Lord Myners, former City minister in the last government, has today made a strong critique of the Independent Commission on Banking report, published this week. This was a very lengthy speech in the House of Lords but for once I’ve printed it in full for those interested in the subject.
Myners knows his way around the City, having chaired numerous companies including Marks & Spencer; thus he has a greater claim to understanding the Square Mile than many other politicians.
His words are an interesting contrast to Labour’s broad support for the proposals when they came out on Monday: Ed Balls’ only real criticism was that the implementation seems a bit slow.
As he is claimed to have said, it also has a negative side.
I propose to avoid politics in my contribution today. I am mindful of Bill Shankly’s observations about the importance of life, death and football, and the matter of banking security, probity and safety is too important to fall back into cheap political point-scoring. However, I shall ask several questions and I am delighted to see the Box filling so that the Minister has no excuses for not answering questions, either in the House or in writing afterwards.
The purpose of the Motion is to discuss the Vickers report of the Independent Commission on Banking. To me it has been rather like a Chinese dinner: I felt quite full after I had first read it but within a short period I became hungry again. It simply fails to address some of the most critical issues currently confronting us in establishing a safer and more economically effective banking system. The Chancellor of the Exchequer sent the ball into the long grass a year ago when he established the Independent Commission on Banking. This dog has come back with the wrong ball.
Let us start with a little context, particularly in the circumstances of the horrendous loss announced by UBS this morning, here in London—a loss of $2 billion, apparently as a consequence of trading by a single person in exchange-traded funds. The current situation in continental Europe feels very similar to the one that we experienced in the UK in the summer of 2008, in the months before I joined the Government. In particular, French banks appear to have lost the confidence of professional depositors, particularly dollar depositors. Major banks are now selling at less than half their price to book value. Senior credit default swaps are trading at a premium of 350 basis points. Funding is taking place at 130 to 150 basis points over LIBOR. These are exactly the conditions that we saw afflicting Royal Bank of Scotland in the early autumn of 2008. France is not alone in these problems. It simply is not a sustainable situation. An early and massive recapitalisation of the European banking system along the lines of the action that we took in 2008 is now absolutely imperative.
Turning to Vickers, there is a massive lacuna in the report. Vickers spends no time at all examining the causes of the collapse of the banking system. He learns no lessons as a result of it. He appears to have completely overlooked a number of the issues in his terms of reference. He says nothing about moral issues, which he was asked to address. Nor does he say much that might inform the UK Government’s negotiations with other countries and multilateral agencies—an explicit requirement in his terms of reference. He does not examine radical solutions; size-capping is not on the list. He does not look at the case for proposing a new enterprise bank along the lines of KfW. He is strong in assertion but weak in evidence in many cases, and frankly lazy in one particularly important piece of evidence. That said, it is better than doing nothing. On that basis, most critically, we should get on with it, rather than delay implementation as has been suggested.
Vickers does not ask core questions about the role of banks. As I said, he fails to opine on the causes of failure; rather, he falls back on the assumption that there will be future failures, so we should find the best way of mitigating and managing them. Ring-fencing and increased capital will help in some way but they will not address the core failures of management and governance, which were at the heart of the banking failure. Put simply, bad management can burn through capital very rapidly. This is not addressed at all by the Independent Commission on Banking, which says nothing about the governance of banks, the competence of their boards of directors or, indeed, the role of the owners—the shareholders—who have been strangely silent. The most critical thing that shareholders can do is to appoint people to boards of directors, yet they stand somewhat distant from that. Over the next year or so I shall strongly urge, through the Kay review, that we change our approach to the appointment process for directors of public companies to put this very much in the hands of institutional investors as members of nomination committees.
The ICB does not reflect on the role and responsibilities of banks in our society and economy. Let us look at it in context. For more than 180 years until the mid-1980s, bank assets in the UK very rarely stretched either side of 50 per cent of GDP. Over the past 25 years, that figure has risen to 600 per cent. I see no evidence that there has been a concomitant increase in economic or social benefit. It has been achieved, on the whole, by leveraging up the impact of a declining return on assets to manufacture a continued, sustainable—or, as it emerged, unsustainable—level of return on equity by putting more and more risk into the banking system. The regulators failed to spot it; they failed to take any action. In many respects, the Independent Commission on Banking has simply swallowed hook, line and sinker the lines produced by the bank lobby on the importance of credit and the banks in supporting the economy.
Let us look at some facts. British banks have assets and liabilities of more than £6,000 billion. Is that significant to UK industry? Loans to UK industry and business—big, medium and small—are approximately £200 billion. Less than 3 per cent of the total assets of our banks are accounted for by loans to business. A further £1,000 billion represents loans in support of home purchases. The remaining £4,500 billion or so is used simply for speculation. If jobs are at risk as a consequence of changes in the banking system, they are not, on the whole, the jobs of ordinary folk. The jobs that would potentially be at risk from Vickers if he had come up with radical solutions are those of international bankers and speculators.
Vickers had to meet some simple tests: to foster a more stable and competitive banking system; to promote resilience; to facilitate resolution; to remove risks to public finances; and, finally, to promote responsible competition. My judgment is that Sir John and his commission have proposed several measures that will reduce risk and be good for the economy in promoting stability. However, in many places the logic of his thinking is poor and there is an absence of strong supporting data. On the issue of competition, Vickers has completely failed to come up with appropriate solutions. Most importantly, the proposed timetable is unnecessarily generous to banks and bankers, creating continued uncertainty and posing numerous risks of moral hazard in the interim—hazard that past experience suggests may be abused by banks.
