back bonuses, the way advice is given to Deutsche Bank. I view it as all banks do now, but we started doing this back in something that is quite interesting, but it is very clear about 2002. So a number of my old bonuses still roll to me that the work that I do on the FPC is far more out. important. It is also clear to me that, if I continue to What I discussed with the Governor was that when do both, there are certain things that I will see and these vesting periods come up, which I have shown hear from the FPC, that it would be inappropriate for the bank, I will consult him in the first instance about me to discuss in these two sessions each year at the whether I am allowed to sell. There are certainly Deutsche Bank Advisory Board. periods when I know that I will not be able to sell. For instance, I am allowed to go to pre-MPC briefings, Q2 Chair: Can you illustrate that? which I did on Friday. Having been to a pre-MPC Michael Cohrs: Sure. This week, in preparation for briefing on Friday, I am now in a period when I would our first Financial Stability Report, we have been not make any financial transactions until the MPC going through some of the risks we see. As part of meets and publishes its report. The same will be true that, I see non-public information on UK banks, which in the FPC. We will have pre-FPC meetings that will is highly confidential. For instance, I hear topics in then go into FPC meetings, which will be minuted. the FPC about things that central bankers may be During those periods I would not be free to transact. discussing. Those types of comment would be This is not dissimilar to what I did when I was at the inappropriate to give to this group of industrialists. bank. When I was at the bank I tended to try to There are many confidential items that I have seen so transact only once a year in January, after year-end far, as part of the work for the FPC, which it would results came out and before we got too far into the be inappropriate to discuss in such a meeting. year. That was the one time that I would transact for my personal account, and I would want to do the same Q3 Chair: The other related issue is to ensure that thing here. I am very mindful of conflicts and I am the fact that you have a continued interest in Deutsche very mindful of doing the right thing vis-à-vis my Bank should not influence what you might say, or personal investments. views that you might take on the FPC. You told us that your investments include a shareholding in Q4 Chair: It sounds as if what we need is a code of Deutsche Bank arising from deferred bonuses. I don’t conduct of some sort for members of the FPC because cobber Pack: U PL: COE1 [E] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

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7 June 2011 Michael Cohrs this may affect others, not just you. Although it goes Q7 Michael Fallon: Your advisory board at Deutsche way beyond this meeting this morning, it sounds as seems to meet twice a year. It is envisaged the FPC though this is something that it might be helpful if should meet at least four times a year. How often do you and your colleagues could discuss with the you think it should meet? Governor, with a view to coming forward and Michael Cohrs: I am spending quite a bit more time publishing such a code. in the FPC, thus far, and I expect that the interaction Michael Cohrs: I would welcome that, and I have the FPC has will be monthly. That may be because, in ideas on how I think such a code of conduct could be my view, we are still in a period when markets are conducted to satisfy you and other people that we very volatile and things are still not very steady, so were doing the right thing. perhaps right now we are meeting more often than we will. We are also probably meeting more often than Q5 Chair: I have one more question, which concerns we will because we are getting up and running; we the new structure of regulation that you are going to are getting to know each other, but right now I am be intimately involved in helping run, and the ICB, spending quite a few hours each week on the FPC. the work of the Vickers Commission. Do you think Michael Fallon: I understand that, but how often do that the proposal he has come forward with on ring- you think the committee should be meeting formally? fencing will have a particular impact on the way the Michael Cohrs: It is hard for me to say that now. FPC and the PRA conducts their work and, if so, how? Michael Fallon: Well, what is your view? How interrelated is the work of the FPC and the PRA Michael Cohrs: I would think once a month. and the work of the Vickers Commission? Michael Cohrs: I think the work of the ICB is very Q8 Michael Fallon: Once a month, I see. Could you important because it is very clear that there are define for us the role of external members? structural issues with financial institutions that make Michael Cohrs: We are there in part to make sure that it very hard to regulate them. It is not just the “too big there is a minimum of group think, because we come to fail” argument; Lehman was not considered a very to the issues with a slightly different view. I think we large institution, yet when it went down the world can be very helpful in making the work more came to an end from a financial perspective. So I think understandable. The amount of jargon in the the structure of financial institutions is quite regulatory world is immense, and getting people to important. The ring-fencing idea is a good write and talk so that everybody can understand what compromise to try to protect the deposit-taking is being talked about is something that the externals function within an institution, which I think is very can do. Given that they are not embedded in the important, because it is clear that having gone through system, the independence of the externals means they the crisis, people of every country now believe that are freer to put their hand up and talk about issues Governments are insuring their deposits. Whether it is they see. true or not that is the perception. I realise that there are schemes in place and in this country you are Q9 Michael Fallon: The original consultation insured up to £85,000, and so on, but I think there is document said it would be “important to ensure that a perception that if you put your money into a bank external members are able to offer insights from direct your deposit is safe. You want people to think that it experience as financial market practitioners”. Why are is safe and there is a perception that the money is safe. you the only one? Therefore, from a regulatory perspective, ensuring Michael Cohrs: I don’t know the answer to that. that that part of an institution is as strong as it can possibly be is very important. Ring-fencing is an Q10 Michael Fallon: Do you think there should be interesting way to get there. It is not going to be more? straightforward, as I am sure that group of people Michael Cohrs: As it is currently constituted, I think have told you. Getting from their proposal to the group has been having pretty interesting meetings. implementation and then regulating the I know that another person will be appointed, and implementation will not be easy, but I think it is therefore I think it would be a good thing if there was possible. somebody else who has direct experience in the industry. Q6 Chair: How is this going to affect, if at all, the way you would go about your work on the FPC and Q11 Michael Fallon: You say “the industry:” your the PRA? own experience is in investment banking, should there Michael Cohrs: I am not sure it affects the work that not be some expertise from the retail side on the we would do that much, in that we are trying to committee? uncover big systemic risk and, regardless of whether Michael Cohrs: Yes. we believe the deposit-taking portion of a bank is well protected, we will still try to speak up; when we see Q12 Michael Fallon: You think there should. How risk that we think will put financial institutions at risk do you expect the FPC to work formally? If there are it is our duty to speak up. disagreements, would you expect to make speeches, I am not sure it will have a big impact. However, it for example, outside the committee, just as members would be nice if—dare I say it—we get it wrong and of the MPC do at the moment? we have another problem, that those deposit-taking Michael Cohrs: That would not be my personal style. institutions, or the deposit-taking part of an institution If there were disagreements I would endeavour to talk are very robust. and talk and talk and talk and keep the meeting in cobber Pack: U PL: COE1 [O] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

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7 June 2011 Michael Cohrs session to see if we could come to some common will not be so bad or we can let the institutions viewpoint. struggle along and/or fail,” but that is a viable option. In this particular crisis it feels to me that Governments Q13 Michael Fallon: You don’t see yourself as felt—I think they were correct—they had no option. having a public role? They had to bail out the institutions because the Michael Cohrs: No, I don’t. financial markets were so unstable. To me, that was the most frightening thing about the experience we Q14 Michael Fallon: Why shouldn’t the public hear went through in late 2008 to 2009. about your work on the committee? Michael Cohrs: I have never felt that that is an Q19 Mark Garnier: Would it be fair to say that your effective way to get the change that you want to definition—if you were to have one—is that happen with a body like this. intervention by a Government is an option as opposed to a necessity, and that is the definition of financial Q15 Michael Fallon: You don’t see yourself as stability? accountable to the public for the work you are doing Michael Cohrs: We have to work towards that. We on the committee? You don’t see any obligation to have to try to get structures and do regulation in such explain to a wider audience what you are doing or a way that Government has the option, as you said, as why you are working in such a way? opposed to the necessity of having to bail out. Michael Cohrs: No. I think I am accountable, certainly within the bank, to the chairman, to the Q20 Mark Garnier: In his note to the Committee, court, and ultimately to this group. However, if I want Professor Goodhart suggested a number of early to ensure that points that I feel strongly about are warning measures—I think there were four—where adopted by the group, I am not sure that making a you have red lights coming up when things look too public pronouncement about them is the most worrying. Do you think that is a sensible way for the effective way to ensure that we deal with the issue FPC to operate, to have a set of indicators that it uses? that I see. If you do, do you think they should be published? Michael Cohrs: We need to have something. I have Q16 Michael Fallon: Why do you think members of to say, I am impressed with the mechanisms that I the Monetary Policy Committee make speeches have seen in place for the MPC, for instance. The around the country? MPC is a very different matter different metrics can Michael Cohrs: I don’t know. be used, but I am a fan of—if I can say it— dashboards; having a dashboard and looking each Q17 Mark Garnier: Mr Cohrs, how would you month at our dashboard and trying to figure out what define “financial stability”? is wrong. I am not saying that is going to solve all the Michael Cohrs: That is a very good question. It is problems but I think having a very systematic probably easier to define what isn’t financial stability. approach to this would be a good thing. I guess financial stability is that when things are very bad the financial institutions continue to function and Q21 Mark Garnier: Do you think if that systematic the services that they are supposed to provide continue approach was published, and people in the financial to be provided. In my view the most important service markets could have a look at it, that would, in itself, they provide is that they hold a deposit and people stave off financial instability? think their deposit is safe. Michael Cohrs: I think it would be helpful.

Q18 Mark Garnier: When you look back at the last Q22 Mark Garnier: You are an investment banker crisis, we were 48 hours or 24 hours from not being by background. One of the requirements in the FPC able to get money out of ATM machines, and the objectives is not to exercise its function in a way that Government had to step in to support the financial would in its opinion be likely to have significant system. Under the definition you have just given me, adverse effects on the capacity of the financial sector that constitutes financial stability but it sounds pretty to continue the growth of the UK economy in the unstable to most people. medium term. How do you see that working? Michael Cohrs: It was certainly not stable. I would Michael Cohrs: I think that is a very necessary thing agree with that. If you look at most definitions they to put in there, otherwise we could simply require would include making sure your deposit is safe, banks to hold levels of capital and take so little risk making sure that payments happen, providing credit that they were not providing the other function they and equity to the marketplace, and providing are supposed to provide, which is to help companies insurance. The thing that probably was not happening in this country prosper. So it is a requirement. during the last crisis, in the traditional definition of However, it is a very hard judgment because if we financial stability, was the provision of credit and look at the last crisis, and the damage that has been equity into the market but, even under those done to the economy and to the people, the cost was definitions, it is very clear that we did not have so high that I suspect right now we will err on being financial stability. In part, the biggest problem was conservative. I have to say, in looking at markets, I that Government did not have a choice in my view. am a great believer in pendulums. When things are There had been other crises when banks were in good the pendulum swings way too far one way and trouble and Government could say, “Look, we have when things are bad the pendulum swings way too far two choices: we can either come in and maybe things the other way. We are clearly right now at a point in cobber Pack: U PL: COE1 [E] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