I turn now to the detail. First, regarding ring-fencing, the key words are “strong” and “flexible”. The proposal is sensible but will the ring-fence hold? The intention is clear. Flexibility in what is inside and outside the ring-fence is preferable to prescription. However, it is difficult not to conclude, on reading the ICB report, that it believes that separation is inevitable. The arguments for rejecting separation but proposing segregation are among the weakest in the ICB’s report. The ICB clearly intends the split to be real. It talks about strict limits on cross-funding, the need for separate boards of directors and independent chairmen, and disclosure by both banks of a standard appropriate for the Stock Exchange. In saying that this is better than full separation, the ICB advances some frankly naive arguments. It says that,
“benefits from the diversification of earnings would be retained”.
This is nonsense. Investors diversify their portfolios and risks through portfolio construction.
The document says that the supply of capital might be available if required. Again, one would be wrong to assume that a cheap supply of capital should come from a related party. If a bank needs more capital, it should turn to its external shareholders. It goes on to say that agency relationships for one-stop shopping might be attractive. I cannot believe that the Vickers commission really believes that nonsense. It talks about shared expertise and states:
“Some operational infrastructure and branding could continue to be shared”.
It is very clear in my mind that Vickers believes that the banks will be forced by their shareholders to split, so I do not know why he did not recommend that. I simply do not understand why the ICB stopped at a halfway point, save under the pressure of lobbying from the banking industry. Who in the mean time will monitor this ring-fence—the Bank of England, which failed on the whole to see the emergence of the crisis? I think not.
On capital, UK retail banks should have 10 per cent core equity capital plus loss-absorbing capital—bail-in bonds or cocos—of a further 7 to 10 per cent. Banks were clearly inadequately capitalised before the crisis and were overleveraged. However, as I said, no amount of capital can make up for bad management or poor stewardship. Vickers’ proposals are actually not significantly higher than those in Basel III. He does not reflect at all on the availability of supply of non-equity loss absorbing capital. He makes an assumption that this capital is available, which I find very questionable. Radical solutions, such as addressing the offsetability of interest against debt in bank capital structures, are simply not considered by Vickers. He has adopted a very conservative, central line approach. Nor has he given any serious consideration to the emergence of “shadow” banks or the passporting of activities by EU-based banks into the United Kingdom to come under the ring-fence.
On the issue of capital, the UK’s four largest lenders have risk-weighted assets of about £2 trillion, implying a need to raise at least £140 billion of as yet untested, and therefore expensive, securities. Vickers expresses no view and seeks no evidence to test whether that type of capital is available. What are we going to see? We are going to see liability management in which some forms of debt will be forced into loss-absorbing debt. We are going to see bankers charging higher margins for their loans, lower margins on deposits and almost certainly paying no dividends. The only dividends that we can expect from UK banks in the foreseeable future will be distributions of debt instruments.
I wish to ask the Minister about some practical issues in this respect. Will the continuing uncertainty about the treatment of senior debt lead to a buyers’ strike? Both Lloyds Banking Group and RBS plan to issue £10 billion to 15 billion of such debt instruments next year. There will be serious consequences for the funding of those banks if this uncertainty is not addressed. What will the Government do to mitigate this? Has HMT received assurances that the ICB’s proposals will be compatible with the European Commission’s CRD4? Mr Banier has said that he broadly supports this but I wonder whether he had actually seen the Vickers report when he was in Marseille last Friday. Perhaps the Minister can tell us that. Perhaps the Minister can also tell us, if the banking system is going to be made secure and safe, whether the bank levy will be dropped because surely we do not need the bank levy if the banking system is secure as a result of the Vickers proposals.
On competition, Vickers gives no serious consideration at all to the size of banks. No serious proposals are examined to encourage new entrants. No proposals are made to establish a national investment bank along the lines of Germany’s KfW. There is no obvious reason why a challenger bank will emerge, yet he almost forces Lloyds into the arms of National Australia Bank—a bank which has been active in the UK since 1987 and has done nothing which seems to me to represent innovation, customer service and challenge. Frankly, he has dropped the ball on competition completely and yet ducks the issue of putting banking to the Competition Commission for a period of time rather than at least starting a slow burn review. Where I say that Vickers has been lazy is over the economic impact. There is an assessment that the cost of the ICB’s proposals will be £4 billion to £7 billion per annum for UK banks. Where did Sir John get this figure from? Amazingly, he got it from investment bank analysts. He simply averaged the number produced by investment bank analysts, which were guesses not forecasts—teenage scribblers, as the noble Lord, Lord Lawson, once described them—based on trying to anticipate what Vickers was going to propose. It is quite extraordinary that a senior economist could put forward such a number as viable.
On the timetable, quite frankly—I am aware that I am at my time limit—Mr Bob Diamond will not be here until 2019. The other leaders of our banks will not be in office until 2019. It is just an extraordinary risk to allow this situation to continue. There is no reason given—we recapitalised the banking system over a weekend in 2008—why something much more radical could not be done in the interim. In the mean time we live in a world in which the sort of extraordinary events announced by UBS this morning can take place. Does the Minister accept that if that $2 billion loss had been incurred by Royal Bank of Scotland or Barclays, the Treasury would potentially stand behind those banks? Does the Minister accept that we underwrite that gambling casino spirit until 2019? If Royal Bank of Scotland comes to the Treasury and says, “In the light of Vickers we want to split our bank into two, and by the way, Minister, we now think you could sell the retail bank but the taxpayer will be left with the casino bank”, will that be acceptable to Her Majesty’s Government?
I would like to ask many other questions but I realise that I am time-limited. I look forward to the response from the Minister, an ex-banker. I am only sadly disappointed that the noble Lord, Lord Sassoon, the Treasury Minister, is not responding to this debate on behalf of the Government. I beg to move for Papers.