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7 June 2011 Michael Cohrs time, having gone through what we went through, months before the run on Northern Rock and the first where the pendulum is towards a very conservative public sight of the beginning of the trouble in the approach. So I think we have to be very careful about financial markets? How would you respond to a not putting in place measures that are too draconian Financial Stability Report that had these but, as I said, we don’t want to go through what we contradictions? have been through again. Michael Cohrs: My response, and I have made this response to my colleagues already, is that the FSR has Q23 Mark Garnier: As our pendulum swings the tended to have a laundry list of all the problems but other way, back to confidence and stability, how do it has not prioritised which of those problems we are you think the FPC should work in order to make sure most concerned about today. You have just given an that people are still conscious of the fact that a example; all the problems were listed, but it is a little financial system is intrinsically fragile and there is still bit like when people put risk factors in what they are a risk, even when the party is in full swing again? trying to sell you. They put all the negatives in a risk Michael Cohrs: I think history and understanding the factor section and there are so many of them that you history of financial crises is very important. We will just wave it away. I think what we have to try to do always have financial crises. There have always been is prioritise the risks we see and try to come to a financial crises. I think studying past ones is quite judgment as to whether any of them, at a point in interesting, because what you tend to find when you time, are risks that we want to highlight specifically study the past crises is that they do not end as quickly and then do something about. as people think they do. The FPC has to always remind itself that even if things were to start looking Q26 Stewart Hosie: How would you prioritise those better, there could be another problem around the risks? That was a small list but it pretty much mirrors corner, so we always have to be very cautious and all the problems that existed immediately prior to the careful. We have to be very mindful of some of the South-east Asian banking crisis, which the Bank of new innovations that take place, while at the same England Financial Stability Report in 2000 identified time recognising that some of those innovations have and categorised. How would you measure up or rank helped to provide positive things for the economy in the risks in a report like that? the past. It is a fine balance that you have to strike, Michael Cohrs: I think you have to try to think but I think it will be our tendency to be slightly through which of the risks are most likely to cause a overbearing—if I can put it that way—given what we chain of events that you don’t want. It is hard for me have just been though. to go back and tell you which ones in 2000 were the correct ones to emphasise. It is fair to say that Q24 Mark Garnier: My final question: in your virtually nobody on the planet saw what was about to opinion, what would be the definition of success for happen and spoke out too forcefully about it. Even the the FPC? people who say they saw it coming I have doubts Michael Cohrs: I would be happiest if I was in front about. of a group like this, and you looked at what we had As I say, we are going through this right now and, in done and you said, “Look your judgments look pretty my own mind, there are certain risks right now that good”. It is very hard to define success. I don’t want trouble me and which we need to speak out about. to say that it is no failures because I personally think There are other things that I would say are on the we need failures; we just do not need failures that laundry list in the FSR but I am saying to myself, bring the whole system down. If we don’t have a “Those are things we don’t need to worry about today. failure it might mean that we have been overbearing— We may have to worry about them in the future but too overbearing—and stifled the economy, so that may not today.” What I am trying to do is prioritise a bit not be a success. All I can hope is that we are more so that people who read this can see what we thoughtful and we take judgments that people think are thinking, rather than just give them all the things were the best they could have been at the time. that could possibly go wrong. Mark Garnier: Thank you very much. Q27 Stewart Hosie: In that case, having done the Q25 Stewart Hosie: You said earlier that you were review of the Financial Stability Report, how would trying to find big systemic risk, and that mirrors one you envisage your assessment being framed and what of the FPC’s objectives linked to the bank’s objective recommendations would you make or would you in relation to systemic risk. One of the ways in which expect to be made? How forcibly or bluntly, if you you will do that, and monitor it, will be to look at the thought there was a real risk, would you make Bank of England’s Financial Stability Report, and I recommendations for a particular course of action, understand you are going through that process at the depending on the risk itself? moment. What would you make of a Bank of England Michael Cohrs: Mr Hosie, that is a very important Financial Stability Report that said there was question. I don’t want to sound indecisive to this weakened credit risk assessment, impaired risk group, but I am aware that in my old career I could monitoring, low premia for bearing risk, high and take decisions and implement them very quickly. I am rising leverage in the corporate sector, a rising aware that doing what I am doing now is different. I systemic importance of large financial institutions, am learning a little bit about this and things move at impaired market liquidity, and so on, but whose a different speed. So I am wondering how forceful overview began, “The UK financial system remains one does have to be. There are certain things right highly resilient”, written or published some, oh, five now in the world that trouble me, and I am saying to cobber Pack: U PL: COE1 [O] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

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7 June 2011 Michael Cohrs myself, “Do we reach for our toolkit immediately— regulators, with American regulators, although I did which we don’t even have yet, we are supposed to interact with the FSA, given that I was resident in develop it—and start putting tools in place to counter London. On the one hand, that privilege meant we some of the risks we see?” In my own case, I will could go forward and give them information but on have to learn a bit about the speed at which this sector the other hand it didn’t go out to the public, and some moves, and I have to learn a bit about the fact that of it probably shouldn’t have gone out to the public. I public pronouncements can be taken the wrong way. think a bit more transparency there would be a good When the Governor or the head of the Fed or the head thing. of the ECB makes certain statements, they do move markets and that can be troublesome. Q31 Mr Ruffley: So you will be arguing for that? Having said that—to go back to Mr Garnier’s point— Michael Cohrs: Yes. the way that I will define my having not done a good job is if I am in front of this group in a couple of Q32 Mr Ruffley: Will you, as an external member, years and we have gone through what we just went be really independent and fearless in challenging what through. I don’t want to be in that position. your other colleagues might say, if you disagree with them? Q28 Stewart Hosie: You said markets can move on Michael Cohrs: I am not sure I would be fearless, but the back of public pronouncements. Of course that is I certainly— correct, but if you were certain that there was a Mr Ruffley: You will not be fearless? particular risk, or a combination of risk and Michael Cohrs: I am not sure because I believe that circumstances, which might lead us into a very bad you listen; I have a lot of experience working with place, I would not want you to be uncomfortable groups, and quite often I go into a meeting with a about moving quickly. What I want to know is that point of view and if there is an intelligent discussion you would be certain enough in your own mind to and you listen, sometimes you change your mind. You either speak privately to the right people immediately, or to reach and build the toolkit, or to make the public pick the moment when you attack or when you put pronouncement, if you saw something that you your points of view across. I certainly have points of believed was genuinely systemically dangerous. view, and I have some points of view that are not in Michael Cohrs: I understand. keeping with my colleagues—we have seen this in several of our meetings already—and I am fighting my corner very aggressively. Q29 Mr Ruffley: Would you agree that the regulation of the financial system requires much greater transparency and openness than the existing Q33 Mr Ruffley: Would you speak out publicly if it system? That is not a difficult one. was a serious matter on which you disagreed with Michael Cohrs: No. I am not sure I do agree with that them? After the due meetings and everyone because, again, in coming to this job, the amount of expressing their view in a very civilised way—as you information available is staggering. It is high quality have characterised it—if there was something you work. If you go to the Bank of England site, if you go thought was wrong, would you go public? to the HMT site, and read the reports that have been Michael Cohrs: Probably. Although you can all tell written in this country, and in the other countries, that I have an aversion to going public because I am about regulation, about what we are supposed to do just not sure how effective it really is. I will promise about the risk, it is staggering how much information you, if I am not happy with what we are doing I will is out there. The problem is making sense of it, make a lot of noise within the committee in the proper because we are just overloaded with information. So way, within the bank in the proper way, and then to I think there is a fair amount of information out there you if it is appropriate. about what is going on. Now, would I like to see more when we do stress tests? Yes. Q34 Mr Ruffley: I am going to give you an Mr Ruffley: That is what I am driving at. opportunity to tell us if you are fearless. Tell me the Michael Cohrs: Absolutely would I like to see more one big major mistake the Bank of England made when we are doing stress tests, to really understand prior to the crisis. Just one thing you thought they every criterion in the model. If we put the models out screwed up on. that we are using, and let the various quants tear them Michael Cohrs: Northern Rock. apart, that could be quite interesting. Q35 Mr Ruffley: How did they do that? The bank’s Q30 Mr Ruffley: Is it your understanding that that posture in the lead-up to Northern Rock, during kind of publication, and making the workings behind Northern Rock as well, how was that wrong? This is your thinking transparent and open, is done at the an important question. I want to know, and I think this moment or will you be arguing for more of that should Committee wants to know, how fearless you are. You you take up this job permanently? are going to be joining the Financial Policy Michael Cohrs: Mr Ruffley, you probably know more Committee, and we want to know what you think the than I do but, as I understand it, there is a privilege— Chairman of that committee, Mervyn King, and his well, I do know this as a former banker—there was a colleagues did wrong prior to the crisis. privilege we had when we spoke to our regulators, Michael Cohrs: Let us be clear. When I said— that things we would tell them were held in Mr Ruffley: I am inviting you to criticise your confidence. I have more experience with continental future colleagues. cobber Pack: U PL: COE1 [E] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

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7 June 2011 Michael Cohrs

Michael Cohrs: I understand, but when I said capital adequacy out of this—what other tools can be Northern Rock, the Bank of England was not used in a direct way? responsible for regulation. However, Northern Rock Michael Cohrs: In my view, the most important tool should not have happened. It was an old fashioned is simple leverage because any time we get into the run; the way the bank was funding itself should have more complicated definitions the banks are making been clear to the regulator and, I suspect, even the assessments about risk weightings, and whether they bank as an observer of the UK financial system. are making those risk weighting assessments correctly Alarm bells should have been ringing and it shouldn’t is an open question. To me, a very simple leverage have been allowed. This was not complicated fancy ratio is the best way to deal with how stable a financial derivatives, this was just old-fashioned; how you fund institution is. Leverage ratios had risen to a bank and do the maturity transformation. extraordinarily high levels pre-crisis and it is quite simple—most people would say it is quite crude—but Q36 Mr Ruffley: That is interesting. So you are I would look at leverage ratios very carefully. likely to make that kind of point when you meet Secondly, it is liquidity. The banks go down because Mervyn King and talk about recent history? I am sure they run out of money, not necessarily because they it will crop up in the FPC. You will have that kind are insolvent, so having money in the bank is of free, robust discussion with him—will you?—from incredibly important. After those two, I think, the next what you are telling us? thing is provisioning. We had gotten into a period Michael Cohrs: Certainly, and probably even more so when we were only able to provision against incurred because I think I have slightly different lessons from losses, whereas the systems that have provisioning, the crisis than some of my colleagues do on the which allow the banks to look forward to expected committee, and I have a slightly different emphasis as losses, do much better when times get bad. to what I think we need to put in place going forward, which I think is not as well established in the Q39 Mr Ruffley: My final question: you will know, regulatory world. having read the Vickers report—you have read the Vickers report? Q37 Mr Ruffley: Those are helpful answers. Can I Michael Cohrs: Yes, I have. move on to two final questions, one in relation to the Mr Ruffley: One of the options for reform is supply of credit? One way to effect that is the capital subsidiarisation. This Committee has taken evidence adequacy requirements. Another way is more direct that that may take the form of separate balance sheets intervention, for instance requirements on loan-to- for casino banking on the one hand and High Street value on mortgages. What is your position on direct banking on the other—separate management interventions in the supply of credit, like loan-to-value structures and so on. You are familiar with the requirements? Are there other tools that you think arguments. One thing this Committee is quite should be used? interested in is the propensity for banks to cheat when Michael Cohrs: Thank you. I think there are other their back is against the wall. They may have separate tools. I am not even sure that capital is all that balance sheets but there are ways around a important when banks think about the credit they subsidiarisation regime. What do you think of that? extend. There is a perception that bankers sit and say, Michael Cohrs: It is a concern. “We have this much capital, let’s do some loans.” That is not how it works. When I took over commercial Q40 Mr Ruffley: If we go on the basis that lending at Deutsche, I was very troubled by the fact subsidiarisation is indeed what happens and we that it seemed like we were always there for our suppose that is the first big problem in your in-tray clients in good times but we always disappeared in as an FPC member, what would you be saying about bad times. It seemed to be a characteristic of that designing a system that would either reduce the particular business, and I vowed to fix it and I did opportunities for cheating or put in place regulatory fix it. rules to prevent cheating, and how would it be In 2007 we announced to our SMEs that we would be monitored? If you could just give us your thoughts there for them, and throughout the entire crisis the on that. size of the loan book went up. It did not go down, it Michael Cohrs: It is not an easy— went up. We did that by hedging the credit book. By Mr Ruffley: No, which is why I asked it. hedging the credit book we weren’t frightened by Michael Cohrs: You are asking me a very difficult what was happening in the marketplace and we could question. I think you are absolutely right to be stay open for business. It had nothing to do with our concerned about it because within a bank it is virtually capital position; it had to do with ensuring that the impossible to split the balance sheet into pieces. It is risk we took didn’t affect us in a time of crisis. So all one balance sheet, and the banks run that way, so there are other things you can do and I think this trying to create the ring-fencing is going to be an concept of getting banks to be there in bad times, interesting challenge. Now, I have read the report. I when clients need them, is a very important point. have listened to their very lengthy session with you, which I thought was a very good session, and I think Q38 Mr Ruffley: That is a very helpful answer. What they are hard at work thinking about how they are are the other tools that you would like to see used? going to put it in place, including the regulatory You have mentioned the hedging that you put in place oversight that will be required to do it. I do think it is in your practical experience. I have mentioned loan- possible but it is not going to be straightforward; it is to-value requirements on mortgages—let’s leave going to have to have a lot of regulatory oversight to cobber Pack: U PL: COE1 [O] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

Treasury Committee: Evidence Ev 7

7 June 2011 Michael Cohrs make sure that—in your words—the cheating doesn’t Q47 Jesse Norman: That is very helpful, thank you. happen. By the way, I completely agree, I think it has been shockingly bad. Let me ask another question. You Q41 Mr Ruffley: Do you think it is possible to have worked for three extremely consensus-based design a system that can ring-fence the two operations organisations; Goldman, Warburg and Deutsche Bank. of a universal bank? Can you give me an example of a time when you Michael Cohrs: Yes, I do. have fought an internal consensus, or taken a major Mr Ruffley: Thank you. decision yourself, in the face of significant threat or challenge from the organisation? Michael Cohrs: One goes back to the discussion I Q42 Jesse Norman: To follow up on that last was having with Mr Ruffley. I and my partner wanted question, is it your view, Mr Cohrs, that it is to hedge our lending books. This was thought to be impossible to split the balance sheets, and indeed outrageous—that a deposit-taking institution would undesirable to split the balance sheets? That is hedge its lending books—and we were warned that certainly one central reading of the idea of ring- within Germany there could be a lot of concern fencing. about this. Michael Cohrs: It is virtually impossible to split Jesse Norman: Because it would reduce profitability them. We have tried to do it. Put it this way, Mr in the short term? Norman: I have tried to do it with clients and you Michael Cohrs: People thought that it would break didn’t know where to carve up, because the balance the traditional concept that a bank takes in deposits sheet was one thing and it is so hard to know which and lends out money. All of a sudden the investment pieces of it go where. Even when we tried to do bankers were hedging the lending book. We were complete demergers of banks, which I have worked using the evil CDSs and other things to hedge our on in the past, it was very difficult to do. I don’t know book. More traditional people within our bank said, of any successful case study we can look to where a “This is going to go down very badly. We mustn’t do bank was effectively split up. this”, but we were determined to overcome the cyclicality of the commercial banking business and Q43 Jesse Norman: That is an interesting discovery. the only way we could see to do that was to hedge Thank you very much for that. Effectively, your view the risk. then is that the strong reading of ring-fencing is a bust. Michael Cohrs: No. Q48 Jesse Norman: Using the same scale of 1 to Jesse Norman: That the idea of separating casino 10, how well do you think the FSA and the Treasury banking, so called—rightly or wrongly—and deposit- performed in their response to the banking crisis? taking, is a bust? Michael Cohrs: Rather badly. Michael Cohrs: I misspoke. I think separating the Jesse Norman: Rather badly. We are down at 1 again, bank into two pieces is very hard to do. I think you or thereabouts, are we? could ring-fence because you would allow the one Michael Cohrs: First of all, we should be clear: balance sheet to exist, but then you are going to have nobody did very well but I have to say, specifically, to have very strict rules. The bank will have to treat Northern Rock was a pretty shocking event. So I think the other piece as if it is an external client, and those that, in particular— rules will have to be enforced, so I do think— Q49 Jesse Norman: You share the view they were Q44 Jesse Norman: With external boards of all implicated, essentially? It was a serious regulatory directors, presumably staff use of the treasury failure across all of those institutions as well as the function? bank? Michael Cohrs: It wasn’t good. Michael Cohrs: All of the above, right? I don’t know this because I don’t have privy into the way they work, but I wouldn’t be surprised if the Vickers group Q50 Jesse Norman: That is helpful, thank you. Risk thought about a complete demerger and came to the models are a real source of concern because, of view that I have come to in my practice, which is that course, the banking sector as one threw itself off the cliff because they seem to evaluate risks in the same it is virtually impossible to take a bank and demerge way. You are responsible for systemic risk on the FPC. it completely. What do you do about mitigating that herd instinct, and spreading more diversity and innovation in Q45 Jesse Norman: Thank you. We are short of time thinking about risk? but let me ask how well you think the financial sector Michael Cohrs: You make sure that you don’t spend was led in its response to the banking crisis and the too much time looking at those risk models. You go public outcry to it. How would you evaluate it? Do back to very fundamental principles. You always insist you think there has been a failure of leadership or do that you see nominal values not netted-out value so you think it has been handled rather well? you can understand. You have to understand always Michael Cohrs: I think it was handled rather badly. the size of the long position, the size of the short position, because what you will normally get from the Q46 Jesse Norman: Rather badly. On a scale of 1 to model is the very little tiny sliver that is theoretically 10, where would you put it? not hedged, and if you think that way you will get Michael Cohrs: Somewhere near 1, if 1 is bad. into trouble. You have to try to dig into those models. cobber Pack: U PL: COE1 [E] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

Ev 8 Treasury Committee: Evidence

7 June 2011 Michael Cohrs

You do not look at VaR too seriously. You look at you couldn’t get enough capital into the two pieces. VaR, it is a tool that means something but if you run The IT had to be carved up— your business based on VaR, which is the risk metric that most bankers use to run their business, it is Q55 Mr Mudie: Which bank did you do this with? supposed to tell you how much money you can lose Michael Cohrs: I am happy to give that to you on a single day, and it didn’t tell anybody within even privately but it would be a client I worked with, which a fraction of what they lost on some of those days would be confidential. back in the fourth quarter of 2008. Q56 Mr Mudie: Which bank were you with when Q51 Jesse Norman: Final question. Given how badly you were doing it? the financial sector performed in its own leadership, Michael Cohrs: I was with Deutsche Bank when I and how badly and complicit the regulators were in was doing this work. the failure of the banking system, do you think there Mr Mudie: Yes, and a client came to you and wanted is a case for a proper wide-ranging commission that to separate them and you found it impossible? would look at all these aspects and try to reach a broad Michael Cohrs: Correct. conclusion, rather than the rather bitty, patchy approach we have had? Q57 Mr Mudie: Was it impossible from Deutsche’s Michael Cohrs: Mr Norman, two comments: one, I point of view or the bank’s point of view? hope you take the point that I include myself in the Michael Cohrs: We couldn’t give that client the bad leadership within the banking sector. I am not solution that they were seeking. sitting here trying to throw stones at other people. We Mr Mudie: You couldn’t? all responded to the crisis, particularly in the way compensation was dealt with after the crisis, in a not Michael Cohrs: They are still one bank. helpful way. However, I think if we want to move forward again, and I think we shouldn’t want to move Q58 Mr Mudie: Vickers took refuge in costs. Then, forward too quickly, this was by all measures one of when pressed by the Chairman to define the costs, first the worst, if not the worst, crisis that we have seen of all, they said they were under-published. Then they in many hundreds of years, particularly in the way it said they were not robust enough but they took the affected people who had very little to do with it. decision on costs. What do you see as the main costs However, I am not sure what another study would of separating the retail bank from the investment side? accomplish. If a study would accomplish something, Michael Cohrs: The main cost would be that you yes. radically change the funding cost of the investment bank when you take away the deposit-taking piece of Q52 Jesse Norman: One thing it might do would be the bank, so the main cost would be one of funding. to look at whether compensation practices contributed However, for the actual cost of splitting the IT system, to systemic risk, which is something that might fall splitting all the elements of the balance sheet, the fees into your remit. that you would encounter to do that would be quite Michael Cohrs: Mr Norman, we know the answer to high, so there would be quite considerable costs. I that. It did. don’t want to give this group the impression that I Jesse Norman: Will that be part of your— think that ring-fencing is not a good solution. I Michael Cohrs: Many banks have changed the thought that what Vickers came up with was clever, if structure of the way they remunerate, so I think— it can be done, because it got away from the concept of a total demerger, which I think is virtually Q53 Jesse Norman: Would monitoring that kind of impossible to do. Yet it did something that I think is threat to systemic risk be part of your conception of quite important, which is trying to build this wall what the FPC should do? around the deposit-taking part of an institution. I think Michael Cohrs: Absolutely. that is very important. Jesse Norman: Thank you for that. Q59 Mr Mudie: In an answer on Northern Rock, you Q54 Mr Mudie: When we met Vickers they did not said you couldn’t understand why Northern Rock had suggest, for a moment, that it would be impossible to not been picked up because it was a straightforward separate the banks—separate the retail side from the traditional bank. It was not dealing in—in your investment side—why do you think it is so difficult? words—complex derivatives. You said earlier the Michael Cohrs: Mr Mudie, I am mindful that there important thing about financial stability was deposits are some very impressive people in that group, so if and depositors. Don’t you think that the retail bank, if they said that they could do it I may need to rethink. split, would be more stable than the complex I have had experience in trying to demerge banks investment side? where a client came to me and said, “Look, we want Michael Cohrs: Mr Mudie, it should be but if I look to separate the investment bank from the retail bank. at this crisis— How do we do this?” We worked on it very Mr Mudie: What do you mean “it should be”? strenuously and we came to the conclusion that it was Michael Cohrs: It should be because, you are virtually impossible to do, because we couldn’t carve absolutely right, we all think of deposit-taking banks up the balance sheet of the bank. It was one balance as being riskless but they are not. In fact, in this crisis, sheet effectively. Then the need to recapitalise both a lot of deposit-taking banks that did not do pieces was so great that, even in good market times, investment banking experienced extreme problems, cobber Pack: U PL: COE1 [O] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

Treasury Committee: Evidence Ev 9

7 June 2011 Michael Cohrs and a lot of investment banks that were taking huge Q66 Mr Mudie: Apart from a couple of banks that risks didn’t have problems. have been pretty doubtful, which banks folded in the last 100 years in the UK? Q60 Mr Mudie: Which investment bank didn’t have Michael Cohrs: Mr Mudie, I am speaking from the huge problems? client perspective. Chair: JP Morgan. Mr Mudie: Are you speaking from an American Mr Mudie: Well, JP Morgan had problems. perspective? Michael Cohrs: I am very proud of the fact— Michael Cohrs: No, from a client perspective. Clients have always told me that their bankers were always Q61 Mr Mudie: They all had problems, didn’t they? there in good times and they couldn’t find them in bad times. It was where it stopped. JP Morgan was eaten up. Someone else has been eaten up, but if they hadn’t been eaten up the crisis would have wiped them all Q67 Mr Mudie: They are not even there in the good out. times in this country at the moment. Now, shadow banking: how seriously should we take it? Michael Cohrs: I think you are correct about that. I Michael Cohrs: It is very serious. think you are correct that everybody was in trouble, but I am saying— Q68 Mr Mudie: How seriously have we taken it? Mr Mudie: Yes. Well, how do you— Michael Cohrs: We haven’t yet taken it as seriously Michael Cohrs: Mr Mudie, may I— as we need to because, in fact, there weren’t as many problems in shadow banking as we thought there were Q62 Mr Mudie: How do you square that with your going to be, because many people took the shadow first answer, which was that there were investment piece of their bank and voluntarily took it back on to banks that weren’t in trouble? Now they are all in their balance sheet during the crisis. We could have trouble. They were all in trouble. They were all at it another crisis where that voluntary bring-back of a in varying degrees, and some were lucky that they subsidiary, which is not consolidated, doesn’t happen. were in a better position than others. You were lucky. Therefore, it is a big issue. I am also mindful that You spotted the sub-prime earlier and hedged the sub- whenever we make regulation, it has to be agreed prime stuff, the swaps. Very, very lucky. globally and it has to be agreed, to some extent, with The Bank of England Governor has sat there and said an eye to how people will gain the regulation we put he wished the banks would get back to traditional in place, because if we move risk out into areas that banking rather than casino-type behaviour. The we don’t regulate we are not accomplishing much. casino-type behaviour is the investment side, the traditional is the retail, and you are saying you can’t Q69 Mr Mudie: That is exactly it, but can we get separate them. Don’t you think you should separate tough enough regulation without dealing with the them? probability that those who are toughly regulated will Michael Cohrs: There is a lot of appeal to a move into the shadow banking world? separation. Michael Cohrs: I think regulation is moving that way. There are new requirements for certain unregulated Q63 Mr Mudie: Yes. Mr Cohrs, the British entities to now start to register. So we are moving Government was on its knees to the banks to lend a that way. I think the right question is, are we moving small amount of money, in terms of the banks’ quickly enough? deposits, to small businesses. They had to beg them. They had to get an agreement for them to do it. These Q70 Mr Mudie: Right. Witnesses before this are the small businesses that we are hoping to Committee always use, “we are moving” or “we are rebalance the economy on, but the British going to” or “we are thinking about it”. How quickly Government has to go on their knees, while the same are we moving and are we moving thoroughly banks are investing abroad through their investment enough? arms. Does it make sense to you? Michael Cohrs: It is a great question. If you read the Michael Cohrs: No. New York Times you will see that the Americans are very fussed this morning, because it turns out that all the regulation that they thought they had put in place Q64 Mr Mudie: Is there not a cry for traditional has not been put in place. They thought they were banking to come back? moving very quickly, yet it is not moving that quickly. Michael Cohrs: If I may say so, it is not just We thought we were moving very slowly because it traditional banking; it is getting away from the looks as though in this country very little has been put cyclicality of traditional banking because I do believe in place, but actually I think we are moving at a pretty traditional banking, as I said, was always there in good pace here. We must be mindful—and I am very good times but always disappeared in bad times. If mindful—of the fact that the interim FPC has a lot of you are going to serve your client you must be there. work to do; we don’t yet have tools, we don’t yet have legislation, all those things. I am taking the viewpoint, Q65 Mr Mudie: Is that an American experience? It and I would hope that you would agree with this—if is not a British experience. you confirm me—we are supposed to act as if we do Michael Cohrs: I think it is an experience that if you have powers and we are supposed to speak up and get talked to— on with it, although part of getting on with it will be cobber Pack: U PL: COE1 [E] Processed: [09-09-2011 12:44] Job: 014596 Unit: PG01 Source: /MILES/PKU/INPUT/014596/014596_o001_th_TC 07 June 2011 - corrected 1125-II.xml

Ev 10 Treasury Committee: Evidence

7 June 2011 Michael Cohrs helping to determine what the final FPC really looks Q76 John Thurso: One of your dials on the like. There are big concerns in the financial world, as dashboard would be a fairly important one. It would we speak, and we must deal with those issues today be sovereign risk? rather than tomorrow. Michael Cohrs: Today it would be right, front and centre. Q71 Chair: Taking up what you have said about the lessons that you take from the financial crisis, you told Q77 John Thurso: Right, front and centre. You also us that we can’t separate balance sheets, and more said that the objective of your work as a group is to recently you told us that there is a lot of appeal in the uncover big systemic risks. It is possible to argue, as separation. Is that your key recommendation? many have before us, that one of the biggest systemic Michael Cohrs: It is not my key recommendation. risks was the sheer size of banks, that they were too big to fail; indeed, you said yourself that in previous Chair: But it is a recommendation? crises Governments had the opportunity, or the option, Michael Cohrs: It is something we need to study to consider allowing banks to fail, which was not an very carefully. option in this crisis. If you and your colleagues on the FPC came to that conclusion, how do you set about Q72 Chair: That is a very cautious reply. Are you putting that across? prepared to go a bit further than that? A moment ago Michael Cohrs: I don’t know, because it is a huge you told us there is a lot of appeal. problem. I think everybody agrees that it is a problem, Michael Cohrs: It does have a lot of appeal. The but nobody has come up with credible ideas on how problem is that the sector was interconnected in a way we will fix it globally. In my view, it doesn’t do us that none of us imagined. That was the real problem. much good to fix it within our country if it is not When Lehman went down it should not have caused being fixed elsewhere because, ultimately, elsewhere the world to come to an end; it was a relatively small affects us, through the operations they do here or bank. But the way banks have become interconnected through the ripple effect. It is a major issue. I think is something that we don’t understand very well, and part of what I have tried to do is look at countries that it is the interconnected nature of the financial sector did relatively well. One country that did really well that worries me, which keeps me awake at night, in this crisis was Canada. I think Canada has some because you don’t know when something very tiny interesting lessons for the rest of the world in how goes down where it is going to ripple through the they run their financial matters. system. That to me is the key. Q78 John Thurso: Of course, they had their banking crisis five years earlier than everybody else so they Q73 Chair: You are making the case for separation had kind of dealt with it, hadn’t they? without being prepared to say you are a separator. Michael Cohrs: They partly had their financial crisis Michael Cohrs: I also said that having tried to back when we were doing privatisations in this separate in my investment banking career, I found it country, and they underwrote them and they didn’t impossible to do. know what underwriting was. That was 20 years ago. Chair: Yes, which makes the ring-fence even more They do have a mortgage market that is structured in difficult to operate. a way that some would say doesn’t allow people to Michael Cohrs: It may make it an interesting way get the mortgages they need, but others would say it to go. is a very robust mortgage system. They had a very strict definition of how much capital was required; Q74 John Thurso: On a number of occasions this they had very strict leverage requirements; they had morning you have said, “Certain things trouble me very strict funding requirements, and they enforced greatly”, and you have mentioned risks that are out their rules. there that are not being addressed. In your view, what is the single biggest risk to financial stability that is Q79 John Thurso: Can I turn quickly to another troubling you out there at the moment? subject that has also come up? Michael Fallon asked Michael Cohrs: Sovereign risk. you about it, and other people, and at